ERP Costs and Benefits

I. Cost/Benefit Analysis of ERP Predecessors MRP and MRP II


MRP: 1970's-mid 1980's

1981 “A Study of MRP Benefits and Costs”
  • Data from over 1700 companies, of which 679 gave valid responses.
  • Cost of Installation (software, hardware, personnel costs): Average installation cost was $375,000 with a fully installed system reaching $618,000.
  • High variance was caused by relationship between costs and total sales: more sales meant greater installation costs. Benefits of MRP survey (below).
"For each of the characteristics below, state (in column II) the current experience given your stage of MRP development. Then state (in column I) the experience that you would expect operating in today's economic environment with your pre-MRP production system. Finally, state (in column III) the future experience that you anticipate given total completion of your MRP development plans."

                                                                                                                            I                         II                     III
                                                 "Pre-MRP"   Current    Future   
Estimate Estimate Estimate


Inventory turnover 3.2 4.3 5.3
Delivery lead time (days) 71 59 44
Percent of time meeting delivery promises (%) 61 76 88
Percent of orders requiring "splits" because 32 19 9
of unavailable material (%)
Number of expeditors (# people) 10 6 5
Average unit production cost N/A N/A N/A

The survey suggested that the largest degree of improvement was found in “better control of inventory.”

MRP II: Mid 1980's-Mid 1990's
  • Case Study of MRP II Implementation by Publishers Equipment Corporation, 1990.
  • System components added: MRP, accounting, purchasing data bases.
  • Costs of educating employees was added to the total system cost.

Item                   Asset Conversion      Cost Avoidance        System Costs

Inventory                 60,000                5,400
Purchasing                                    117,000
Expediting                                      1,400
Lead-Time Reduction    1,391,820              125,263
System Hardware                                                      280,000
Education                                                             55,000
Totals                 1,451,820              249,063                335,000

  • Asset conversion creates liquidity by reducing inventory and earlier recognition of orders.
  • Cost Avoidance lowered indirect costs and administrative costs within purchasing dept.
  • Since time of implementation (1988), savings have either equaled or surpassed those listed above.

II. ERP Cost Benefit Analysis:   Mid 1990's-Present 


The AberdeenGroup Manufacturing ERP Implementation Survey:
  • Wanted to find the importance of total cost of ownership to ERP users and how the major ERP vendors differentiate on this criterion.
  • The survey was given to 1100 companies, of which 689 became the sample size because they used one vendor only. The companies were split up based on size.
  • Small companies were less than $500 million, mid-size were between $500-$1 billion, and large were companies over $1 billion in worth. The five vendors chosen were based on all having at least 100 users in the survey: SAP/Oracle/QAD/Lawson/Infor.

From the survey, the two main points of selection criteria were functionality and total cost of ownership. TCO was a more crucial selecting tool for the larger companies; 78% of them said TCO was the most critical criterion. In order to measure TCO, three costs must be identified: amount spent on software, amount spent on external services, and internal costs. Internal costs are tough to quantify so only the first two are looked at.

Average Software and Services Costs by Co. Size:

In US $                       Avg. # users        Avg. Software Costs        Software Costs per user        Avg. Service Costs         Avg. SW + Services Costs         SW + Services per user
< $50m            38          138806              4820                  98635             235606                  7853
50m-100m          84          363425              4622                 339321             702746                  8827
100m-250m        150          480048              3171                 485590             965638                  6869
250m-500m        256          527273              2916                 600455            1127727                  6247
500m-1b          292          561667              2463                 495000            1056667                  2537
>1 billion      1485         1137500              1535                1562500            2700000                  3278

This chart shows the increasing total costs of an ERP system to the larger organizations by users.

Now we examine the costs of implementing ERP by Vendor:

In US $                       Avg. # users        Avg. Software Costs        Software Costs per user        Avg. Service Costs         Avg. SW + Services Costs         SW + Services per user   
Infor            104          237170              2290                 169035             406205                  3922
Lawson           195          408333              2086                 383333             791667                  4044
QAD              148          328706              2201                 301633             630339                  4221
Oracle           440         1159091              2633                 960455            2119545                  4816
SAP              385          830033              2249                1382500            2212533                  5995

This chart shows that regardless of number of users, SAP and Oracle are considerably more costly than the other three vendors.

Total costs and number of users is not a good measure of price performance because ERP systems are underutilized. It is estimated that  27.6% of ERP is used by companies. This number is compacted with the fact that 10.51 modules out of 24 total are used on average and of those 10.51 modules, they are used at 63% functionality. So a real cost analysis would be to analyze each company and vendor by the cost per user per % of functionality used to get a better idea of what companies are paying for.


In $                  Avg. # modules used                Unweighted avg (based on 24            Avg % of Functionality                 Weighted Avg.                     Cost Per user Per %
                                                                                modules)                                                            used                                        (Columns B x C)              point of func. used

<50 m          9.79                 40.79%                        62.01%                25.29%                $314
50-100m       10.31                 42.97%                        61.52%                26.43%                $316    
100m-250m     10.13                 42.22%                        63.09%                26.64%                $241
250-500m      10.83                 45.14%                        63.10%                28.48%                $154
500m-1b       10.86                 45.24%                        57.65%                26.08%                $139
>1 billion    11.71                 48.78%                        69.72%                34.01%                $53

This chart shows a decline in cost per % of functionality used as functionality increased. Once a company passes a certain early stage threshold, payback multiplies for these companies because ERP penetrates more broadly into the whole organization.

The last chart from the study shows the business benefits ERP implementation has brought to companies per each vendor. Usually, companies look for time to implementation and standardization as two key measures of ERP success, but this chart quantifies the survey results into real cost savings in different parts of manufacturing: inventory costs, admin costs, etc.

                          QAD     Infor    Lawson    Oracle    SAP
decrease inventory costs  17.4%   12.1%    17.8%     16%       14%
decrease mfg. op costs    13.4%   11.9%    8.5%      11.6%     10.6%
decrease admin costs      15.7%   13.9%    11.9%     14.7%     14.9%
improved complete         23.8%   17.9%    17.9%     15.1%     19.1%
and on-time shipping
improved mfg. schedule    20.1%   16.8%    12.1%     16.5%     13.8%
compliance
average                   18.1%   14.5%    13.6%     14.8%     14.5%
cost per % pt. of         $233    $270     $297      $326      $414
improvement

This allows us to see the actual cost savings on average that ERP systems bring to companies while also showing us which vendor provides the most cost effective product.

III. Single Module Benefit from ERP  Implementation


The Business Performance Improvement Consultancy is a British group that " helps manufacturing companies to improve their business performance through better planning and control,  particular, better use of ERP and MRP systems."

In their sample ERP implementation, the BPIC summarizes how ERP implementation would benefit a manufacturing companies' inventory structure.

First, the costs of implementing the system:

Amounts in pounds      One time   On going (future updates)

Hardware               100,000     20,000
Software               200,000     40,000
Customizing/            60,000     30,000
configuring
Data Control
Inventory Records      150,000     10,000
Bill of Materials       30,000
Routings                30,000
Education
External                90,000     14,000
Internal                20,000      3,000
Direct Labor             3,000
Full time Project       35,000
Leader
Full time project      115,000
team (4)
Outside consultancy     75,000      5,000
Misc.                  125,000     18,000

Total Implementation 1,030,000    143,000
Costs


There are three main benefits ERP can bring to this situation: increasing sales, decreasing costs, and decreasing inventory.

BPIC projects a 5% increase in sales if product is always in stock.
BPIC projects a 10% purchasing cost savings due to better material information.
BPIC projects a 5% labor cost savings due to no material shortages and better scheduling.
BPIC projects a 25% potential inventory stock savings due reductions in: raw materials and WIP.

If we take the costs of setting up the ERP system and combine them with the possible cost savings, we can arrive at both the net cost of capital and the payback period for this module.

Amounts in British pounds

 Sales opportunity  240,000
 Direct labor efficiency  125,000
 Cost of material  1,500,000
 Inventory holding cost reduction  360,000
 Total Annual Saving
 2,225,000
 On-going costs  145,000
 Net Annual Benefit  2,080,000
 One time Cost
1030000
 One time cost Saving 562000
 Net Capital Cost
468000
 Payback Period (yrs)
 .25

IV. Key points about ERP costs and benefits: 


Meta Group Study 2002 found that total ERP system payback occurred 8 months after full implementation (31 months).

Some of the hidden costs mentioned above (as well as others include):
  • Training
  • Integration and Testing
  • Customization
  • Data Analysis
  • Prepared to replace your best and brightest
  • Implementation can never stop

Paying attention to return on investment (ROI) is key. AberdeenGroup found that companies which focused on ROI from the get go obtained greater rewards from ERP Implementation.

"The companies that Aberdeen Group identified as "Best Performing" were able to produce, on 93% more improvement with their ERP systems across a variety of metrics such as cost reductions, schedule performance, headcount reduction or deployment, and quality improvements."

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