Written by
Anne Mulvenna

How to Conduct an ERP ROI Analysis

Genius ERP: ready out-of-the-box for custom manufacturing.

Why analyzing an ERP system’s ROI is crucial

If you are trying to sell upper management on the benefits of getting an ERP system, one of the best ways to do that is to do an ROI analysis. Plotting out a business case for a new ERP system, including costs, benefits, and ROI will help put your argument into a language your top brass understand—dollars and cents.

Of course there are many benefits of an ERP system—check out our blog post on how an ERP system will benefit your CEO to find other benefits to help back up your business case. But, an ROI analysis will give you a concrete sense of the value an ERP will add to your organization, and can be a crucial tool you can use to convince upper management that a system is needed.

An ROI analysis will also point out where you are currently struggling with inefficiencies, and where you are wasting time and money in your manufacturing processes. Conducting an ROI analysis will help you build your case that your shop will benefit from an ERP as it will point out all the problematic areas within your shop, as well as how an ERP can help your organization become more streamlined and efficient. Even if your organization ultimately decides that the time is not right to implement a new ERP system, your ROI analysis will have identified gaps in your processes, and places where your manufacturing shop needs to improve to become a better, more efficient business.

If you do decide to go ahead with a new ERP, having done an ROI analysis will also help you during the selection phase of your ERP project. The ROI analysis will have helped you to identify the strengths and weaknesses of your business, and where you need help to improve your productivity. Armed with this information you can identify what features and functionalities you need in an ERP system to help you improve your business—which will help you to better evaluate between competing ERP systems.

Calculating and ERP’s ROI

Now that I have you sold on the need to conduct an ROI analysis of an ERP system I’ll break the bad news—doing an ERP ROI analysis is hard. ERPs are large and complicated systems that connect and interact with every department, process, and system within your organization. Conducting an analysis of such a wide-reaching system, and one where the benefits can sometimes be hard to quantify, is no easy task.

Because an ERP system is so wide-reaching, it is difficult to accurately and completely parse out both the hidden costs to how you are doing things now, as well as the hidden benefits of an ERP system. For example, ask yourself how much it actually costs your organization to run your business off of Excel spreadsheets. What about delays in production that happen because your staff is working off of spreadsheets with errors and inaccurate information? You will need to think long and hard about your current business processes. Conversely, ask yourself how much is it worth to improve strategic planning within your organization? Putting a dollar value on something like this can be difficult, but the data you can pull out of your ERP system will help you with your strategic and long-range planning, which will in turn bring you many benefits down the line.  See, I told you it wasn’t going to be easy!

And something to keep in mind regarding all ROI analyses—they are only projections of what may happen when you implement a new system. Nothing can perfectly predict the future, so it’s not guaranteed that your project will line up exactly with the targets and benefits you will have identified with your ROI analysis.

But the fact that you have completed an ROI analysis, and identified these targets and benefits, is extremely useful, and can actually help you meet your projected targets, because your team will have tangible results that they can be striving towards as your implementation project progresses. You can also use the benefits you identified in your analysis to act as benchmarks, helping your organization to chart the value you have received from your new ERP after implementation.

The basics of an ROI analysis

Basically, to do an ROI analysis you need to identify and calculate the net benefits and gains from your new ERP system as well as the net costs of the new system and then compare the two sets of figures to determine the return on investment that you will get from the new system. Seems simple enough in writing, but as we’ve already discussed, identifying all the costs and benefits associated with such an all encompassing system isn’t easy.

Take time to really try to parse out all the areas where you are inefficient and losing time and money, as well as all the places an ERP will help you. Also, there isn’t necessarily a one-size-fits-all way to calculate ROI for your organization. Below are three different ways of determining ROI. Pick the method that is most relevant and useful to your shop.

Benefits vs. Costs

This method is basically doing what is stated above—calculating to the best of your ability all of the costs and all of the benefits of an ERP system. Using this method, you can either divide the total benefits by the total costs (ROI = Total Benefits / Total Costs) or you can divide the net profits by total costs (ROI Gain = (Net Profit / Total Costs) x 100). In either case, remember that this number will be represent ROI over a multi-year period. Remember what I said above about how an ERP can improve your strategic planning? It will take time for your organization to see all the benefits of an ERP system, and this should be built into your total costs and total benefits calculations.

Annual ROI

For organizations that prefer to look at ROI year by year, you can take the above result and further divide it by the expected lifetime of the system in years. And not to get too technical on you, but it’s important to note that this average won’t reflect amortization because the majority of costs associated with any ERP project (for example buying the software and taking the time to train employees) will be incurred within the first few months of getting a new system, while most of the gains will be realized later on in the lifetime of the system, as your organization gets more efficient from using the ERP system.

The Payback Methodology

Another way to look at ROI is by calculating a payback period (how long it takes to earn back the cost of the system or Payback = cost / annual return). This method is useful if you want to  determine when benefits will become profits. But as with the annual ROI calculation, it can’t show how costs and benefits are distributed over the life of an investment.

No matter what method you use, after putting in some legwork, and really diving deep into both the benefits and costs of an ERP system, you will get a good idea of what kind of return your manufacturing shop will see from implementing an ERP solution. Conducting an ROI analysis is no easy feat, but it will help you get a greater understanding of your organization, as well as give you a helpful metric to use in trying to persuade upper management that an ERP system is a worthy investment for your organization.

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