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The Buy vs. Build Dilemma
The financial service industry has changed significantly over the last decade. Following the
demise of Lehman and the implosion of AIG, the pace of change has increased
dramatically. This rapidly changing environment requires significant investments in
technology. Financial service firms are expected to spend over US$390 billion on
information technology by 20121. Technology can be expensive, but if executed well, can
become a key competitive advantage. A firm’s technology must be capable of tackling
today’s complex challenges while remaining flexible and scalable enough to keep up with
future market innovation.
Ten years ago, ‘outsourcing’ had a negative connotation, as it implied vendor risk as well as
loss of operational control and security, all of which were compounded by concerns about
inadequate vendor response time. Today, it is considered to be an alternative strategy for
firms who prefer not to allocate internal resources to years of development, testing and
maintenance, with the added risk of the technology becoming obsolete by the time of
launch. It is also a strategy that is growing in prevalence: according to a 2009 Deloitte
Consulting poll of over 800 financial services executives, 74% of respondents reported that
their firms have begun to outsource functionality.
The decision to outsource, however, should not be taken lightly and requires an
appropriate level of evaluation to ascertain whether a vendor system is more suitable than
an internally developed system.
Decision Factors
COST
Historically, vendor systems were chosen for their cost-effectiveness. A recent report
published by the research and advisory firm, Celent2, highlights that ‘in-house efforts for
derivatives analytics require an upfront investment of at least $9 million. Moreover,
depending on the aggressiveness of an institution, recurring annual costs can range
between 25% and 50% of initial investment in order to keep pricing and risk analytics
relevant. This translates to $11 million to $22 million over a five-year production lifecycle’. It
also notes that ‘over the total software lifecycle, firms adopting in-house strategies for OTC
pricing will require investments between $25 million and $36 million alone to build out,
maintain, and enhance a complete derivatives library’.
Some estimates suggest that vendor systems can enable a firm to experience 30-40%
savings in operational costs in the first year alone, and with systems that are fully serviced
by a third party provider, savings as high as 80% may be achieved. In addition, the licenses,
support, and training associated with a vendor system are generally fixed costs and much
more easily budgeted. Vendors also offer economies of scale, as they typically spread fixed
costs and optimise technology utilisation across many clients, allowing them to reduce cost
per client.
For all firms, especially in a recessionary environment, there is intense scrutiny on the
bottom line. They must systematically evaluate the costs associated with research and
development, time-to-market and maintenance of an in-house system vs. purchasing a
third-party system bundled with built-in resources, support and ongoing development.
Although time consuming, developing a system in-house provides the ability to design
functionality that exactly meets user requirements, allowing for more control over the
functionality and the underlying business process. However, the ability to fine-tune
functionality must be weighed against the most protracted aspects of building an in-house
system, including gathering requirements and writing specifications in addition to
development and testing. All of which is alleviated when a system is purchased from a
solutions provider.
PROVEN TECHNOLOGY
Outsourcing enables firms to benefit from economies of scale, especially when dealing with
complex technology. The specialist vendors who support large, complex processes that
require leading edge technology have developed, refined and perfected their systems over
an extended period of time. They also obtain feedback from existing clients, allowing them
to test and prove the technology in the marketplace.
MAINTENANCE
The cost of maintaining systems in many organisations has been observed to range from
40% to 70% of total cost of the entire software lifecycle2. The additional cost associated
with on-going maintenance, bug-fixing and development can be significant. Firms often
underestimate this cost which, based on a conservative estimate, is nearly three times that
of a vendor system.
Working with a vendor brings added functionality and value beyond what is contained in
the software. In addition to necessary bug fixes, product enhancements and updates,
vendors have the dedicated development resources that on-going maintenance requires.
This makes it possible for vendors to focus purely on the task in hand compared to in-house
resources, which may be faced with the challenges of other business demands. Solutions
providers act as partners rather than providers and are able to take on challenges that firms
without dedicated resources are unable to manage.
FLEXIBILITY
Vendors generally take a long-view approach to their products and purposefully develop
systems that are flexible, dynamic, customisable and scalable. It is therefore much easier for
a vendor to satisfy the challenges faced by rapidly changing markets. This level of flexibility
takes time and money to achieve and is therefore not always built into in-house systems,
which are often developed with a short-sighted view to solving the task at hand rather than
planning to meet future challenges. These systems frequently take much longer to update
and are often behind the market. While internal systems are developed to satisfy firms
existing requirements, they are seldom designed to handle future growth and challenges.
As a result, these systems usually require re-engineering to implement new requirements.
IMPLEMENTATION
For vendor systems, there are implementation and selection risks. The configuration and
integration of a vendor system into an existing environment can be complex and take
longer than expected if not properly managed. During the vendor selection process, firms
should check the vendor’s implementation track record and where possible, qualify it.
However, with vendor solutions, firms tend to have the option to expand system
functionality as the business expands. The majority of vendors offer a phased deployment
with initial features implemented to address current priorities and then subsequently
expand functionality. By adopting this approach firms acquire a more cost-effective short
term solution and can factor in the incremental costs of adding functionality to satisfy long
term requirements.
INNOVATION
Vendors not only have to ensure their technology remains current for all of their clients, but
in order to continue selling their solution to new firms, they have to remain relevant and
innovative. These pressures require outsourced systems to remain up-to-date and in step
with the financial markets, with little additional investment on part of the client.
Innovation is a key component of all technology implemented within the financial services
industry. Assets are continuously being packaged into new products and subsequently
sliced and diced into complex trades, as market participants seek new investment
opportunities and new ways to hedge their risk. As a result, many firms are turning to
vendors as a way of utilising sophisticated technology and expertise to support financial
innovation.
ATTRITION
When firms choose to build a system rather than purchase one, they are more susceptible
to the risk of in-house resources eventually leaving the firm, further compounded by the
loss of precious IP and expertise. The internal system has the potential to become a
tremendous liability, as there are usually a limited number of individuals that possess the
knowledge to maintain the system. This can be quite problematic– unless everything has
been well documented, and again, requires a considerable investment of resources,
including both time and money, to train new staff to be able to maintain the system.
All firms should carefully evaluate the resource and time commitments before choosing to
build or buy a system. If a vendor solution is the best choice, selecting the right vendor with
a strong track record is essential. Finding a vendor, who can act as a partner and provide a
sophisticated, robust and scalable solution that remains relevant, will ultimately allow firms
to focus on the core of their business.
Summary
BUY BUILD
2. Celent: Optimizing the OTC Pricing and Valuation Infrastructure - Addressing Analytics Costs and
Inefficiencies, May 2010
3. BCS: The Chartered Institute for IT - A study in project failure, Dr John McManus and Dr Trevor Wood –
Harper, June 2008
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