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The ROI of ERP

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The ROI of ERP The ROI of ERP Make More Money with Less Work, Less Risk, & Less Worry Synopsis When evaluating the return on investment (ROI) of enterprise resource planning (ERP), it is wise to compare the increased profitabilitythatanERPsolutioncandeliveragainstthetimeand resourcesrequiredtopurchase,configure,andlearnit.Today,we’ll exploreahandfulofcommonmetricsyoucanusetobenchmark yourcurrentoperationalperformance,profitability,andefficiency; andwe’llcomparethoseindicatorsagainstindustryaverages providedintheDoorandHardwareInstitute’s2014Financial Report.We’llalsotakealookathowdistributorswholeverage ERPsoftwareoutperformthoseaveragestogiveyouareliable ideaofthepotentialprofitabilitygainsyoucanexpectifyou,too, investinERP.Withthisinformation,you’llbewellonyourwayto calculatingyourROIonERP. The Evolution of ERP EnterpriseResourcePlanning,asaconcept,hasbeenaroundsince the1960’s.OriginallycalledMaterialRequirementPlanning,MRP systems were primarily developed to automate inventory control and simplifymanufacturingplanning. Only very large corporations could afford MRP systems as they often ran upwardsof$3Milliondollarscreate(that’sin1960’sdollars!).However,the netlong-termprofitabilitygainsprovidedbyanMRPapplicationjustifiedthe investment,andanincreasingvarietyoforganizationsbegantotransitionto anautomatedoperationalenvironment. ThehundredsofERPproductsavailabletodayare,byyesterday’sstandards, incrediblyrobustandaffordable.Almosteveryfacetofacommercial operationresultsinanaccountingtransaction(thinkinventory,AP,AR, invoicing),soERPsystemshavenaturallyevolvedbeyondsimpleinventory management to tie accounting to shop floor management, delivery Whether you scheduling,customerrelationshipmanagement,retailpointofsale,andfield realize it or not, servicemanagement.Additionally,thewidespreadadoptionofcomputer you probably automation,combinedwithadvancesinhardwareandsoftwaretechnology, already run havesignificantlydecreasedthecosttowriteandusesophisticated solutions, making ERP commonplace and a virtual necessity to compete in your business acomplexdistributionormanufacturingenvironment.Whetheryourealize from an ‘ERP’ itornot,youprobablyalreadyrunyourbusinessfroman‘ERP’mindset.For mindset. example: do you track individual purchase or sale transactions in a hand writtenledger?Ofcoursenot!Youmostlikelyusespreadsheets,QuickBooks, or even a simple ERP application to log invoice payments or inventory purchasestoageneralledger. Earlyinnovatorsspentmillionsofdollarsbecausetheyknewexactlyhow anautomatedplatformcouldprovidethemareturnontheirinvestment. ThoughthevalueofERPhasbeenrepeatedlyprovensincethen,itwouldbe unwiseforadivision8distributortodaytoinvestresourcesinamodernERP solutionwithoutfirstcalculatingitspotentialreturnforhisspecificbusiness. Where early pioneers had to estimate how an MRP system would improve profitability,wecanusereadilyavailableindustryfinancialreportsforinsight intopreciselyhowERP-baseddivision8businessesperformcomparedto theirnon-automatedcounterparts. Short-termSolutionsVs. Long-termProfitability Manydistributors,eventoday,arediscouragedfromleveragingtechnology tomanagetheirbusinessesbecausetheinitialinvestmentseemstoohigh. Instead, they rely on familiar, seemingly less-expensive, manual solutions tomeetdemandandgrowoperations.But,justasitisplaintoseethatthe limitations of a hand-written, manually administrated accounting system wouldeventuallydriveabusinessintotheground,whenviewedfroma long-termperspective,itbecomesclearthatrelyingexclusivelyonmanual processes,andthepeopletorunthem,isjustasexpensiveanddangerous. Forinstance,whenjobcapacityismaxedout,buttheproductionlineneeds toincreaseoutput;orwhenthesalesteamwinsmorejobsthantheproject management team can manage, the traditional response is to add another bodytothepayrollandhopethemarketcansupportyourbiggerfootprint downtheroad.Investinginsmartpeopleisagoodtemporarysolution,but what happens when superstars leave and new, less-experienced folks have tolearntheirjob?Orevenworse,whenthemarketfluctuatesandthereisn’t enough work to support a staff of highly experienced industry veterans? Relyingtooheavilyonkeypersonnelandtheir“tribalknowledge”(the processes unique to them that they take with them when they leave or retire) makesitdifficulttoscalebusinessintimesofrapidindustryexpansion,and tomaintainitintimesofindustrycontraction. Thereisalwaysademandforgoodhelp,butwhenyouautomatethe mundane and time consuming components of your operations – especially those that are prone to costly errors – you turn good help into great help, enableyourtrustedemployeestodomoreandbetterwork,andreducethe needtoincreaseheadcounttogrowyouroperations.Whenyoudohirenew employees,youcantrainthemfasterandmoreefficientlyonstandardized processes (which means you can hire from a less experienced candidate pool),andthecontributionstheymakeduringtheirtenurestaywiththe businessaftertheyexit. OutsideofCOGS,payrollisthelargestlineitemonthebalancesheet,so it makes sense to focus on how an ERP solution can decrease payroll expensetoincreasenetprofitability.However,automationcanlowerahost of other costs too, like vehicle and asset maintenance expenses, collections expenses,andshippingandinventoryrelatedexpenses.Wewillexaminea numberofKPIsrelatingtomanydifferentareasofthebusinesstoestablish a comprehensive picture of how an ERP solution can drive long-term profitability. MeasuringYourBusinesswithKPIs Manyfactorsaffectthestability,profitability,andgrowthpotential ofanoperation,andinmostcases,thosefactorscanbemeasured andcomparedacrosstheindustryusingkeyperformanceindicators. No one indicator can provide a complete picture of the health of youroperation,andeachshouldbeviewedinthecontextofallthe others.FollowingareXXKPIsthat,takenasawhole,caneffectively representyourbusinessandprovideabasisforcomparisonagainst otherbusinesseslikeyours. Net Sales $ Net sales is total revenue, less the cost of sales returns, allowances, and discounts.Thisistheprimarysalesfigurereviewedbyanalystswhenthey examinetheincomestatementofabusiness,andisoftencomparedagainst previousyearstoestablishperformanceandmarkettrends.In2014,the typicalDHImemberfirmproduced$16.3MMinnetsales,a44%increase from5yearsago.HowdoyoursalescomparetotheaverageDHIfirm’s?Are your sales trending higher, as well? TypicalFirm $16,309,393 My Company $ GrossMargin% Grossmarginisthedifferencebetweennetsalesandcostofgoodssold (COGS)dividedbynetsales,expressedasapercentage.COGSincludes materialsanddirectlaborcosts,andwhentheyincrease,retailpricingusually increasestocompensate.TheaveragegrossmarginamongDHImembers haswidenedslightlyinthepast5years,movingfrom29.1%to30.5%which suggeststhatretailpricinghasoutpacedwholesalematerialandlaborcosts duringtherecentconstructionboom. DHIAverage 30.5% My Company % Calculation: (net sales – COGS) / net sales OperatingExpense% Operatingexpensesincludeallthecosts,besidesCOGS,adistributorincurs torunhisbusiness:inotherwords,everythingexceptmaterialsanddirect labor.Division8distributorscangroupoperatingexpensesintopayroll expenses,occupancyexpenses,andotherexpenses(depreciation,baddebt, vehicle,insurance,marketing,etc).Outsideofleveragingmanufacturing innovationorlargevolumepricing(COGSrelatedexpenses),businessescan mosteffectivelyscaleprofitsbycontrollingtheseoperatingexpenses.The ratioiscalculatedbydividingtotaloperatingexpenses(excludingaccounting adjustmentsandinterestexpenses)bynetsales. In the past 5 years, operating expenses ratios have remained steady, meaningrevenueandcostshavegrownproportionately.Thissuggests thatmostdistributorsareworkinghardertomakemoreprofit,andarenot effectivelyscalingtheiroperationsorcompoundingthebenefitoflarger salesvolume.Scaleisthetermusedtodescribethesituationwhererevenue increaseoutpacescostincreasesenoughtosubstantiallychangeprofit margin. DHIAverage 27.5% My Company % Calculation: total expenses excluding COGS / net sales ProfitMarginPercentage If you have calculated your net sales, gross margin, and operating expense correctly,youcaneasilycalculateyourprofitmarginpercentageby subtractingyouroperatingexpensepercentagefromyourgrossmargin percentage.ItbecomesplaintoseethatwhenCOGSarerelativelyfixed,the bestopportunitytoincreaseprofitmarginistoloweroperatingexpense. AccordingtotheDHIreport,typicaldistributorsoperateona2.8%profit margin(pre-tax).Inotherwords,theaveragefirmproduced$16MMin revenue,butkeptonly$448,000ofit. DHIAverage 2.8% My Company % Calculation: gross margin % – operating expense % Payroll Expense Percentage Payrollexpenseincludessalaries,wages,taxes,andbenefitsforall employees other than those directly involved in the manufacturing process(theirwages,benefits,andtaxesareincludedinCOGS).Payroll expenseisparticularlyrelevanttoevaluatingthepotentialbenefitofan ERP implementation as one of the primary roles of ERP is to eliminate dependence on the kinds of manual processes that require a large administrativestaff.Payrollexpenseforthetypicalfirmremainedsteady at20.4%ofrevenuefrom2010to2014,suggestingmostdistributors substantiallygrewheadcounttodriverevenue-resultinginlittletononet increaseinprofitmargin. DHIAverage 20.4% My Company % Calculation: payroll expense / net sales Inventory(Assetfigure) Inventoryisanassetthatisintendedtobesoldwithinoneyearthroughthe ordinarycourseofbusiness,evenifitisnotimmediatelyreadyforsale(as in the case of work-in-progress goods like door and window frames that areintheproductionprocess).Inventoryincludesrawmaterials,aswell asfinishedgoods,andistypicallyclassifiedasashorttermasset.More sophisticated performance indicators provide insight into the relationship betweeninventoryandgrosssales,netsales,andaccountspayable,butfor
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