HOW TO CALCULATE THE TRUE VALUE OF NEW ERP

At ACC, we’re passionate about helping small-to-mid-size businesses (SMBs) to recognize the many ways in which modern technology and (post)modern ERP solutions can benefit their bottom-line.  That being said, we recognize that the decision to implement a new system cannot be taken lightly and most organizations will benefit from a comprehensive cost analysis.

Of course, when implementing a new ERP system, one of the first questions everyone asks is: How much will it cost? Many factors are involved, from purchasing and installing equipment to configuring the software, to ongoing maintenance.

Advancing technology, increasing competition, and educated consumers all foster the need for businesses to calculate the True Value of a new ERP solution. In this post, we’ll walk you through a cost analysis process that can help you best determine the true cost of a new solution but also determine which solution is the best fit for you and your business.

ROI isn’t enough – How to Calculate True Value

At your business, you likely need to get management or c-suite approval for large expenses.  For the sake of simplicity, we’ll say $500.  However, you could probably hold a meeting lasting a few hours with 20 people without anyone questioning the cost.  But the truth is, that meeting is costing your business employee time and effort.  The same holds true for ERP costs.

Most companies understand the importance of a complete capital expense justification or return on investment (ROI) analysis.  But they must also recognize that they need to calculate their Total Cost of Ownership (TCO) of their system to determine all costs associated with implementing a new solution. TCO isn’t calculated by just the upfront and obvious costs such as hardware expenses, software license fees, IT staff, and initial implementation costs. It also includes hidden costs such as employee’s time and effort to implement the system, future system customizations, retraining, and upgrades to name a few.

The true value of an ERP implementation investment is calculated by subtracting your TCO over five years from your estimated ROI.

True Value = ROI – TCO

Most pricing models just calculate the initial hardware infrastructure, software licensing expenses, and implementation costs, but do not consider the impact of ongoing operating expenses.

For even deeper insight, compare this number to the price of putting off an ERP decision, or maintaining current systems.

Return on Investment (ROI)

Most companies will complete a capital expense justification (ROI analysis) before committing to an ERP investment. ROI analysis is the process of identifying the expected direct and indirect costs of the project compared to the benefits, both over some reasonable lifetime – typically 5 to 10 years for an ERP system. If the return is sufficient to meet buy-in from leadership, the project can be given the green light. Every company’s situation, needs, and solutions are different and therefore each company’s costs and benefits will be different.

A true return on investment or true cost is equal to the net benefits (calculated as return – investment) of the ERP project divided by total investment.

True ROI = Net Benefits / Total Investment

While there is no “generic” ROI analysis, your solution provider or consultant can help you with cost estimates and suggest benefits and returns as experienced by other customers. It is important to complete the ROI calculation for a reasonable lifecycle for the system – at least 5 to 10 years – and include all identifiable ongoing costs as well as one-time purchase and implementation costs. The following list should provide a good starting point for your own ROI calculations.

Purchase and implementation costs

• Computer hardware, operating system, database, networking, and tools including installation, startup, and testing
• Application software (ERP) license, installation, tailoring, data conversion/loading
• Procedure development, testing, and documentation
• User training
• Vendor and consultation assistance with implementation

Ongoing costs

• IT departmental costs for utilities, personnel, consultants and support
• Software annual licensing / maintenance fees
• Continued training for skills enhancement and new employees
• The budget for system expansion and enhancement

Benefits

Direct benefits fall into two general categories: 1) cost savings and cost avoidance and 2) increased revenue and profit. However, all benefits from ERP flow from:

• Having greater visibility to demand and schedules
• Closer management of materials, equipment, and personnel
• The ability to better manage workflow and production schedules
• Greater coordination of resources to efficiently deliver the right products in the right quantities at the right time

Cost savings and cost avoidance

• Inventory reduction, including materials, parts, finished goods and work-in-process
• Increased productivity and throughput in the plant
• Reduced scrap, rework, expediting, and wasted materials
• Less overtime, expediting, premium freight, and additional set-ups due to last-minute schedule changes

Increased revenue opportunities

• Increased sales due to better customer service, improved quality, better on-time delivery and shorter lead time
• Sales and margin improvements due to faster time-to-market for new products and product variants, cost reductions

Indirect benefits

These are a little harder to identify and measure, but can be at least as valuable as direct savings and return.

• Improved retention and higher productivity from employees who are less frustrated and more effective in their jobs
• Less panic, disruption, and chaos in the plant and in the office due to fewer last minute changes and surprises; more stable schedules; less expediting
• Smarter moves in the market – pricing decisions, specials, product releases or changes, inventory deployment, to name a few – due to better information and insight into market conditions, customer needs, and competitive activity

Total Cost of Ownership (TCO)

The TCO of an ERP system is calculated by always using the purchase price and implementation costs of the ERP system, but must also include the operating costs for the 5 to 10 years the system will be in production.

The upfront costs include hardware expenses, software license fees, and IT staff and for installation of the overall system. The actual implementation of the software business process, user training, and customization all round out the initial costs.

As easy as it is to consider these clear-cut costs, there are concealed expenses to consider. We use the illustration of an iceberg to show how these expenses are not apparent to the buyer. The tip of an iceberg just above the water but a massive body of ice hides underneath, a veritable obstacle if undetected. The underwater body of ice is indicative of hidden expenses.

For this reason, we break down the cost of an ERP system into four components so that all costs are taken into account; the top two are the clear costs and the bottom two are the hidden costs businesses may fail to include in their budget for the life cycle of the new system:

1. Software fees: For software license and maintenance
2. Implementation people costs: For consultants and staff time to implement and adjust to the new system
3. On-going infrastructure expense: For maintaining or replacing Servers System software, Networking equipment, and user devices
4. On-going people cost: For contractors and staff for hardware and networking support, software upgrades and bug fixes, and custom development

Hidden Costs of ERP

In order to prepare a realistic budget and project plan, and to avoid unpleasant surprises, below are some hidden costs of ERP implementation projects that are often not anticipated.

• Employee Time: The time your employees will spend implementing the system, learning how to use it, developing, and documenting new procedures. This is often viewed at no additional cost if no additional or temporary staff is required.  However, there is a cost for what doesn’t get done, or what doesn’t get done as well as is standard because of time spent on the ERP project.
• Executive Time: The same consideration should be given to executive’s time spent on ERP projects. Executive and C-Suite buy-in is vital to the success of any ERP project.  Leadership must provide the proper time, management, and motivation to keep projects on track and on-time.
• Change Management: A multi-disciplinary, cross-functional team must be heavily involved in the project in order to get the most out of a new system. The project team must learn what the new system does, how it works, map new functions and procedures into regular (and expanded) daily activities, conversion and testing, and documentation.  This all takes time and resources form a wide cross-section of employees and management in affected departments.
• Retraining of End-Users: In addition to the first round of initial training for all users, there will undoubtedly be a need for advanced training after the initial project completion. New hires and people moving into new positions within the organization will also need the training to support new or added duties.
• Future System Modifications and/or Consulting: Your business will change. Your system will likely need to change to support new technologies, revenue sources, services, or processes.  Try to anticipate and set aside what you’ll need in terms of additional applications, follow-up consulting, customizations, and additional training.

Need help calculating the true cost of an ERP investment? Acumatica recently introduced their new True Cost calculator which can help you to determine both ROI and TCO.  SoftwareAdvice.com also has a non-biased ERP TCO calculator.

And as always, you can contact one of our specialists today to learn more about the benefits of a new ERP system.