This blog is the 2nd installment of the 3 part ‘Build vs. Buy’ series of articles. In this series, we explore various aspects that Industrial OEMs should consider when embarking on an Installed Base management solution.
You can read part 1 of the series here.
One of the first classes I took in business school was Finance 101.
Prof. Bob Bruner, one of the best finance teachers in the US taught us back in the day.
A few things he taught stood out & remain with me to this day:
- Sunk costs just are
- Cash is king (or queen),
- Time value of money matters
The first is a difficult one to reconcile for most people and is also known as the gambler’s fallacy. It requires people to choose between a rational vs. emotional response. The premise here is that just because you spent money on something in the past, you shouldn’t keep spending money in the future in the hope of getting something back.
The second one is easier to accept because we understand the power of money – cash in hand is way more valuable than not.
The last one though, is generally hard for most people to understand. Yes, we certainly all do Return on Investment calculations and build simple/complex spreadsheets to justify those decisions. But do we really make investment decisions like a portfolio manager? Do we gloss over the risks with the unbridled optimism that ‘everything will just work out’?
In other words, do you calculate what is the Net Present Value (NPV) and Internal Rate of Return (IRR) of any investment or initiative that you embark upon? How does that NPV or IRR compare to alternatives? The short answer is no.
“Most people and companies don’t do adequate future calculations & risk analysis to the extent that they should when starting new projects.”
And most people and companies don’t realize the above. If they did, the odds of companies starting on a “build vs. buy” decision for a technology development project would quickly realize that –
- Not only is build typically more expensive and riskier for ideas outside your core, but
- It also takes longer than deploying a commercially off-the-shelf solution.
A “build” project is simply put, poor NPV and poor IRR.
In our experience, we see the following downsides of a build decision:
- Longer development cycles, sometimes 4-5X longer than deploying commercial software (and delay of planned benefits).
- Limited view on what’s possible (because the universe of developers is only focused on internal build issues).
- Support and maintenance and upgrade costs ignored – until it is too late. We know this far too well as we are almost always brought in to salvage projects from a graveyard of legacy tools.
- Development costs 8-10X (fully loaded) of commercial software – an in-house solution engineer has to do trial-and-error for months to get onto the right path.
- Increased development & delivery risk.
All of these create an unattractive financial return for the corporate portfolio.
So, why do corporations routinely make “build” decisions for non-core capabilities? At Entytle, being in the business of data, analytics, and software, we come across the ‘builders’ all the time.
When we rationally try to understand these decisions, a few things come to mind:
- The company hasn’t had the time to explore the universe of potential commercial alternatives
- These orgs believe that their use case is too unique and not addressed by off-the-shelf solutions, which again, is likely due to not having had time to explore commercial solutions
- The company has invested so much politically into this path that turning away will cause a “loss of face”
- The company truly believes that retaining control of the IP is worth the cost incurred and delay in deploying an internally built solution vs. buying commercial software. In other words, strategic considerations outweigh purely financial metrics.
So, here’s a simple framework for corporate decision-makers to use in deciding whether to build or buy:
- What is the timeframe of the desired benefits/outcomes?
- Is there a strategic value in building this solution internally?
- Could we use these internal resources for other higher NPV/IRR initiatives?
Responses to these questions will surface the right answer for the organization.
So, what is your build justification?