Return on Investment (ROI) is the method business leaders use to determine which investments to make. It also determines the financial success of most investments. Quite simply, ROI is a comparison of the expected benefit of a particular investment measured in monetary units, compared to the cost of that investment in the same monetary units.
This number can also be expressed as an annual percentage for comparison to other investments, or, more commonly, in the form of a "payback period,” the length of time it will take for the benefit gained from the investment (in months/years) to exceed or recoup the expense of the investment. The shorter the payback period, the more financially beneficial the investment, in theory.
ROI calculations are made for tangible investments such as additions to property or equipment, as well as intangible assets such as software. While the benefits derived from investments in property or equipment can be easily quantified in terms of, perhaps, additional production or warehouse capacity; the benefits derived from investments in software, such as Enterprise Resource Planning (ERP) systems can be difficult to quantify.
The implementation of an automation solution, like CRM, Accounting software, or a full suite like ERP can have a dramatic impact on business processes and operations. While business leaders tend to justify software investment spend against the bottom line, it’s rare that sales or income is directly linked to ERP software, unless the investment is part of a larger strategic initiative such as the entry into international markets with a multi-currency ERP or other new, expanded capabilities. Customer Relationship Management (CRM) module as part of the ERP implementation does more readily allow for improved selling opportunities; but that is another ROI conversation.
So describing the most readily identifiable and quantifiable benefits of an ERP implementation can be a tough concept to explain to the board or executive leadership. Whether you’re getting a new ERP system approved, or you're showing the benefit of a recent implementation, we’ve put together the most important benefit categories below, along with a measurement for each category to help quantify your results:
Improved Inventory Management
ERP systems improve the tracking and accounting for of inventory movements. However, it is the Inventory planning capabilities of ERP systems that provide the greatest benefit to Inventory Management. Having the right inventory in the right location to meet customer or production demand is the name of the game for any business. Measuring the number of "stockouts," or OOS (Out-of-stock) events is one way to monitor the effectiveness of ERP planning processes.
Anyone can avoid stockouts by having excess inventory available; but excess inventory requires excess space, and ties up capital which could be used elsewhere. Monitoring the "number of days’ supply" for each inventory item, and comparing it to future forecasted demand is one means of ensuring that inventory will be available as needed without extreme excess.
Improved Customer Service Experience
The Customer Experience is fast becoming a business strategy instead of an afterthought. No longer can business simply count on a great product and neglect the experience of consumers in finding, buying, and receiving it. Customer Service excellence is providing the customer all of what they want, when they want it, with accurate billing, shipping, tracking, and return processes. The bar is set high, and failure on any part of the process affects company image more than any success. Tracking line item fill rates, order fill rates, on-time deliveries, and invoice accuracy are common measurements of customer service performance. Comparing these measures to historical results can identify trends and potential issues before they become problems.
Improved use of IT Resources
Many companies adopt ERP software from a desire or need to change an organization's internal IT delivery model or improve capabilities. Perhaps the new ERP software will replace older, in-house applications, or a way to free up needed IT time from “legacy” applications. Either way, reducing in-house down time, in-house development costs and time savings for employees are another indirect way of seeing ROI.
If the implementation of ERP software includes a change of application deployment from on-premise to a Cloud SaaS environment, then reductions in current and future IT infrastructure additions should be estimated and included. These shifts in IT delivery models can significantly reduce IT costs.
Improved integration with Accounting
While Accounting activities follow set closing and reporting cycles, ERP systems can support timely posting of financial transactions across all facets of a business. The integration of transactional impact provides an interim financial picture of business operations, and highlights Budget versus Actual (BVA) trends that might need attention. Finding out about budget shortfalls after the fact doesn’t allow for any corrective action!
Improved compliance capability
In today's business world, all enterprises must establish and document compliance with the requirements of various tax and regulatory agencies. These requirements place a significant burden on the internal processes and staff of SMBs. The implementation of ERP software can significantly improve compliance and the auditability of an organization’s records, reducing risk of fines as well as the cost of compliance.
This is the one you were waiting for! Reducing inventory levels through better inventory planning reduces costs. Improving invoice accuracy can decrease collection cycles and improve cash flow. Monitoring financial performance through updated budget-versus-actual analysis can trigger corrective actions to adjust for unexpected budget differences. Transformation of the IT delivery model will also deliver tangible benefits and reduce operating costs. All of these benefits of ERP software can assist in controlling costs and improve overall profitability as a result.
However, these benefits can only be realized if operating performance metrics are monitored and corrective actions are taken. Keeping track of metrics in a spreadsheet adds work, promotes errors, and delays information regarding performance of critical processes.
Ideally, ERP systems should automatically track key performance metrics, calculate variances, and present the information in a concise, meaningful manner, such as a "Dashboard" to facilitate interpretation and drive appropriate corrective actions. This is a big reason why we’re excited to partner with Microsoft’s Power BI software — read more here.
Perhaps the greatest fallacy regarding ROI is when business leaders don’t bother to calculate it! Smaller and midsize companies often make the mistake of thinking they’re small enough not to worry about it.
But with the right ERP system, business leaders can accurately measure the benefits of an ERP software investment and prove the value of it for years to come.
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