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Calculating your ROI on an ERP

Suppose you are considering a new ERP system and the total cost is $30,000.  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)?

There are a couple of ways to calculate the ROI. One method is that the return on this investment is 500% and a second method would be a 80% gain, if you prefer to look at it that way. Remember, though, that the $30,000 is the total cost of the system for the entire 5-year period and the $150,000 return is the sum of all the benefits for that same 5 years.

Method 1 is to divide Total Benefits by Total Costs

  • Return on Investment (ROI) = Total Benefits / Total Costs
  • Total benefits = $150,000
  • Total costs = $30,000
  • ROI = $150,000 / $ 30,000 = 5 or 500%

Method 2 is to divide Net Profit by Total Costs

  • Net profit = Total Benefits – Total Costs
  • OI Gain = (Net Profit / Total Costs) x 100
  • ($150,000 - $30,000) / $30,000 = 4 or 400%

You may prefer to look at the annual return, which, in this case is 80% per year on average. Be aware that the return will not be the same each year. A majority of the costs will likely be “front-loaded” meaning that more costs are incurred in the first months or years while the benefits can be expected to start small and grow over time. The return in the first year might well be negative, and it may take another year or two to “earn back” that initial benefit before a real gain is realised.

Payback methodology
Another way to look at ROI is the payback period – how long it takes to “earn back” the costs. If the cost for your new system is $100,000, and the benefits are $50,000 per year, the payback period is 2 years.
  • Payback = cost / annual return

Benefits of $25,000 per year yield a payback period of four years. In our previous example with $150,000 in benefits over five years, the average benefit is $30,000 per year resulting in a 3.33 year payback period. The benefits after 3.33 years are “profit.” Keep in mind that costs and benefits will not be equally distributed over the projected life of the investment, so any annualised payback period based on total cost and total return will be misleading.

Not making the investment also has a cost
Many companies decide to replace an existing ERP, system at least in part, because the cost of maintaining hardware and software is high – and getting higher – as equipment and programs age, become unreliable, and cannot support the growing demands of the organisation and new technologies. Even if that’s not the case, your old system may be costing your company lost business (from customer service deficiencies) or inefficiencies that increase your cost of doing business or prevent you from effectively competing online or in other evolving market opportunities.

Benefits of an ERP

Direct benefits
  • Cost savings, cost avoidance
  • Inventory reduction, including materials, parts, finished goods and work-in-process
  • Increased productivity and throughput in the plant
  • Reduced scrap, rework, expediting, and wasted materials
  • Less overtime, expediting, premium freight, and additional set-ups due to last-minute schedule changes
  • Improved visibility across the entire business to make faster and better decisions.
Increased revenue and profit
  • Increased sales due to better customer service, improved quality, better on-time delivery and shorter lead time
  • Sales and margin improvements due to faster time-to-market for new products and product variants, cost reductions.
Indirect benefits
  • Improved retention and higher productivity from employees who are less frustrated and more effective in their jobs
  • Less panic, disruption, and chaos in the plant and in the office due to fewer last minute changes and surprises; more stable schedules; less expediting
  • Smarter moves in the market – pricing decisions, specials, product releases or changes, inventory deployment, to name a few – due to better information and insight into market conditions, customer needs and competitive activity.
 
To select the best solution for your business, the first step is to have a discussion and assessment of what your business needs.  We are ready to discuss this with you, get in touch with the Helm team and we will make a time to investigate what is best going to serve your business.
 
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