Do You Need ERP? The Magnum Group Technical Publications Division

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1 Do You Need ERP? A Cost-Benefit Analysis of ERP with Respect to Small and Medium Business Enterprises Compiled by the Database Services Division of The Magnum Group

2 What is ERP? Today s business scenario is characterized by fierce competition, fast-changing market needs and advancing technology. In such an environment, businesses have realized that survival depends on how fast they adapt to changing market requirements, and how fast they adopt state-of-the-art technologies in order to stay competitive. In short one has to keep running to stay in the same place. Today s business scenario is characterized by fierce competition. In order to obtain efficiencies across all functional areas of an organization, businesses need to automate critical processes in both line functions as well as in administrative areas of the organization. This automation of business processes needs to focus on the various long-term and short-term resources used in each of the functional areas and how to allocate, process and utilize these resources in an optimal and efficient manner. One of the computer-based technologies used to achieve this is an Enterprise Resource Planning (ERP) system.

3 ERP Deconstructed An ERP system is a comprehensive and integrated business management software system that automates the business processes of an organization across all functional areas. It provides organization-wide access to accurate and real-time information across locations and functions, enabling their efficient and optimal functioning. The adoption of an ERP system entails reorganizing business processes around the ERP system. This increases integration across all interfunctional interfaces of the organization; it requires the re-design of organizational processes, controls, reporting and information flows. Put another way, it calls for business process re-engineering. An ERP system automates all functional areas included but not limited to inventory, manufacturing, distribution, logistics, shipping, production and accounts.

4 ERP Deconstructed (cont.) An ERP system follows an integrated approach for automating functional areas rather than using a standalone software application for each function. As a result, an ERP system improves productivity and accuracy with the resulting improvements in financial indicators while offering an integrated, uniform and consistent processing environment within and outside the organization. An ERP system follows an integrated approach for automating functional areas rather than using a standalone software application for each function. Historical Perspective In the late 1950 s, when computers were first applied to business, the applications were accounting, payroll and inventory control. As these stabilized, the scope of computerization expanded to include sales, order processing, purchasing and production planning.

5 Historical Perspective (cont.) Production planning applications were the first generation of the ERP systems of today. These were used to plan and optimize production based on sales forecasts and finished goods inventories. As these applications stabilized and spread, an element of control was added to alter and finetune the production plan on-the-go due to changing requirements. This was the first-generation of the Production Planning and Control application, known for short as PPC. Production planning applications were the first generation of the ERP systems of today. As PPC applications took root, businesses realized that the key input to the Production process, i.e. materials, had to be planned to avoid production stoppages and bottlenecks. This led to the second-generation: Materials Requirements Planning or MRP-I applications. It was soon realized that materials were only one of the four M s of production, namely materials, manpower, machines and money.

6 Historical Perspective (cont.) Hence the scope of planning had to be widened to include manpower planning, manpower scheduling, machine scheduling, capacity planning and working capital management for production-related areas. Enter the third generation: Manufacturing Resources Planning, known as MRP-II. Enter the third generation: Manufacturing Resources Planning, known as MRP-II. Finally it was realized that the MRP-II applications and legacy applications (like accounts, payroll, sales and purchase) could not exist in isolation. They had to integrate with each other and with other application areas within each function to realize the full benefit of computer-based planning across the enterprise. The result was a single-platform, seamlessly integrated, relationaldatabase-rooted, user-friendly and secure software system for automation across all functions of the enterprise that provided all the functionality of earlier legacy applications and much more. This was the first ERP system.

7 Historical Perspective (cont.) With the rapid expansion of the Internet in the 21 st century, ERP has now evolved into ERP-II, which integrates the organization s basic ERP with the supply chain (customers, suppliers, subcontractors et al) and with external entities (such as statutory and government authorities). This is achieved by providing web-based access to customer relationship management, supply chain management and statutory reporting applications to the external entities. SME: A Definition With the rapid expansion of the Internet in the 2000 s, ERP has now evolved into ERP-II, which integrates the organization s basic ERP with the supply chain. SME stands for Small and Medium Enterprises. In the EU, SMEs are defined based on headcount and / or turnover as follows: Small Enterprises < 50 Employees < 10 Million Euros revenue Medium Enterprises < 250 Employees < 50 Million Euros revenue

8 A typical ERP System for SMEs automates various application areas in an enterprise like Finance and Accounts, HR and Payroll, Customer Relationship Management, Supply Chain Management, Production Planning and Control, Quality Control and Maintenance Management. The application of ERP in these areas yields a number of benefits some of which are measurable and are visible on the company s financial statements. There are also intangible benefits which cannot be quantified but do make a significant difference to the company s overall work environment and brand image. The tangible and measurable benefits of ERP for SMEs are tabulated below functional area-wise with % quantification wherever available on the basis of surveys. In the Benefit Description the highlighted phrases are the benefits which can be computed from the Balance Sheet / Profit & Loss A/c / Cash Flow Statement. Functional Area Customer Relationship Management Benefit Description % as per Surveys Reduction in Customer Order processing lead time resulting in increased customer orders and reduced order processing costs Reduction in finished goods Inventories due to better planning, resulting in reduced inventory carrying costs and reduced working capital requirements More efficient customer invoicing cycle resulting in better monitoring of receivables and reduction in level of receivables reduction in working capital costs 80% 10-30% 90%

9 Functional Area Supply Chain Management Production Planning Quality Control Benefit Description % as per Surveys Reduction in Purchase Order processing lead time resulting in improved material availability and reduced PO processing costs Reduction in raw material and indirect material Inventories resulting in lesser inventory carrying costs and reduced working capital requirements More efficient supplier bill processing cycle resulting in better management of payables and reduced working capital needs (current assets less current liabilities) Increase in production levels at the same capacity due to improved planning and scheduling and reduction in idle time Reduction in work-in-process inventory levels due to better integration of sequential processes and consequent reduction in working capital Better tracking of process flows on the shop floor, identifying bottlenecks and capacity planning for removal of bottlenecks Better identification and tracking of defects at all stages from input materials to finished goods, thereby reducing rejections and wastage 80% 10-30% 90% 60-90% 10-30% 60-90%

10 Functional Area Finance Accounts & Benefit Description % as per Surveys Better management of cash and bank balances resulting in reduced balances and increased income from funds invested in other income-yielding shortterm investments Improved cost tracking, allocation, budgeting and budget utilization monitoring resulting in cost control and reduction of unnecessary expenditure More accurate cost figures enable better pricing of products resulting in more competitive pricing and higher market share HR & Payroll Improvements in manpower tracking and planning, resulting in reduced employee costs and enabling higher levels of operation at same staffing levels Maintenance Management Improvements in hiring processes leading to reduced recruitment costs Reduction in equipment downtime enabling higher level of production and productivity Reduction in repairs and maintenance costs through better routine, better preventive maintenance and better maintenance planning Reduction in maintenance-related inventories of spares and tools through better planning % 30-40% 60-90%

11 ERP confers several intangible benefits. The intangible benefits of ERP implementation at SMEs are: 1. Improved accuracy of online stock vis-à-vis physical inventory for finished goods, raw materials and work-in-process 2. Increase in the percentage of on-time deliveries of orders to customers 3. Improved accuracy in customer invoicing and supplier bills recording with proof-of-delivery documents 4. Improved regulatory compliance and statutory reporting 5. Improved availability of accurate and timely information across the organization 6. Increased stakeholder confidence and business performance 7. Improved reporting across all functions; better accountability and transparency of analytical data. 8. Better employee productivity due to reduced workload and job enrichment.

12 ERP Costs 1. Direct Costs a. Hardware and software b. Infrastructure & site preparation c. Salaries of IT staff d. Consumables (recurring) The costs at right need to be quantified based on budgeted actuals and compared with measurable benefits to arrive at a costbenefit analysis. Some of the techniques which can be used to analyze the viability of an ERP project would include payback period (either undiscounted cost of funds), ROI and other financial ratios. 2. Overheads a. Administrative costs b. Office and meeting facilities 3. Long-Term costs a. ERP licensing cost b. Maintenance and upgrading costs c. Training cost d. Employee attrition cost e. Consultancy and customization cost f. Conversion and development cost.

13 Conclusions While most external surveys have not done a full-fledged project evaluation of ERP implementation, it has generally been seen in some larger enterprises that from the time of initial investment in ERP till the reengineered business process stabilizes, the costs incurred tend to be recovered due to benefits accruing in a time-frame ranging between 3-8 years depending on the rate of discounting used. Also, ROI from ERP projects over a 10-year time frame can be as high as 10-15% per year based on the tangible benefits as computed from the company s financial statements. A number of companies have also managed to transition to a higher volume of operations, in some cases even a doubling of capacity with almost the same level of staffing, by implementing ERP as part of the capacity expansion project.

14 Conclusions (contd.) In other cases companies facing a two-fold or three-fold increase in market demand found that the main bottleneck was in production planning, generation of stores issue documents and shop order documents based on the production plan. In conclusion it is seen that a financial viability study is very much needed at the planning stage of an ERP Project for an SME. Based on survey data applied to the company s financials, this usually justifies the ERP Project showing low-medium payback periods and reasonably good ROI. Apart from these there are the intangible benefits impacting the company s work environment and brand image. TMG and ERP TMG has decades of experience in the ERP area. Specific areas of expertise include ERP feasibility studies, ERP cost/benefit analyses, ERP implementation, modification of existing ERP systems, data warehousing, performance tuning and online ERP training. Learn more at To discuss possibilities of how we can assist you, please us at mail@themagnumgroup.net. We guarantee a response in one business day or less and look forward to hearing from you.

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