This post is on a topic that is normally an exception scenario but may become more common because the economic impact of the COVID pandemic may disrupt companies more than a typical recession.
The Problem: Companies faced with materially lower revenue projections need to look beyond temporary cost reduction and achieve a new lower cost structure that is sustainable. Tier 1 ERPs are expensive to operate (software maintenance, IT infrastructure, and IT staffing) and the fixed cost may not be a good fit with the new economic reality.
The Opportunity: Tier 2 ERPs, especially cloud-based ones, have improved greatly over the past decade and can be implemented at a reasonable cost. In some cases, the entire cost of acquiring and implementing a new tier 2 ERP can be less than the current cost to operate a tier 1.
Two examples I have seen in which the original choice of a tier 1 ERP system was overkill are:
- A company was running SAP S/4HANA primarily for their corporate processes with capital project and related procurement processes soon to be implemented. Core operations were on a best-of-breed niche system that was scalable and intended to be kept for years. The cost of an upcoming SAP upgrade and implementation of the additional processes was estimated at 50% higher than the cost to acquire and implement a tier 2 ERP that covered the same scope. Viable options existed to replace SAP and reduce software maintenance costs.
- A non-profit organization was running Oracle EBS because some niche accounting requirements existed they originally felt could best be met with a tier 1 ERP system. The annual maintenance alone was more than 1% percent of annual revenue. Viable options existed to replace Oracle EBS with a niche system given the size this organization expected to remain for the foreseeable future.
Is it reasonable to replace your tier 1 ERP system?
In the past, the idea of taking on an ERP project when a company had a working system would have been a complete non-starter. ERP projects are not easy and present significant operational risk. In the post-COVID world, having a cost structure that no longer fits your business reality is a real threat happening right now. Not looking at options is a risk.
Here are questions you can ask yourself to determine if your company may be a candidate for restructuring around a tier 2 ERP.
- Will my transaction volumes in the ERP, going forward, be less than 15,000 per day?
- Tier 2 ERPs can become poor fits at high transaction volumes (this constraint is often more relevant than number of users). Companies may already have systems separate from the ERP that focus on the high-volume part of the business, so the key is to focus on what transaction activity the ERP is required to support.
- This question will filter out the largest companies quickly; however, there may still be business units that are run in a decentralized organization that could meet this criterion.
- Was my tier 1 ERP system implemented 5+ years ago? Is it overdue for a functional upgrade?
- The older your tier 1 ERP version is, the more likely new tier 2 ERPs have comparable functionality to what you have now. In my experience, few companies truly utilize the depth of functionality their ERP provides (whether tier 1 or tier 2). So, in a long-term cost constrained environment, right-sizing your ERP can be a productive trade-off.
- Do I have difficulty maintaining internal subject matter expertise in IT to support the ERP system and make incremental enhancements?
- The depth and breadth of tier 1 ERPs tends to mean individuals focus on specific functional modules and few individuals can provide end-to-end support. New tier 2 ERP systems, especially SaaS ones, generally require less expertise to make incremental functional changes. Business analysts and IT oriented end users can be trained and perform as functionally oriented system administrators. Implementation VARs can be utilized on-demand for complex projects.
How can I quickly judge whether replacing my Tier 1 ERP is worth spending time on?
Answering yes to the above questions is a trigger for doing some economic analysis. This may take a little more effort depending on how your company’s IT budget categorizes costs and whether you want to do your own research on tier 2 ERP costs. The basics are:
- Identify your minimum annual total cost of ownership for your tier 1 ERP.
- Include maintenance costs on the software and any dedicated infrastructure, plus costs for IT employees and service providers primarily focused on supporting your ERP system.
- Identify any large one-time costs expected in the next three years for an upgrade or roll-out of new modules.
- Assemble a conceptual estimate of the costs to acquire and implement a tier 2 ERP.
- You can contact one or two ERP vendors directly and have a very general discussion so you can qualify them, and they can qualify you for fit. Alternatively, a consulting firm or benchmarking company can share experienced perspective on this. A “back-of-the-envelope” estimate is normally easy to generate with just some basic info about your company.
If the costs to implement a tier 2 ERP system are materially less than the current annual support and the expected one-time costs, then it is likely the ongoing cost structure will be lower. The idea of replacing your ERP is worth assessing more rigorously.
Even if further analysis concludes replacing the tier 1 ERP is not the right direction, your organization can become recommitted to their investment and actively seek out increased value to better leverage the fixed costs.
Casey Hall is the Managing Director, Business and Technology of Vaco’s Houston team here. Request to speak with Casey Hall in the “How can we help” form field.
