Justifying a New ERP Software Solution

Introduction

If you have reached that point where a critical mass of your employees have decided that your current ERP solution might need to be replaced, what’s your next step? Many firms just launch a search, assuming that at some point they will find the best suited ERP solution. Well….there’s just a tiny flaw in this approach. How can you search for a new ERP solution if you don’t know what you are looking for? If you were purchasing a sophisticated piece of machinery, you would need to define precisely the capabilities this machine would have to possess. You certainly would not call vendors and ask them to tell you what you need, but that seems to be the case when it comes to purchasing a new ERP software solution.

Rather than just calling ERP vendors as your first step, you need to determine not only what you require in terms of functionality, but also the outcome you require. A complex production machine needs to be able to produce a specified number of parts in a specified time frame at a cost that does not exceed a specified cost (cost per piece produced). This same rigorous cost analysis needs to be applied to the purchase of a new ERP software solution. What do you require (improvements) and how much is it going to cost to achieve this level of improvement?

Put very briefly you need to justify the cost of your new ERP business management solution. It really doesn’t matter whether you are going to spend $10,000 or $10,000,000. You need to determine exactly what you need in terms of functionality, by how much this functionality will improve or increase your operating costs, how much these improvements will cost, and finally of course the net return for this anticipated investment.

The question now becomes simple. How are you going to “find” the monetary gains that will be required to justify what could prove to be a sizeable investment?

Reduce Days Sales Outstanding

There are two sources of low-hanging fruit; reducing AR Days Sales Outstanding is probably the easiest target. If you sell on credit, it is very likely that your customers are not paying you on time. You might offer Net 30 days, but your customers might be paying you on average in 60 days, perhaps even more. If you can reduce your AR by just 5 days (seems like a very achievable target), you can generate $13,700 in cash flow for every $1 million in revenue (based on a 365 day year). This translates into $137,000 for a $10 million firm. Unlike operational improvements that can be counted on every year, an improvement in AR generated a one-time cash flow; substantial to be sure, but just once. Since a new ERP solution consists of a substantial one-time cost (purchase and implementation), this cash flow can be used to reduce your up-front investment.

While getting customers to pay you sooner, there are two additional opportunities for reducing AR. First, reduce the time it requires to actually generate an invoice. Time is quite literally money here and the sooner you submit an invoice to a customer the sooner you are going to be paid. Second, reduce invoice error rates. If you submit an incorrect invoice to a customer, it isn’t going to be paid until it’s correct.

Improve Inventory Management

The other substantial asset that can drive cash flow is inventory. If you can manage your inventory more effectively, you will be able to improve inventory turns and therefore generate a one-time cash flow just as I have suggested for Accounts Receivable.

Balancing inventory levels is a tricky business. While you can certainly reduce quantities on hand, this may lead to stock outs. You cannot sell what you do not have. In a manufacturing environment stock outs can bring the manufacturing process downstream to a halt. That’s why many large ERP solutions include sophisticated advanced planning applications. That’s also why lean manufacturing is becoming so important. Rather than having sufficient quantities on hand to avoid stock outs at all point in the manufacturing process, lean manufacturing extends the planning process out to suppliers as well as in-transit inventory.

Reduce the Cost of Purchasing

It’s amazing sometimes how expensive it is to purchase inventory. Take a close look at how many people are involved in the purchase process from initial vendor relationships to the point where purchased goods are received. Each time someone has to “touch” this process adds cost to the material being purchased. Given the sophistication of today’s ERP solutions, it should be possible to construct a process workflow that is based on the assumption that everything’s OK. Spend time (and therefore money) building a rock solid relationship with vendors whereby unit costs and delivery requirements are known and acceptable. Once the replenishment system has triggered a purchase notice, the resulting purchase order sets the best quantity (based on current forecasts and quantify price breaks). If the suggested order quantity falls within specified limits, the purchase order is sent to the vendor automatically with no touches from anyone in the purchasing department.

Once a purchase order has been issued, no human needs to become involved, unless the vendor submits a warning, or no advanced ship notice has been received. Only at that point should someone become involved. No reports need to be generated and reviewed at any point in the process.

Exception management should rule the purchasing process. The entire process should be based on the fact that a purchase order will be completed with no issues. If an issue is identified, users should be able to resolve the issue using the equivalent of an internal task management system.

Increase the Efficiency and Effectiveness of the Reporting System

Eliminate all printed reports, particularly those containing rows and columns. This is a soap box that I have jumped on for many years. My point is simple. Static reports are no more than a single picture in time. They give you no direction with respect to where conditions have been or where they might go in the future. Again I come back to the concept of exception management. Users need to be spending their time improving those critical operations that need to be improved. They don’t need to be wasting their time trying to figure out what needs to be improved.

Users waste precious (costly) time drilling down from static reports to underlying source data. Why not just start with the source data? Identify those lowest common denominator values that represent critical operations. It could be inventory turns or any other factor that represents those things that a company needs to do very well. If you need to drill down from what you consider to be a critical value, then you haven’t gone deep enough. Assuming that you correctly identify these critical values and concentrate on improving them, everything else in an income statement will take case of itself. Basically you don’t need an income statement except for those activities by a CFO that requires an income statement and balance sheet.

Having defined these critical values, track them over time (month to month or some other appropriate time frame). Use a line graph to track these values and a second line graph to specify where the values should be. Now you have a complete time-phased picture that you can use to identify where you need to spend your time. If the graph indicates no changes, a quick view is all you need and then you can go on to the next graph. I think a huge amount of time can be saved by not analyzing information that does not need to be analyzed. Conversely, you can spend more time improving those areas of the business that really need your attention.

Summary

Since this is a blog and not a formal article, I have but skimmed the surface. If you are contemplating the purchase of a new ERP solution, you have to specify precisely how you are going to be able to improve your business. Each of these improvements needs to have a monetary value attached to them. Your task at this point in time is defining a realistic transformation. What do you really want? How can you improve your business? What cost saving or revenue improvement can be associated with each improvement? If you don’t define what’s realistically possible, how can you possibly justify your investment in any ERP solution?