WHITE PAPER

THE BUY VS BUILD DILEMMA:

EVALUATING THE OPPORTUNITIES
AND RISKS

Authored by Robert Goldstein (Head of Client Services, Quantifi)

Explores challenges faced by financial firms implementing technology solutions

Reviews pros and cons of building vs. buying a software system

www.quantifisolutions.com
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.

What Options Do Firms Have?

There is no question that technology investment is increasingly a strategic rather than an
operational decision. The question is not whether to use technology, but rather which one
to use. Is it better to attempt to build a proprietary application, which allows for complete
ownership of development, support and operational infrastructure? Or alternatively, is a
vendor system the more viable and sensible option, as firms benefit from vendor insight
and expertise? It is the classic ‘buy vs. build’ dilemma. This debate is now more important
than ever as we enter a new era for financial services where IT investments are large, the
required systems complex, and the margin for error small.

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.

DEVELOPMENT & IMPLEMENTATION PROCESS

The development and implementation process is resource-intensive and an important
consideration when deciding to internally build a system. From the initial decision to
develop a system, to the implementation and subsequent on-going maintenance, the
development process is costly and time-consuming. An in-house system can take months
or years to develop, requiring a dedicated and sizeable team, including business analysts,
software developers and project managers. Vendor systems, on the other hand, can be
implemented much faster due to their existing product offerings that firms benefit from
right out-of-the-box, usually with little or no additional development required.

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.

For an in-house system, keeping expertise and resources focused on maintaining

technology requires a considerable investment of both time and money. In order to remain
competitive firms are usually forced to improve systems more frequently than originally
anticipated. As business needs change, the cost of improvements increases and eventually
the system must be replaced. The typical lifespan of a complex software system in a rapidly
changing environment is between 5 and 10 years. A vendor system lessens many of these
pressures as the cost of innovation and support are borne across multiple clients.

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.

However, flexibility comes at a cost. A system designed to meet the requirements of

multiple customers requires more configuration and setup, adding to its overall complexity.
In-house systems can be streamlined for specific requirements without the pressure to
customise for the needs of multiple clients.
COMPLIANCE
In today’s volatile markets, government agencies are mandating financial reform to alleviate
the risk that stems from these unpredictable markets. This change often comes in the form
of increased transparency, reduced operational risk and the enhancement of systems to
better manage credit and market risk. Like all firms, vendors possess market expertise and
knowledge surrounding shifting regulatory requirements. They are able to implement the
necessary regulatory and compliance updates into their systems, ensuring their clients
address the latest policies. Continuously responding to these new reforms is an additional
time-consuming burden which firms that purchase a vendor system avoid having to allocate
resources and money to.

RESOURCING & RISK OF FAILURE

In a recent survey it was found that almost a quarter of IT projects are never completed and
over 87% fail by some measure. Of the projects that complete, over 42% are at least 25%
over budget3. In-house development carries not just a significant cost but a significant
project risk. The risk and consequences of failure add to the concerns and pressure around
time and budget. Often companies have internal IT resources that are geared towards
support and integration. When a complex, new development project is required there can
be the risk of insufficient resources with the right skill set

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.

Making the right decision

As the financial industry continues to evolve, it is increasingly important that firms are
focused on their core strengths. As volatility increases, the complexity and cost of the
required IT systems continues to shift the optimal balance between in-house and vendor
systems.

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

Functionality  Out of the box functionality  Initial functionality usually

may not match needs exactly matches business needs exactly

 Typically higher flexibility to  Often flexibility not a priority. As

adapt over time with
changing business needs
Cost  Significantly lower cost (as low  High cost
as 30-40%) compared to an
internal system
 Development costs spread
across many clients
Development &  Implementation times much
Implementation shorter
 Existing system carries much
lower implementation risk
 Vendor selection and
integration risk should not be
overlooked
Maintenance  Dedicated development
resources that on-going
maintenance requires
business needs change, may be
difficult to adapt over time and
will degrade faster than a vendor
system
 Complex projects carry
significant financial risk
 Maintenance cost usually higher
than anticipated, typically 40 –
70% of total cost.
 Research and development time
can be significant with great
project risk
 Resourcing may be difficult
based on existing internal
resources
 Cost of on-going maintenance
and bug-fixing is significant and
is often underestimated

 Built-in upgrades and  Maintenance costs can be nearly

development three times compared to a
vendor system
 Technology evolves in step
with the market

1. Celent: IT Spending in Financial Services: A Global Perspective. January 2010

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
ABOUT QUANTIFI
Quantifi is a leading provider of analytics, trading and risk management
software for the Global Capital Markets. Our suite of integrated pre
and post-trade solutions allow market participants to better value,
trade and risk manage their exposures and respond more effectively to
changing market conditions.
Founded in 2002, Quantifi has over 120 top-tier clients including five of
the six largest global banks, two of the three largest asset managers,
leading hedge funds, insurance companies, pension funds and other
financial institutions across 15 countries.
Renowned for our client focus, depth of experience and commitment
to innovation, Quantifi is consistently first-to-market with intuitive,
award-winning solutions.
SUPPORT
Quantifi’s reputation is built on a culture of client service and
outstanding support. Experienced financial engineers offer
guidance on pricing and modelling everything from simple vanilla
instruments to the most complex structured products. Technology
experts ensure the seamless integration of Quantifi products into
existing environments. From the evaluation stage to production
and on-going support we are available to assist at every step of
the way.
SERVICES
Quantifi Client Services comprises of highly skilled financial and
technical experts with extensive experience in top-tier financial
companies. Our range of value-added services, including proof-
of-concept, product customisation, implementation and training
are tailored to address the specific needs of each client. We are
dedicated to helping clients reduce costs, improve time to market
and increase efficiency while consistently exceeding expectations.

CONTACT QUANTIFI

EUROPE NORTH AMERICA ASIA PACIFIC

16 Martin’s Le Grand 230 Park Avenue 111 Elizabeth St
London, EC1A 4EN New York, NY 10169 Sydney, NSW, 2000
UK USA Australia enquire@quantifisolutions.com

+44 20 7397 8788 +1 212 784 6815 +61 2 9221 0133 www.quantifisolutions.com

© Quantifi Inc. All rights reserved. Quantifi, Quantifi XL, Quantifi RISK, Quantifi CVA, Quantifi COUNTERPARTY RISK, Quantifi CLO, Quantifi
TOOLKIT, Quantifi GRID are trademarks of Quantifi Inc.