ERP cost benefit analysis for stand-alone projects

In this excerpt, find out how to implement an ERP system without enterprise software and create your ERP cost benefits analysis. Learn what steps should be on your ERP implementation checklist.

ERP: Making It Happen: The Implementers' Guide to Success with Enterprise Resource Planning, Ch. 5
Table of contents:
Preparing an ERP implementation plan: ERP audit and assessment
Introduction to ERP and designing a business case for ERP
ERP cost benefit analysis for stand-alone projects

ERP Only

Now, what about a company that separates doing ERP only? Figure 5-4 shows a possible cost and benefits analysis for ERP by itself. Although each situation is wildly different, you can make a rough assumption that the ERP only numbers are additive to an ES project that has come before or will come after ERP.

This excerpt from ERP: Making It Happen: The Implementers' Guide to Success with Enterprise Resource Planning by Thomas F. Wallace and Michael H. Kremzar is reprinted here with permission from John Wiley & Sons, Inc.; Copyright 2001.

What's exciting about this ERP only analysis is the payout and cash flow are as attractive as the ERP/ES total effort. Certainly, the numbers on both sides of the cost/benefit ledger are smaller but equally attractive. The project pays out in 7 months with a 170 percent rate of return. If you can find a better investment, go for it. But remember that this one will continue to return $553,000 each year in savings along with the one-time inventory cash savings of $4,500,000.

Please note that the benefit numbers are larger for ERP/ES than for ERP alone. The major difference between doing ERP and ES together or doing just ERP is the enhanced speed and accuracy of information flow when using an ES. Every decision from forecasting to sales to production will be more accurate and faster and will thus generate added benefits.

However, you can still have an impressive change in your business with ERP even with a non-integrated information system. We have assumed that the ERP project would fund one of several attractive supply chain software packages available but this would be a standalone assist to the forecasting/planning effort. There may be some added costs if ES comes after ERP due to the need to connect the ERP wiring to ES. However, this cost should be relatively small compared to the rest of the project.

Here's a familiar question: Does size matter? In terms of the payout, not as much as you might think. For a very small company, the challenge usually is resources. There are simply too few people to add a major effort such as this without risk to the basic business. Too often, small companies (and, to be fair, large ones also) will hire consultants to install ES and will ignore the ERP potential. These companies are usually very disappointed when they realize the costs have not brought along the benefits.

Large, multinational companies should be able to allocate resources and should find that the benefits are even more strategic. The problem with larger companies is trying to get all parts of the company, worldwide, to adhere to a common set of principles and practices. If pulling together all aspects of the company is difficult (like herding cats), we recommend that the project be attacked one business unit at a time. The impact for the total company will be delayed but the more enlightened business units that do install the total project will see rapid results.

Here are a few final thoughts on cost/benefit analysis.

1. What we've been trying to illustrate here is primarily the process of cost/benefit analysis, not how to format the numbers. Use whatever format the corporate office requires. For internal use within the business unit, however, keep it simple—two or three pages should do just fine. Many companies have used the format shown here and found it to be very helpful for operational and project management purposes.

2. We've dealt mostly with out-of-pocket costs. For example, the opportunity costs of the managers' time have not been applied to the project; these people are on the exempt payroll and have a job to do, regardless of how many hours will be involved. Some companies don't do it that way. They include the estimated costs of management's time in order to decide on the relative merits of competing projects. This is also a valid approach and can certainly be followed.

3. Get widespread participation in the cost/benefit process. Have all of the key departments involved. Avoid the trap of cost justifying the entire project on the basis of inventory reduction alone. It's probably possible to do it that way and come up with the necessary payback and return on investment numbers. Unfortunately, it sends exactly the wrong message to the rest of the company. It says: "This is an inventory reduction project," and that's wrong. We are talking about a whole lot more than that.

4. We did include a contingency to increase costs and decrease savings. Many companies do this as a normal way to justify any project. If yours does not, then you can choose to delete this piece of conservatism. However, we do encourage the use of contingency to avoid distractions during the project if surprises happen. Nothing is more discouraging than being forced to explain a change in costs or benefits even if the total project has not changed in financial benefit. Contingency is an easily understood way to provide the protection needed to keep working as various costs and benefits ebb and flow.

Figure 5-4 Sample Cost/Benefit Analysis: ERP only

COSTS
Item	One Time	Recurring	Comments
C - Computer
Hardware	$200,000		Additional workstations or system upgrade.
Software	200,000	$50,000	Supply chain support software.
Systems and programming	200,000	100,000	Fitting the SC software to your system.
B - Data
Inventory record accuracy	700,000	100,000	Includes new equipment and added cycle counters.
Bill of material accuracy and structure	200,000		Bills will need to be restructured into the modular format. Experienced engineers will be needed for this step.
Routing accuracy	100,000
Forecasting	200,000	100,000	Full time person for Sales forecasting. Needs to come on board early.
A - People
Project Team	600,000		One FT person per plant and one corporate leader for two years.
Education	800,000	150,000	Key leaders and teams to learn ERP principles and techniques, and their application within the company.
Professional guidance	200,000	50,000	Two days per month during installation.
SUB-TOTAL	$3,400,000	$550,000
Contingency	$510,000	$82,500
15%			A conservative precaution against surprises.
TOTAL	$3,910,000	$632,000
BENEFITS
Item	Current	% Improvement	Annual Benefits	Comments
Sales	$500,000,000	3% at 10%	$1,500,000	Modest improvement due to improved product availability at the profit margin. You could assume this as no improvement to be more conservative.
Direct labor productivity	25,000,000	5%	1,250,000	Reductions in productivity idle time, overtime, layoffs, and other items caused by the lack of planning and information flow. This is very conservative.
Purchase cost	150,000,000	3%	4,500,000	Better planning and information will reduce supplier costs.Not as much as with complete ES connections and speed.
Inventories				One time cash flow:
Raw Material and WIP	25,000,000	6% at 15%	230,000	1,500,000
Finished goods	25,000,000	18% at 15%	680,000	4,500,000 These are very low numbers for a Class A company.
Obsolescence	500,000	20%	100,000	Conservative savings
Premium freight	1,000,000	30%	300,000	Produce and ship on time reduces emergencies - but not as good as with the complete information system.
SUB-TOTAL			$8,560,000	$6,000,000 One time cash flow.
Contingency		15%	-1,284,000	1,500,000
Recurring			-632,000
TOTAL			$6,644,000	$4,500,000 One time cash flow.
Cost of one-month delay	$553,000
Payback months period	7 months
Return on investment	170%

GO/NO-GO DECISION

Getting commitment via the go/no-go decision is the first moment of truth in an implementation project. This is when the company turns thumbs-up or thumbs-down on ERP.

Key people within the company have gone through audit/assessment and first-cut education, and have done the vision statement and cost/benefit analysis. They should now know: What is ERP; is it right for our company; what will it cost; what will it save; how long will it take; and who are the likely candidates for project leader and for torchbearer?

How do the numbers in the cost/benefit analysis look? Are they good enough to peg the implementation as a very high -- hopefully number two -- priority in the company?

Jerry Clement, a senior member of the Oliver Wight organization, has an interesting approach involving four categories of questions:

• Are we financially ready? Do we believe the numbers in the cost/benefit analysis? Am I prepared to commit to my financial piece of the costs?
• Are we resource ready? Have we picked the right people for the team? Have we adequately back-filled, reassigned work or eliminated work so the chosen resources can be successful? Am I prepared to commit myself and my people to the task ahead?
• Are we priority ready? Can we really make this work with everything else going on? Have we eliminated non-essential priorities? Can we keep this as a high number two priority for the next year and a half ?
• Are we emotionally ready? Do I feel a little fire in the belly? Do I believe the vision? Am I ready to play my role as one of the champions of this initiative along with the torchbearer?

If the answer to any of these is no, don't go ahead. Fix what's not right. When the answers are all yes, put it in writing.

The Written Project Charter

Do a formal sign-off on the cost/benefit analysis. The people who developed and accepted the numbers should sign their names on the cost/benefit study. This and the vision statement will form the written project charter. They will spell out what the company will look like following implementation, levels of performance to be achieved, costs and benefits, and time frame.

Why make this process so formal? First, it will stress the importance of the project. Second, the written charter can serve as a beacon, a rallying point during the next year or so of implementation when the tough times come. And they will come. Business may get really good, or really bad. Or the government may get on the company's back. Or, perhaps most frightening of all, the ERPknowledgeable and enthusiastic general manager will be transferred to another division. Her successor may not share the enthusiasm.

A written charter won't make these problems disappear. But it will make it easier to address them, and to stay the course.

Don't be bashful with this document. Consider doing what some companies have done: Get three or four high-quality copies of this document; get 'em framed; hang one on the wall in the executive conference room, one in the conference room where the project team will be meeting, one in the education and training room, one in the cafeteria, and maybe elsewhere. Drive a stake in the ground. Make a statement that this implementation is not just another "flavor-ofthe- month," we're serious about it and we're going to do it right.

We've just completed the first four steps on the Proven Path: audit/ assessment I, first-cut education, vision statement, and cost/benefit analysis. A company at this point has accomplished a number of things. First of all, its key people, typically with help from outside experts, have done a focused assessment of the company's current problems and opportunities, which has pointed them to Enterprise Resource Planning. Next, these key people received some initial education on ERP. They've created a vision of the future, estimated costs and benefits, and have made a commitment to implement, via the Proven Path so that the company can get to Class A quickly.

THE IMPLEMENTERS' CHECKLISTS

At this point, it's time to introduce the concept of Implementers' Checklists. These are documents that detail the major tasks necessary to ensure total compliance with the Proven Path approach.

A company that is able to check yes for each task on each list can be virtually guaranteed of a successful implementation. As such, these checklists can be important tools for key implementers -- people like project leaders, torchbearers, general managers, and other members of the steering committee and project team.

Beginning here, an Implementers' Checklist will appear at the end of most of the following chapters. The reader may be able to expand his utility by adding tasks, as appropriate. However, we recommend against the deletion of tasks from any of the checklists. To do so would weaken their ability to help monitor compliance with the Proven Path.

Q & A WITH THE AUTHORS

TOM: Probably the biggest threat during an ERP implementation is when the general manager of a business changes. You've lived through a number of those, and I'm curious as to how you folks handled it.

MIKE: First, try to get commitment that the torchbearer will be with the project for two years. If the general manager is likely to be moved out in less than that time, it might be best to select one of his or her staff members who'll be around for the long haul. Second, if the general manager leaves, the executive steering committee has to earn its pay and set the join-up process for the replacement. This means the new general manager must get ERP education and become thoroughly versed with the project's vision, cost/benefit structure, organization, timetable, and -- most important -- his or her role vis-a-vis ERP.

In big companies, change in management leadership is often a constant and I have seen several business units flounder when change happens without a "full court press" on engaging the new leader.

IMPLEMENTERS' CHECKLIST

Functions: Audit/Assessment I, First-cut Education, Vision Statement, Cost/Benefit Analysis, and Commitment

1. Audit/assessment I conducted with participation by top management, operating management, and outside consultants with Class A experience in ERP.

2. The general manager and key staff members have attended first-cut education.

3. All key operating managers (department heads) have attended first-cut education.

4. Vision statement prepared and accepted by top management and operating management from all involved functions.

5. Cost/benefit analysis prepared on a joint venture basis, with both top management and operating management from all involved functions participating.

6. Cost/benefit analysis approved by general manager and all other necessary individuals.

7. Enterprise Resource Planning established as a very high priority within the entire organization.

8. Written project charter created and formally signed off by all participating executives and managers.

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