Enterprise resource planning (ERP) systems deliver immense value by integrating core businessfunctions, such as finance, inventory management, manufacturing, sales, project managementand human resources (HR), with a single, unified platform that provides centralized accessto critical data. With greater visibility into these functions, business leaders canincrease efficiency, reduce costs and unlock new growth opportunities.
Quantifying that value — the return on investment (ROI) of your ERP — is crucialto building a business case that justifies an ERP investment in the first place. Further,the analysis that goes into quantifying the ROI of ERP helps businesses evaluate andanticipate the impact of an ERP system on their organizations and also refine their ERPapproach over time so that the ERP’s value to the business continues to increase.
But because ERP systems have the potential to touch so many different aspects of a business,quantifying their impact — and, therefore, their ROI — can be complex. This isespecially true for businesses migrating to cloud ERP systems, which deliver intangiblebenefits whose ROI is less easy to quantify in dollars. In this article, we break down themany benefits of ERP systems, how to accurately calculate their ROI and tips to help yourcompany get the most value from its ERP investment.
Benefits of an ERP System
Before calculating the ROI of an ERP implementation, it is crucial to establish why yourbusiness is investing in an ERP and what it hopes to achieve. The following rundown of thebenefits ERP systems can bring to a business, and how ERP generates those benefits, willhelp to articulate those expectations.
- Data stored in a common database. ERP systems collect data from across anorganization and house it all in a common database. That allows employees in general,and key business leaders in particular, to monitor the pulse of their business using asingle, accurate and integrated view of business operations, from back-end financeprocesses and warehouse operations to lead generation and sales success.
- Unified view limits silos. Working with a unified view of theorganization breaks down data silos and saves a great deal of time when making informedbusiness decisions. For instance, real-time insight into supply chains, inventorycapacity and projected customer demand could help a manufacturer maximize output withoutexceeding the capabilities of its teams.
- Allows for companies to scale quickly. Cloud-based ERP systems, inparticular, offer an attractive growth platform, especially for companies that need toscale up quickly to manage the growing complexity of their operations. Take supply-chainlogistics provider Green Rabbit, whichspecializes in fast delivery of perishable goods. Green Rabbit adopted a cloud-based ERPto rapidly expand from startup to countrywide operation, helping its customers delivertens of thousands of orders across America, every day, with zero delays or inventoryerrors.
- Mitigates human error. ERP systems also help businesses improve thetimeliness of orders and payments with streamlined invoicing. In contrast, manualbookkeeping is slow and prone to human error, which can lead to unnecessary costs anddelays. As the saying goes, time is money. The faster a business can process, ship andinvoice an order, the faster it reaches the customer and the sooner the business getspaid.
- Reduces personnel needed to accomplish tasks. Much of the valuebusinesses derive from ERP systems stems from the way ERP integrates processes thatinvolve multiple departments. Consider a standard procure-to-pay process, which involvesmany teams and touch points, from sales to warehousing to fulfillment.
With an ERP, stakeholders throughout this chain can track and manage the entire process froma single system. For instance, a salesperson who just closed a major account can check thestatus of the order at any time and keep their customer updated, without having to rely onanyone else. This process increases efficiency and saves money, helping to build strongercustomer relationships built on accountability and trust.
Video: Quantifying the ROI of ERP
How to Calculate the ROI of an ERP System
The benefits of ERP systems are well-documented, but calculating the return on investment ofany given ERP implementation is a nuanced process. Before working through an examplecalculation, let’s explore three important distinctions: on-premises vs. clouddeployment model, “hard” vs. “soft” returns and initialimplementation vs. ongoing usage.
The choice of deployment model has an important effect on ERP ROI calculations. Technically,the term “ROI” doesn’t even apply to cloud-based systems because they aregenerally paid for via monthly or yearly subscription fees, which are treated as operating expenses foraccounting purposes. The “I” in ROI refers to a capital investment, and capital expensesrequire more complex accounting treatment. ROI does apply to on-premises systems, which typically require upfrontcapital expenditure to purchase the licenses and the computer hardware and infrastructurerequired to operate the software. Nonetheless, organizations that deploy cloud ERP use theprinciples of ROI to understand the value their ERP systems provide.
There is also a useful distinction to be made between “hard” and“soft” ROI. Hard ROI refers to traditional returns that can be easily assigned aquantifiable financial value, such as incremental revenue gained or costs reduced. Forinstance, NetSuite ERP customers saw a 40% to 60% improvement in order process efficiencysince implementation of their systems, and 40% to 55% saw a reduction in reporting times,both of which can be easily quantified in dollar figures and therefore fall in the categoryof hard ROI. On the other hand, soft ROI refers to intangible gains, such as a rise inemployee morale or improved brand equity with customers. Both of these benefits can have animmense impact on a business’s bottom line, but the exact dollar value of theircontribution is less clear.
ERP implementations have two main phases: the initial installation and then ongoing use byemployees trying to make the most of the new technology. Within these, companies will oftenlean on their ERP vendors to help with the implementation and, in most cases, migrate datafrom their previous system to the new ERP. But employee training and ease of use areessential to maximizing the ROI of a new ERP system. This is why many successfulimplementations focus on employees’ initial training to learn the ins and outs of howtheir new system meets and exceeds their needs, and on user experience — the simpleinterfaces and mobile functionality, among other criteria, that makes the system easy to useover the long run.
ERP ROI Formula
Now let’s introduce the basic hard ERP ROI formula and work through an illustrativeexample:
ROI = (total value of investment - totalcost of investment) / total cost of investment x 100%
Translating the formula into plain English, ERP ROI is the ratio of the gains delivered by anERP investment (expressed as a dollar value) to the total cost of ownership (TCO), orinvestment. That ratio is expressed as a percentage. The TCO for an ERP includes the upfront cost of the solutionand any expected costs throughout its life cycle. Traditionally, this formula would applyonly to on-premises ERP, since TCO, by definition, refers to the capital expense of apurchased asset plus related ongoing operating expenses. So, even though technically not“TCO,” in the case of a cloud-based system, the equivalent costs would includemonthly or yearly licensing fees to use the ERP software. The higher the ratio of gains toTCO (or its cloud equivalent), the higher the return on investment, or ROI.
Consider the example of a consumer goods manufacturer that implemented a cloud-based ERPsystem, paid via yearly subscription. The company needs to calculate the ROI of its newsolution three years after going live, based on an upfront implementation cost of $50,000and yearly fees of $100,000. That yields a three-year cloud-equivalent TCO of $350,000. Ofcourse, this example is simplified to fit in this article; the manufacturer’s totalcost might also include the cost of training employees to use the new ERP solution,implementation partner fees and others, in addition to upfront installation and yearlylicensing fees, depending on the specific use case and ERP deployment model.
As for returns, the manufacturer has chosen to focus on hard costs, so it calculated theincremental sales growth, higher margins and lower production costs it can attribute to itsERP system, as shown in this table:
| Benefit | Year 0 | Year 1 | Year 2 | Year 3 | Total |
|---|---|---|---|---|---|
| Sales growth | $0 | $50,000 | $80,000 | $100,000 | $230,000 |
| Productivity gains | $0 | $30,000 | $40,000 | $90,000 | $160,000 |
| Cost savings | $0 | $60,000 | $100,000 | $115,000 | $275,000 |
| Total | $0 | $140,000 | $220,000 | $305,000 | $665,000 |
The value provided by the software over this three-year period (ignoring inflation) is$665,000.
Plugging the total value of gains attributed to ERP and the manufacturer’s simplifiedtotalcost into the ERP ROI formula, we get ($665,000 - $350,000) / $350,000 x 100, which equals a90% return on investment.
It’s important to emphasize that the gains in this example are also simplified. Thetotal value a business can attribute to ERP will depend on the nature of the business andmight include improvements in product, transportation or inventory carrying costs, increasedorder volumes, reduced head count and lower administrative costs. In addition to these hardreturns, a company may also derive intangible benefits from its ERP implementation, likeimproved employee morale, which should also be factored into ROI calculations.
One final nuance to note is that some organizations prefer to measure the ROI of their ERPyear over year rather than over the system’s life span. One approach for doing so isto use the formula outlined above and apply only the revenue and/or savings for that year.But this is not always ideal, as much of the upfront costs will not be repeated insubsequent years. For instance, employee training is most intensive in the first few monthsafter installation and less so in subsequent years. Similarly, ERP returns tend to increasein the first couple of years after implementation, as new efficiencies and opportunities areunlocked, driving better returns, before flattening out into a steady state.
5 Tips to Increase the ROI of an ERP System
There is no one-size-fits-all way to maximize the ROI of an ERP implementation, as everybusiness has specific goals and resources to work with. There are also industry-specificconsiderations — for instance, a service-basedbusiness like a marketing agency is not subject to the same supply-chain issues as amanufacturer.
That said, the following five tips can help you to squeeze extra value from your ROI system,whether you opt for an on-premises, cloud-based or hybrid ERP solution.
Prioritize training. The only way to nearly guarantee that a new ERPsystem delivers returns is for employees to embrace new ways of working and use thesoftware to its full potential. Employee training will increase the cost of a newERP implementation in the early days, seemingly reducing its ROI, but these up-frontinvestments pay off quickly — and then they begin to pay long-term returnsthat swing the ratio back in a positive direction. In contrast, employees who arenot trained and encouraged to use a new ERP have been known to continue usingspreadsheets and manual processes, significantly reducing the impact of this majorsoftware investment.
Get buy-in from the top. ERP implementations live and die by thebreadth of a company’s vision and commitment to using the new solution. Everyexecutive, department head and manager must be on board with the new ERP andunderstand its critical role in helping drive growth and success. This is the key totransformation and to bringing employees along for the journey. Take , a leading retailer of men’s grooming products. It got its newERP system up and running in just 20 days and saw its year-on-year sales jump 50%, all without increasinghead count. Much of its success is due to the fact that the project was initiated byits co-founders, whose enthusiasm and vision trickled down to every team andemployee.
Never stop evaluating. Another key to maximizing ERP ROI is toconstantly evaluate and refine your approach. At least once per year, businessleaders are advised to take stock of their costs and returns from the ERP solution,compare them to their baselines and consider new ways of cutting costs andextracting value from the system and the data it provides. NetSuite’scloud-based ERP allows businesses to set departmental and companywide keyperformance indicators (KPIs) and track them religiously to ensure they areconstantly improving their performance. Crucially, this helps keep a company ontrack to reach its specific goals, in addition to broader cost and time savings.
Be realistic about costs and benefits. It is notoriously difficultto estimate the cost of a new technology implementation, especially for small ormidsize companies transitioning to a more sophisticated way of working. Manybusinesses turn to their ERP vendor or implementation partner for guidance ontimelines, costs and how to train employees effectively and efficiently. It isequally important to accurately measure the benefits of a new ERP to gain a completepicture of ROI, including both tangible and intangible benefits. For instance, reduced its payroll processing time by 84%, freeing up staff formore value-added activities, leading to a boost in employee morale that, in turn,drove performance gains.
Avoid common ERP pitfalls. A number of common pitfalls holdbusinesses back from realizing the full potential of their ERP systems. The mostcommon trap is treating ERP implementations like a traditional technologydeployment, with a single upfront cost and short-term payback period. In reality,most successful ERP implementations are rolled out in phases over time, with ROIcalculated at each milestone.
It is also important to know when to stop measuring ROI, especially for cloud-basedERP systems. In the case of a capital expense, like a piece of machinery with anestimated life span of 10 years, it is easy to quantify its cost and return eachyear and to stop calculating them once the machine is decommissioned. In the case ofcloud-based software, however, there is rarely a set time frame, especially asupgrades and updates occur automatically. At some point, the new ERP simply becomespart of the business’s standard operating procedure, and so ROI is no longermeasured.
Finally, it is crucial to be self-aware and rigorous when setting metrics andcalculating ROI. Not all businesses have the bandwidth or expertise to calculatemetrics like internal rate of return (IRR) or hurdle rate, which is understandablegiven they are focused on core strategy and growth. A prudent approach is to startby setting and aligning business requirements with departmental goals, such as theelimination of silos or integration between processes. To that end, NetSuite offersBusiness Needs Evaluation scorecards and TCO scorecards to its customers to assistwith this exercise and bring rigor to their ROI calculations.
Conclusion
ERP systems are large and complex, and they touch every part of a business organization, fromfinance to customer service. It is challenging enough to analyze an ERP’s impactacross all of these operations, much less calculate returns across different lines ofbusiness that come in different forms and at different times in an ERP’s life cycle.But a successfully implemented ERP can provide your business with unparalleled insight intoits performance, opening up new opportunities to drive revenue while cutting costs andsaving valuable time. This is where the true ROI of ERP comes to light and where the tipsoutlined above can ensure maximal returns.
This is also why many businesses choose a cloud-based ERP. With no ITinfrastructure or resource changes to manage, businesses can gain visibility across theiroperations, expand their core management platform and gain a clear vision for the ROI theyhope to achieve from their implementation.
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ROI of ERP FAQs
How do you calculate ERP implementation ROI?
Calculating the ROI of an ERP implementation is a complex process involving a detailedanalysis of the benefits and costs following deployment. The formula to calculate ROI is asfollows: (total value of investment - total cost of ownership) / total cost of ownership) x100. The higher the ratio, the higher the ROI.
What is the business value of ERP?
ERP systems deliver value to a business in many ways. Above all, they provide leaders and keydecision-makers with end-to-end visibility across their company’s operations, so theycan make informed choices regarding business strategy, growth opportunities and futureinvestment.
How long does it take to see a return on cloud ERP investment?
There is no set time frame for returns on an ERP investment, but the combination of asuccessful implementation and employee training to make sure teams make good use of thesolution can make an impact right away. These returns might include sales growth, loweroperating costs and employee productivity gains. That said, on-premises systems have beennotoriously difficult to implement and can take a year or more to provide value — ifever.
What is ROI of ERP implementation?
The ROI of an ERP system is a combination of the tangible and intangible benefits seen due tothe implementation. Tangible benefits, or “hard” benefits, are easilyquantifiable and include metrics like revenue growth and reduced overhead. Intangiblebenefits are less easy to quantify but no less impactful. They include metrics like improvedemployee morale and customer trust.
What is the average failure rate of integrating an ERP?
By some estimates, 50% of ERP implementationsfail on the first attempt. However, it is worth noting that the lessons learned from thesefailures raise the chances of success on subsequent implementations.
What are the 5 elements of a standard ERP?
The distinguishing features of an ERP system are a common database that allows businesses tocentralize information from multiple departments, a consistent user experience acrossdepartments and roles, integration with existing business processes and workflows, theability to automate repetitive tasks and the power to break down departmental silos toincrease efficiency and improve communication across the organization.
