IT trustworthiness dependence for sustaining business growth

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IT trustworthiness dependence for sustaining business growth

  1. 1. May 15 2008 ERP COST OF OWNERSHIP A report covering the less defined cost element with the highest impact on costs over an ERP systems life ERP Cost of Ownership 2008 | Radar Group International
  2. 2. 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 2 average CO proved to be on an average 6 times the original ERP investment Page including adaptation cost.
  3. 3. 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. 3 Page
  4. 4. 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 4 Page
  5. 5. 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. 5 Page
  6. 6. 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. IT resources utilization 25% Run IT environment 53% Optimize IT environment 22% Transformation Source: Radar IT efficiency report 6 Page
  7. 7. 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. 135 130 125 Sweden 120 Denmark 115 Finland 110 105 Norway 100 EU15 95 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: OECD (GDP per hour worked) 7 Page
  8. 8. 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” 8 Page
  9. 9. 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. 9 Page
  10. 10. 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, Infrastructure and network expansion upgrades and disaster recovery ERP software purchases incl. licenses, Other software such as databases, middleware, security customization, upgrades and maintenance and operating systems Data migration Data migration Installation Installation Implementation Implementation Training Training Support & Help desk S upport & 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. 10 Page
  11. 11. 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: Main Pre Project Rollout Operational Upgrade Project Software upgrade Software costs Maintenance Analysis Implementation Hardware upgrade Hardware Operations costs Re adaptation costs Pre studies Training Adaptation Support costs Rollout costs 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. 11 Page
  12. 12. 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. 12 Page
  13. 13. 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. 13 Page
  14. 14. 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. CO index structure 400 339 350 300 270 250 200 150 100 100 50 26 3 0 Main project Pre Project costs Roll out costs Operational costs Upgrade cost investment © Radar Group I nternational 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. 14 Page
  15. 15. 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 Direct costs for software, hardware and (ERPPI) 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: CO cost breakdown 16% 36% Software 48% Manhours Other 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. 15 Page
  16. 16. 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. 16 Page
  17. 17. 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 17 Page
  18. 18. 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. Suppliers CO evaluation •Industry & size •The model •Project specific •Benchmark •Adjusted •ERP systems CO •Suppliers assumptions rating • Requirements to proceed with Requirements CO calculation Contact Radar Group for further details and cost for this one day packaging: info@radargroup.se 18 Page
  19. 19. 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. 19 Page

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