Selecting a new enterprise resource planning (ERP) system is a major investment that requires careful financial planning. With multi-million dollar price tags and complex implementations spanning years, ERP purchases can make or break an organisation. That’s why assessing the total cost of ownership (TCO) is critical for finance leaders embarking on an ERP project.
TCO encompasses all expenses associated with acquiring, implementing, maintaining, and operating the ERP system over its lifetime. It goes far beyond the initial software licensing and deployment costs. Without a full understanding of TCO, companies risk cost overruns, budget issues, and failed implementations.
This article provides practical guidance to help finance directors conduct realistic TCO evaluations during the ERP selection process. We’ll examine why TCO matters, key cost considerations, and steps to accurately estimate and control expenses. With careful TCO analysis, finance leaders can ensure their organisations choose ERP solutions that deliver maximum value and align with budget realities. Let’s explore how to assess total cost of ownership to make informed investment decisions that meet both present and future business needs.
Define Total Cost of Ownership
Total Cost of Ownership (TCO) is the comprehensive assessment of all costs associated with an ERP system over its lifetime. This includes much more than just the initial software licensing fees. A complete TCO analysis should factor in these key elements:
- Software licensing and maintenance fees
- Implementation costs including consulting, customization and data migration
- Integration expenses to connect the ERP with other systems
- Ongoing training and change management needs
- Hardware upgrades required to support the system
- IT staffing and resources to maintain the ERP
- Business disruption and lost productivity during transition
- Any additional 3rd party software required
Getting a full picture of total cost of ownership is crucial for finance leaders considering a new ERP investment, as the upfront costs are just a fraction of long term spending. Understanding the complete costs allows for more accurate budgeting and cost-benefit analysis.
Why TCO Matters for ERP
Underestimating TCO risks budget overruns, project delays, and dissatisfaction with ERP outcomes. Finance leaders must have a clear understanding of total cost of ownership when embarking on an ERP implementation or upgrade. Without realistic TCO estimates, organisations often end up spending far more than anticipated to get the ERP system operational. This leads to going over budget, which requires asking for more funding or cutting back on project scope.
It also causes timeline delays as teams scramble to deal with unexpected costs. Ultimately, poor TCO planning undermines the ROI from ERP investments and can even cause projects to fail entirely. By thoroughly evaluating all costs upfront, finance leaders can secure the necessary budget, plan appropriately, and set realistic expectations across the organisation.
This improves the chances of a successful implementation that achieves the desired business value. Understanding TCO is imperative for finance chiefs guiding major ERP investments in their company.
Cost vs Value Analysis
When evaluating ERP solutions, a key question is whether to choose a lower cost option or a higher value option. Finance leaders need to carefully weigh the pros and cons.
Lower cost ERP options often come with fewer features and customisation capabilities. However, the lower price tag can help companies conserve cash flow for other investments. A basic ERP may suffice if your finance processes are relatively straightforward.
Higher value ERP options provide more robust functionalities, integration, analytics, and flexibility. While more expensive, they can pay off in the long run by streamlining processes, reducing manual work, and providing actionable insights. The right high-value ERP becomes a strategic asset.
Conduct an in-depth analysis of your finance team’s pain points and growth goals. Get user input on desired features. If basic requirements are met with a lower cost solution, it may be the prudent choice. However, don’t compromise on key capabilities that will drive productivity and insights.
The optimal balance depends on each company’s situation. Focus on value, not just cost. Look for the intersection of maximum ROI and minimum TCO. With careful selection, a high-value ERP can more than justify the investment over time.
Hidden Costs to Watch For
When evaluating the total cost of an ERP implementation, there are several hidden costs that are easy to overlook. Being aware of these expenses upfront will help finance leaders develop a more realistic budget.
Customisations
No two organisations have the exact same processes and needs. Expect that your ERP system will require customisations and configurations to support your workflows. These tweaks don’t come for free. Factor in costs for consultant fees and internal IT resources for any custom development work.
Integrations
Modern ERP platforms rarely operate in isolation. There will likely be integration costs to connect the ERP with other key systems like CRM, HRIS, and specialised software unique to your industry. Don’t underestimate these expenses which can really add up.
Training
Thorough training across the organisation is crucial for ERP adoption and realising the full value of your investment. But training materials, sessions, staff time and travel expenses for trainers need to be accounted for. Consider eLearning options to reduce costs where possible.
Change Management
The human factors of major IT changes are often overlooked. A strong change management program will ease the transition and drive ERP success. While hard to quantify, don’t neglect the investment required for communications, training reinforcement, and user support. This is an area where spending more upfront can prevent headaches down the road.
Get Realistic Total Cost of Ownership Estimates
When evaluating ERP solutions, it’s critical to get realistic total cost of ownership estimates from vendors upfront. Many vendors will lowball TCO numbers to make their solutions look more appealing. But hidden costs have a way of creeping up once a system is implemented.
Work closely with vendors during the evaluation process to get detailed total cost of ownership estimates. Require them to break down all costs related to software licensing, implementation, annual maintenance and support, training, customisations, integrations, hardware upgrades, data migration, and ongoing internal personnel requirements. Don’t accept vague responses or ranges when asking for cost details.
Push vendors to justify their total cost of ownership estimates with specifics. Ask them to explain their methodology and assumptions behind the numbers. Compare TCO estimates across multiple vendor proposals to get a sense of realistic costs. Conduct independent research on the true costs of ERP systems as well. With persistence, you can get TCO clarity before moving forward with a vendor. This will help avoid sticker shock down the road.
Plan for Ongoing Costs
When budgeting for a new ERP system, it’s easy to focus solely on the upfront costs of software licenses, implementation, customisation, data migration, training, etc. However, finance leaders must plan for significant ongoing costs that will continue year after year.
One major area of ongoing cost is support and maintenance fees paid to the ERP vendor. These annual fees often run around 20% of the initial software license cost. ERP vendors charge these fees to provide product support, patches, bug fixes, regulatory updates, and access to customer portals.
Another regular cost is version upgrades. Most ERP vendors release new versions every 2-3 years. While upgrades are not mandatory, sticking with an outdated version can limit features and integration. Upgrades often require paying new license fees, added customisation and testing time, retraining users, migrating data, and addressing integration issues.
To get an accurate, multi-year total cost of ownership estimate, finance leaders need to work with the ERP vendor to forecast maintenance, support, and upgrade costs over a 5-10 year period. Building these ongoing costs into the overall budget will prevent surprise expenses down the road.
Build total cost of ownership into Budget
When undergoing an ERP implementation, it’s crucial to build the full TCO into your budget from the start. Many organizations only account for the upfront software licensing and implementation costs in their capital budget. While these expenses are substantial, they are just one piece of the puzzle. To get an accurate budget picture, you need to factor in costs across the entire ERP lifecycle.
This includes planning for ongoing support, maintenance, upgrades, training, customizations, integrations, and more over the next 5-10 years. Building out a detailed TCO model will provide visibility into these future costs. Make sure to include the full total cost of ownership estimate in your capital budget request for ERP, rather than just the initial implementation costs. Getting stakeholder buy-in on the long-term budget impact is key for success.
Proper budgeting prevents nasty surprises down the road, when the annual recurring costs start hitting but weren’t planned for. The last thing you want is to have budget shortfalls after go-live, which could force you to cut back on critical areas like training and support. Taking a total cost view upfront and incorporating it into ERP budget planning will set your organisation up for an effective implementation and rollout.
Monitor Spending Closely
Once your ERP project is underway, it’s critical to track actual spending against the total cost of ownership estimates you’ve established. This helps ensure the project stays on budget and avoids cost overruns that could impact your ROI.
Set up regular check-ins with your implementation partner to review spending to date. Require detailed invoices that break down costs by project phase and resource.
Closely monitor internal spending as well, including employee time invested in the project. Ensure timesheets and expense reports tag spending to the ERP initiative.
Watch for scope creep that may drive costs higher than planned. Require signoff for any out-of-scope items that arise to avoid unexpected expenses.
Keep leadership updated on spending versus budget at least monthly. Quickly flag any overages or concerns so they can be addressed in a timely manner.
Leverage ERP reporting functionality to generate spending reports and dashboards. Automate where possible to streamline monitoring.
If costs start trending higher than expected, work to right-size spending through the remainder of the project. Look for areas to scale back that won’t compromise the outcome.
Staying disciplined about tracking total cost of ownership will help maintain budget integrity and maximize the value delivered by your ERP investment. Adjust quickly when spending gets off track.
Selecting a new ERP system is a major investment for any organisation. While the upfront software licensing costs are substantial, finance leaders need to look beyond this to understand the full total cost of ownership. Total cost of ownership encompasses all direct and indirect costs over the lifetime of the ERP system, from planning and implementation to ongoing operations and maintenance.
By taking a cost vs value approach, finance directors can assess whether the benefits justify the total expenditure. This requires analysing factors like ROI, flexibility, scalability, and long-term total cost of ownership. It’s also critical to account for hidden costs around customisation, integration, training, and data migration. Get realistic total cost of ownership estimates upfront and build these into your budget.
With careful planning and monitoring, organisations can control ERP costs and maximise value. This starts with finance leaders having full visibility into total cost of ownership. By keeping close tabs on spend throughout an ERP project, finance can help ensure the investment delivers strong returns over time. Moving forward with an ERP initiative requires striking the right balance between cost and value.
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