A recent conversation with a client looking to upgrade an old accounting system prompted us to make some suggestions about calculating the Return on Investment (ROI) that can be derived from a strategic investment in ERP. Rightfully, our contact figured the next step after our process analysis would be to justify the entire investment to their owners. She knew her task would be to quantify the benefits across their team. In response, we proposed a few ideas of our own about how and where to look for ROI. Since we think our advice is apropos in any similar situation, we are reprising our suggestions in our next two blog posts. Part One follows…
Much, though not all, justification for an ERP system is often derived from its return on investment (ROI). Following are some thoughts on the topic you’ll find useful.
1. Hard vs. Soft Costs. When quantifying cost savings, there are hard cost savings, and soft cost savings. The hard savings are those in which costs are directly lowered and the bottom line directly impacted. An example would be having 3 warehouse staff, and finding after system implementation that only 2 are required. That one person, fully burdened for benefits, taxes, etc., might represent a hard cost savings of, say, $30,000 in a year. (This assumes you actually let that person go.) Multiply that by 3 years (a typical payback assumption), and you’ve recaptured $90,000 at the bottom line.
A soft cost saving occurs when you lighten someone’s load, but not their hours. If it formerly took someone 4 hours a day to schedule production, and it now takes only 1, you’ve saved about 15 hours per week. Do the math on that scheduler and you come up with some annual savings (say, $10,000), but… you don’t realize the savings unless you actually cut that person’s hours, or let them go – not likely. Instead, you’ve more likely reassigned them to another task.
When evaluating ROI then, while you might not count the 15 hours weekly savings, you should consider the added top (or bottom) line economic value of the new (and presumably more productive) tasks that person now performs: i.e., replacing what otherwise might have been a new part-time hire, or spending time on inside sales calls duties, or whatever works for you. Their 15 hours saved per week might not drop to the bottom line, but the increase in sales they generate (or insert your own example here) might help the top line.
2. The little stuff adds up. ERP systems save a lot of time previously wasted on redundant data entry. Companies frequently double, triple or quadruple-enter data into disparate systems. It’s important to add up the actual time abused this way. Multiply those hours per day per person (across two or more people?), and apply a standard labor rate (plus insurance, taxes, etc. as a “burden”) and pretty soon you’re talking real money. Saving just ten hours per week from two people adds up to three thousand hours over three years, and at even $10 or $15 fully burdened per hour, you’re talking tens of thousands of dollars slipping through the cracks. So, look for the small stuff as well as the big, and do your own math. But do it honestly, rigorously, and without bias.
In our next post, we’ll finish up, with 4 more areas that affect the ROI of ERP. Stay tuned…