Exploring RoI aspects of ERP

Exploring ROI aspects of ERP Implementations and beyond

R.J. Lalwani Chairman CSI Indore Chapter. drlalwani@yahoo.com

Subhajit Mazumder Consultant PricewaterhouseCoopers, India. subhajit.mazumder@in.pwc.com

Sajal Jain Software Engineer Impetus Technologies sjain@impetus.co.in

Abstract This paper is an endeavor to present ideas gathered from various ERP implementation experiences of the authors. We discuss the Return On Investment as a metric and suggest a model to provide insight to the top management and company strategists to make efficient, effective decisions on their technology implementation planning.

We understand that the investment in implementing ERP is immense in most cases and also has risk factors associated. Therefore, company strategists and people who visualize the future of the organization need to ponder on the end results, the returns that such a technology investment could give. Thus Return on Investment (ROI) is one of the key factors in deciding to go for technology upgrade.

Breadth and Repeatability (BR factor), is a good non-mathematical way of getting close to calculating ROI. Breadth signifies more the people affected by the solution, higher the potential ROI. Repeatability is more often the ERP helps people, higher the potential ROI. Despite best efforts and abilities of ERP consultants, ERP implementations don’t take off the grand way it is supposed to do. There are many deterrent parameters that often result in a negative ROI. The most important of these are the human factors that impact application value.

The basic tenet of empowering an organization with new technology: if the end-users won’t use the application, the ROI will likely be negative needs to be realized by ERP consultants worldwide, be it on any platform.

To maximize this return value, the organization must devote as much energy, to addressing human barriers during deployment and the first operational year, as they did to select the ERP. We have derived our own empirical relation considering various factors, to produce a ROI Indicator. This indicator takes into account the following components: Business Process Enhancement, Technology Upgrade, Spectrum of Application, HR maturity and learnability, Payback Period and Organizational factor.

We further layout an effective 6-step action plan that can be adhered to, for actively monitoring fluctuations in ROI indicator with evolution of the ERP. This model though empirical, can be a very good estimate in computing the Return on Investment, coupled with the suggested action plan. The suggested model has been derived after closely observing various ERP implementations using various ERP packages. Therefore the model is a generic one and has a lot of flexibility, in tune with the dynamic implementation environments.

The model is being used currently in implementation sites in Bangladesh and Malaysia, where the authors are involved in live implementations.

1. Introduction Enterprise Resource Planning or ERP as it is more popularly known has been prominent in the Industry for quite some time. We often hear of successful implementations and at other times learn about the devastating impact that a failed ERP implementation can have.

It is important to reflect on what is meant by a successful implementation and how an implementation is considered to be a failure. We ask ourselves, can we really measure the degree of success of an implementation, and this brings us to the learning, which we as ERP consultants have experienced and learnt.

This paper is an endeavor to present ideas gathered from various ERP implementation experiences of the authors. We discuss the Return On Investment as a metric and suggest a model to provide insight to the top management and company strategists to make efficient, effective decisions on their technology implementation planning.

2. Need for Metrics like ROI We spoke about fathoming the degree of success of an ERP implementation. This becomes important in light of reality, which is way apart from the myths of inherent benefits any ERP package promise. The need for metrics should be realized, most importantly by CIO/CTO/CFO of the concerned organization.

An organization going in for a ERP inadvertently goes in for investment depending on its size, capability and market share. Investment comes in many forms: • Financial Investment, which means spending a large sum of money in acquiring a suitable ERP package such as SAP, People soft etc. In addition, an equally (sometimes more) huge amount goes in customizing the base product to capture the business logic of the organization.

• Human Resource Investment, which means dedicating some of its manpower to actively participate with external consultants, giving their organizational knowledge to the cause.

• Material Resources like computers, servers, networks and other infrastructure that is required for the job.

• Informational Resources like company chart of accounts, accounting policies, audit information etc. that is critical to the organization for its survival is released for the implementation.

We understand that the investment is immense in most cases and also has risk factors associated.

Therefore, company strategists and people who visualize the future of the organization need to ponder on the end results, the returns that such a technology investment could give. Thus Return On Investment (ROI) is one of the key factors in deciding to go for technology upgrade.

The next pertinent question is “Is there a key to maximize the return on investment from a ERP solution”? We answer this question in 2 words: •

Breadth – how wide is the spectrum in which the ERP operates. That is whether the ERP is operating in modules, and not in its entirety and what is the % of employees who are being affected by the change. The impact that the ERP has created in daily organizational operations decides breadth.

Repeatability – how often the ERP comes into play, in daily activities of the organization.

The BR factor is simple, and should be kept in mind, throughout the process of choosing and deploying the solution. [2].

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Moderate ROI

High ROI

Breadth

Low ROI

Moderate ROI

Repeatability Fig. Relationship between ROI and BR factor The figure explains BR Factor further. Breadth signifies more the people affected by the solution, higher the potential ROI. Repeatability is more often the ERP helps people, higher the potential ROI. The rules of Breadth and Repeatability apply even after the ERP has been implemented and it is evolving, as features within the ERP offer varying opportunities for returns.

Most decision makers do not employ any financial technique to determine ROI. They rely more on intangible benefits. The BR factor though not a financial technique can keep top management focused on the goals and avoids meandering into myths.

3. Measuring Return on Investment Cost benefit analysis is an indirect way of understanding Return on Investment. A cost-benefit analysis of an ERP solution is best calculated by examining the following key elements: • ERP project costs will include items such as software, servers, client upgrades, network upgrades, support and maintenance contracts, professional services, IT training, application customization and development, implementation labor and on-going support and administration.

• Business unit costs are often underestimated and include user training and change management.

• Operating efficiency benefits are the process improvements that can help the company improve productivity, re-deploy labor resources, avoid purchases or eliminate expenses.

• Business benefits are improvements in revenue or development of new revenue opportunities.

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Project risk includes everything from schedule and budget overruns, functionality shortcomings, slow adoption and resources risks that may affect planned costs and benefits.

Intangible benefits are strategic and important but non-quantifiable in monetary terms such as brand advantage or business agility. [1]

Before we go in to further intricacies of ROI, we should understand what we mean by Returns.

3.1 Quantifying Returns •

Tangible Benefits:

These benefits are most often cost savings and timesavings for different business activities.

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Semi-Tangible Benefits:

Semi-tangible benefits are more difficult to calculate, and they should be considered estimates.

The exact increase in revenues or profits that can, for example, be derived from a new BI application is often difficult to pinpoint. Also, there are many other factors that may affect, for example, sales performance and have nothing to do with the new applications in a company. If the general business environment and the financial climate are improving and if this coincides with the implementation of a new BI system, then this is something that may also help increase revenues or profits alongside the new BI application.

Other semi-tangible benefits may be better work climate, leading to increased moral and happier employees. This, in turn, may mean fewer work absences. The value of having the employees present at work due to an improved work climate is something that can be estimated. Another result stemming from a new application may be more active employees taking more initiatives to new and improved ways of working. Once again, the exact value of these new employee initiatives is difficult to calculate, but often-valid estimates can be done.

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Non Tangible Benefits:

Non-tangible benefits should be included in an ROI, but will not add any figures. They may, however, be the most important and the most likely to meet political resistance. For BI applications, non-tangible benefits are typically the fact that more business users are able to do analyses. The organization is, therefore, more likely to find new and interesting phenomenon and come to new conclusions.

ROI can be analyzed and presented by the following financial calculations: ROI = Net Benefits/Costs Risk adjusted ROI = Net Present Value (NPV) of net benefits/NPV costs Net Present Value = net cash flow of the project translated into today's dollar terms using a risk adjusted discount rate.

Internal Rate of Return (IRR) = the effective project return, calculated as the discount rate for this project which brings the net present value equation to zero.

Payback Period = the period it takes usually in months, for the ERP to reach cash flow positive (where Cumulative benefits exceed Cumulative costs) 4. Parameters which prevent accurate measurement of ROI Despite best efforts and abilities of ERP consultants, ERP implementations don’t take off the grand way it is supposed to do. There are many deterrent parameters that often result in a negative ROI. The most important of these are the human factors that impact application value. The basic tenet of empowering an organization with new technology: if the end-users won’t use the application, the ROI will likely be negative needs to be realized by ERP consultants worldwide, be it on any platform.

We broadly categorize 4 categories of human barriers faced in ERP implementations: • Individual – this pertains to the willingness of individuals of the organization in sharing knowledge and information. Individual employees often feel insecure in doing so perceiving that their domain knowledge once incorporated in the ERP would render them dispensable.

• Structural – Groups within the organization may not share information freely and technology alone will not change them. This usually happens more between departments that worked in isolation Pre-ERP. • Hierarchical – ERP leads to transparency across the organization and this contradicts the usual hierarchical barriers of managers and line staff. ERP changes these ideologies.

• Cultural – This refers to ERP implementations integrating the enterprise with suppliers and customers across the globe. Different countries have different cultures and initially cultural barriers also prevent the ROI from reaching its potential. [2] Our implementation experience has shown that human factors can influence upto half the potential value to be derived from the ERP. To maximize this return value, the organization must devote as much energy, to addressing human barriers during deployment and the first operational year, as they did to select the ERP. Issues such as this come under the purview of Change Management. It is extremely important to educate end-users about the concept and the ideology of a ERP. Most implementations begin with users not aware of what they are going in for. This results in a gap between expectation levels of the client team and implementers. Training sessions on how to adapt to the changing environment and making users aware, help in reducing the shock of the changes that the ERP brings.

5. Return On Investment Indicator (RoII Principle) The process of measuring ROI should ideally begin, at the time of the organization’s Annual Budgeting & Forecasting period. This is the best time for the organization to visualize the future based on financial year’s performance.

When the top management decides to go in for a ERP, they should consider many external factors: • Position of the Organization in the market, in the last 3 years of operations

• • • • •

How the organization sees itself doing in the current year How the organization sees itself in the market 5 years down the line A comprehensive market research needs to be done, and case studies of implementations in the organization’s own sector needs to be analyzed.

How business associates (like vendors and customers) will be impacted.

Change management.

The first step is a step towards conviction. The company can go forward, with the right notions and expectations from the ERP. Often expectations from a ERP is misplaced and leads to a gap between the deliverables and client satisfaction. Hence the first step if meticulously performed would prevent this gap.

Having assessed this, the company should take up the following issues which will ultimately derive a ROI indicator: • Business Process Enhancement (BPE): The biggest advantage of implementing a ERP package is that, it brings with it time-tested streamlined Business processes which are standards across countries and across sectors. Sector specific verticals come as add-on’s to give thrust to that particular industry. The challenge lies in the organizations adaptability to the new post-implementation business scenario.

This is a +ve component to the ROI indicator.

• Technology Upgrade (TU): Another important factor is keeping with times and changing the way business is done, by means of advanced technology. Technology has proved to be a boon and benefits derived from this include, better and more efficient manner of execution of tasks, better reliability, better availability, more productivity and less manual intervention. But this is also a volatile component, because only the right kind of technology for the right company will be beneficial.

This is a +ve component to the ROI indicator.

• Spectrum of Application (SoA): The organization needs to thoroughly analyze the scope of implementation. The spectrum that would be impacted by the implementation is a key factor of ROI. More mature organizations will get higher ROI from wide Application Spectrum whereas less mature organizations with less IT infrastructure and awareness will get higher ROI from a limited Application Spectrum. The best solution for these less mature organizations is to incorporate an iterative model of ERP implementation with “a module – at – a time” approach. The change management becomes easier and less techsavvy employees can take their time to grasp the new system. With successful implementation of each module, the acceptance factor reaches a high, and in turn gives a high ROI. This is a +ve component if SoA is correctly fixed. Otherwise this can become a major –ve component in the ROI indicator.

• Human Resource Maturity and Learnabilility (HRML): The organization should go in for external consultation for assessing this factor, unbiased. The people of the organization can have a radical impact on the ROI of ERP. With this factor in mind, the implementation process needs to be selected, in order to provide high ROI. The process adjustment would negate low HRML index, and will be matured enough to introduce the ERP in a gradual comprehensive manner.

This is a –ve component in the ROI indicator. Process maturity and adjustment will try to lower the –ve index (taking it towards +ve) but will seldom be able to eradicate the –ve component completely.

• Payback Period (PP): The payback period is the period from inception of implementation to the point when the ERP begins to give pertinent answers to business problems. The

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shorter the payback period, the higher is the ROI, which means these are inversely proportional to each other.

This would be a divisor in the relation.

Organizational Factor (OFac): Every organization is unique, and would have organization specific factors, which will impact the ROI of ERP. In our implementation experience, we have witnessed this and found it difficult to classify. This is therefore a generic factor, which will be decided by the organization, if found to have a bearing on the ROI. This could be a +ve or –ve component in the ROI indicator.

Thus we arrive at the following empirical relation: ROI indicator = (BPE + TU +/- SoA – (5-HRML) +/- OFac)/PP The components will be measured in terms of Assessment Points (integral index between 5 & 1).

When the component is more favorable, then a higher (tending towards 5) AP will be used. When the component is not favorable a lower AP (tending towards 1) will be used.

In case of SoA and Ofac, the sign (+ or -) has to be judiciously selected. By this we mean that the Spectrum of Application may be high (i.e. a high AP) but this will overall bring down the ROI of the application for reasons mentioned before, such as organization’s maturity and whether it is geared up to go in for such a wide application. Same applies for Ofac.

5.1 Action Plan Step1: Market survey and study. Analysis of external factors, organization goals & case studies.

Step 2:Tabulating the BPE, TU, SoA, HRML, OFac and PP in terms of APs. This tabulation would involve considerable analytical ability and should be done by heads of all involved departments.

Step 3:The APs need to be reviewed independently by an external ERP Consultant, who is not the implementer.

Step 4:Throughout the implementation, while giving requirements, while defining business logic, while prototype testing, the BR factor and the APs should be kept in mind.

Step 5:A new tabulation of APs should be maintained i.e. a new version so as to proactively monitor the deviation (if any) from the original expectation framework.

Step 6:Post-implementation, the ROI indicator should be recomputed and compared with the Preimplementation ROI indicator.

6. Verify your ROI Calculation Though ERP implementations end in a finite time frame, almost all ERPs evolve with time. This introduces a big challenge in maintaining a positive ROI indicator, since uncontrolled changes without impact analysis may lead to the ROI indicator tending towards a –ve value.

For this reason, it is important to compare the ROI indicator as calculated before and after implementation. Higher deviation would indicate lack of control strategies during implementation.

In fact we advocate, a ROI indicator revaluation every 45 days in post-implementation phase, till the ERP has completed 1 year of operational life cycle.

7. Conclusion ERP has been the buzzword for quite sometime, and we have seen organizations choosing to implement ERP without any foresight or thought about the practical issues, which the organizations get to face during and for a period after implementing. We have observed stock values of companies, going down for a few months immediately after implementation. We have seen manufacturing organizations coming to a halt due to tremendous changes brought about by the ERP. Sometimes organizations never gear up to meet the challenges and this has a highly negative impact.

This model though empirical, can be a very good estimate in computing the Return on Investment, coupled with the suggested action plan. The suggested model has been derived after closely observing various ERP implementations using various ERP packages. Therefore the model is a generic one and has a lot of flexibility, in tune with the dynamic implementation environments.

The model is being used currently in implementation sites in Bangladesh and Malaysia, where the authors are involved in live implementations.

References [1] CIO Insight – March 2003 Issue [2] Nucleus Research White paper – PDF edition [3] ICDDR, Bangladesh implementation process documentation