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ERP Guide : Cost beneit analysis

Tutorial by:      Date: 2016-05-16 04:49:05

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It is difficult to give a general estimate for the costs of an ERP implementation. A very rough rule of thumb for the estimated implementation costs of ERP is one per mile of annual revenue [CFOIT, 2003]. Surveys give a diverging image of ERP implementation costs. One survey under 500 companies showed average ERP implementation costs of US$ 5.3 million [FERF, 2003], while another survey under almost 100 companies reported an average of US$ 15 million for an initial ERP implementation [Nucleus Research, 2003]. Although the estimates are wide apart, they do show that ERP implementations come with considerable costs.

The absence of a generally applicable estimate also holds for the benefits of ERP. Theoretically, the main characteristics of ERP, data integration and support for best practices should be beneficial for organizations. Survey-based research confirms this. In a survey under over 400 mostly American companies, eighty percent of the respondents indicate that ERP increases the deficiency in the supply chain and reduces working capital requirements [FEI, 2002]. However, exact numbers on the extent to which the financial position of organizations improve are not available.

It was already noted that ERP can be beneficial for organizations, but also that ERP implementations have inherent costs and risks. In the third step of the ex ante evaluation of ERP a cost benefit analysis of the implementation is executed, in order to create a better understanding of the costs and benefits that can be expected for companies that consider an ERP implementation.

A thorough cost benefit analysis satisfies at least three criteria in order to realize this better understanding. Firstly, the analysis has to have a financial outcome. Every investment in an organization leads to financial, other quantitative and qualitative benefits. An example of a potential financial benefit after an ERP implementation is lower working capital requirements. A potential non-financial quantitative benefit could be lower emission of toxic gas by better production planning. An example of a qualitative benefit is lower workload in the finance department during financial month ends because of a higher degree of automation. In the past fifteen years, especially during the Internet dream, IT investments have more than strictly necessary been justified on the basis of non-financial benefits alone.

When everyone woke up from the Internet dream, billions of investments had gone up in smoke. In order to prevent a too shallow justification of an ERP investment it is important to express the benefits of an ERP implementation in financial terms. This will allow a fair comparison of ERP with other investment opportunities, and it also allows a better evaluation of benefits realization after the implementation has been completed.

Secondly, a thorough cost benefit analysis has to be complete. In most companies, many investment opportunities exist, while the total investment budget is limited. The budget that is made available for an ERP implementation could also be used for alternative investment proposals that could potentially have higher benefits. For this reason, the ERP cost benefit analysis has to be complete: all relevant costs and benefits have to be included and not just a few obvious categories. Only when cost benefit analyses are complete, organizations can make well-founded investment decisions.

Thirdly, a cost benefit analysis has to be integrated. The outcomes of the other two steps in the ex ante evaluation, the functional it analysis and the risk analysis, are in financial terms already, and now have to be incorporated in the cost benefit analysis. In the functional it analysis, the costs and benefits of process modifications have been estimated, as well as the costs of software modifications. These estimates have to be incorporated in the cost benefit analysis. The risk analysis also has a strong connection with the cost benefit analysis. The severities of the various risks in the cost benefit analysis need to be taken into account as ERP implementation costs. After this, the costs and severity reduction has to be included for each of the control measures that have been selected for implementation in the risk analysis. Finally, the costs associated with the critical success factors have to be added to the cost benefit analysis.

 

 Cost beneit analysis for an ERP implementation

It would be interesting to study the trends in costs and benefits of ERP for companies that are implementing ERP, or have finalized their implementation. Unfortunately, most companies do not disclose the costs and benefits of their ERP implementations. One of the rare exceptions is the Malaysian subsidiary of Shell. In 1998, the company started an SAP implementation [Lim, 1998].

In above image the costs and benefits of the project are described. The currency in Malaysia is the Malay Ringitt, which in 1998 was worth around €0.24. It is remarkable, though not uncommon, that in the description the costs are presented in financial terms, while the benefits are largely expressed in qualitative terms. It is indeed difficult to express Millennium or other compliance in financial terms. However, reduction of paperwork and other work with low added value can be estimated in financial terms, and the same holds for phasing out a number of IT systems. Shell may have carried out the analysis in financial terms, but the company obviously chose not to mention these estimates. It is also remarkable that the description of costs is concentrated on costs during the implementation, while the impact of ERP in the later phases of the ERP life cycle is not mentioned. Software and hardware in the Shell project account for only a small proportion (ten percent) of the project costs, while the largest part of the budget (forty percent) is spent on implementation consultants. This is consistent with information from other projects.

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