ERP (Enterprise Resource Planning) - Part One
I finally had some time today to get the first part of this article completed and I decided to post it as a sneak preview. I will expand on this topic and am planning to add a lot more information later.
1) What is ERP?
ERP stands for "Enterprise Resource Planning". ERP is a software product that is capable of running and integrating multiple different organizational functions such as accounting/financials, human resources and payroll in a shared database. Without going much into detail on what this means, let me jump right into a real life example. I'm assuming that you know a little about the employment process, perhaps from your work experience.
Let's say you are applying for a job. The process is pretty straightforward nowadays - you find a good position worth applying for either online or through other resources such as recruitment agencies, then submit your resume and wait for a call or email follow-up. After a while you get screened and interviewed by a company that is interested in your skills. Then, if you are the right candidate, you get hired.
Sounds simple and straightforward right? But how about the employer? The recruitment process for the employer, unfortunately, is not as simple.
An organization that is interested in filling an open position goes through a substantial list of complex tasks and processes. This list can be quite extensive, depending on the size and the requirements of the company. A small company, for example, would perform some or all of the following processes:
- The HR department of the company gets notified about an available position and is requested to recruit candidates.
- A detailed job description is created, which lists such things as required skills, prior experience and education.
- The job description, along with the rate of pay is either submitted to a recruitment agency or the HR department itself performs all of the recruitment tasks such as posting of the vacancy online, performing initial candidate screening, background checks, etc.
- Once potential candidates are identified, they are invited for a formal interview with the management of the company, which then picks one final candidate for the open position.
- If both the employer and the candidate agree on the salary, benefits and terms of the employment, the employer creates an offer letter and sends it to the candidate, after receiving prior approval from the senior management of the company.
- The candidate signs the offer letter and sends it back to the company.
- The company performs the hiring process via an HR software system (sometimes called "HRIS" or "HRMS") that stores both personal and professional information of the new hire. Such data as Social Security Number (SSN), first name, last name and date of birth is saved into these systems. The salary information is stored in a payroll system, which takes care of calculating various state and federal taxes, deductions and performs other payroll-related activities. Medical, dental, insurance, 401K and other benefits are also entered into benefit providers' computer systems.
- Once the above tasks are completed, several departments get involved in preparing the new work environment, purchasing equipment, plugging in phones and other corporate devices, creating business cards and email accounts, etc.
The above list is typically called a "business process" in the ERP world. Business processes vary from company to company, from simple to very complex. Most small and medium-sized companies perform these business processes manually, fully relying on their human resources. Such simple, yet vital tasks as data entry into multiple computer systems become "points of failure", resulting in synchronization issues, loss of data and other potential risks.
Most organizations store their data in multiple computer systems created by various software companies. Because of this, sharing information between systems is extremely complex and a lot of organizations fall back to manual data entry. And that's where problems start accumulating over time. John Doe could potentially be "John Doe" in one system, "John Do" in another, and "Jon Doe" in the third. Well, it is not a big problem, you might think, since all three are the same person and would still have the same social security number across all three systems, right? Well, what if the SSN number is wrong in any of the systems? You get the point...
Some companies create bridges, called "interfaces" between software products. These interfaces are designed to export key information from one system and import into another. For example, if your personal information such as your name, address and your salary is stored in one database (HR & payroll) and your time and attendance in another, an interface would feed your attendance details (such as total hours worked and overtime) into the payroll system so that you can get paid. But interfaces are costly to maintain, as any changes in software could require updates to the interfaces. A single malfunction in an interface could stop the entire process from running, impacting business and causing synchronization nightmares.
For the above recruitment process example, a company could be using 5 or more different software packages to manage the company data:
- HR (human resources to store personal and other employee data).
- Time Management (software that records employee time, hardware that lets employees punch in and out).
- Payroll (the system that computes taxes and pays employees).
- Benefits (to manage health plans, insurance, 401K, etc).
- Financials (financial software that stores accounts payable/receivable, general ledger and other financial data of the company).
To get you paid correctly, at least the first four of the above software components need to be able to "talk to each other". The HR database stores your name that will be printed on the payroll check. Time Management records the number of hours you have worked in a given pay period. Time data is then fed into the payroll system that multiplies total hours worked by your hourly wages. State, federal and other applicable taxes and your benefit premiums are deducted from the total amount and a final check is then printed from the payroll system. Last, the payroll results are posted into the financial system for analysis, reporting and reconciliation. Can you imagine what happens if any of the above fail? A potential disaster! Either way, the last thing an organization wants to do is mess with employee checks. Payroll problems equal endless class-action lawsuits. And this is an oversimplified example of the payroll process...you can imagine what the real process is like, especially in large organizations.
How about other business processes though? If the company is a manufacturer, then add additional software packages for managing inventories, production, quality control, supplier/customer relationship management, product life-cycle management, etc. Depending on what the company does, there is also specialized industry-specific software. Now, try to picture what companies have to go through to make everything work. All of the above systems have to talk to each other, each software component needs to be regularly maintained and updated to keep up with new laws and regulations, not to forget that the company also needs to figure out how to extract this data from all of applicable systems and create reports to monitor and efficiently run the business.
Aren't there software products that combine all of the above into a single software package?
Historically, it was impossible for software companies to create an all-in-one software suite that contains so many components. First of all, these components are extremely complex in their nature and creation of a single software product that suits everyone's needs was also an impossible task to achieve. On top of this, you have laws and government regulations that require periodic modifications to software products to stay compliant. During the last 30 years, because of a lack of standards, software products evolved in too many different directions and most companies chose to work with software products that suit their needs better than others. Small software companies that successfully customized their software for one company had tremendous growth opportunities if their software was also usable in other similar companies and start ups. Eventually, those who were the most successful were able to develop highly customizable software suites that could be used in multiple industries. They standardized software by listening to customers in different fields and created an idea of "best practices", which is basically how most companies choose to run their businesses. Standardization and best practices, especially in manufacturing, became keys to success and many large manufacturers rushed to adopt this hot idea. Seeing the success of standardization in manufacturing, software companies quickly started selling the idea to other industries. Eventually, they kept on adding more and more integrated software components using the same software architecture, resulting in large software suites that we call "ERP" today.
In our previous example, what if the company had tightly-integrated software that had Financials, HR, Time Management, Payroll and Benefits capabilities all in a single product? What if there was an automatic information flow and exchange between the aforementioned software components? What if you could add more capabilities to this product when your business expands and your business requirements change? Sounds beautiful, doesn't it? So does the idea of ERP.
But ERP is also expensive and hard to implement, which is why companies hold off on purchasing and implementing it. Most small and medium-size businesses do not have the luxury to spend millions of dollars in software and implementation costs. In addition, ERP systems are extremely complex and could take years to implement, consuming colossal company resources.
2) ERP Implementation: Pros and Cons
If ERP is so powerful and can do so many things, why isn't everyone implementing it? Isn't it logical for all companies to invest into an ERP platform? In this section, we will analyze the pros and cons of an ERP solution.
Here are the advantages of ERP:
- Consolidation of data into a single platform is probably the biggest advantage of ERP systems. Data consolidation leads to accurate, almost real-time results that many businesses need to be able to effectively react to changes in the global marketplace. Fast-growing companies have rapid data growth, which makes it extremely hard to manage multiple systems and their integration. Introduction of new divisions within the company bring more software to the mix and data integrity, security, compliance and reporting become big headaches, creating information silos across the organization. An "all-in-one" integrated ERP software package that answers most of the needs of the company, eliminating information silos and blending various systems into a single, yet manageable platform becomes the most logical choice. In laments terms, ERP puts multiple sources of information into a single database. Senior management no longer needs to request the same information from multiple departments and systems (only to find out that all the numbers are different) - they can access this information themselves and not worry about inconsistencies.
- Information transparency plays a key role in ERP systems. Making data available to all areas of the company leads to information transparency, which in turn, enhances communication and increases efficiencies throughout the company. For example, a sales department employee, while working with a potential customer, could retrieve information on product stock/availability from the warehouse, look up current and past product pricing in real-time, evaluate pricing by looking at the number of units sold and make an immediate decision on the selling point, all through a single software product, without waiting for anyone to provide the data.
- Information security is another key element of an ERP system. Maintaining access to multiple systems consumes valuable resources and poses serious risks on information security. ERP systems greatly enhance the security by providing controlled, centralized access to various company data. This single point of access control simplifies the security policies and protocol and helps to reduce information "loopholes".
- Industry expertise and best practices are extremely important for companies of all sizes and it is one of the hottest selling points of ERP systems. Why reinvent the wheel, when you could easily adopt what other similar companies have been successfully doing for decades?
- Manual processes, especially in a fast-moving environment hurt businesses. Automating manual processes by creating process models via software is ideal and ERP systems can make this happen. A simple manual process automation example is an invoice approval process. Every company pays vendor invoices and each company defines their own level of control and approval process to pay these invoices. For example, month-to-month electric bills might need a minimum level of approval from a company accountant, who physically stamps the invoice and pays the vendor, whereas a large invoice for construction material might have to be approved by the president of the company. Traditionally, the invoice would be sent to the president for his physical stamp or signature, which is required for the accountant to process the invoice. With an ERP system, a workflow process could be designed whereby the invoice is electronically scanned and the system automatically triggers the right workflow path and routes the invoice to the correct person for approval. Different criteria and thresholds could be set on the software level that fully automate this process. In this case, the accountant scans and processes the invoice and simply forgets about it. The invoice goes through the approval process and once it is approved by the authorized staff, a check is automatically processed for payment. If a vendor calls to find out the payment status, an accountant could simply look up the invoice and provide the status of payment in real-time.
- Sarbanes-Oxley and other government-driven laws have complex and specific requirements for auditing, reporting, recruitment and other business processes. Compliance is very important and companies want to minimize associated risks by investing into ERP systems that can handle and quickly react to complex government regulations. Furthermore, multi-national organizations have a hard time keeping up with all local laws and regulations. An ERP solution that is capable of dealing with multiple currencies, payroll systems, local taxes and regulations is the answer.
- Companies want to invest in systems with a good future. The last thing you want is invest money in a company with unknown or no future. It is unfortunate when organizations choose to spend millions of dollars on customized solutions with local software vendors that quickly go out of business and cannot continue to provide their services. Most large ERP system vendors with a good customer base have solid growth. They spend millions of dollars in R&D and continue to enhance and update their software, quickly reacting to potential changes and immediately addressing software problems.
- Flexibility and ability to customize applications to suit company's needs is extremely important for some companies. ERP systems are so flexible, that some companies completely change the core functionality of the product and create their own breed of the system, heavily optimized for their businesses. Customization is not always the best practice as it opens up potential problems, but if a company has competent resources that are able to create their own solution, rigorously test it and prove that it works better than the "out-of-the-box" solution, ERP vendors do not mind such practice. In fact, ERP companies evaluate such implementations and sometimes choose to adopt customized solutions that could be used by other potential customers.
- And last, but not least, implementing an ERP system is a good way to clean up existing data. Most companies have a hard time keeping their data consistent and accurate. Implementing an ERP solution helps to clean up the data and start over "fresh". If all processes are designed correctly and heavily tested, future data inconsistencies could be prevented for good.
On the other hand, implementing an ERP system also has its disadvantages:
- The first and the foremost reason why companies stay away from implementing an ERP system is cost. The larger the company, the higher the cost of implementation and ongoing maintenance of ERP systems. ERP vendors typically charge an arm and a leg for their software and their "premium" support. In addition to license costs, there are also consulting fees for implementing and customizing an ERP system. Add training, support costs and other related fees and you are potentially looking at millions of dollars of investment. It is typical for companies to over-spend and under-budget ERP projects. There are a lot of hidden costs in ERP systems, which we'll discuss later in more detail.
- Time is another big disadvantage of implementing an ERP system. A typical implementation takes 6-12 months, depending on the project scope, which could easily be extended to multiple years if not managed properly. There are some rare cases when companies implement ERP systems in under 3 months, but it typically only happens in start-ups or in companies that are willing to implement "ready-to-go" industry solutions.
- Implementing an ERP system drains company resources, which negatively affects the ability to run and maintain business as usual. In many cases companies end up hiring additional staff to accomodate the resource requirements of an ERP implementation, in addition to providing internal human resources on a part-time basis. It is not possible to successfully implement an ERP system without dedicating existing company resources. Consultants have no idea what you want and how your business operates - they need to understand your objectives in detail and the solution would be customized based on those needs.
- Organizational change and change management is also a big problem. Nobody likes to change the way they normally do things, especially those who have been doing it for years. ERP systems introduce heavy changes to the way business operates and impacts most day-to-day activities. Everyone at all levels of the company must be fully aware of the ERP implementation and there must be solid senior management buy-in or the company will face heavy resistance to change.
- Potential disasters related to improper planning and implementation. More than half of the ERP implementations fail, some from the get-go and some later on in the process. Sounds scary, but it is true. Each case of failure is different, but most have the same pattern along improper planning, inadequate internal resources, high expectations, incompetent staff and/or implementation partner, under-budgeting/overspending and insufficient training. A failed ERP implementation can bring a company down to its knees, especially if serious problems are discovered after going live.
It only makes sense to implement an ERP system when advantages far outweigh the disadvantages in your environment. This requires a good in-depth analysis of business processes, current issues, potential risks, TCO (Total Cost of Ownership) of current systems (software, hardware, consulting, etc) and much more. Once the analysis is complete, you would then have to weigh in the benefits of an ERP system. What would ERP do for you that your current software cannot? How would it help you optimize your business and run your business more efficiently? Would it provide competitive advantage? Would it help you reduce operating costs? How would it appeal to employees and company stakeholders? Who would benefit most from the ERP system? How much would it cost to implement ERP and replace your current system? What is the ROI (Return on Investment) and TCO for implementing ERP in your environment? Which ERP vendor would you choose and why? These are just some of the questions you will have to ask and research before making a decision on whether it is worth implementing ERP for your company or not.
Related posts:
