Buy or Build?  That’s a critical question companies small and large ask themselves on a regularly basis.  This often arises when a company is looking to update its technology, as it evolves from a small business to a mid size company.

Let’s look at a specific function — Corporate Finance.  Small businesses often manage financial reports using Microsoft Excel.  It’s a very simple, flexible tool that businesses can customize to their specific needs.  At the start of a company when they are no more than 5 people in the Finance organization, it is not uncommon to manage actual financial records in Excel.  Then, these files are distributed via simple email.

At a certain point, as its finance organization grows bigger, the company realizes Excel is no longer a feasible solution.  Version control and integration becomes too much of a time and resource drain.  In addition, it increases the possibility of human error, which is especially dangerous when it comes to financial reporting and bookkeeping.  At that point, the CFO may consider overhauling its financial system to a small Financial ERP (Enterprise Resource Planning) system.  The company will want a centralized system for its employees to track changes and generate financial reports both real-time and concurrently.  The question of build or buy arises now.  Should we build an ERP?  Or should we buy one from the market?

To properly respond to this question, the Finance Team will construct a business case to evaluate the economics of buying an off-the-shelf solution versus having its own IT team build it in house.  There are numerous trade-offs to this.  Below, I’ve listed a few that are apparent:

• Building may be more expensive.  It requires acquiring (perhaps via IT consulting companies) resources with the expertise in developing a Financial ERP system.  Furthermore, there is constant maintenance of the software.

• Building is more tailored.  If you are building the system yourself, you can build it exactly to your requirements.  On the other hand, a 3rd party system may not fit your needs exactly.  In fact, it may require a lot of expensive configuration to get to your company’s specifications.  Furthermore, you may be forced to change certain financial processes to fit with how the ERP is designed.  This requires training and sometimes even organizational restructuring.

• Building is more time consuming.  Depending on the urgency of the situation, building may not even be an option, as it can take a year longer to fully roll out a custom built financial system.

A key question that will certain arise and drive the final decision (especially for the CFO) is: Is it more expensive to Build or to Buy?  The answer to this will be driven by the financial business case.  The purpose of the business case is to quantify the economics of certain capital budgeting decisions.  This not only involves business case analysis of building up the cost of investment of both options — A) building a system in house vs. b) buying the license of a market solution and customizing it to the organization’s needs — but also quantifying other financial factors, such as opportunity costs, short term and long efficiency gains, headcount impacts, potential revenue impacts, value of added features, among others.

Beyond operational issues, as the Finance ERP example just described, the business case is an important tool for core, strategic technology innovation decisions.  The business case is used to drive R&D funding decisions of major High-Tech Manufacturers.  This can range from technology product development decisions of an Internet Start-up to telecommunication infrastructure investments of a major cell phone carrier to manufacturing center locations of a chip manufacturer.