Can an ERP system really pay for itself?
The challenge for any specifier of a high-value purchase is to identify and calculate the return on the substantial investment. You want to do this both before you commit, so you are certain it is the right decision and you want to check it afterwards to make sure you achieve the savings you expected.
Some investments are so fundamental to the core business that without it there is no business. In this case a return on investment (ROI) calculation is not a means to determine whether or not you can do the investment, but merely a means of finding the most cost-effective option.
For other investments which seek to improve the business, the ROI calculation can identify if it is worth making the investment at all.
So how can you calculate if an ERP system can attain a good return? Whilst in some cases there are instances a new piece of functionality allows a completely new capability that was not previously possible, most of the time the benefits come in the form of greater efficiency. This can be difficult to quantify, but not impossible.
Efficiencies can come in time saved (e.g. it may take an accounts clerk 30 minutes less every day to reconcile a bank statement) or direct cost savings (e.g. better planning means a reduction of material used in machine setup). The trick of course is to make sure that the time savings follow through into real savings. If you save your accounts clerk 30 minutes per day, that is only useful if they make productive use of those 30 minutes. But that, after all, is the job of management to make sure all staff are productive to the maximum of their capacity.
But it is the calculation that matters. And this is where many fall down. It is a painstaking job to calculate to the required level the extent of the efficiencies, but that is what must be done.
Start with why you want the new system. There has to be many reasons or else you wouldn’t bother doing it. In my experience, one major driver is the inefficiency of the legacy system, double or triple entry of key information and long-winded procedures for producing results that now can be achieved with the click of a button.
So identify those processes that are currently long-winded and identify by how much those procedures can be streamlined. Measure the time saving for one transaction, calculate how many times that transaction needs to be done in a day/week/month. Multiply the saving in time by the frequency per year and the cost per hour of the individual doing that action. This gives you an annual saving.
If you do this for all of the major savings you expect, add them all together and divide this sum into the expected cost of the new system. This will give you a payback period measured in years, or the length of time before the new system provides you with an overall saving.
For an investment of this sort of size you should expect up to two years for a payback, but clearly the more inefficient the position you start from, the shorter will the payback period be.
This is never an exhaustive exercise as you may get many smaller benefits that you don’t expect, so the exercise should only be continued until you get to the point where you are happy you will get the benefits you need.
Having done this exercise to justify the project in the first place, you should re-visit the whole calculation once the system is in place so you can prove to yourself the decision was a correct one.
And why do businesses bother to go to these lengths?
Simply it is Risk.
Management want to de-risk their operations and their investment choices. ERP implementations do not always have successful outcomes and many do not achieve the expectations of the business. This exercise allows the business to understand what it should expect and where in the business process the benefits should manifest themselves.
This allows you to get the expectations right and shows where to exert effort to achieve the benefits.