Word on the Street: Analyzing Build vs. Buy Decisions

April 2, 2008
MDNG Psychiatry, April 2008, Volume 9, Issue 4

An industry's preferred answer to the "build vs. buy" question can reveal much about its mindset and priorities.

When looking to take advantage of an opportunity or seeking a solution to a problem, business executives must choose whether to rely on their company’s current assets to reach their goal, or go outside the company and purchase orotherwise acquire the necessary resources. These “build vs. buy” decisions depend in large part on the assumptions executives make regarding a project’s cost, risk, effectiveness, and other factors. Making the wrong assumptions or ignoring important factors can lead to incorrect decisions and significantly higher costs. An industry’s preferred answer to the “build vs. buy” question can reveal much about its mindset and priorities. I think it is obvious that Wall Street is more inclined to buy solutions rather than build them, whereas the healthcare industry is far more likely to build solutions internally than to buy them. Does this have anything to do with the fact that productivity in healthcare has declined for the past six years while productivity for fi nancial services increases steadily each year?

Why do Wall Street’s build vs. buy analyses more often yield a “buy” decision than similar analyses in healthcare? My experience is that build vs. buy decisions on Wall Street diff er materially from similar analyses in healthcare in the following four aspects:

Impact on revenue

In the past five years, I have seen many healthcare providers wrestle with whether they should build an application themselves or buy a pre-built application. Rarely did I hear any consideration of increased revenue, yet this can be the most important part of the decision. If a provider is able to use its new disease registry to show that their diabetes patients’ outcomes differ markedly from national norms, this is bound to attract more diabetes patients and more revenue.

Opportunity cost

Many build vs. buy decisions in healthcare are based on hard dollar costs of the software compared to some allocation of the internal cost of the effort. This type of comparison assumes that the internal resources have nothing else to do. Th is is normally not the case. A proper consideration would assign some tangible value to the project they would have worked on and assign this opportunity cost as another component of the cost to build a solution.

Delivery risk

Any solution, whether it is purchased or developed internally, has risk. A risk component must be assigned to make the correct decision. On Wall Street, calculating the risk aspect of any project is a way of life and is often the most important element to reach a decision. For example, if a cost-to-buy decision has a risk premium of 0.1 and the cost to build has a risk premium of 0.6, then this factor alone could determine the outcome of the analysis. The risk assigned to a project can be predicted and controlled to a large extent. The risk from buying can be largely controlled by purchasing a product that already exists. If one plans to make changes to the product, the risk increases but can often be mitigated contractually. The time and monetary risk of building a solution from scratch is always greater than buying.

Time to deliver

The phrase “time is money” may have originated on Wall Street. If not, it certainly describes the prevailing attitude on the Street. All too often, healthcare professionals give no consideration to delivery timing. If the application is delivered tomorrow, then they will use it just the same as if it arrives a year from now. A proper analysis must refl ect the tangible and intangible benefi ts of early delivery. It seems obvious that healthcare would shift many of its “build” decisions to “buy” decisions if the industry is to objectively consider the factors included here. Th is has certainly been the case as Wall Street has used these to conduct thorough analysis. Even when the analysis is conducted correctly and a decision to build the application internally is reached, the institution would still be more secure in its decision knowing that the analysis had considered all relevant issues.

Mr. Kennedy is the President and Chief Executive Offi cer of RemedyMD.