ERP Buyer's Guide Part 5

How to Plan and Build Your ERP Budget

Considerations for Building a Strategic ERP Budget

Capital expenditures represent substantial investments in the future of a business and must be carefully planned in order to deliver a strong return on investment. An Enterprise Resource Planning (ERP) solution is one of the most important capital expenditures a small to medium-sized manufacturing enterprise (SMB) can make.

As part of our 7-part guide aimed at ensuring that manufacturing SMBs have the information they need to make timely, strategic, and financially sound ERP decisions, this section details the key considerations involved in planning and building an ERP budget. Getting these details right will enable your business to choose the most appropriate vendor and software solution, and create a foundation for reliable profits and business growth, year after year.

The roles of management and ownership

An investment in an ERP is an investment in improving every department and function of your business, and in boosting the efficiency and cohesion of your business as a whole. The decision to upgrade to a new ERP solution is a statement about leadership’s view of the company’s current financial condition, market opportunities, and prospects for future growth.

Most capital budgeting decisions – especially ERP – are constructed to cover periods of five to ten years and are closely tied into a company’s long-range goals. In the interim, a solid ERP investment will have a profound impact on lowering operational expenses and making the business as lean and competitive as possible.

Management may evaluate ERP options using a variety of accounting methods including throughput analysis, net present value, internal rate of return, discounted cash flow, and payback period. Each of these methods offers some value in the process, as ERP is the one capital investment that cuts across capital budgeting categories:

Replacement projects for maintaining business
Replacement projects for reducing costs and need for resources
Expansion projects
New product/service market development
Compulsory projects, required by regulations

Because ERP is so foundational to all business planning, strategy, and activity, some SMB owners or CEOs often choose to hire a consultant with ERP expertise to work with accounting and to be the internal ERP champion. Others take the job on and learn about ERP to take on themselves.

The capital budgeting process for ERP

We advise our clients to complete the following recommended capital budgeting process as follows:

1. Business process review:

Conduct a review of your current business processes to determine what your requirements are for the new ERP system. Assemble a team of executives representing each department or function to share their business critical needs and workflows. Your system requirements and corresponding budget requirements will ultimately depend upon the following considerations:

Business functions and processes to improve or automate
Process and data entry redundancies to reduce or eliminate
Communications improvement needs between departments
Business objectives
Which departments will use the system and how
Whether your IT personnel will maintain an on-premises solution or your solution will be hosted in the cloud/Software as a Service (SaaS) model.

2. Estimation of costs:

The next step is to determine the incremental and total costs required to meet the needs uncovered in step 1. This is one of the most intensive steps because it requires internal and external research. Internal research includes talking with IT staff about existing hardware, software, and personnel resources. External research includes costing with vendors in the consideration set. The estimation step should ideally begin with a prioritization of the considerations in step 1. Consider the investments required and financing costs, if applicable, to determine actual investment costs. Break the costs down as follows:

Technical costs:

Hardware
Installation and configuring of hardware and software
Software licensing and hosting
Operating system
Customizations, if not an industry-specific solution
System testing prior to go-live
System validation, if required in your industry
Network and technical communications
Maintenance and support
Cybersecurity

Software is typically customized by modules and features. You will likely choose models to fit your business, which will include accounting/financial management, product planning and development, sales and marketing, CRM, HR management, purchasing, supply chain management (SCM), manufacturing/engineering/production, and inventory management, among others. Further customizations become necessary when a non-industry-specific ERP solution is chosen, or when the vendor’s product is not an ideal match for the company’s needs. Customizations often require debugging, which is another considerable expense. Best-of-breed ERP solutions offer the flexibility to develop customized reports and tailor the software to specific processes without expensive customizations. Look for software designed by, or with input from experienced industry professionals.

Data costs:

Data extraction from legacy (current) system
Data accuracy tests and scrubbing
Data migration to new system

Human resource costs including man-hours:

Support from vendor personnel
Internal support personnel (for on-premises solutions)
Change management
Project management
Process redesign management
Employee training

Opportunity costs for re-appropriating employees Making an upgrade to a new ERP solution will require a redesign of existing inefficient processes. Once this is complete, employees will require training and a ramp-up period before go-live in order to become familiar and proficient with their new system and software packages. They will need to be taught how to use the programs and who to rely on for technical questions and assistance. For this reason, strongly consider vendor support when choosing your ERP solution. Best-of-class vendors offer in-person and online training, as well as a variety of training resources and forums for getting answers to questions.

3. Estimation of cash flow, cost, savings, and ROI:

Project the resulting financial benefits the business will be expected to generate and accrue over time with the new ERP solution in place. In terms of return on investment, assign cash flow and/or cost savings values over time to the items in step 1. Strongly consider labor cost reductions, improved cash-to-order cycles, and new efficiencies in supply chain and inventory management.

4. Assess risk:

Itemize the associated risks of the project, and evaluate each item against its estimated cash flow or cost savings benefit to determine if the benefits outweigh the risks. In instances when the risks may outweigh the benefits, consider eliminating the associated features from your costs. For example, you may decide that on-premises servers present the risks of cybercrime and data security breaches and opt instead for a cloud-based solution.

5. Implement:

The finalized implementation plan includes a timeline with key project milestones leading up to the go-live date, how the project will be paid for, a method for tracking costs, and a procedure for recording cash flows and cost savings.

Pricing models to consider: cloud-based (SaaS) vs. on-premises

On Premise
For SMBs, this model has become prohibitively expensive and difficult to manage, not to mention unnecessary for most manufacturing and job shop companies. Though the model does offer a well-defined cost of ownership, a permanent license to use hardware and software, and a gradual reduction in costs over time, this is generally a much more costly solution to implement.

On-premises solutions require in-house infrastructure, IT personnel, heavy upfront investments in hardware and software, and ongoing equipment operational expenses. They lack the flexibility and scalability that cloud-based (SaaS) solutions offer, which enable companies to add modules and features as the business grows. Worse yet, many on-premises systems are plagued by a lack of adequate cybersecurity features, which are made affordable by the economies of scale the cloud model offers.

Cloud-based
SMBs increasingly, and now overwhelmingly prefer the flexibility and growth support offered by the cloud-based or SaaS model. The model aligns closely with business needs, requiring substantially lower upfront investments in infrastructure, personnel, hardware, software, and licensing fees. It is subscription-based, so that costs can be spread out over time and based on user numbers, transaction volumes, and features and modules used— when they are needed. Businesses have the flexibility to try modules to determine if they are beneficial, rather than make risky, unnecessary investments.

The only negative in choosing a vendor that goes out of business, which would require a more immediate transition than from an on-premises solution. This can be avoided by choosing an established vendor.

The importance of a strategic ERP budgeting process

There are several ways to finance the purchase of an ERP and management will need to determine whether the capital expenditure should come directly from company funds, or if it should be financed. Depending on your country, state, and municipality, grants may be available to help with financing. Learn more from the following resources:

A strategic ERP budgeting process is essential to a successful implementation, and ultimately, to innovating your business as you move forward. Because this system will integrate, manage, facilitate, and automate all of your business processes, it is so important to conduct comprehensive system and vendor due diligence.

An ERP Buyer's Guide for Manufacturers

This 7-part series includes:

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