In a nut shell
- Comprehensive TCO assessment is essential for formulating a defensible ERP ROI and business case.
- Cloud-based systems present new challenges in assessing true ERP implementation efforts and its ongoing expenses.
- Organizational change related factors are very significant but commonly obscured by technical components or software license pricing. For cloud-based ERP, this is also true, and at times even more so.
- Thorough understanding of TCO helps not only with ERP business case but also with avoiding common implementation and use pitfalls.
- TCO includes upfront implementation expenses (often prorated) and ongoing maintenance and support with functionality enhancement.
ERP systems are crucial to streamline operations and resources. ERP effectiveness is commonly expressed as Return on Investment (ROI) used to justify investment in ERP. But the ROI is meaningless or, worse, misleading, if ERP costs are poorly gauged.
Historically, many ERP deployment projects (including Cloud-based) underestimated the business changes, and resulted in underfunding of the change management, leading to budgets overruns, and unanticipated increase in Total Cost of Ownership (TCO).
Last decade marked a notable shift toward Cloud-based (SaaS and alike) systems. And in the past two years, the volume of Cloud-based ERP implementations (arguably) exceeded on-premises installations.
SaaS is attractive due to its accessibility and convenience, and Cloud ERP adoption is increasing because of its scalability, flexibility, and lower upfront costs. The ERP market is becoming more diverse, with vendors offering modular implementations and simplified licensing, appealing to SMBs.
However, negligible upfront expenses and ease of SaaS implementation can be misleading, resulting in surprise costs and failures. ERP implementation mishaps become evident when listing out ERP Total Cost of Ownership (TCO) constituents. This is why TCO transparency can help organizations avoid errors and poorly estimated efforts in ERP implementation and running.
ERP Total Cost of Ownership
The Total Cost of Ownership (TCO) of an ERP includes various costs that a given organization incurs throughout the entire system lifecycle. These costs vary depending on the deployment model (cloud-based or on-premises), the size and complexity of the system, the specific features and modules being utilized, and the level of customization or integration with other platforms, etc. But they can be split into two more or less distinct buckets: implementation and running.
Covering implementation costs at any significant level of detail is outside this article’s scope. This subject becomes more interesting in the context of estimating costs for a prospective ERP somewhere along the selection journey. But in case of an already implemented ERP solution, the implementation costs would already be allocated to the relevant budget and be well known (unless the implementation project isn’t doing well and goes into eternity).
So let’s just organize those cost categories in a structured list with brief descriptions
1. Assets Procurement
(mostly for on-premises deployment)
1.1. Software licenses
1.2. Server(s) hardware
1.3. Workstations and specialty hardware (e.g. barcode scanners, thermal printers, PLC’s, kiosks)
1.4. Network and Data Centre uplift
An Integrator and/or Functional Consultants facilitate and perform various professional technical and business change tasks to ensure smooth deployment and configuration of the system that would meet the organization’s specific requirements. This applies to both cloud and on-prem implementations, unless noted.
2.1. Installation (for on-premises)
2.2. Configuration. Tuning ERP configuration parameters to suit company needs.
2.3. Customization. Adjusting the out-of-the-box functionality to better fit the needs of the organization.
2.4. Data Migration. Migrating data from legacy systems or other sources to the new ERP involving data cleansing, data validation, data mapping, and data conversion activities.
2.5. Functional Training. Training of the Key Users or all users in general.
2.6. Business Process Reengineering. Change existing business routines according to the best industry practices and to optimize the ERP use according to its functional design.
2.7. Integration. Integrating the new system with existing business applications through developing interfaces, data mapping and testing.
2.8. General Testing and QA
3. Project Management.
Professional planning, directing, and controlling resources (people, time, and money) to meet defined timeline and scope of the implementation project.
4. Risk Management.
Addressing risks of system downtime, data breaches, and potential recovery costs (generally does not apply to true SaaS implementations, but might still be needed for cloud hosting or hybrid implementations).
4.1. Implementation of security measures
4.2. Backup systems
4.3. Disaster recovery plans
4.4. Insurance costs
5. Legacy system take-down and disposition
6. Indirect costs
Expenses associated with redirecting internal employees to the implementation project and losing productivity while adapting to the new system.
6.1. Functional Training costs related to employee time spent in training sessions and possible travel time and expenses
6.2. Change Management efforts to manage resistance and ensure adoption of the new software.
6.3. Business Process Reengineering and Process Audit related to analysis, documentation and employees’ time spent in respective workshops and other activities.
6.4. Testing and validation of data migration, integration and customizations
6.5. Downtime and Disruption. Inevitable loss of productivity and revenue caused by downtime or disruption as the new platform is being deployed and adopted.
6.6. Project Governance. Management effort to coordinate, monitor, and govern the project resources and activities. Not to be confused with Project Management.
The list above does not include pre-implementation activities, which are typically carried out prior to official ERP Project kick-off, but can be costly too and worth taking into account. Those include strategic road-mapping, followed by the ERP selection. Whether the related expenses are to be included in the TCO calculation or not is a management decision, and there is no right or wrong answer to it.
Project Contingency is also not specifically listed, because it is rather a Project Management best practice for safe budgeting, than ERP implementation concern.
Running (ongoing maintenance and support)
An ERP system comes with costs beyond the initial investment. Once it is up and running, ongoing maintenance and support are essential to keep it functioning optimally. This includes (for cloud and on-premises):
Above ordinary support arrangements provisioned right after the new system goes live, which insure quick vendor response to issues, as well as extra contracted personnel (consultants) available to provide immediate help operating the new system. HyperCare costs are often included in the implementation phase.
2. ERP Software Support subscription
This buys vendor assurance against downtime, decreased performance, and security risks. There are differences and additional complexities in this area for SaaS implementations, mainly concerned with “tenancy”, which go beyond the scope of this article.
2.1. Regular software updates to patch bugs and improve functionality
2.2. Upgrades to new versions
2.3. Technical support with appropriate level (e.g. “Gold”, “Silver”, “Bronze”).
3. Other subscriptions
Hardware and Software Maintenance/Support subscriptions for the components supporting ERP (mainly for on-premises).
4. Enhancements. Continuous improvements
4.1. Customizations of the existing modules. Usability improvements.
4.2. Introduction of new modules/functionality
Continuous learning and development opportunities to ensure that employees are proficient in utilizing the system to its full potential. This rightfully might not be included in TCO calculation, but be part of the overall employee Orientation Training & Development expense. But an argument can be made that if such training goes hand-in-hand with enhancements and continuous improvement efforts, then it belongs to ERP TCO.
6. Power costs
In today’s day and age carbon footprint can be an important metric to gauge, which comes with its price tag that can be attributed to running your system (for on-premises mainly).
ERP systems are considered long-term investments with a lifespan of 10 to 20 years. However, with the rapid pace of technological advancements and changing business landscape, the lifespan of an ERP is shrinking. So, having a system deployed now and then lasting 15 years with just upgrades and enhancements seems unlikely.
Such shrinking lifespan adds more pressure to justifying ERP investment, especially for the initial implementation phase, and especially for on-premises installations, where initial assets procurement draws out a lot of cash.
Based on industry research, surveys, and vendor data, it is estimated that the implementation costs of an on-premises ERP system contributes from 20% to 50% of its TCO.
That is a lot to swallow when it is a relatively common business practice to require full project costs recovery within 2-3 years after the implementation. On the other hand, there could be a preference to “buy out and own”, instead of dealing with big recurring and ever increasing subscription fees, as is the case with SaaS.
A decision to deploy an ERP depends on company specific preferences and rules around investments, asset amortization, and dealing with cash flow. A clear understanding and presentation of ERP TCO estimate can play a pivotal role in such a decision. And an IT leader, driving ERP initiative at any stage, should have a good level of awareness of those business rules and financial preferences in order to position ERP costs accordingly.
Underestimating project management and efforts of process reengineering, governance and change management disproportionately exaggerates initial investment for on-premises implementations, and unjustly opens the doors for SaaS, where it might not be warranted. The costs of Running do not end with maintenance and support subscriptions either.
Attempting at reaching ERP TCO transparency (whether through ROI exercise or not) has indirect benefits of allowing an organization to avoid errors in ERP implementation and its running.