Building a Business Case for ERP

How to justify cost and demonstrate the ROI of an ERP Initiative

One of the most difficult (and most important) steps involved in an ERP initiative is building a business case. It’s not easy to convince the people with the authority to write the checks that they should invest in a new system, especially when this often involves changes to business processes that may have worked just fine for many years without failure.

There are a few key steps that will help you establish a convincing case for investing in a new system and put your company on the path to realizing greater profits and a return on investment (ROI) that is worth the risk involved.

Educate First

One of most important ERP project critical success factors is executive buy-in and support. Key people need to learn about ERP before they can do a proper job of evaluating costs, risks, and benefits. Otherwise, it’s like trying to build a house on top of sand.

They need to learn five crucial elements:

Many companies make the mistake of presenting a business case before they take the time to educate the decision makers. It's important to realize that you can’t justify the cost of ERP if doesn't really understand what it’s all about.

Without the proper background knowledge, your job of presenting a convincing business case will be much more challenging. Decision makers will likely underestimate the importance of the initiative, assuming that ERP is just part of a computer system and that this is just a software project - resulting in the misconstrued perception of the costs, benefits, and risks involved. If they think ERP is a computer system, it then becomes very difficult to establish ERP implementation as a high priority across the company.

Who needs this education?

Any decision makers you’ll be presenting the business case to, including top management and operating management. Don’t include more people than necessary, but make sure that anyone who will be held accountable for costs, benefits, and overall success or failure of the ERP initiative is involved. It can be difficult to get participation across the board on this education process, but it’s key to your success as an organization, so don’t hesitate to lead and present educational materials yourself and frame it as part of the business case presentation.

Develop a definitive set of case justifications

Once you’ve educated your decision makers, the next step is to present your case. The easiest way to do this is to put together some fact sheets to present on the following:

Alignment: Create a list of ways the ERP solution you’re recommending aligns with your organization’s goals, business process, and daily operations and why they’re a good fit
Benefits (both tangible and intangible): a list of benefits, what goals they align with, and how success will be measured.
Risks: Create a list of investment risk factors and the corresponding concerns/implications

The next step is to present a cost/benefit analysis. Instead of just throwing a massive price tag on your ERP initiative, your decision makers will be much more receptive if you present a carefully outlined list of the anticipated costs (expenses) and benefits (income). You should present each item in a way that tells your project expenses as more of a complete story, leading up to and preparing your decision makers for the final price tag and anticipated ROI.

Here’s an example that we found in an excerpt from ERP: Making It Happen: The Implementers' Guide to Success with Enterprise Resource Planning by Thomas F. Wallace and Michael H. Kremzar. To illustrate the process, they created a hypothetical company with the following characteristics:

Annual sales: $500 million
Employees: 1000
Number of plants: 2
Distribution centers: 3
Manufacturing process: Fabrication and assembly
Product: A complex assembled make-to-order product, with many options
Pretax net profit: 10 percent of sales
Annual direct labor cost: $25 million
Annual purchase volume (production materials): $150 million
Annual cost of goods sold: $300 million
Current inventories: $50 million

Here’s how this hypothetical company would present their cost/benefit analysis:

COSTS
Item	One Time	Recurring	Comments
Computer
Hardware	$400,000		Costs primarily for workstations.
Software	500,000	$75,000	Can vary widely, based on package
Systems and Programming	2,500,000	200,000	Adapting the software to your company and training in its use. These costs are pegged here at 5 times the software purchase cost.
Data
Inventory record accuracy	700,000	100,000	Includes new equipment and added cycle counters.
Bill of material accuracy and structure	200,000		Bills will need to be restructured into the modular format. Experienced engineers will be needed for this step.
Routing accuracy	100,000
Forecasting	200,000	100,000	Full time person for Sales forecasting. Needs to come on board early.
People
Project Team	1,200,000		Six full-time equivalent people for two years.
Education	800,000	100,000	Includes costs for education time and teaching the new ES interactions to the organization.
Professional guidance	400,000	50,000	4 days per month during installation.
SUB-TOTAL	$7,000,000	$725,000
Contingency	$8,050,000	$834,000
+15%	1,050,000	109,000	A conservative precaution against surprises.
TOTAL	$9,100,000	$943,000

BENEFITS
Item	Current	% Improvement	Annual Benefits	Comments
Sales	$500,000,000	7% at 10%	$3,500,000	Modest improvement due to improved product availability at the profit margin of 10%
Direct Labor Productivity	25,000,000	10%	2,500,000	Reductions in idle time, overtime, layoffs, and other items caused by lack of planning and information flow.
Purchase cost	150,000,000	5%	7,500,000	Better planning and information will reduce total purchase costs.
Inventories
Item	Current	% Improvement	Annual Benefits	Comments
Raw Material and WIP	25,000,000	10% at 15%	380,000	2,500,000 One time cash flow.
Finished goods	25,000,000	30% at 15%	1,130,000	7,500,000 One time cash flow.
Obsolescence	500,000	30%	150,000	Conservative savings
Premium freight	1,000,000	50%	500,000	Produce and ship on time reduces emergencies
SUB-TOTAL			15,660,000	$10,000,000 One time cash flow.

Less costs for:
Contingency	15%	-2,349,000	1,500,000
Recurring		-720,000
NET ANNUAL BENEFITS		$12,591,000	$8,500,000 One time cash flow.
Cost of a one month delay (Total/12)			$1,049,250
Payback time (One Time Cost/monthly benefits)			7.7 months
Return on investment (Annual benefits/One Time Costs)			193%

Once benefits, costs and risk are quantified and analyzed, an ERP investment can then be appraised and (hopefully) approved.

By following the steps outlined above, you’ll be able to clearly and articulately build a business case for your ERP initiative and make sure your audience is making an educated decision. Getting the executive support and buy-in for your ERP initiative will lead your organization to success.

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