The Case for ERP Systems

Abstract

Too often it's made on faith, not good judgment Will it cut costs? Common pitfalls in implementation Enterprise Resource Planning (ERP) can be a blessing or a curse. Many companies find ERP systems help them make better-informed decisions. Others discover too late that their purchase has been based more on faith than good judgment, and run up tens or even hundreds of millions of dollars in extra costs and schedule delays. How, then, can senior managers ensure that their companies build a sound business case for deploying ERP systems? And what can they do to guarantee that the promised benefits are not eclipsed by the costs of integration, process redesign, and training? One answer is to take a cost-based approach to the business case. Another is to be aware of common pitfalls. Is ERP for us? ERP systems (made by SAP, Baan, and PeopleSoft, among others) have received much attention for their potential to help companies make more effective decisions. The plaudits are often deserved. ERP can reduce the financial reporting, purchasing, and support expenses of management information systems (MIS), and lead to more timely analysis and reporting of sales, customer, and cost data. One large pharmaceutical company has used it to consolidate manufacturing support operations such as purchasing and vendor management; as a result, it employs fewer staff and has generated a return of more than 20 percent on its capital investments. One international biotechnology company expects its ERP system to help it save more than $10 million a year on financial reporting, purchasing, and MIS support. But for all the talk of employee productivity gains and cross-business marketing opportunities waiting to be tapped, savings can prove elusive. Hard returns, such as reduced headcount resulting from streamlined operations, are simple to predict and control, but are only part of the picture. Soft returns, such as revenue or employee productivity gains, are neither easy to predict nor under a company's direct control. The problem is a common one in evaluating IT investments.(*) In the case of ERP systems, the length of the payback period and the size of the investment needed- in terms of both cash and human resources- make it unwise to assess a project on anything but a hard-returns basis. This is not to suggest that an ERP system cannot help a company boost revenue, or that employees cannot learn to become more productive with the aid of superior MIS. But the difficulty and expense of deploying ERP mean that most companies should appraise such an investment purely in terms of its potential to cut costs. Five steps Building a sound, cost-based business case for ERP entails extracting the savings that depend on ERP alone from the total savings to be had from ERP together with other sources (just as you can weigh a cat by holding the cat while weighing yourself, then deducting your own weight). The process consists of five steps: * 1. Create a base case of year-by-year savings from cost cuts that could be made without the ERP system in place. * 2. Create an ERP case of year-by-year savings that could be made with ERP. This should include savings that do not depend on ERP (the base case of step 1) as well as those that do. * 3. Subtract the base-case savings (step 1) from the ERP-case savings (step 2) on a year-by-year basis, and calculate the net present value (NPV) of the residual cashflow. A positive NPV will indicate that you should probably proceed with the deployment of ERP. * 4. If step 3 produces a positive NPV, conduct a sensitivity analysis to ensure that the business case is strong enough to withstand slippage and cost overruns. * 5. Back-allocate all ERP system deployment costs to individual business units so that they can factor them into their planning. Ensure each unit is held responsible for producing the promised savings. …

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