This article outlines a framework for evaluating these two options, and identifies key considerations in formulating assumptions and identifying challenges that are often encountered during the process.
Are Both Feasible?
Perhaps the most important phase of the Buy vs. Build decision process is the early-stage determination of the feasibility of the two paths. In some cases, IP existing in the marketplace is patented and a lack of known work-arounds means a Build approach would be unrealistic or particularly risky from a litigation perspective. An understanding of the capabilities of potential target businesses and their willingness to engage in a transaction is critical to evaluating the practicality of a Buy strategy. At times, the necessary customization of acquired IP can result in a Build strategy being far more feasible.
If Both Feasible – Model Both Cases
Once it is determined that both Buy and Build options are viable, choosing a path forward is ultimately a strategic investment decision. Generally, as it relates to the determination of quantifiable impacts, the process involves assessing and comparing the net present value of the two options. Typically, this involves the modeling of specific cash flows expected under each option and discounting of such cash flows using an appropriate rate of return.
Factors to Consider
The mechanics of this modeling exercise require the formulation of several key inputs. One of the most critical is the development of a forecast horizon, which is likely to be a function of the time to market advantage of a buy decision vs. building. For instance, what length of time will be required to close the growth gap between the two scenarios, and what are the primary factors driving this convergence?
Considerations affecting time to market and revenue generation not only include the amount of time required to create the IP/product in the Build scenario, but also the time required to integrate the purchased IP/ product in the Buy scenario. Further, market momentum and the technology adoption cycle should be assessed when evaluating the time to market advantage of a buy decision and relative disadvantage of a build decision.
Buy Considerations
In the Buy scenario, other specific inputs or considerations may include deal costs (legal, due diligence, etc.), integration costs (IT/operations, severance, transition services, etc.), and the impact of any anticipated amortization resulting from the acquisition (on GAAP financials and/or on cash taxes). To the extent quantifiable, transaction-related risks can be considered; such as integration, employee retention, the Buyer’s existing sales capacity and ability to sell immediately, and potential negative reactions of existing customers of the target.
Build Factors
Build scenario inputs will likely include the direct and indirect costs necessary to create the IP and the rate of market penetration once completed. Build-related risks could include the risk of technological failure, the risk that in-house skills are ultimately not aligned with the task, or even the notion that cost and revenue projections in this scenario are likely to include a greater margin of estimation error than the projections used in a Buy scenario.
Other Considerations
There are a number of other potential implications that may be more difficult to quantify. For instance, what talent is being acquired along with the IP and how critical is the retention of these employees to the successful exploitation and integration of the IP and execution of the overall business model? Is it feasible for development to be outsourced to offshore resources, and what is the opportunity cost incurred by engaging existing in-house resources to Build versus focusing on other internal initiatives?
Glen Kernick is Managing Director and Global Technology Industry Leader, and Justin Kloos is a Director, at Duff & Phelps. This article first appeared in the firm's Valuation Insights publication.
The third annual Duff & Phelps IP Value Summit will take place December 7-8, 2016 at The Ritz-Carlton in Half Moon Bay, California. Corporate executives, attorneys, investors and other experts will discuss intellectual property best practices, case studies, challenges and opportunities.