ERP (Enterprise Resource Planning) system implementation is a major decision for any business. It is marked by a significant investment of both finances and time, as well as a complete organisational transformation.
While the benefits of this acquisition are well-known, the actual financial returns can be a lot more tricky to comprehend. Therefore, this article will guide you through the process of measuring the ROI (Return on Investment) for your ERP software implementation, to help you make a better-informed decision.
Understanding ERP systems and their impact
Before we get into the ROI calculations, let’s briefly discuss the impact and the overall purpose of an ERP system.
Enterprise resource management software primarily aims to integrate and centralise the various functions of a modern business within a single programme, such as finance, supply chain, sales management (CRM), human resources, and other operations. As such, this technology plays a pivotal role in a transformed management of organisational resources. It optimises processes, streamlines / automates operations, improves efficiency, enhances data management with real-time insights, and much more.
Most companies notice a significant improvement in their overall productivity and a considerable cut in operational costs (by 23% on average), resulting in higher profitability too.
Calculating the ROI of ERP implementation
In order to calculate the ROI, you will need to consider three key components: total cost of ownership for the software, your tangible and intangible returns. Here’s how to do that:
Breaking down the ERP costs
To calculate your returns, you first of all need to calculate your investment - or the total cost of ownership for your chosen ERP system. This will include a few different, direct or indirect, outgoings.
- Software acquisition - Any expenses associated with getting your hands on the software, such as subscription fees per user, licence fees or other;
- Consultancy and implementation services - Project management, data migration, custom solutions developments, and any other costs from services provided to you by an ERP partner;
- Hardware investments (if applicable) - If you choose to install your software on-premise, as opposed to using cloud-based deployment, you will have to purchase your own servers and other hardware;
- Maintenance costs - The software will need to be regularly maintained and updated, so you must factor associated costs too. This may come in the form of IT labour outgoings or a yearly maintenance fee agreed with your ERP partner.
- Training - In order to achieve the highest operational efficiency and productivity possible, you may consider getting ERP training for your staff, which introduces additional expenses;
- Change management - You may also include any outgoings related to the change management of your organisation, such as loss of productivity during the implementation process, staff’s paid time spent training, fees for support or consultations you may have had for your change management processes.
The majority of these costs can be estimated in advance, however, keep in mind that slight deviations are very likely as you start the implementation project. For instance, you may decide to acquire additional functionality or encounter unforeseen challenges.
Tangible and intangible returns
Calculating the costs of ERP installation is pretty straightforward and similar for most businesses, but the returns are much trickier to estimate and can differ substantially from one company to another.
The benefits of ERP systems bring on two types of returns in an organisation: 1. tangible (quantitative); 2. intangible (qualitative). Both are highly valuable and should be considered in this scenario, however, quantifying the intangible results can be challenging. Let’s look at what each of these types include.
- Efficiency gains - An ERP system will increase the efficiency of your business, meaning you will be able to produce more products / services with less time and resources. How will this translate into your production costs and worth?;
- Better data management - Improving / centralising your information flow and getting real-time data will bring benefits to various areas within your business. For example, it will help optimise stock management, which will lead to lower storage costs, reduced waste, and demand-based inventory levels.
Additionally, your purchasing teams will use real-time data to establish better (lower-price, longer-term) contracts with your suppliers and vendors. All of these factors will lead to cost savings and higher profitability;
- Reduced labour costs - Consolidating multiple systems into a single ERP platform can result in significant savings in IT support and infrastructure costs. Additionally, optimising or automating certain processes will lead to a decrease in overall labour costs across all departments;
- Improved financial management - Enhanced accounting and financial control can lead to reduced accounting errors and more accurate budgeting. Quantify the savings from fewer financial discrepancies and the impact on cash flow management;
- Supply chain visibility - ERP systems streamline supply chain processes, resulting in faster turnaround times and reduced logistics costs. Assess the reduction in delivery times and transportation expenses;
- Enhanced CRM (Customer Relationship Management) - With better customer relationship management and order tracking, an ERP CRM software can lead to increased sales. Analyse the potential growth in sales volume and customer retention rates, based on the opportunities you currently lose due to poor / slow customer support.
All of these as well as any other potential returns that may be specific to your particular business / industry are quantifiable, meaning they can be turned into numbers using the company’s historical data.
The intangible aspects of ROI is where the estimations become tricky, as it is not always possible to assign a direct monetary value to them. These are typically the earnings or expenses that are not as obvious and do not occur on a regular basis. Here are some examples:
- Improved customer satisfaction - ERP software helps improve customer experience through faster order management and effective customer service. This can lead to increased repeat business and customer loyalty, which would directly impact your revenue;
- Happier employees - Streamlining processes, improving internal communication, and overall managing human resources better will create a happier employee base. This will result in higher productivity within your teams (quicker project turnaround) as well as increased employee retention rates (lower recruitment and training costs);
- Regulatory compliance - ERP systems help in maintaining compliance with regulations and standards, reducing legal risks. This can help avoid potential costly fines or ruined company reputation;
- Reduced likelihood of errors - ERP systems automate and optimise processes, minimising human errors in data handling. This results in cost savings from fewer mistakes, improved operational efficiency, and enhanced reliability in reporting and compliance;
- Better decision-making - ERP systems provide accurate and real-time insights to decision-makers. This can create returns through more strategic decisions, such as overhead reductions or investments.
Additionally, real-time insights allow businesses to adapt to any market trends or changes quicker, resulting in faster time-to-market for new products or services, and potentially increasing market share.
ROI calculation formula
If you have successfully calculated the estimates for both your ERP implementation costs and returns, you can use the below formula to calculate the ROI for this project:
ROI (Return on Investment) = (Net Returns ÷ ERP Costs) x 100
Net Returns: This is the total gain from the investment minus the costs of the investment. Choose a specific time period / number of years for this.
ERP Costs: The total costs (investment) of ERP software implementation.
In essence, the ROI formula measures the percentage return on an investment relative to its cost. A higher ROI indicates a more profitable investment.
For example, if the total investment cost for an ERP system is €65,000 and the gains over 3 years add up to €120,000, then the ROI = ((120,000 - 65,000) / 65,000)) x 100 = 84.6%.
Break-even point formula
Another useful calculation is the break even point, which allows the business to estimate the amount of years it will take to start seeing returns after ERP implementation. Any returns made after the company breaks even are profitable.
Break Even Point (Years) = ERP Costs ÷ Annual Net Returns
Annual Net Returns: The estimated annual financial gains the ERP system will provide minus the annual ongoing costs (such as maintenance costs, subscription fees, etc.).
For instance, if the company’s total ERP costs are €65,000, the annual gains are €30,000, and the annual costs are €4000, the Break Even Point = 65,000 / (30,000 - 4000) = 2.5 years.
Short-term VS long-term considerations
In assessing the ROI of ERP system implementation, it's crucial to distinguish between short-term and long-term considerations. In the short term, ROI is often evaluated through immediate improvements in operational efficiency, such as reduced processing times and lower error rates. These benefits, while significant, only scratch the surface of the system's full potential.
The long-term ROI, however, delves deeper, encompassing strategic advantages like enhanced decision-making capabilities and better scalability for business growth. Over time, the ERP system can facilitate innovation, improve customer satisfaction, and lead to new market opportunities, which are integral for an enduring impact on the organisation's profitability and market position.
Thus, while the short-term returns focus on immediate efficiency gains, the long-term ROI is a more comprehensive measure that reflects the ERP system's role in driving sustained business growth.
Have any questions? Talk to our Odoo ERP consultants!
As GOLD Odoo partners with more than 10 years of ERP implementation experience, we can guide you through this important decision. We value honesty and transparency, so if Odoo ERP system is not the right choice for your company at this stage, we will tell you.
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