In last few years, we spent most of our time working in the world of ERP, apart from other major assignments as well. These three letters “ERP” are the ones that bring jitters to several business leaders. They are right at their place as ERP projects are extremely high risk and have a massive failure rate, but they necessarily don’t have to.
We have clients for whom well-implemented ERP solutions have proved to be a game changer. Can you imagine of lower inventory levels, streamlined processes, higher on-time deliveries, knowing the status of every order and clear cash flow management – what else can you ask for? However; before implementing any ERP solution, there are two questions which are to be asked mandatorily:
- How much will it cost?
- What would be the payback period?
Though we are on the other side of the table, as service providers, we suggest all out clients to have a cost benefit analysis done before opting for an ERP project. Appropriately done ROI analysis builds a business case for the entire project. This analysis also builds up a base that can be used to measure future performance of your systems.
Return on Investment with context to an ERP project
ROI for an ERP project is all about the metric of completed due diligence and the time phased plan that very well defines when and how much and for what purpose – money will be needed. Usually ROI calculation is made by dividing monetary gain by the amount spent. But if I have to put it straight, calculating the expenditures incurred for an ERP project is way easier as compared to gains from the project.
This is so because there are several gains from the project that are intangible and not quantifiable. ROI involves a payback period, whether for ERP or not, which happens to be length of time taken for the cumulative expenditure to equal cumulative cost of investments.
Now that you are investing a fortune for the ERP project, let us also list down the Tangible and Intangible benefits of ERP, for the benefit of one and all. I would like to draw everyone’s notice here, implementation of an ERP solution does not necessarily lead to reduced headcount, yes there of course might be a reduction in few lower ended positions in the payroll, however; the accounts payable is likely to get counter balanced by additional higher paid IT staff.
Tangible Benefits of ERP:
- Reduced levels of inventory, which includes raw material, work in progress and finished goods, and all this through improved planning and control.
- Reduced materials cost due to improvised procurement and accounts payable practices, less obsolescence and wastage.
- Reduced labor cost through better allocation and reduction of overtime of employees directly involved with production, technicians and skilled workers.
- Enhanced production throughput for better scheduling of critical equipment and sub-contracting operations, thereby reducing shortages, interruption and rework.
- Reduction in the cost of after sales services.
Intangible benefits of ERP
- Integration of information resulting into efficiency, transparency and effective MIS and dashboards
- Error reduction leading to accurate inventory records
- Improved customer service, on time shipments and shorter order to shipment cycle
- Creation of standardized procedures
- Improved accounting control and shorter sales to cash cycle
- Legal and regulatory compliance
How to calculate ROI for an ERP project?
We have been providing ERP solutions for more than a decade now and believe us, there is no standard method of calculating ROI for an ERP project, however; a structured method of analysis is achievable – for sure. You as an entrepreneur may find it too cumbersome and subjective a task to factor in intangible benefits. But these are the factors which are so very important for creating an overall business case and in several instances, where ROI is not calculated, they at least form a base line objective for the project.
The first step is to determine the cost of various components of the project including, consulting fees, modifications and implementation costs, hardware costs etc. Maintenance fees for pre-determined period, which may be of 3-5 years, should be added at Total Cost of Ownership over the specified period. The estimated expenditure should be time phased over the period for calculating TCO.
The second step is may be more difficult if compared to first one. Here you are required to estimate expected benefits over a period of time and for this estimation you would need wide consultation and reference to statistics emanating from several survey reports. Benefits will likely come into existence through reduction of inventory level, operation cost, labor cost and improved production. The last three elements might have a direct impact on profit and loss accounts, the reduction in inventory ensures release of additional cash which can be assigned to a yearly value of saving, based on organization’s standard internal rate of return.
Connection between time phased cost and benefits will certainly give you a time phased ROI which, I am sure, would be negative at the outset but are likely to turn positive over the pay-back period.
Calculating ROI might be a challenging task particularly due to unquantifiable figures. But it offers you measures of success or the project. ROI measurements help in many circumstances specially buy in from project stakeholders, which enhance chances of a successful completion of the project.