It’s Not “Buy vs. Build”; It’s “Buy and Build”
Newsletter #5
The “Buy vs. Build” Debate
Organizations regularly struggle with buying vs. building when it comes to innovation. The guidance most companies receive when investigating this question is “it depends,” which sounds a lot like Yogi Berra’s legendary advice: “when you come to a fork in the road, take it.” Unfortunately, it provides no useful recommendation for a company to follow.
While I principally work within the consumer products industry, in today’s newsletter I examine the best practices of technology companies, which continuously wrestle with whether to purpose-build a solution in-house as opposed to buying externally.
In Techworld, the prevailing wisdom for buy vs. build boils down to this: unbundle the requirements for a software product into a prioritized list of features or functions needed to meet the needs of key user stories. Then, for each feature, conduct an assessment of whether it would be best to buy or best to build, considering:
All-in cost to create, implement, and maintain the feature
Proximity of the feature to the core of the current business
Whether the feature could offer a long-term competitive advantage
Speed to market
Competency to create it in the future
This is compelling and different from the way most consumer products companies think about buy vs. build for two reasons:
The methodology goes beyond one specific project deliverable to consider a broader aperture of what is required to win, with a more complete account of user needs in mind. In other words, most consumer products companies should think beyond one project to a more holistic question of how best to win in a consumer demand space or partition. By way of example, the question becomes, “how do we win in the convenient and healthy breakfast occasion?” vs. “should we buy an existing D2C smoothie company or launch our own D2C smoothie product?”.
The methodology grants that a combination of buy and build is likely required. Instead of assuming there is one right answer for an entire project, a feature-by-feature assessment allows for the benefits that a combination approach provides. This way, a company can access the benefits of external ecosystems such as speed, the ability to test not-yet-validated hypotheses in lower-commitment ways, and capabilities beyond internal ones. But they can also harness the benefits of building customized and differentiated elements that can create competitive advantage.
What Prevents Companies from Embracing “Buy”?
With few exceptions, most CPGs have underbought their innovation in recent years. For the past four years, M&A in the consumer and retail space has decreased every year, while many (if not most) of the M&A dollars spent have not been focused on innovation. If we consider CVCs (corporate venture capital) in CPG as one M&A bellwether, the majority make too few bets to move the needle; most make fewer than five investments per year.
What’s holding these companies back?
The belief that multiples are too high — Companies should redo the math using a “what is it worth to me?” mindset vs. a “how much do I have to pay?” mindset. This requires potential acquirers to be very clear about the sources of parenting advantage and potential synergies before considering an acquisition. The tech industry pioneered this approach.
It’s hard to find deal flow — Companies with a serious M&A agenda invest to build internal capabilities, including sourcing and screening capabilities. They employ people who can define and map the market; who can execute proprietary sourcing approaches, including screening and prioritizing potential targets; who can build relationships with potential targets; and who can do this across multiple sectors and intellectual disciplines that may be relevant. These individuals have a truly external orientation. Companies that are successful in this sphere also invest in tools to spot trends and find earlier-stage companies.
Difficulty extracting full value of acquisitions in the past —Most large CPGs tend to treat their acquisitions in one of two ways: to leave them entirely alone or overintegrate them into the parent. Neither approach usually promotes optimal value creation. What’s required here is investing to build a detailed integration thesis—linked to the deal thesis—that delineates a clear blueprint for what should vs. should not be integrated.
Some of the most iconic M&A deals in history come from the technology industry. If we think about acquisitions like Instagram and YouTube, these are iconic because of the size of the checks, the valuation multiples, and the uncertainty of the outcomes. They’re also iconic because of the value creation these acquisitions delivered to the new parent companies, but only after the parent companies invested in and built on their newly acquired businesses. CPGs would do well to spend more time assessing tech M&A approaches and understanding how they can learn from them.