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How To Calculate an ROI for your Manufacturing ERP?

January 20, 2016
By Simon De Brito
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How To Calculate an ROI for your Manufacturing ERP?

This guide is specific for small to medium manufacturers looking to enhance their business through increased productivity, company-wide visibility, and revenue. The following information will assist you in calculating your Return on Investment (ROI) with the aid of an ERP software system.

What is an ERP system?

ERP systems make processes more efficient and reduce costs. An ERP software system saves you time and enables your business to function smoother and more effectively through integrating multiple systems into one central system. This system will collect, store, manage, and interpret data from your business activities such as: product planning, cost, manufacturing, marketing and sales, inventory management, and shipping and payments. When applied to the Manufacturing Industry, it becomes a complete Manufacturing Software capable of handling any task, process, and activity required in the manufacturing of a product.

Read Also: How to Choose a Manufacturing ERP Software?

How do you calculate the ERP ROI for your business?

This is tricky and will depend solely on your analysis of your business. The cost of implementation is easily accessible, but seeing the benefit of an ERP system will take time. Some additional information you should know:

What happens when you install an ERP system?

When you install an ERP system it will gather all the raw data from your business and transform it into information that is understandable or readable in a tangible way. After installed, this “understandable” data shows you the health of your business and all areas of product management such as: processes of manufacturing, accounts, sales, invoices, inventory, and the performance of your business.

But in order to calculate your ROI with an ERP system, all the data and processes must be given a dollar value so you can calculate the efficiency levels and increase. This is where evaluating an ROI is difficult as you now have to estimate monetary numbers for intangible data.

Examples of intangible data are: Customer Satisfaction, Inventory Management/Coil Tracking, Production, Shipping/Logistics, Task and Time Management, and Project Opportunity.

For those in accounting and dealing with finance, estimating ROI comes easy as they work with tangible data. They can compare the prior year’s revenue and costs.

Some tangible benefits of an ERP system may include:

• Better management of equipment to increase efficiency in manufacturing and production
• Improved allocation of resources to reduce labor costs
• Management of data in one central system to eliminate errors or duplication
• Improved procurement procedures to decrease the cost of materials
• Enhanced planning and control to shorten work-in-progress times

As mentioned above, you must give all intangible benefits a numeric value. If you want to find more examples, we wrote an article about tangible and intangible benefits.

Some of the intangible benefits to consider may include:

• The ability to compare quotes with actuals
• Better accounting control and tighter sales cycle
• Standardized procedures
• Faster order-to-shipment cycle
• Improved Customer Service
• Error-proofing enhanced, increased accuracy of inventory data
• Multiple systems acting as one central system with full-transparency and visibility to all departments
• Analysis of product – improving gross margin and job margin

After you have established a numeric value to your intangible benefits in the remaining areas of your business, let’s discuss a few costs of installing an ERP system.

These may include for example: license fees, consulting fees, support plans, hardware costs, and implementation costs. All of these fees are tangible and go along with calculating your ERP ROI.

Read Also: ERP Software for the Manufacturing Industry

We will call all of these fees (costs) your Total Cost of Ownership (TCO). Before proceeding, ask yourself these two questions:

1. How long do I intend to use the ERP system?
2. And what are my anticipate-monetary benefits of its use?

Hint: An ERP system’s primary benefits come from improved production, reduction in labor costs, operational costs, and stocks.

For our example, let’s say your TCO amounts to $200,000; you plan to utilize the ERP system for 10 years, and your anticipated increase in profits is 10%.

Use the following equation to calculate your ROI:

ROI = (200,000/10 + 200,000 x 10%) = $40,000

For this example our ROI would be $40,000.

Because it is difficult to quantify everything in a monetary format, your ROI will fluctuate, but it’s important to quantify all avenues of your business, as it will allow you to gauge the benefits of implementation and how to manage and improve project success.

The best way to determine which ERP system is right for you, and to assist you in calculating your ERP ROI, is for you to write out your pitfalls for the previous year. For example, perhaps some of these were your leading issues and drawbacks for the year prior:

• Inconsistent data
• Manual data entry
• Duplication of entries
• Inventory overstocked
• Long inventory closing
• Costly errors or delays (order and shipments)
• Slow solutions to problems

So your next questions would be, “How do I improve on these? And, what do I want from the ERP system?” If we are keeping with the examples above, you may say you would like the ERP system to help your business in the following areas:

• Operate with one central system
• Automate data entry
• Remove old business systems
• Reduce duplication of work
• Improve planning
• Improve operational productivity and employee efficiency

Now that you’ve established what your weak areas were (or still are), and how you want to improve on them, you can work to quantify these costs or obstacles to determine your ERP ROI.

To review:

ROI = Total Benefit – Total Investment
ROI (%) = Total Benefit / Total Investment

It is important to keep in mind that the success or failure of your business, as well as your ERP system, is up to you. ERP systems are only as effective as the business that incorporates them. Meaning, an ERP system does nothing if you do not follow or change your business processes based on what the ERP system supports. Oftentimes, businesses purchase an ERP system and expect just by uploading the software that their businesses will be saved, or they’ll see large increases in revenue and reduced costs. This is not realistic if they still function on their old processes. It is evident that if you want to improve an area of your business you must change and adapt. If you maintain your old habits and routines or processes, no ERP system will help you achieve your goals, and sometimes, you may see worse gains.

The trick to a sustainable and improved business is to change and improve your business processes that lack productivity and efficiency. An ERP system will show you the methods and ways by which to do this through their supported processes.

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