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 = 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.