You know your business will benefit from a new ERP system, but, like most purchases in life, it’s time to talk about the price. So how much does a new ERP solution actually cost?
Answering this question isn’t as straightforward as simply providing a dollar amount. ERP systems vary significantly and so do their price tags, because they are built with different target audiences and business complexity in mind. As a result, the capital investment required will depend on the size and scope of your business, the industry you operate in, and any specific needs, customizations, or integrations you may require.
In this article, we’ll look broadly at the factors and considerations that impact the cost of a new ERP system – both in the short and long term. Equipped with this information, you can make an informed decision as to whether a new system will deliver the return on investment (ROI) you need over the lifespan of the solution to justify your purchase.
Comparing apples and oranges
The cost of a new ERP system will depend on many factors specific to your organisation, which we will explore in more detail below. Firstly, it’s worth providing context – the expenses associated with ERP implementation vary and can’t always be evaluated directly against other solutions. In short, you can’t compare apples and oranges.
So, what are the key terms, features, and concepts you need to be familiar with to make an educated, data-backed, and beneficial decision?
- Total cost of ownership (TCO): TCO considers the cost of an asset – in this case, an ERP solution – over a time horizon. It includes the purchase price plus the cost of operation. This is often the most important cost to consider, as solutions with higher upfront price tags may prove to be cheaper in the long run.
- The difference between the costs associated with implementing and managing on-premise, cloud, and hybrid solutions: On-premise solutions (perpetual license model) will typically demand higher upfront expenditure than the price of comparable cloud-based alternatives. However, depending on your business’s structure, nature, and scale, the TCO may be lower with one deployment model compared to the others because of fewer ongoing costs.
- Your organisation’s recent IT investments: For example, a company that has recently upgraded its infrastructure, and hired three additional full-time employees to maintain it, will have a drastically different perspective from that of a start-up business trying to maximise their spending on growth.
- The difference between Software as a Service (SaaS) and ‘perpetual’ licensing: Under a SaaS arrangement, you will pay a periodic subscription to use software hosted and managed by a provider in the cloud. Instead of a connection through your desktop or laptop, with a SaaS-delivered solution you typically access that software via the internet, and often on your choice of device. The provider maintains and updates the software on a periodic basis for you. Also, SaaS models enable you to flex your licensing agreement as your business needs shift – in other words, you only pay for what you need. In contrast, ‘perpetual’ licensing means you purchase the software license and take care of maintenance and updates yourself, but your choices are your own and you may have additional capability to tailor the platform to suit more of your business-specific needs.
- CapEx vs. OpEx budgets – CapEx refers to capital expenditure, which includes upfront and one-off costs. In contrast, OpEx encompasses operating expenses. This consists of the ongoing expenses required to support day-to-day business activities.
How does SaaS (cloud) vs. perpetual software licensing (on-premise solutions) impact cost?
Suppose you are deciding whether or not to break free from a traditional perpetual software license pricing model typically seen with conventional on-premise ERP installations and embrace a SaaS solution. In that case, from a cost perspective many factors will come into play in the decision-making process. Let’s break down some of the costs to uncover how your chosen deployment strategy will impact the total investment required.
Costs associated with an on-premise ERP system
An on-premise ERP investment can be divided into several categories of spend, including:
- Physical servers (either rented or owned), as well as space and power to run them
- Operating system and database licensing
- Security software and hardware
- Employees to manage and patch the infrastructure to ensure it functions smoothly
- Employees to create and manage a backup and disaster recovery plan
- Professional services and internal staffing to implement the solution
- Maintenance costs, including annual helpdesk service fees, the external and internal costs associated with deploying new versions and patches into the ERP software itself
You may need to fund some or all of these costs. However, suppose you already have an established and mature IT infrastructure. In that case, for example, the costs associated with purchasing the hardware, the security and data recovery infrastructure required to facilitate an on-premise solution might be lower, making it a more appealing option.
Costs associated with a cloud ERP system
Here are the categories of spend related to a cloud-based ERP solution:
- Subscription fees
- Implementation costs (as above, but generally does not include services for actually “installing” the software for you)
- Minimal hardware and infrastructure costs
You should also consider the risk of subscription fee increases. Fees are not typically fixed and will likely rise over time, so it’s a good idea to lock in any such increases at a known ceiling for the course of the agreed subscription contract term.
CapEx vs OpEx budgets
SaaS subscriptions and perpetual license purchases are generally treated differently in your financial accounts. So, whether you choose one or the other may come down to resource availability across your CapEx and OpEx budgets.
SaaS contracts – even when paid annually – are usually considered an OpEx. In contrast, perpetual licenses for on-premise solutions are generally accounted for as a CapEx on your business’s balance sheet and expensed over future periods for the estimated life of the system.
SaaS sounds like a no-brainer – what’s the catch?
Why would someone pay for all the perpetual licensing, hardware, and maintenance costs and shoulder the burden of data security, updates, and patching when they could simply pay a monthly fee and leave it to the professionals?
Well, it’s a bit like the difference between buying a warehouse and renting warehouse space. If you purchase a warehouse, you have complete control over it. You don’t risk increasing rent costs or being forced to leave if the owner decides to sell.
However, if you buy a warehouse today, there’s no guarantee it will be suitable for your business in five or ten years. The size and location of your warehouse might limit your business’s ability to grow, and moving to a new warehouse will require a significant capital investment and downtime.
Alternatively, if you rent a warehouse, you can move easily if you require more space.
Your particular complete set of circumstances will determine which model financially is right for you, and delivers a total cost of ownership (TCO) based on your needs, your objectives, your people, and so on.
Calculations to help you cost a new ERP system
How to calculate TCO
TCO analysis helps companies define the actual cost of an asset so they can prioritise long-term savings over short-term wins.
A simple TCO calculation involves three figures:
- Initial cost (I): The upfront cost of the asset.
- Maintenance cost (M): The cost of ensuring the asset functions and is useful over its forecasted lifespan.
- Remaining cost (R): The asset’s price in the long term.
Using these three figures, the TCO formula is as follows:
TCO = I + M – R
Depending on the asset and its intended use, you may need to factor in additional costs. Other expenses can include operational, downtime, and production costs.
How to calculate return on investment (ROI)
Expressed as a percentage, ROI is a calculation that helps businesses better understand the profitability of an investment. You can determine your ERP’s ROI using this formula:
ROI = (Cost of investment / net return on investment) x 100%
Depending on the nature of your organisation, you can determine the net return on your investment by considering the following:
People savings: Consider inefficient processes that could be automated and streamlined with an ERP system:
- Automating data entry and downstream processes.
- Embedding business rules into systems that enforce standard approaches.
- Integrating end-to-end processes to reduce time-expensive reconciliations.
- Faster processing of supplier invoices, reducing effort in operational tasks.
- Simplifying end of month and year processes.
- Accessing real-time data anywhere, anytime to create reports or secure answers to ad hoc enquiries.
- Reducing the burden on the internal IT team.
- Cutting down barriers through greater access to shared data to empower collaboration.
Reduced errors: An ERP can drive lower costs, faster turnaround, and superior customer service by:
- Reducing rework.
- Improving quote accuracy.
- Reduction in penalties for late or incomplete delivery.
- Removing the need for extensive reconciliations.
- Enhancing customer satisfaction.
Improved utilisation: An ERP empowers your people to get more out of their time and equipment:
- Reducing setup and closedown time for equipment, generating savings, and boosting machine time availability.
- Improving task scheduling, allowing for more throughput.
- Better matching capacity and resources (people, machines, inventory) to demand.
- Understanding dependencies and factoring them into planning.
Inventory benefits: Having enough inventory to satisfy demand is crucial:
- Improving visibility and control to potentially reduce inventory holdings and save cash.
- Enabling cost of capital savings.
- Minimising the amount of warehouse space required, but also
- Delivering the service level (that is, the % of times you can fulfil an order or internal demand for inventory) that makes sense for your business model and nature of your supply chain resilience.
Increased revenue: An ERP system can boost your revenue and profit margin:
- Enabling employees to better serve your customers with tools like CRM and quoting systems.
- Reducing manual processing ensures you invoice for everything your business is entitled to.
- Capturing revenue leakage, even in complex billing and funding environments like that of aged care and contract-driven operations.
Mitigating the cost of doing nothing: When calculating ROI, be sure to also consider the cost of doing nothing. What is your current environment costing you, and how could an ERP solution reduce or eliminate those costs? Here’s how an ERP can help:
- Allowing scalability that your current systems do not cater to.
- Realising your ambitions to grow without proportionally growing your business’s operational costs.
- Retaining staff by removing points of friction and frustration in their day-to-day.
ERP systems are not one-size-fits-all
The cost of your ERP solution will also vary according to the level and type of ERP that best fits your business. There are four tiers of ERP and thousands of ERP software options on the market. Which tier of ERP software your business requires comes down to the stage of growth and future goals of your business and depends on several factors, including:
- Your organisation size (e.g., how many users you require)
- The complexity of your software requirements (e.g., do you need core financials and one or two additional modules, or do you need an ERP to power your whole business?)
- Geography (e.g., is your team operating from the one location, or do some employees work remotely or on-site?)
Tier 1 solutions are generally expensive to buy and time-consuming to implement. Moreover, they cater to large enterprises with bespoke needs, global networks and highly standardized approaches to all aspect of the business (e.g., SAP).
Tier 2 solutions best serve mid-sized businesses with relatively extensive networks and industry-specific needs (e.g., Epicor Software), or SMEs with greater complexity, or perhaps looking to cater for future growth.
Tier 3 solutions are built for the smaller end of small-medium enterprises, typically with 20 or fewer users. They are usually simpler and less feature-deep, making them cheaper and quicker to implement (e.g., MYOB, Pronto).
Tier 4 solutions offer basic accounting systems for very small businesses (e.g., Xero).
Sometimes, depending on the nature of a given set of business requirements, the best ERP software solution may be a cross between two tiers – e.g., “Tier 2/3”.
Ready to make a business case for ERP?
A new ERP platform can be a game-changer. It can drive growth by tapping into the business’s potential, helping you and your team work smarter and bring in more revenue. What’s more, an ERP can reduce the costs associated with outdated or underperforming software, driving measurable savings that balance and then exceed the investment in licensing, implementation and so on. If you are ready to explore what a new ERP system can do for your organisation, reach out and book a discovery call with one of our ERP specialists today.