The process for calculating enterprise resource planning ROI (return on investment) seems straightforward enough: add up the costs, add up the benefits, and compare the two figures. However, there are a number of factors that need to be considered to make sure that your results are valid – and useful. It’s important to have a complete view of both costs and benefits, now and in the future, for both the existing system and the new system under evaluation. Following are expert tips based on dozens of ERP implementations.
Use a reasonable time frame for ROI analysis. To ensure your analysis will cover the full lifecycle of both costs and benefits, consider a time frame of at least five years.
Look for cost differences between the legacy system and the replacement ERP system. To do this, you need to enumerate current costs to maintain your legacy system as well as future ERP upgrade costs. Remember that a key motivator to change systems is to add new functionality to remain competitive – so include a realistic estimate of upgrade costs for the legacy system.
Be thorough. Make sure you have gathered each and every cost estimate: for acquiring the new system, getting it implemented, and operating it effectively. In many cases, new system operating costs will be less than existing system costs. Also consider the projected benefits when calculating your ERP return on investment, recognizing that those benefits will be realized over time.
Think positively but realistically. If your company is product based (for example, a distributor or manufacturer), you might envision a significant inventory reduction – but do your homework to understand what result is typical. Also keep in mind that savings will not happen automatically, nor right away.
Why this much detailed work? ROI is often required for financial planning purposes. It’s also important to understand total project costs and benefits to justify your ERP investment and to evaluate system performance against expectations once implemented. The ERP ROI calculator worksheet below can help you accurately identify your costs – while offering tips and advice to make the process smoother.
This page will guide you through a series of tables to be completed. Each step will provide information to assist in filling out those tables.
As you go through the process you can create your own custom spreadsheets based on these tables. We’ve also created a downloadable ERP ROI template worksheet to help you.
How the ERP system is deployed significantly impacts the cost estimates. These are four options:
Which deployment options will be compared?
Table 1: ERP Deployment Options
This section of the worksheet is designed to calculate the total cost of ownership (TCO) for both the existing ERP legacy system and the new replacement system. There are typically four areas of investment:
For the initial project justification, it will be necessary to estimate these costs (before you go out for proposals and quotes). Many or most of the items listed here may be included in a package quote but expect to pay for additional services, training, hardware, and software to complete the job.
Growth and support costs will be significantly higher if your existing system is old, not well supported by the developer, or if it is “down-level,” that is, not up to date with developer fixes and releases.
In addition to the initial costs, estimate the cost of upgrades and expansion beyond the initial purchase. Since this is a time-oriented estimate – all costs will be replicated (and escalated) through the five years (at least) of the lifecycle – place these upgrade and expansion costs in future years as it is unlikely that you will need to upgrade or expand during the first year or so.
Table: 2: ERP Infrastructure Costs
Here, you will want to budget for the cost of upgrades and expansion beyond the initial purchase. The annual fees may rise over time as additional users or applications are added, depending on a supplier’s pricing strategy.
Table 3: Software Costs
Next you need to estimate the costs of implementing both the initial system and the planned upgrades over the five-year period. Most software suppliers have one or two major releases during a year. Each release is in fact a mini implementation. First, the project team must review the release to determine the overall impact to the current business process. Then the release is loaded and tested. Before going live, the users should be sufficiently trained on the new software. Potential costs to consider include:
Table 4: ERP Implementation Costs
Estimate the “normal” operational costs for keeping your new ERP business system up and running. When considering on-going (recurring) costs, be as realistic as possible and include a reasonable expectation for escalation or inflation year-to-year. The major items will be a blend of internal IT staff and consultants’ time and expenses such as:
Table 5: Ongoing ERP Personnel Costs
From the four tables above, transfer the total for each area of investment, as well as the subtotals of the new system costs, to the table below. You will now be able to see the total savings or additional costs of going to a new system. Expect a mix of negative and positive subtotals for the “5-Year Difference.”
Table 6: Summary of ERP Costs
What to do with this information
If the five-year cost of the new system is more than the cost of maintaining the legacy system, then you will need sufficient additional benefits to justify making the change – otherwise, why make the switch?
For example, if you anticipate more revenue and higher margins as a result of the upgrade to a new ERP – or if the system will deliver more value and a higher level of customer support – these benefits might help you rationalize the upgrade to a new ERP.
Some of the new system’s benefits are by nature a bit harder to separate out and assign to the new system but well worth the effort to do so. In most cases, there will be plenty of direct benefits to more than justify the new system implementation. But documenting and estimating the indirect benefits will help in project planning, setting priorities, and measuring the results of the ERP implementation on the organization. Even if you cannot assign a monetary value to these benefits, go ahead and list them in the ROI worksheet and the project plan.
For this worksheet, sample ERP benefits have been organized into five areas of improvement:
The lists below are samples of the benefits. There will be many more that you and your team will uncover when reviewing customer success stories, analyst reports, business requirements, software options, and new technology. List the possible benefits and capture initial estimates for process improvements and their financial value.
The worksheet below is a sample spreadsheet for documenting your observations and estimates for process improvements and their financial value. Remember to populate each column in your own spreadsheet.
Identify the direct and indirect benefits for each department in your organization. Following is an example of benefits in the finance and accounting area. You’ll need a table like this for each department in your organization.
Table 7: Example ERP Benefits for Finance and Accounting
Once all the areas of improvement have been considered, add the sum of the five-year total from each department to determine the total benefit.
Also, if you found that the “Total 5-Year Difference” from Table 6: Cost Summary in was positive, then it clearly will be more expensive to maintain your legacy system then replace it. The amount of savings is a direct benefit amount and should be added to the table below in Line 6. If that number was negative (new system costs more than existing) place a zero (0) in Line 6.
Table 8: Summary of ERP Benefits
You will not need a spreadsheet for this phase.
At this point, you should have all the information you need to calculate the ROI on your ERP investment using this formula:
ROI = (Benefits – Investment)/Investment
Here’s where you find the information:
In most cases the benefit will be larger than the investment and you will end up with a ratio greater than 1.
For example, if the five-year benefit is US$2,000,000 and the five-year investment is $575,000, the ratio would be ($2,000,000 – $575,000) / $ 575,000 = 2.479 and that is rounded to 2.5.
Multiply that ratio by 100 to get the ROI percentage that results from upgrading your ERP system. In our example, the 2.5 ratio represents a 250% ROI.
If the benefits and ROI are sound, the next step is to expand the effort to match your company’s planning and budgeting process. Since software affects both operating and capital budgets, you may need to involve more stakeholders.
Get the ERP ROI calculation worksheet to get started today!
This post originally appeared on the SAP Insights blog