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This is a personal blog. Although the authors are affiliated with Coda Payments, the views expressed here are their own.

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Friday
May172013

Buy vs. build, part II

Last year I wrote about the fact that very few mobile operators have built their own payment platforms, choosing instead to buy (or, more strictly speaking, license) them from specialized vendors. It turns out that this is how operators get most of the content and services that they offer to customers: rather than building, they buy.

This is largely true for banks, too. There is a healthy industry of software companies that sell everything from core-banking systems to white-label personal-financial-management tools to banks. Of course, banks do develop some systems in-house—at minimum, big banks have to employ large numbers of developers to make sure that all the other software that they have bought can talk with each other—but generally speaking there is a preference to buy rather than build.

On the other hand, all of the fast-growing startups of the past decade (I am thinking of Facebook, Google, and the like) have built their core products from scratch. As I pointed out in my previous post, such companies had to build because they couldn’t buy: if Sergey Brin and Larry Page could buy a good search engine, they probably wouldn’t have bothered to start Google.

That MNOs and banks buy rather than build is entirely defensible. For the most part, their competitive differentiation vis-à-vis their rivals does not dwell in software. Airtel in India is famous for outsourcing just about everything that did not give them a competitive advantage, and of course IT was one of the first functional areas to be spun off. Likewise, banks have historically competed on the basis of their branch networks, their interest rates, or their customer service—not their software.

But the competitive landscape is evolving, and in both financial services and telecommunications we are more and more frequently seeing the buyers start to compete with the builders. PayPal was the original example of this in financial services, and today there are scores more technology companies, led by Square, with the disruption of traditional financial institutions on their agenda. And of course the increasing rivalry between MNOs and OTT players is by now old news.

It seems to me that these new challengers have, by virtue of their ability and preference to build software, a huge competitive advantage over the buyers. I see several interrelated reasons for this.

  • One of the reasons that buying software makes sense for the incumbents—if your requirements are standard, it’s more cost effective to buy software from vendors that can sell it over and over again to similar players—means than it is almost impossible to buy your way to a position of competitive differentiation. When Square came out with a dongle that transformed any iPhone into POS device, banks didn’t have the luxury of buying something similar from a vendor. Nothing similar existed.
  • Firms that develop their own software are far more agile than those that can’t, for obvious reasons. If Mark Zuckerburg thinks of a new feature for Facebook, he can get a prototype thrown together in a hackathon in a matter of, literally, hours. Compare this to the grinding procurement process that banks and MNOs are obliged to follow when buying new software. 
  • When engineering and product development are in-house, a fairly intimate relationship between those who are creating software and those who are using it can arise, allowing companies to build and iterate their products based on feedback that they gather from their customers. When software is bought or its development is outsourced, this feedback loop is at best extended and at worst broken: vendors have no direct channels through which to gather end user feedback, and so naturally find it more difficult to build products that meet their needs.

As a case study, we can look at text messaging, where mobile operators are seeing their cash-cow SMS franchise being eaten alive by the likes of WhatsApp, WeChat, and so on. Such services caught on initially not only because they tend to be more cost effective for users, but also because they offered (and continue to add) new bells and whistles (emoticons, photo-sharing, stickers) that customers like.

Now of course, MNOs are trying to build competitive messaging platforms. The most prominent is an initiative from the GSMA called Joyn, which is a rich-messaging service that is supposed to compete with OTT offerings. But the process of getting Joyn to market has been painfully slow: the GSMA started working on Joyn in 2007, and it is only now starting to become available to customers in a handful of markets. Part (not all) of the delay stems from the fact that the GSMA, like its members, has no in-house product development and software engineering capability. Other operators are going it alone: Indosat in Indonesia just announced that it will offer an exclusing messaging platform, but again, because they are not a software company they are in the process of evaluating vendors that might build it for them. This of course suggests that any such platform is at least a year away from being ready for launch.

MNOs are in the process of losing the messaging wars, and I believe a major reason for it is that they, by and large, lack the capacity to build competitive products themselves. If this skirmish between the old guard of buyers and the new guard of builders is any indication, then, the moral is clear: be a builder.

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