If you are one of the many businesses considering the transition to Enterprise Resource Planning software, chances are you have given some serious thought to cost. As a business, your first concern must always be whether investing in an ERP will be worth it in the long term for your bottom line. ERP is an investment that can reap serious dividends for your business. How do the numbers play out, however, and can you justify the cost of ERP? Let’s look at the math for calculating the ROI of an ERP replacement.
Calculating the ROI of an ERP Replacement
To calculate your potential return on investment on ERP, let’s assume a total cost of $100,000 for a mid-sized business. The savings that would result from implementation of that ERP thanks to increased efficiency, revenue, et al. would total $150,000 over five years.
If you divide your total benefits by total costs, you would get an ROI of 150%. As an alternative, you could also divide net profit by total costs delivering an ROI of 50%, or an average of 10% per year. Keep in mind that, given the upfront costs of many ERP solutions, the first year ROI may well be lean, with benefits increasing year over year.
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%
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%
You can also calculate ROI using a ‘payback’ method that reflects how long it will take your new ERP to pay itself off. Your payback period is easy enough to calculate and involves dividing the cost of the system by your annual return. Based on our original numbers, your payback period would be around 3.33 years.
Calculating the Cost of ERP
All that being said, what will your costs be if you transition to ERP? There are four central components involved in the cost of any ERP solution:
- Licensing fees
- Infrastructure costs
- Implementation costs
- Ongoing maintenance costs
Which type of ERP solution you settle on directly affects each of these. You have three main options to consider in selecting an ERP system: cloud-based, hybrid and on-premises. We looked at the differences between these options and which of these ERP solutions is the best fit for your company in a previous blog post.
A complete cloud-based version of ERP, for example, ameliorates cost significantly across all four cost sectors. A hybrid solution which combines on-premises infrastructure with cloud-based components, shaves a bit off. Any on-premises ERP will involve significant upfront investment and require sizeable ongoing costs in staff and maintenance.
Whichever approach you decide to take, working with the right ERP partner can make all the difference. They can help you determine which approach works best for your company and give you a realistic picture of your upfront costs.
What experiences have you had with ERP and calculating the ROI of an ERP replacement? Let us know in the comments below. To explore your own ERP options, visit this webpage.