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Does SaaS ERP ROI always beat on-premises ERP? It depends

An ERP consultant shows how to look beyond the early savings of SaaS to determine its true long-term ROI vs. on-premises ERP.

Software as a service (SaaS) is a method of deploying ERP software in a hosted or on-demand environment. Unlike the traditional method of purchasing ERP through software licenses, the SaaS model allows the ERP package to be rented or licensed for a protracted period of time. Organizations are increasingly turning to cloud and SaaS ERP to replace their on-premises systems.

My consulting company's 2014 ERP Report shows that roughly one in four organizations is already using cloud-based ERP software. But as we have seen in previous years, the vast majority of respondents (85%) are implementing on-premises ERP software. That leaves 15% of respondents choosing SaaS and cloud ERP this year.

In fact, when asked what percentage of cost savings their organization realized or expected to realize from cloud use, more than half of respondents (54%) indicated that they had only recognized between zero and 40% cost savings.

The cost of customization often comes as a shock, and organizations that implement SaaS technology to save money should consider the true cost of ownership over time. Those that perform the due diligence of blueprinting and requirements gathering will find that whatever software they choose -- cloud or on premises -- will be a much better fit and require less customization if it has gone through those planning processes.

At Panorama, we have found that, on average, this allows an organization to realize a positive return on investment (ROI) around five to seven years after implementation.

Calculating ERP ROI

To calculate the ROI of SaaS, organizations should compare the subscription pricing of SaaS to the cost of on-premises software, hardware and operations. Customization, security and compliance costs should be taken into account as well. While organizations may find that SaaS costs less than on-premises software in the short-term, it's important to remember that transitioning to SaaS cannot guarantee the complete retirement of on-premises hardware and other resources.

Organizations calculating the ROI of SaaS should account for the substantial up-front cost of on-premises software and consider how SaaS can eradicate hardware and maintenance expenses. I found a basic but useful ROI calculation for SaaS versus on-premises ERP in a recent Microsoft-commissioned article on the Forbes magazine website, written by David Linthicum, a cloud proponent who is also a contributor to several TechTarget sites.

Linthicum begins by showing the typical annual costs in the first three years for a hypothetical ERP project. First-year infrastructure, consulting and installation costs reach $1.8 million -- a million of which goes to the ERP software -- which, with annual operational costs of $600,000 added, totals $2.4 million. Only the operations figure remains in years two and three, but the total climbs to $3.6 million.

In contrast, the only costs from SaaS ERP are a $10,000 monthly subscription fee and the same amount for internal support. Even if a rate hike by the SaaS provider brings third-year annual subscription costs up to $300,000, the three-year total is only $780,000 -- a fraction of the on-premises ERP cost.

SaaS ERP not always the best choice

While there are many advantages to SaaS -- such as a lower up-front cost, reduced implementation time, limited need for technical support and a predictable expenditure cycle -- SaaS is not ideal for every organization. In general, SaaS options are more suitable for smaller, less complex and less operationally unique organizations, while on-premises systems are commonly more appropriate for larger, more complex and operationally unique organizations. Most companies fall somewhere in between, which is why weighing the pros and cons can be difficult.

Regardless of which path you choose, the advantages and disadvantages must be carefully reviewed as part of your organization's ERP business case. Be sure to compare the two scenarios objectively against your business needs, which is ultimately the most important consideration.

About the author:
Prior to founding Panorama Consulting Solutions, an ERP-targeted consulting group, Eric Kimberling banked 15 years of ERP consulting experience at firms such as Price Waterhouse. Eric is an expert on ERP implementation project management, as well as ERP software selection and ERP organizational change.

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This was first published in July 2014

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