There’s Financing New Projects … and Then There’s Financing ERP Projects
Every company must invest in equipment and technology to increase output, improve efficiency, and grow the business. Prudent management will only make investments that will pay off. Investments that return benefit to the company that exceeds the cost. It is customary, therefore, to view each and every potential investment through a cost-benefit analysis prior to committing to the project.
In the case of production equipment, the cost-benefit is quite straightforward. The new equipment will benefit by increased output, faster operation, automating what is now manual (reducing labor content), and other easy-to-quantify returns on the investment.
Information system costs and benefits can be a bit more difficult to quantify. Your potential supplier will no doubt provide a complete quote for hardware, software, installation, annual maintenance, and related services. The vendor may not include other hidden costs that are typically required, such as user training; lost output or productivity during the changeover; and database clean-up. It is interesting to note that total cost is clearer in a cloud situation, since the vast majority of system and support costs are bundled into the monthly fee. Swapping the capital expenses associated with an on-premise system for the operating expenses of a cloud system changes the equation as well.
An effectively implemented ERP system will almost always provide a sterling return on investment. After the obvious returns like reduced inventory and higher productivity, it’s harder to assign a value to benefits like improved customer service, reduced chaos on the plant floor, improved employee satisfaction/retention, and higher quality, to name a few.
It is necessary to gather costs and expected benefits over a defined time period because costs are heavily front-loaded (higher in year one and lower thereafter)—whereas benefits don’t usually accumulate until later, after the system is fully implemented and operational improvements begin to take effect. How long should that justification period be? That’s a question for your accounting and finance team, but we often see 5-year ROI analyses—even though most companies keep their ERP systems longer than that. Why? Because ERP is at the heart of a company’s operations, and replacing an ERP system is a major investment in money, time and resources. And that brings us back full circle to justifying the financing of new projects. Fortunately, most companies are able to reap significant benefits from a new system and the improved processes and controls that follow.
Is your company generating full benefit from its existing ERP system? Would a new and different system provide enough return-on-investment to justify a replacement?