Chapter 3

Benefits and Cost of an ERP System

LEARNING OBJECTIVES

After reading this chapter, you will be able to understand:

 Benefits of an ERP system

– Strategic benefits
– Operational benefits
– Managerial benefits
– Organizational benefits
 Intangible benefits
 Cost of an ERP system
 Cost-benefit analysis

3.1 INTRODUCTION
In the previous chapters, we learnt that an ERP system is a semi-finished product that has to be
configured for the host company. We also learnt that an ERP project costs between 1 to 3 per cent of
revenue of the host company if all modules of the ERP system are implemented. A company spends
money on the ERP system because it expects to benefit from the system. An ERP system may deliver
strategic benefits, operational benefits and managerial benefits. But a company would set an objective
for implementing the ERP system and focus on the set objective. In this chapter, we will learn about
these benefits in detail. A company can measure success of its ERP implementation by setting a
quantitative objective and measuring the performance of the system against the objective. A
quantitative benefit that the organization is looking for may be to reduce inventory by ten per cent, and
a qualitative objective may be to increase customer satisfaction. Problems with qualitative objectives
are those which cannot be verified. IT systems are known for bringing in many intangible benefits that
may be difficult to measure directly. The objective of ERP should be aligned with the firm’s competitive
strategy. Benefits have to be weighed against the cost. An ERP project involves direct as well as indirect
costs. Once we have a handle on the benefits and the costs, we can do a cost-benefit analysis to justify
the project and get funding for the project.

3.2 BENEFITS

ERP may bring in many benefits that can be divided into four groups as shown
in Figure 3.1. Let us look at the benefits that each of these groups offer.
3.2.1 Strategic Benefits

 ERP supports current and future business growth. The company can handle lot more
transactions which are conducive to business growth. Since the data becomes easily
available and the cycles become shorter, introducing new products and services are
encouraged. The company can analyse data in timely manner at the desired grain
level to identify niche geographical and functional areas.
 All business units get integrated. Moreover, if a company acquires another company,
the newly acquired company may be integrated easily and faster through ERP system
which facilitates business growth.
 Strategic planning needs timely and accurate picture of the organization. ERP system
makes accurate picture available to the management in a timely manner that helps
them come up with appropriate market strategy and identify new business process
chains and areas.
 Streamlined and efficient processes help a company become cost leader in the
market.
 ERP helps a company to provide customized products and services to its customers.
World economy has moved from being a manufacturing economy to service
economy. A manufacturing company now has to provide a solution to its client, not
just a product. A car distributor now worries about maintaining the car after its sale.
The distribution Centre or its collaborators follow up with customers to make sure
that the car gets serviced on regular basis. The service is customized based on the
customer data that ERP stores and provides. A manufacturer may shift their
manufacturing strategy from make-to-store to make-to-order. Make-to-order will
require linkages with suppliers, distributors and related business parties. ERP-II or
extended ERP includes customer relation management and supply chain management
to build external linkages. Suppliers, customers and your own marketing offices,
manufacturing facilities could be spread globally. ERP is an international package and
facilitates seamless (almost) integration of data across geographical limits. One can
centralize world operations, manage global resources, deploy multiple tax rules and
handle business transactions in multiple currencies and multiple time zones.
 ERP system may improve organizational and process flexibility.
 Customer/supplier satisfaction and relations can be enhanced by using ERP system.

FIGURE 3.1 Benefits Offered by an ERP System to the Organization

  ERP system may help the organization to reduce marketing costs and improve
market share.
 The organization may be able to establish itself as a leader in new technology.
 ERP system may help a company to gain competitive advantage and establish itself as
market leader.

3.2.2 Operational Benefits

ERP help companies to improve data management, communication, decision

making and reduce response time to queries. The companies that implemented
ERP experienced operational benefits that can be largely classified into the
following categories:

 Cost reduction: The following are the cost reductions:

– Reduced labour cost: An ERP implementation will in the least automate and
integrate business processes of an organization. Consequently, processes become
efficient. Coupled with rationalization and reengineering, the process become even
more efficient as the redundancy in processes and the redundant processes get
eliminated. The required staff in customer services, production planning, order
fulfillment, administrative processes, purchasing and financial management reduces.
– Inventory cost reduction: The carrying cost reduces due to better material
requirements planning, less efforts in inventory management and warehousing.
– Administrative cost reduction: The paper work, printing effort, printing cost and
moving papers around reduces. According to the company’s marketing manager after
implementing ERP, their system has become very efficient even though they have not
changed their processes. The integration and availability of data online has made a lot
of difference—their sales have gone up by 10 million in one month after they
implemented Navision (ERP software). The reason being it was difficult to keep track
of defaulters earlier. They buy 4,500 items from different vendors. In spite of their
best efforts, they were not able to maintain three vendors for each item and bargain.
At times, the purchase manager would create a crisis by saying that there is only one
vendor in the market and there is shortage of the item that they supply. The
management used to give them a go ahead for purchase at the vendor price because
they did not want the production to suffer. A purchase order involved looking up
many files for consolidating the information required including appropriate vendor,
his address, request for quotation, vendor quotation, quality records of the vendor
and his outstanding bills if any. The person responsible for placing an order had to
contact many persons to get data. If a person is on leave, his data will not be
accessible and it delays the process. The whole organization was people centric. The
processes were dependent on people and not all the processes were documented.
After ERP implementation, all processes are documented and the processes are built
 into the ERP system. Absence of a person does not cause any delay. It is simple to
track overdue payments, defaulting vendors, non-performing sales and marketing
executives. A person who was able to create two purchase orders in a day is now
creating ten orders. Job of every person has been profiled. Employees are happy
because they themselves do not depend on others for their performance.
 Cycle time reduction: There are many cycles that exist in an organization. These
cycles involve customers, employees and vendors. ERP system has helped companies
cut down cycle times.
 Customer support activities: These activities include order fulfillment time, billing,
delivery and customer service activities become faster.
 Employee support activities: These activities include month-end closing, purchasing
and reporting become fast.
 Supplier support activities: They have also become better. A company can combine
multiple orders to get discounts from their vendors.

3.2.3 Managerial Benefits

In an organization, management is responsible for resource management, decision making and

performance. The key ingredient to resource management and decision making is the data. The
data helps management to manage their assets better. ERP helps in better production
management due to the availability of the data required for production management.
Management is better equipped for responding to changes that promotes proactive culture.
The changes may be in the market, cost or business strategy. Planning and administrative
procedures also improve. All these improvements lead to improvement in the service quality
within the organization and to the customers. Manpower can be better utilized because job
profiling for each employee can be easily done. The job allocation may also be changed
according to the changing requirements. Monitoring is an important component of the
management activity. One can sit in his own office and monitor the desired activities without
having to worry about geographical proximity or distances. The activities that are closely
monitored include financial performance, manufacturing performance, and overall efficiency
and effectiveness of the management itself. In simple word, if one has access to timely and
accurate data, management is sure to perform better in all its functions.

3.2.4 Organizational Benefits

The organization should experience the following benefits:

 ERP should facilitate business learning and broaden employee skills. The business
processes get clearly defined that should help willing employees to enhance their
business skills.
 Clearly defined and seamlessly integrated processes empower employees to be
proactive problem solver. The overall responsibility and accountability improves.
 There is less of firefighting, the role of management in routine activities decreases
which results in better planning. An ERP system should help an organization in
integrating clearly defined processes in a seamless manner. In some organizations,
the number of management layers decrease and the organization becomes flatter.
 Another expected benefit is improved interpersonal communication, homogeneous
business units that share common and consistent vision across the organization.
 ERP definitely cuts down on some repetitive activities.

The benefits have been summarized in Table 3.1.

3.2.5 Intangible Benefits

These are the benefits that cannot be easily quantified. Many of the benefits of ERP systems are
intangible and there is no mechanism to measure these benefits in monetary terms. There is no
way to account for intangible benefits into productivity measures. The information technology
investments are no more a choice but necessary to survive in the market. The returns may not
be direct and immediate. Here is a list of some intangible benefits of ERP systems.

 Enhanced customer and vendor satisfaction

 Increased flexibility
 Improved resource utility
 Improved information accuracy
 Improved decision capability
 Better employee experience in the organization

The characteristics of intangible benefits are:

 Difficult to quantify
 Difficult to measure
 Difficult to put monetary value
 Strategic Benefits Operational Benefits

 Business growth  Reduced labour cost

 Business integration  Reduced inventory cost
 Real time data availability  Reduced administrative cost
 Best practices  Cycle time reduction
 Better and personalized services  Better customer support
to the customer  Better employee support
 Lower marketing cost  Better supplier support
 Technology leader
 Competitive advantage

Managerial Benefits Organizational Benefits

 Improved resource utilization  Employee empowerment
 Improved decision making  Employees can enhance their skill
 Better performance set
 Proactive management  Less management layer
 Improved planning  Efficient organization
 Better job-skill mapping  Automation of routine jobs
 Better monitoring  Improved interpersonal
communication
 Consistent vision across the
organization

TABLE 3.1 Benefits to an Organization from an ERP System

3.2.6 What Benefits an Organization May Expect?

Benefits listed above are far too many to be realized by an individual company. Only some of
these benefits are aimed at when an organization goes for an ERP implementation. The
selection of groups of the benefits and sub-benefit should be done carefully. The objective of
ERP should be aligned with the firm’s competitive strategy. It is better to set quantitative
objective; for example, the objective is to reduce inventory by five per cent in a year’s time or
to increase market share by two per cent, the data can be collected and analysed to show the
performance. If, however, the objective is to increase customer satisfaction, then it is difficult
to measure satisfaction level. The same objective may be stated as to reduce the number of
customer complaints by 10 per cent from existing 50 complaints per 10,000 customers in one
year then it becomes a quantitative objective.

3.3 COST OF AN ERP IMPLEMENTATION

One of the popular ways to assess cost of an ERP implementation is to benchmark the
organization against a similar organization, if one is available. This method is referred to as
analogy based cost estimation. The parameters that one can use to check similarity between
two organizations are as follows:

 Number of users
 Number of sites
 Number of interfaces required
 Number of modules implemented
 Number of companies of the organization
 Electronic data interface
 Number of modifications required in the software
 Number of distinct reports to be generated
 Number of plants that the organization has

Experiments have shown that number of modules, interfaces, users and sites are the
parameters that decide effort required for ERP implementation. The implication is that if these
four parameters are similar, the effort and cost would be similar even if other parameters do
not match.

3.3.1 Direct Costs

 Hardware: An ERP implementation would require a computer server to run the ERP
server, as most of the ERP systems are based on client/server architecture.
 Software: ERP vendors usually charge for the software—client-side software and
server-side software. In addition, they charge per user license fee which is essentially
the number of logins you are allowed to create. Usually, number of concurrent users
are much less, about one-third to half of the number of licenses. The cost of
implementation and testing tools is covered by the license fee. But it is not a bad idea
to verify with the vendor upfront.
 Consulting: An ERP implementation always requires an external consultant. Most of
the non-IT organizations would not have core competence to handle ERP project. It is
one of the major cost component.
 Add-on hardware and software: One may need additional hardware and software
such as operating system, database, networking cables and router. ERP system stores
 every transaction in the database. At the end of the fiscal year, data is archived for
which one may need a file server with plenty of disk space. One may also need an
interface converter to facilitate communication between ERP database server and the
back-up file system. Network setup may require a router and cables. Network
security, data backup server and disaster management system are additional add-ons
that must be allocated funds. One may include these costs under hardware and
software heads.
 Training costs: The vendor and implementation partner would train handpicked
people from the organization who in turn train all end users in the organization. This
train-the-trainer program also costs and should be accounted for.
 Project team cost: The resources (people) put on ERP project team would account for
this cost head. Most of the companies use time sheets to account for the resource
cost.
 Other: One can put all miscellaneous expenditure under this head. These may include
costs such parallel run cost. In the last chapter, we mentioned that business
continuity is an absolute must. The legacy systems may have to run in parallel till the
ERP system stabilizes and goes live. The parallel run cost may be included under this
head.

3.3.2 Indirect Cost

 Lost productivity cost: The management and employees of the organization while
working on ERP project are away from their otherwise assigned duties. There may be
a loss of productivity and this may be a major source of indirect cost.
 Dedication to explore the potential of the system: In the beginning, users spend time
exploring the system. The cost of this time is another indirect cost component which
is very difficult if not impossible to account for. If learning happens through trial and
error, the cost can escalate even further.
 Employee motivation: This is an interesting indirect cost factor. After ERP system has
gone live, if motivation level of the employees is low and they do not use the system,
there is a huge indirect cost that the organization incurs..
 Changes in salaries: There may be a change in salaries of employees as a result of
improved employee flexibility and staff turnover. These changes are always in the
upward direction. The employees expect an immediate gratification. There are
numerous interesting examples available. In one SAP project, the project manager
decided to quit his job in the middle of the project and starthis own consultancy firm.
The company hired him at a much higher cost. In another instance, employees were
given some incentive to learn and adapt the new IT systems that became a
permanent perk. Some employees just move to another place instead of adapting
new ways of working, costing a considerable amount to the company.
After the go-live stage, the following two budgets will be required:

 Running cost: The system would require system-support staff and infrastructure to
run. One would include the running cost of the system under this head. A thumb rule
is to make it 20 per cent of the total project cost.
 Upgrades and maintenance: For software products, maintenance involves three
types of activities, namely—corrective, perfective and adaptive. Corrective
maintenance refers to removing any bug that may get discovered by the users. ERP
vendor releases new versions at regular intervals and may discontinue support for
older versions. Some technology upgrades may also be required to possibly handle
larger transaction volumes or to make system faster. These costs must be accounted
for and included in the maintenance cost. A new upgrade is generally adaptive and
perfective both. The host company would go for an upgrade to improve their existing
information systems.

3.4 COST-BENEFIT ANALYSIS

Various studies have been done to figure out the benefits that companies expect from ERP
systems if they are in the process of implementing an ERP system and benefits they have been
to realize if they have already deployed the system. The following tangible benefits have been
highlighted:

 Inventory reduction
 Personnel reduction
 Productivity improvements
 Order management improvements
 Financial close cycle reduction
 IT cost reduction
 Procurement cost reduction
 Cash management improvement
 Revenue/Profit increases
 Transportation/Logistics cost reductions
 Maintenance reductions
 On-time delivery

A table similar to the Table 3.5 is created and expected benefits are documented.

The cost of the project is expected to be around 5,00,000,00 (1 per cent of the sales). Recall
that the cost-benefit analysis is done prior to the commencement of the project when actual
cost of the project is not known. In any software project, the initial estimates can be off by a
factor of 4. The annual running cost of the project will be close to 20 per cent of the project
cost. Table 3.6 gives the cost-benefit analysis for this particular example.

The ROI is 12.6 per cent for this ERP project. Most of the companies would get a return of 5–25
per cent on their investment (Table 3.7).

TABLE 3.5 Benefit Analysis

TABLE 3.6 Cost-benefit Analysis for the Example

Head Cost ( ) Benefits ( )

Total annual saving 1,63,18,750

On-going cost 1,00,00,000

Net annual benefit

One time cost 5,00,00,000

One time cost saving 4,57,500

Net capital cost 5,00,00,000

TABLE 3.7 Return on Investment (ROI) and Percentage of Organization That

Achieved Specified ROI

Estimated Return Per cent

<5 16.5

5–15 38.0

15–25 30.4

25–50 11.4

>50 3.7

CONCLUSION

There are different types of benefits that an ERP system may potentially deliver.
These benefits can be categorized in strategic benefits, operational benefits,
managerial benefits and organizational benefits. There are many benefits that are
intangible and difficult to quantify. It is important to identify intangible benefits as
well. An ERP system cannot deliver all the benefits. An organization should set
objectives and benefits that it expects from the ERP system. It is important that
the benefits are defined in quantitative terms so that it can be verified.

For estimating the cost of an ERP project, the general practice is to benchmark an
organization with a similar organization who has already implemented an ERP
system. The parameters used for checking similarity are number of users, sites,
interfaces and ERP modules being implemented. There is no popular or standard
algorithmic way of estimating the cost of an ERP project. Major direct cost heads
include hardware, software, training cost and consultancy cost. An ERP project
involves direct as well indirect costs. A sense of implementation time, return on
investment and life span would help a project manager in managing an ERP
project.