Calculating ERP ROI: A New Machine or New ERP?
by Jeff Rassie, Eastern Area Customer Account Manager for Western Computer, Cleveland, OH
Evaluating Return on Investment (ROI) between buying a new machine or new ERP is not so simple. I’ve found that often times the financial officer or the owner of a company wants more than a “soft” projection of the potential improvements (e.g., improved customer service “What’s that supposed to mean and how can I take that to the bank?”) a new ERP application has to offer.
I’ve found an empirical ROI analysis is very helpful when dealing with those individuals in the manufacturing vertical, especially owners, but it is not so easy to calculate. I’ve observed that owners easily understand the ROI “math” for new plant equipment, such as a CNC, which can actually be more costly than the price of a new ERP application. To the owner this means they know if they can push so much work through the new potential CNC they can assume a profit margin of so many dollars over the course of the year.
But the software industry has often times done a poor job of helping the finance officer or the owner work through the process of cost justifying (computing ROI) of the new ERP application and then be able to back it up (the “proof statement”) with customers who have made the claimed ROI based improvements.
So when the financial officer or owner has to make the tough decision as to which capital investment to make. i.e. new plant equipment or a new ERP application, they gravitate to that which they understand best -- the ROI of a new piece of equipment!
We certainly understand them taking that position but, unfortunately, it skips the valuable and important exercise of evaluating all possible points of improvement in the operation which an ERP solution can bring.
Here are some thoughts for inputs on this complex decision:
Pros for New Equipment
New up- to-date equipment could involve less breakdowns and service, more throughput, less set up time, and a lower direct cost per unit leading to better pricing and a lower quote which could result in increased volume and even worker satisfaction.
Pros for New ERP Software
ERP affects all aspects of the operation. With a tight, well thought-out process, i.e. starts with quoting and ordering, shop floor control, real-time cost reporting, simplified labor capture, the ability to run with a smaller amount of inventory on hand leading to greater turnover, fewer stock-outs, better scheduling leading to fewer shop floor disruptions, improved employee morale, and less overtime. This all results in better use of capital.
With an MRP function, there is improved visibility for finished components or raw material demands. This can help reduce costs associated with expedited purchases from vendors and / or being able to place larger, lower unit cost orders since material planners have visibility to production requirements over a much longer horizon.
Of course, this assumes the company has purchased an ERP system which is well suited to their mode of operation and implemented it properly.
Owners of many job shop operations will usually choose the purchase of new equipment as opposed to a new ERP system to employ their scarce capital. There is no question that this is usually a simpler and lower risk option. But a new end-to-end ERP solution also offers great potential that will enhance productivity for the entire operation.