May 15 2008

ERP Cost of Ownership 2008 | Radar Group International

ERP COST OF OWNERSHIP

A report covering the less defined cost element with the

highest impact on costs over an ERP systems life

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Executive Summary

Western Europe (WE) is a high cost region with modest economical growth. The

IT maturity is high and ERP investments are increasingly becoming more

strategic as tools to:

– Drive process and production efficiency

– Drive transformation of business to suite a market and a constantly

changing business landscape

– Gain agility in operations to quickly adapt to changing market demands

The productivity in the economy has increased with an average of over 2 percent

every year since 2001. That implies that an organization that does not improve

efficiency with over 4 percent in the region is losing productivity and

competitiveness thus underlining the importance of an ERP system that supports

efficiency, flexibility and gains in business logic.

The Line of Business directs changes in strategy, tactics and business processes to

meet new challenges such as new ways of doing business, changes to gain

competitive advantage or governments setting new regulations. No business stays

the same and the pace of transformation is rapidly increasing. The ERP system

might start to become an obstacle to necessary change if the life time cost is too

high.

Cost of Ownership (CO), defined as the operational costs and the upgrade costs

over the life of a system are the less scrutinized costs in ERP procurements in the

region. Without proper evaluation of the CO in any ERP investment it will be

exposed to risk. Any uncontrolled cost will jeopardize not only the economy in

the investment but the organizations ability to be agile and competitive. Therefore

it is of outmost importance that the CO is taken into strategic consideration

during evaluation and selection in order to proof any ERP system for the future.

Cost of Ownership (CO), the combined costs of operational and upgrade costs, is

somewhat a measure of complexity in operations. For ERP software, complexity

will mean both higher costs and less ability to keep the ERP system up to meet

ever-changing needs of the business. The result of this study shows that the CO is

the single largest cost item over the life time of an ERP system in this region. The

average CO proved to be on an average 6 times the original ERP investment

including adaptation cost.

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This finding will have a major impact on how companies are buying ERP and on

decisions that companies need to take regarding their existing solutions.

Very little effort and time is spend, in an already extended procurement

processes, on the major cost elements of an ERP systems. The study found that the

CO was the less known and defined and further that the upgrade cost as the

largest cost element have the potential of adding more than 3.3 times the original

ERP investment cost to an organization.

The CO can be an obstacle or an advantage to drive the necessary change to an

ERP system in order to stay agile over the system’s life time. The study shows that

the CO of an ERP system can differ with more than double the yearly cost

between different suppliers with similar usage.

The report has found that the CO is the least defined part of the cost structure in

an ERP investment. During the life time of the system an organization will need

to pay over 6 times the original ERP investment amount for the operational costs

and the upgrade costs on a mean level. The upgrade cost has the potential of

becoming the largest cost contributor with 3.39 times the original ERP investment

cost over the life system. If the cost of upgrades is high companies might not be

able to do the necessary changes and that will have a major impact on the

company performance.

CO evaluation will need to be performed as a strategic part of all ERP system

evaluation processes as the CO will have increased strategic importance for Line

of Business potential in this region to achieve targets and goals.

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Content

1. Introduction

2. ERP investments

The ERP drivers

The procurement roadmap

3. Radar Group Cost of Ownership model

The ERP CO model

ERP CO comparisons

Assumptions

4. Radar Group Cost of Ownership findings

Findings

Conclusions

5. The importance of CO in evaluations

6. About Radar Group International AB

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1. Introduction

The objective for this report is to help customers get a better understanding of

how the Cost of Ownership (CO) affects the life time cost of an ERP system.

CO is defined in the chapter Radar Group Cost of Ownership model. CO is a

major contributor to the success or failure of an ERP investment and needs to

be investigated based on the regional differences in more detail.

This report has been completed by performing benchmark studies of over 250

enterprises and in-depth interviews with 200 CIO´s and CFO´s. Also by using

market data collected by Radar Group regularly and from Radar Group on-

line real-time benchmark tool www.it-position.com.

The cost experiences on existing implemented systems have been collected by

Datadia on our behalf. All insight and analysis has been performed by Radar

Group consultants.

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2. ERP investments

Western Europe (WE) represents a region of modest economic growth and

shows all the signs of a mature IT market. IT investments through the

dedicated IT budget encompass an average of 4 percent of the total turnover in

the organizations in the region. IT growth is on a strong level, twice that of the

average economical growth in the region. This is indicating the importance of

IT in the investment portfolios of the organizations.

In WE the strategic drivers for investments are to achieve lower costs and

increased efficiency. In a high cost region it is crucial to manage IT

investments correct in order to gain productivity. Line of Business,

management and owners has become increasingly involved in IT investments

as the IT investments are the key to success. Efficiency requirements will force

costs down and favor IT solutions that will add productivity to the

organization. Flexibility requirements will drive solutions for IT productivity

based on new demand structures and new business models.

Source: Radar IT efficiency report

53%

22%

25%

IT resources utilization

Run IT environment

Optimize IT environment

Transformation

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Close to 25 percent of the combined IT resources in a WE organization is used

to transform the operations today whilst the remaining 75 percent are spent on

operations of the present IT production environment. The most effective and

agile organizations will be those that can redistribute as much as possible from

operations over to transformation. The ERP system is a major influence on cost

as the single largest cost item in the IT production of an organization standing

for approximately 9 percent of the total IT spend.

The total value of ERP solutions in WE amounts to 8.2 billion € and represents

the largest market segment. License sales amount to 2 billion € and service

sales 6.2 billion €. The annual compound growth will be 6 percent in 2008.

The ERP drivers

The region is an established ERP market. Strong economical growth and an

increasingly more rapid change process to stay agile are major contributors to

the demand for increased ERP functionality.

The need for efficiency improvements, flexibility and need for quicker changes

and adaptation for new business logic are the prime drivers for ERP market

growth in WE.

Source: OECD (GDP per hour worked)

95

100

105

110

115

120

125

130

135

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Sweden

Denmark

Finland

Norway

EU15

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The productivity in the WE economy has increased with an average of over 2

percent every year since 2001. That implies that an organization that does not

improve efficiency with over 2 percent in the region is losing productivity and

competitiveness thus underlining the importance of an ERP system that

supports efficiency, flexibility and business logic gains.

The change processes in the market is becoming even more rapid and the

possibility of upgrading the system will become increasingly more important.

The users of ERP systems have experienced a very high life time cost for

implemented systems at the same time as many suppliers have high margins

on the after sales business. This has also forced many customers into having

no possibility to upgrade their existing systems. When comparing the number

of upgrades in the installed ERP base, as many as over 42 percent of the users

of a specific system with the lowest upgrade number had not performed any

upgrades at all over the life time (12 years) of the system. The spread was large

between different systems and in best case 94 percent had performed

upgrades and in worst case only 58 percent had performed upgrades. Cost

was given as the prime reason for not being able to upgrade.

The procurement roadmap An investment in an ERP system is a change process that will effect more or

less the whole comapany. Organizations, management, external resources and

even owners are spending a lot of time and resources.

Many customers has bought ERP systems at least 1 – 2 times before. Despite

WE being a mature ERP market much effort in is spent on functionality and

implementation and little on the life time cost.

The decision process is under the influence of management and owners and a

tentative ERP investments needs to be prepared well for the management

decision. Two strategic dimensions drives the customer perception of Return

of Investment:

- Cost reduction - “more for less”

- Gains in efficiency - “competitiveness”

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A general roadmap for an ERP investment can be described as below:

As the roadmap outlines a lot of effort will need to be put in to an ERP

investment.

Lessons learnt from project that have failed to provide value in the region are

importance of:

- Driving change

- Being able to measure costs and value over time

Lessons learnt from projects that have provided value in the region are:

- Focus not only on investment costs but on life time cost in the project

- Sponsored as a strategic project by the management

A sourcing processes needs not only to have focus on system capabilities and

supplier competence but also on the strategic cost aspects over the system life.

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3. Radar Group Cost of Ownership model

Radar Group’s Cost of Ownership model is based on the Total Cost of

Ownership model, but focus on the costs after the initial implementation

project. The following cost elements are usually considered in a Total Cost of

Ownership (TCO) model:

External costs Internal costs ERP hardware purchases incl. maintenance,

upgrades and disaster recovery

Infrastructure and network expansion

ERP software purchases incl. licenses,

customization, upgrades and maintenance

Other software such as databases, middleware, security

and operating systems

Data migration Data migration

Installation Installation

Implementation Implementation

Training Training

Support & Help desk Support & Help desk

ERP system management ERP system management

Indirect costs incl. costs for asking colleagues, system

downtime, user unique development costs etc

In order to complete a TCO analysis the benefits and the Value of Ownership

of an ERP investment needs to be taken into consideration. Benefits such as

increased accuracy in inventory, increased manufacturing on schedule,

increased compliance on-time and on-quality, reduction in costs, increased

efficiency and increased flexibility needs to be calculated and put to value.

Benefits and values are difficult to measure and to calculate in a TCO analysis.

Based on our experience the value differs between different solutions that all

meet customer requirements are relatively small. The main project investment

is in an ERP project well defined, consequently the initial cost is well known

and the value is difficult to calculate. Therefore we have chosen to focus on the

cost of the ERP system after it has been implemented as it is less known and it

will have the major impact on the strategic and operational value of the ERP

investment.

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For the breakdown of the general cost elements of an ERP system in the

region, we have used the most spread and common model (the Gartner TCO

model) which encompasses the elements defined below:

The five different cost elements in the model are all defined and should be

known to a buyer of a system. The main project cost as well as the pre project

and roll out costs are all part of the procurement process and as such

scrutinized in depth in most of the investments performed. The operational

cost and upgrade cost are the two parts that contributes to the Cost of

Ownership (CO) of the life of a system. The operational cost is mostly man

hour costs whilst the upgrade cost is a more complex cost structure around

software, hardware and reoccurring costs for adaptation and rollout.

Both elements of the CO represent less known costs and in our experience less

scrutinized cost items in an ERP investment project. As the Line of Business

expects an organization to be agile and highly productive, CO is a

measurement that we will put focus on in this report.

Main Project

Software costs

Hardware

costs

Adaptation

costs

Pre Project

Analysis

Pre studies

Rollout

Implementation

Training

Operational

Maintenance

Operations

Support

Upgrade

Software upgrade

Hardware upgrade

Re adaptation

costs

Rollout costs

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The ERP Cost of Ownership method

The ERP Cost of Ownership method takes into consideration that the change

process in a maturing ERP market is becoming increasingly more rapid and

efficiency and flexibility requirements are of a high importance. Close to 25

percent of the combined IT resources in organization in the region are used to

transform the operation today. The ROI for ERP investments have focus on

driving costs down and efficiency up in an environment where results are

hard to measure and hard to follow up. CO is actually a measure of

complexity in operations. For ERP software, complexity will mean both higher

costs and less ability to keep the ERP system up to meet ever-changing needs

of the business.

The Line of Business directs changes in strategy, tactics and business processes

to meet new challenges such as new ways of doing business, changes to gain

competitive advantage or governments setting new regulations. No business

stays the same and the pace of transformation is rapidly increasing. For ERP

systems to be able to stay up with constant evolving business need to meet the

long term requirements for efficiency, flexibility and changing business logics

but also offer simplicity in operations and upgrade or the CO will increase

dramatically.

CO is important to evaluate and measure to make sure that the ERP system

does not start to become an obstacle to necessary change in the organization.

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Assumptions

In order to complete a TCO analysis all cost aspects as well as the benefits of

an ERP investment need to be taken into consideration. Benefits are hard to

calculate and can be assumed to have a close to equal contribution from any

operational ERP systems as the selected system in each case will have had a

good fit against the customer initial requirements. We will instead take a

stance from the requirements driving the performance needed of a future

proof ERP system and look at the cost elements with the largest cost

uncertainty. They are the CO elements operational cost and upgrade cost.

Our research has found the present mean level of number of upgrades

performed to be 1.8 upgrades over the life time of the system in WE.

Our earlier research has showed a correlation between customer satisfaction

and upgrades to the ERP system. Independent of what system you had in use,

those that had done no upgrades showed a lower general satisfaction

compared to those that had performed upgrades during the operational phase

of the system.

The assumptions that will be used for the CO comparison are based on the

trends that are driving the ERP requirements in a maturing WE market as well

as consideration of present level of upgrades in the installed base of ERP

systems in use in the region.

We have concluded that the will use the assumptions of a need for a version

upgrade of an ERP system every four years and a total life time of 12 years for

the purpose of establishing a common model based on requirements for

comparison reasons.

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4. Radar Group Cost of Ownership findings

Quantitative research have been conducted covering over 900 organizations in

order to find the distribution in cost between the different elements based on

user experiences and by applying our assumptions. The finding was that the

CO (operational cost and upgrade cost) will be over 6 times the original main

project investment and by far the largest cost element.

© Radar Group International AB

Definitions:

Main Project Hardware, software and unique adaptation costs

Pre project Costs for pre studies and analysis

Rollout Implementation and training costs

Operational Costs for maintenance, operations, help desk and support

Upgrade Software upgrade, Hardware upgrade, re-adaptation and

re-implementation costs

The finding is that the less known cost elements are the largest costs over an

ERP systems life time in the region. Our research also found that upgrade

costs is the largest cost contributor in the CO calculation.

100

326

270

339

0

50

100

150

200

250

300

350

400

Main project investment

Pre Project costs Roll out costs Operational costs Upgrade cost

CO index structure

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As the operational cost is mostly internal or external man hours in defined

processes we will put the focus our continued focus on the largest of the less

defined cost element – the upgrade cost.

As a general facilitated CO formula for simple benchmark calculation the cost

distribution on the mature WE ERP market can be summarized as:

ERP project investment

(ERPPI)

Direct costs for software, hardware and

adaptation of solution against

requirement

Pre Project 0.03 * ERPPI

Rollout 0.26 * ERPPI

Operations (12 years) 2.70 * ERPPI

Upgrade (3 upgrades) 3.39 * ERPPI

The upgrade cost is complex as it has different cost elements such as time,

software, hardware and reoccurring costs of other cost elements. Our finding

based on user experiences was that the largest cost drivers within the upgrade

cost are man hours and software costs. The upgrade cost breakdown in the

region was found to be:

Man hours, both external and internal resources, was found to be the largest

cost contributor with an average contribution of 48 percent of the upgrade

cost. Software was the second largest with an average contribution of 36

percent of the incurred costs.

36%

48%

16%

CO cost breakdown

Software

Manhours

Other

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The report has found that the CO is the least defined part of the cost structure

in an ERP investment. During the life time of the system an organization will

need to pay over 6 times the original ERP investment amount for the

operational costs and the upgrade costs on a mean level. The upgrade cost has

the potential of becoming the largest cost contributor with 3.39 times the

original ERP investment cost over the system life.

CO is the less scrutinized cost in ERP procurements in the region. Without

proper evaluation of the CO in any ERP investment it will be exposed to risk

and uncontrolled high cost will jeopardize not only the economy in the

investment but the organizations ability to be agile and competitive.

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Conclusions

The main conclusions of the CO report can be summarized as:

- The CO elements is on an average over 6 times the cost of the initial

investment including adaptation

- Upgrade cost amounts to 339 percent of the initial investment

including adaptation over the life time of the system

- Software cost is 36 percent of the total upgrade cost among those who

have performed upgrades

- The CO differs largely between different suppliers. The diffence can be

as much as double the CO per year for similar cases.

- The largest cost over an ERP system life time is the least defined, the

upgrade cost although organisations in the region makes 1.8 upgrades

over the life of an ERP system today. Cost for performing upgrade is

the prime reason for not have performed any upgrade among those

who state they have not.

- CO evaluation will need to become the most important part of a well

performed ERP evaluation process in the future

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5. The importance of evaluate Cost of Ownership in a procurement

The largest contributing cost element of an ERP systems total cost over its life

time cannot be neglected in procurement. A potential cost of more than 6

times the initial total ERP investment over a twelve year period represents a

very high cost to all organizations. CO must therefore be addressed as a part

of detailed evaluation of an ERP system.

Radar Group has developed a more detailed ERP CO model that can be used

in order to evaluate different systems CO based on the unique prerequisites of

any individual procurement. The CO evaluation takes only one day to

perform and will be important to perform during the preparation or selection

phase.

Contact Radar Group for further details and cost for this one day packaging:

info@radargroup.se

•Industry & size

•Project specific

Requirements

•Benchmark

•Suppliers

Suppliers•The model

•Adjusted assumptions

CO calculation

•ERP systems CO rating

• Requirements to proceed with

CO evaluation

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6. About Radar Group International AB

Radar Group covers the whole ICT ecosystem with focus on the Nordic

region. We research and analyze the technology enablers, the value adding

partner and distribution channel and the end customers. We work with

detailed business planning forecasts for all hardware, software and service

categories in the ICT market as well as with the development of all cost

elements and indicators in the ICT management role of the ICT department.

This is done by research every 6 months of all enterprises in the Nordic region

with more than 200 employees, through our unique on-line models for IT

benchmarks and value measurements and through several hundred in depth

interviews with ICT decision makers every 6 months. Using these facts from

all sides of the ecosystem we build the insight that we use in our strategic

work towards our customers.

Radar Group has offices in Stockholm, Oslo, Copenhagen, Helsinki, London

and Paris.