5 Keys For Maximising Your ROI Through Optimal ERP Performance: Key No. 2 - Managing the Total Cost of Ownership - What You Need to Know

Something that is borne out in every survey of those who have implemented an ERP system, or those who are contemplating doing it, is that the three most important concerns are functionality, ease-of-use and total cost of ownership.

Functionality and ease-of-use are both purely technological issues that rely on a proper understanding of your requirements and how well the system or systems under consideration comply with and, hopefully, anticipate those needs. Total cost of ownership, on the other hand, extends well beyond the IT/user arena, into wider operations, finance, management, and even into sales and marketing as it can impact on profitability as well as efficiency. There are cases where a disastrous IT implementation has taken down the whole organisation, or at the very least severely damaged it, so you had better get your numbers right from the outset.

The emphasis should always be on the "total" cost, and this figure can be sliced and diced a number of different ways.

Firstly, the upfront or project costs are those costs related to the initial purchase & implementation. They include:

• Software licensing & hardware costs, although these can be deferred though leasing or hosting options.
• Implementation costs contained in the supplier's proposal;
• Costs associated with any interfaces or system modifications;
• Costs associated with data conversion from the legacy system

Secondly, ongoing costs you will face during the system's lifecycle (and don't forget that this could extend up to a decade). These are:

• Leasing or hosting costs depending on the method of initial purchase.
• All costs associated with system communications;
• Costs associated with employing additional or specialised staff; and
• Annual costs for system upgrades and helpline support.

These costs are influenced by a number of factors, including:

• Number of users; and
• Amount of functionality implemented (i.e. number of modules).

Finally and most importantly, there are business benefits achieved, which should be incorporated into the cost equation as a positive, as they are influenced by functionality (and whether and how well you use it), ease-of-use and efficient and effective upgrades and customisation. These potentially include:

• Improved delivery performance percent on-time and complete shipments;
• Improved back-office efficiency due to order processing automation
• Reduced order lead time
• Reduced levels of inventory;
• Fewer number of days needed to close a month;
• Reduction in administrative costs.

Immediate cost issues.

The five immediate cost issues mentioned above can be dealt with through a variation of mechanisms.

Software and implementation costs

You should firstly avoid any ambiguity when communicating the specific requirements of your business. You should ensure that potential vendors are given every opportunity to understand your business processes and needs as well as you do. It also means avoiding big unknowns such as conversion, customisation and integration - activities for which vendors can legitimately say they are unable to give you a fixed cost.

You should also be aiming for, at least, a 5 to 10 years relationship with your vendor. A 2007 benchmark report on a survey by the Aberdeen Group on ERP in manufacturing found "the average age of implementations to be almost nine years, implying the longevity of these solutions often exceeds the anticipated life".

With software and implementation, there is the opportunity of seeking a fixed price proposal, where the software vendor contractually accepts some of the risks associated with your system implementation.

Interface customisations and system modifications

Wherever possible, you should try to avoid any modifications or customisations. Modifications in particular should be avoided at all costs unless they are absolutely 'show stoppers' or business critical. This is particularly because modifications often prevent upgrades from being applied and you will be stuck with outdated versions of the software.

This is not as easy as it sounds, though. Aberdeen reports that only 11 per cent of respondents to its survey of organisations undergoing ERP implementations had zero customisation.

"If your business processes were developed over time - in an unstructured way - the possibility exists that no ERP system will match exactly."

But it agrees that, while some customisation of software may be necessary, doing so does add expense and effort to the initial implementation and the complexity of future upgrades.

Rather it recommends you search out ERP solution providers with customers in your industry, evaluate the fit, and balance the need to adapt your business processes to conform with the software against aligning the software to your processes.

System communications

One area often neglected by many organisations is the significant disparities between different vendors when it comes to the efficiency with which their systems manage data behind the scene, i.e. the speed with which information is processed and transmitted around the organisation.

As surprising as it might sound, there can be a cost difference of 5-7 times between vendors for exactly the same transaction. Multiply that over the system's lifetime and then by the number of users in an organisation and the figures mount up.

Additional or specialised staff

Implementing a new system can mean new recruits in your IT department, such as database administrators or systems analysts or additional training of existing personnel. This has obvious salary and employment costs, particularly as, in a competitive global environment, specialists are in high demand and regularly headhunted and enticed away with better salary packages and career prospects.
A key criterion in deciding which software vendor you choose should include whether you can implement your ERP system without having to increase the number of technical staff. The implementation of new technology should be seen as an opportunity to reduce the IT burden instead.

System upgrades and helpdesk support

This is probably the easiest cost to determine, because it is normally presented as an annual percentage of the vendor's software pricing list.

One thing to keep in mind is that you are normally much better off if your support comes directly from the software vendor - agents do not qualify as part of the vendor's organisation. There are too many cases where support has been outsourced offshore, with the service quality suffering accordingly.

Aberdeen points out that, very often, "the ratio of services to software costs is indicative of both ease of use and ease of implementation".

Users and modules

It is a corollary of software implementation that, the larger the organisation the more users you have, and that means the total cost of software and services will rise as well.

However, it is not always a linear increase.

Surveys by Aberdeen of medium and large-sized ERP users shows that average maintenance cost per user might actually drop when you reach certain economies of scale, thanks to potential volume discounts.

The number of modules implemented will also impact on TCO, since the more extensive the implementation, the more services may be required.

Of course, the larger you are, and the larger the deal, the more bargaining power you may have over the TCO. But again Aberdeen warns that "with rising costs and weakening economies, we see evidence that cost savings are becoming harder to produce".

Ongoing business benefits

While later articles in this series cover in greater detail the potential business benefits you can achieve on an ongoing basis through an ERP system, in summary it is fair to say that, when implementing a new ERP system, you have a great opportunity to improve business processes. So it is important to not just simply re-implement existing processes. Not only may you may be able to save costs during implementation, but also achieve significant benefits from an improved business process on an on-going basis.

Aberdeen research has shown that those organisations which pay the closest attention to the ROI of a project reap far more rewards. "Yet few demonstrate the discipline to closely monitor this level of payback and performance."

"While TCO has proven to be a significant factor in software selection, it is important to keep both costs and benefits in mind throughout the life of an ERP implementation and beyond."

Whether you are an IT or operations manager, or a C-level executive, it is vital that you consider all elements that comprise an ERP system's TCO. In addition to evaluating whether the ERP system fits your business requirements, you need to consider what the ongoing costs will be in the long run. If not careful, these may add up to significantly more than the initial capital outlay for the software and user licences.

In simple terms, you need to table a comparison of all of these cost elements for your preferred supplier and their competitors. What you will glean from this exercise is a clear insight into the true life-cycle costs associated with running an ERP system and a much better perspective on your ROI.

The next article in this series will look at "7 Essential Criteria For Selecting Your ERP Solution & Technology Partner".

References:
• IBS, "5 things you should know about total cost of ownership (TCO) for ERP systems", IBS Australia, March 2008
• Jutras, C., "The total cost of ERP ownership in mid-size companies", Aberdeen Group, July 2007
• Jutras, C., and Barnett, R., "The total cost of ERP ownership in large companies", Aberdeen Group, July 2008
• Jutras, C., Trost, J., and Dalle Tezze, H., "Taking the ERP plunge for the first time", July 2007