Measuring the return on investment (ROI) before pursuing any business project, especially something as integral as your ERP platform, is critical. While it may seem simple to come up with a calculation of a payback period where you’ll earn back your investment, there are often setbacks, such as hidden costs. On the flipside, there are indirect benefits like an increase in teamwork and quality of life for your employees.
Below I explore best practices for how to calculate your ROI, how to determine project costs (both initial and ongoing), and how to quantify the expected return on your investment.
Calculating Return On Investment
The first step in determining ROI is a cost/benefit analysis. This is simply a process whereby you delineate the costs on one side and the return (money value of benefits) on the other. Below is an example on calculating the ROI for a project, as well as two different methods on how to tackle the problem.
Suppose you are considering a new ERP system and the total cost is $100,000. Let’s assume that the system will save the company $150,000 over the next 5 years. What’s the expected return on this investment (ROI)?
Method 1 is to divide Total Benefits by Total Costs
- Return on Investment (ROI) = Total Benefits / Total Costs
- Total benefits = $150,000
- Total costs = $100,000
- ROI = $150,000 / $ 100,000 = 1.5 or 150% (Return on Investment)
Method 2 is to divide Net Profit by Total Costs
- Net profit = Total Benefits – Total Costs
- ROI Gain = (Net Profit / Total Costs) x 100
- ($150,000 – $100,000) / $100,000 = .50 or 50% (Gain on initial investment)
You can also calculate ROI in terms of a payback period. The payback period equals the cost divided by the annual return. For example, if your new ERP system costs $100,000 and the annual return is $50,000, the payback period (time in which the project will pay for itself) is 2 years. All of this is explained in further detail in our free whitepaper, which you can download here.
It’s important to point out that these are simplified formulas. Starting with these calculations gets you in the right ballpark, but it’s then crucial to sit down with your accounting team to factor in things such as the time value of money.
It’s also essential to realize there will be significant costs associated with not moving forward with your project. For example, your old system is costing you an increasing amount in maintaining outdated systems and preventing you from utilizing valuable new technology, such as mobile access.
When calculating the cost of a project, you must factor in both initial and ongoing costs. The below list is by no means exhaustive, but it’s a good start. A more detailed list is in our free whitepaper.
Initial (First Year) Costs
- Hardware and system software for an on-premise installation
- Application software
- Additional complementary systems or services (third-party purchases)
- People costs
- IT departmental costs for utilities, personnel, consultants and support
- Software annual subscription licensing
- Budget for system expansion and enhancement
- Cost of implementing periodic upgrades (software releases)
- Ongoing training and procedure development – due to promotions, attrition, new release functionality, integration to other systems
There are both obvious, or direct, benefits of an ERP replacement, as well as ones that aren’t as easy to see, or indirect. The list below, much like the list of costs above, is a great jumping off point of discussion for all of the returns you could receive. Again, please see our full whitepaper for more details on this list.
- Cost savings, cost avoidance
- Improved visibility across the entire business to make faster and better decisions
- Increased revenue and profit
- Improved retention and higher productivity of employees who are less frustrated and more effective in their jobs
- Less panic, disruption, and chaos in the warehouse, plant, store and back office due to fewer last minute changes and surprises
- Smarter moves in the market – pricing decisions, specials, product releases or changes, and inventory deployment
Before a project can begin, the “why are we doing this?” question needs to be answered. By carefully considering all of the costs and benefits of an ERP replacement project, as laid out in our free whitepaper, you can guarantee that your company will know what to expect when the time comes to move forward with a decision. Our team and global network of Partners are here to help you put together a thorough analysis and demonstrate why improving your ERP is almost always a great idea. Get in touch today with one of our experts.