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Calculating ERP ROI: A New Machine or New ERP?

Calculating ERP ROI: Evaluating Return on Investment between buying a new machine or new ERP is not so simple. I’ve found that oftentimes 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 Return on Investment (ROI) analysis is very helpful when dealing with those individuals in the manufacturing vertical, especially owners, but it is not so easy to calculate the ERP ROI. 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 oftentimes done a poor job of helping the finance officer or the owner work through the process of cost justifying (computing an ROI) of the new ERP application, and then be able to back it up (the “proof statement”) with customers who have made those claimed ROI based improvements.

So when the financial officer or owner has to make the tough decision as to which capital investment to make – the new plant equipment or the new ERP application – they naturally gravitate to that which they understand best, the ROI of a new piece of equipment.

We certainly understand them taking that position but it, unfortunately, 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:
ERP affects all aspects of the operation. With a tight, well thought-out process that 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, less overtime, etc. 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 in reducing 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 further 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.

One of the leveling factors is the enormous amount of staff time and effort in acquiring and learning a new end to end software solution for the plant. There is a much greater risk of partial or total failure with ERP that must weighted.

Summary
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 affect production but the entire organization.

The Cost Justifier for Manufacturing offered for free by CTSguides helps a sales rep help the owner or financial officer who’s tasked with making that tough investment decision “understand the ROI math” of an ERP investment…

Jeff Rassie is the Eastern Area Customer Account Manager for Western Computer in Cleveland, OH. You can reach him at JeffRassie@WesternComputer.com or (440) 319-3190.