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Businesses constantly need to make decisions relating to new capacities they would like to have and whether they should build the capacity themselves or pay for the use of a pre-existing capacity.
Individuals and families need to do this also.
Two popular tools used in business are the Total Cost of Ownership calculation and the Return on Investment calculation. These are quantitative measurements favored by accountants. They only have one problem:
TCO and ROI are usually shitty indicators of value. There are at least two reasons for this:
- They are based on assumptions that are almost always biased toward the decision desired by the person or team making the calculation. Or they are based on assumptions that conflict with each other because the assumptions are formed by people with conflicting biases. Biases can be something as simple as an “industry standard” or an average or an assumption pulled out of one’s nether region.I don’t think I’ve ever participated in a TCO or ROI calculation that was free from bias. In other words, TCO and ROI don’t often map very well to the real world.
- They don’t consider other costs that are qualitative or ambiguous. Examples of those costs are opportunity cost, which can be qualitative, the emotional cost of a decision (e.g. morale, the negative emotional consequences when there is low buy-in on a decision, the realities that people often buy things simply because they want it, etc.)
Many years ago, I was involved in helping a leader justify a substantial software purchase. I was in favor of the purchase but there was a lot of resistance to it. I did a lot of research — more than the research conducted by those who opposed the decision. We debated and we had some different ideas of TCO and ROI but in the end, my position was better-argued because I tailored the argument to the biases of the leader. Those opposed based their arguments on “the better system,” which coincidentally was the one we had in place. The leader chose in favor of the purchase.
One of those people who didn’t support the decision later complained that it was a waste of money and we just did the project because it’s what the leader wanted. I asked the individual if he had ever bought a video game that he couldn’t afford (because Xbox was one of his passions). He replied, “Sure.” I asked him how he justified it. He said, “Well, I just charged it.”
I told him, “Leaders are just like you. They buy things because they want them. The only difference is that their checkbook is bigger than yours.”
That’s really what the build or buy decision comes down to: desire.
And the predominance of desire in a purchase decision is what is always ignored in the evaluation of the decision. Yes, desire is assumed at the beginning of the process but it’s not part of the value calculation. Once the decision to build or buy is made, the level of desire isn’t part of the calculation at all. In other words, there is no factor in the ROI or TCO calculation that attempts to weight and value the level of desire involved in the acquisition of a new capacity.
You could perhaps argue that if your hurdle rate is 12% and the ROI is less than 12% but still choose to build or buy the capacity, you have implicitly factored desire into the calculation. But that begs the question: If you were going to do it anyway, why go through the ROI motions?
I tend to ignore these article not only because they deny the value of desire but they ignore another important kind of value.
This article bases the decision to DIY or hire someone solely on a pro-rated amount of your net salary. They don’t take into consideration whether you have the talent to do it or whether it will actually take more time to DIY (because it ALWAYS takes more time to DIY). Further, the calculation doesn’t consider the quality of the results. Sure, I might be able to paint my walls but every time I’ve painted the walls, I have regretted the mess and the process because at the end of every painting project, the fact that I did it myself is very apparent. So too would the quality have been apparent if I had hired someone to do it.
In addition, there are the potential consequences from a DIY effort: frustration, unfinished projects, arguments with friends and loved ones that last during the project’s duration, damage to property as a result of inadequate skills, the costs of single-use tools that can’t be used in future projects, personal injury, liability from poor work that adversely affects others, and so on.
So, I get the intent of the article and the calculation tool. But it’s incomplete because it doesn’t take into consideration that there is much more at play then merely a pro-rated cost based on one’s net income.
Let me put it this way. I worked for a man who invited me into the real estate appraisal industry. We had some great talks as we worked on appraisals together. Kern told me that he was a bit of a hellion in his youth and as a result he was always poor. He had to fix everything he owned. The one thing that caused him to change the way he lived his life was he decided he didn’t want to have to fix something again. He wanted other people to fix his things. And that meant that he needed to approach his life more responsibly.
In most cases, I would rather pay someone else to do something, even if I could “do it myself” for less money. And that’s because I have found that in the long term, it is better for me emotionally, circumstantially and financially.