The cost of an ERP implementation is significant, as is the impact on your business. It’s truly an investment in your company’s future. Naturally, you want to know that you’re going to see a return on that investment. But many SMEs don’t know how to calculate the ROI (return on investment) for their ERP project. The main reason is that they don’t have accurate, reliable data on their ‘before’ state. They just know where they’re feeling pain and need to improve. This lack of visibility is often a driving factor in the move to an ERP system.
Even without solid numbers on your current state, you can still evaluate the ROI of your ERP project.
How to calculate return on investment
There are two components to consider in your ROI calculation:
Cost of investment: What your ERP project costs. This includes software licenses, implementation services, maintenance and support fees, infrastructure costs (if you’re hosting on-premise) and the time investment from your team.
Value of investment: The savings and efficiencies you expect to see post-implementation. Keep in mind that the payback period can vary based on the complexity of your organization.
Using these two values, you can use this standard formula to calculate your return.
ROI = (Value of investment – cost of investment) / Cost of investment * 100%
Measuring the business benefit of ERP
To measure the value of your ERP system, look to your ERP project objectives. You should have KPIs (key performance indicators) tied to each objective so you have something to measure against before and after implementation. It’s not always possible to get good ‘before’ data from legacy systems, but you and your team likely have a good gut feel of what your present state is. Even if it’s not entirely accurate, it gives you a reference point.
Above and beyond your business objectives, here are three common areas where most companies will see savings and efficiency gains that lead to ERP implementation success.
1. Displaceable costs
When you invest in an ERP system, you’ll inevitably make changes to your business. Many of these changes result in hard dollar cost savings – either one-time or ongoing.
Lower inventory costs
Improving inventory management opens the door to lowering your overall inventory investment. You’ll see the results in lower carrying costs, reductions in expedited shipments and increased inventory turns.
Reduced labour costs
Leveraging automation to streamline processes and reduce manual effort is one of the biggest benefits of an ERP system. You can redirect your people away from highly manual, time-consuming tasks to more meaningful and productive work. This translates into cost reductions that you can see. Before their implementation, Aircom Instrumentation was planning to hire an additional resource in one department. That need disappeared after they went live with SAP Business One, saving them the cost of an extra annual salary.
Reduced days sales outstanding
Another direct impact on cash flow is the ability to collect payment faster. There are two ways an ERP system helps here:
With your entire quote to cash process integrated in a single system, you can quote, sell and invoice in a fraction of the time because there are no delays between departments. Nexus Exhibits reduced their invoicing time from three months, to two weeks, giving their cash flow a major boost.
Your ERP system will give you better visibility into when invoices were sent, how long they’ve been outstanding and how many attempts you’ve made to follow-up. You can also easily identify customers who are routinely slow to pay so you can start the follow-up process early.
2. Avoidable costs
What costs can you avoid by implementing an ERP system? For distributors, this could be as significant as avoiding a lease on a new warehouse due to lower inventory levels. On the labour side, you could avoid increasing your headcount and reduce your avoidable overtime costs.
3. Intangible costs
Intangible costs are the most difficult to quantify but play an important role in your ROI calculation. Consider things like increased sales due to improved opportunity and relationship management or the addition of an integrated eCommerce solution. Reduced materials costs through better vendor negotiation is another common intangible cost benefit. And be sure to include the cost of errors – this will be the hardest to quantify, but the savings from reduced errors can be significant.
How much can you save with a new ERP?
These are all areas of measurable value that should be considered in your ROI calculation. Even though you won’t be able to measure the return until you’re live with your new system, think about how you’ll measure the return early in the project. If you can, pull the numbers from your old systems to give you a benchmark to measure against. You can also get input from your team pre- and post-implementation about their day-to-day. They can tell you how long it takes to perform certain tasks so you can measure the impact on efficiency.