the roi of erp · 2019-03-21 · only very large corporations could afford mrp systems as they...

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The ROI of ERP Make More Money with Less Work, Less Risk, & Less Worry

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Page 1: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

The ROI of ERP

Make More Money with Less Work, Less Risk, & Less Worry

Page 2: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

When evaluating the return on investment (ROI) of enterprise

resource planning (ERP), it is wise to compare the increased

�profitability�that�an�ERP�solution�can�deliver�against�the�time�and�

resources�required�to�purchase,�configure,�and�learn�it.�Today,�we’ll�

explore�a�handful�of�common�metrics�you�can�use�to�benchmark�

your�current�operational�performance,�profitability,�and�efficiency;�

and�we’ll�compare�those�indicators�against�industry�averages�

�provided�in�the�Door�and�Hardware�Institute’s�2014�Financial�

Report.�We’ll�also�take�a�look�at�how�distributors�who�leverage�

ERP�software�outperform�those�averages�to�give�you�a�reliable�

idea�of�the�potential�profitability�gains�you�can�expect�if�you,�too,�

invest�in�ERP.�With�this�information,�you’ll�be�well�on�your�way�to�

calculating�your�ROI�on�ERP.�

Synopsis

Page 3: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

Only very large corporations could afford MRP systems as they often ran upwards�of�$3�Million�dollars�create�(that’s�in�1960’s�dollars!).�However,�the�net�long-term�profitability�gains�provided�by�an�MRP�application�justified�the�investment,�and�an�increasing�variety�of�organizations�began�to�transition�to�an�automated�operational�environment.

The�hundreds�of�ERP�products�available�today�are,�by�yesterday’s�standards,�incredibly�robust�and�affordable.�Almost�every�facet�of�a�commercial�operation�results�in�an�accounting�transaction�(think�inventory,�AP,�AR,�invoicing),�so�ERP�systems�have�naturally�evolved�beyond�simple�inventory�management to tie accounting to shop floor management, delivery scheduling,�customer�relationship�management,�retail�point�of�sale,�and�field�service�management.�Additionally,�the�widespread�adoption�of�computer�automation,�combined�with�advances�in�hardware�and�software�technology,�have�significantly�decreased�the�cost�to�write�and�use�sophisticated�solutions, making ERP commonplace and a virtual necessity to compete in a�complex�distribution�or�manufacturing�environment.�Whether�you�realize�it�or�not,�you�probably�already�run�your�business�from�an�‘ERP’�mindset.�For�example: do you track individual purchase or sale transactions in a hand written�ledger?�Of�course�not!�You�most�likely�use�spread�sheets,�QuickBooks,�or even a simple ERP application to log invoice payments or inventory purchases�to�a�general�ledger.

Early�innovators�spent�millions�of�dollars�because�they�knew�exactly�how�an�automated�platform�could�provide�them�a�return�on�their�investment.�Though�the�value�of�ERP�has�been�repeatedly�proven�since�then,�it�would�be�unwise�for�a�division�8�distributor�today�to�invest�resources�in�a�modern�ERP�solution�without�first�calculating�its�potential�return�for�his�specific�business.�Where early pioneers had to estimate how an MRP system would improve profitability,�we�can�use�readily�available�industry�financial�reports�for�insight�into�precisely�how�ERP-based�division�8�businesses�perform�compared�to�their�non-automated�counterparts.

Enterprise�Resource�Planning,�as�a�concept,�has�been�around�since�

the�1960’s.�Originally�called�Material�Requirement�Planning,�MRP�

systems were primarily developed to automate inventory control and

simplify�manufacturing�planning.�

The Evolution of ERP

Whether you realize it or not,

you probably already run

your business from an ‘ERP’

mindset.

Page 4: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

Many�distributors,�even�today,�are�discouraged�from�leveraging�technology�to�manage�their�businesses�because�the�initial�investment�seems�too�high.�Instead, they rely on familiar, seemingly less-expensive, manual solutions to�meet�demand�and�grow�operations.�But,�just�as�it�is�plain�to�see�that�the�limitations of a hand-written, manually administrated accounting system would�eventually�drive�a�business�into�the�ground,�when�viewed�from�a�long-term�perspective,�it�becomes�clear�that�relying�exclusively�on�manual�processes,�and�the�people�to�run�them,�is�just�as�expensive�and�dangerous.

For�instance,�when�job�capacity�is�maxed�out,�but�the�production�line�needs�to�increase�output;�or�when�the�sales�team�wins�more�jobs�than�the�project�management team can manage, the traditional response is to add another body�to�the�payroll�and�hope�the�market�can�support�your�bigger�footprint�down�the�road.�Investing�in�smart�people�is�a�good�temporary�solution,�but�what happens when superstars leave and new, less-experienced folks have to�learn�their�job?�Or�even�worse,�when�the�market�fluctuates�and�there�isn’t�enough work to support a staff of highly experienced industry veterans? Relying�too�heavily�on�key�personnel�and�their�“tribal�knowledge”�(the�processes unique to them that they take with them when they leave or retire) makes�it�difficult�to�scale�business�in�times�of�rapid�industry�expansion,�and�to�maintain�it�in�times�of�industry�contraction.�

There�is�always�a�demand�for�good�help,�but�when�you�automate�the�mundane and time consuming components of your operations – especially those that are prone to costly errors – you turn good help into great help, enable�your�trusted�employees�to�do�more�and�better�work,�and�reduce�the�need�to�increase�headcount�to�grow�your�operations.�When�you�do�hire�new�employees,�you�can�train�them�faster�and�more�efficiently�on�standardized�processes (which means you can hire from a less experienced candidate pool),�and�the�contributions�they�make�during�their�tenure�stay�with�the�business�after�they�exit.

Outside�of�COGS,�payroll�is�the�largest�line�item�on�the�balance�sheet,�so�it makes sense to focus on how an ERP solution can decrease payroll expense�to�increase�net�profitability.�However,�automation�can�lower�a�host�of other costs too, like vehicle and asset maintenance expenses, collections expenses,�and�shipping�and�inventory�related�expenses.�We�will�examine�a�number�of�KPIs�relating�to�many�different�areas�of�the�business�to�establish�a comprehensive picture of how an ERP solution can drive long-term profitability.

Short-term�Solutions�Vs.�Long-term�Profitability�

Page 5: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

Many�factors�affect�the�stability,�profitability,�and�growth�potential�

of�an�operation,�and�in�most�cases,�those�factors�can�be�measured�

and�compared�across�the�industry�using�key�performance�indicators.�

No one indicator can provide a complete picture of the health of

your�operation,�and�each�should�be�viewed�in�the�context�of�all�the�

others.�Following�are�XX�KPIs�that,�taken�as�a�whole,�can�effectively�

represent�your�business�and�provide�a�basis�for�comparison�against�

other�businesses�like�yours.�

Measuring�Your�Business�with�KPIs�

Page 6: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

Net sales is total revenue, less the cost of sales returns, allowances, and discounts.�This�is�the�primary�sales�figure�reviewed�by�analysts�when�they�examine�the�income�statement�of�a�business,�and�is�often�compared�against�previous�years�to�establish�performance�and�market�trends.�In�2014,�the�typical�DHI�member�firm�produced�$16.3�MM�in�net�sales,�a�44%�increase�from�5�years�ago.�How�do�your�sales�compare�to�the�average�DHI�firm’s?�Are�your sales trending higher, as well?

Gross�margin�is�the�difference�between�net�sales�and�cost�of�goods�sold�(COGS)�divided�by�net�sales,�expressed�as�a�percentage.�COGS�includes�materials�and�direct�labor�costs,�and�when�they�increase,�retail�pricing�usually�increases�to�compensate.�The�average�gross�margin�among�DHI�members�has�widened�slightly�in�the�past�5�years,�moving�from�29.1%�to�30.5%�which�suggests�that�retail�pricing�has�outpaced�wholesale�material�and�labor�costs�during�the�recent�construction�boom.�

Net Sales

Gross�Margin�%

My Company

My Company

Typical�Firm

DHI�Average

$16,309,393

30.5%

$

%

Calculation: (net sales – COGS) / net sales

$

Page 7: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

Operating�expenses�include�all�the�costs,�besides�COGS,�a�distributor�incurs�to�run�his�business:�in�other�words,�everything�except�materials�and�direct�labor.�Division�8�distributors�can�group�operating�expenses�into�payroll�expenses,�occupancy�expenses,�and�other�expenses�(depreciation,�bad�debt,�vehicle,�insurance,�marketing,�etc).�Outside�of�leveraging�manufacturing�innovation�or�large�volume�pricing�(COGS�related�expenses),�businesses�can�most�effectively�scale�profits�by�controlling�these�operating�expenses.��The�ratio�is�calculated�by�dividing�total�operating�expenses�(excluding�accounting�adjustments�and�interest�expenses)�by�net�sales.�

In the past 5 years, operating expenses ratios have remained steady, meaning�revenue�and�costs�have�grown�proportionately.�This�suggests�that�most�distributors�are�working�harder�to�make�more�profit,�and�are�not�effectively�scaling�their�operations�or�compounding�the�benefit�of�larger�sales�volume.�Scale�is�the�term�used�to�describe�the�situation�where�revenue�increase�outpaces�cost�increases�enough�to�substantially�change�profit�margin.�

Operating�Expense�%

My Company

DHI�Average 27.5%

%

Calculation: total expenses excluding COGS / net sales

Page 8: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

If you have calculated your net sales, gross margin, and operating expense correctly,�you�can�easily�calculate�your�profit�margin�percentage�by�subtracting�your�operating�expense�percentage�from�your�gross�margin�percentage.�It�becomes�plain�to�see�that�when�COGS�are�relatively�fixed,�the�best�opportunity�to�increase�profit�margin�is�to�lower�operating�expense.�According�to�the�DHI�report,�typical�distributors�operate�on�a�2.8%�profit�margin�(pre-tax).�In�other�words,�the�average�firm�produced�$16MM�in�revenue,�but�kept�only�$448,000�of�it.

Payroll�expense�includes�salaries,�wages,�taxes,�and�benefits�for�all�employees other than those directly involved in the manufacturing process�(their�wages,�benefits,�and�taxes�are�included�in�COGS).�Payroll�expense�is�particularly�relevant�to�evaluating�the�potential�benefit�of�an�ERP implementation as one of the primary roles of ERP is to eliminate dependence on the kinds of manual processes that require a large administrative�staff.��Payroll�expense�for�the�typical�firm�remained�steady�at�20.4%�of�revenue�from�2010�to�2014,�suggesting�most�distributors�substantially�grew�headcount�to�drive�revenue�-�resulting�in�little�to�no�net�increase�in�profit�margin.�

Profit�Margin�Percentage

Payroll Expense Percentage

My Company

My Company

DHI�Average

DHI�Average

2.8%

20.4%

%

%

Calculation: gross margin % – operating expense %

Calculation: payroll expense / net sales

Page 9: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

Inventory�is�an�asset�that�is�intended�to�be�sold�within�one�year�through�the�ordinary�course�of�business,�even�if�it�is�not�immediately�ready�for�sale�(as�in the case of work-in-progress goods like door and window frames that are�in�the�production�process).�Inventory�includes�raw�materials,�as�well�as�finished�goods,�and�is�typically�classified�as�a�short�term�asset.�More�sophisticated performance indicators provide insight into the relationship between�inventory�and�gross�sales,�net�sales,�and�accounts�payable,�but�for�our�purposes�it�is�sufficient�to�simply�state�that�efficiently�run�businesses�minimize�inventory,�turn�it�quickly,�and�seek�to�finance�it�as�much�as�possible�through�their�suppliers.�By�doing�so,�a�business�can�effectively�generate�a�greater�return�on�fewer�assets,�allowing�it�to�drive�greater�profit�with�less�exposure�to�risk.

The�typical�DHI�distributor�maintains�$1.8�MM�worth�of�inventory�(representing�28.7�%�of�its�total�assets),�and�with�it�generates�$16.3�MM�in�sales.

Inventory�(Asset�figure)

My Company

DHI�Average $1.8 MM

$

Page 10: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

Closely related to inventory turnover, inventory supply period tells how many days�of�inventory�are�on�hand,�and�can�be�calculated�by�dividing�365�days�by�the�inventory�turnover�figure�we�just�calculated.�It’s�good�to�have�stock�on�hand�to�provide�optimal�service,�but�a�large�inventory�is�capital�intensive�and�problematic�for�other�reasons.�The�shorter�the�supply�period,�the�less�likely�stock�will�become�obsolete�and�the�more�quickly�capital�is�available�to�fund�further�operations.�On�average,�DHI�member�distributors�keep�54�days�of�stock�on�hand.�

Inventory Supply Period

My Company

DHI�Average 54

Calculation: 365 days / inventory turnover figure

Inventory turnover is an indication of how quickly merchandise dollars move�through�the�business,�and�is�calculated�by�dividing�COGS�by�average�inventory�over�the�course�of�a�year.�A�higher�rate�of�inventory�turnover�implies�that�purchasing�is�tightly�managed.�Conversely,�a�low�turnover�suggests�either�a�distributor�may�have�a�flawed�purchasing�system�that�bought�too�many goods, or that he increased stocks in anticipation of sales that did not occur.�The�typical�DHI�member�turned�inventory�over�6.8�times�in�2014.��

Inventory�Turnover�Figure

My Company

DHI�Average $1.8 MM

$

Calculation: COGS / inventory

Page 11: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

The�average�collection�period�is�the�average�time�it�takes�for�a�distributor�to�receive�payment,�in�terms�of�receivables,�from�customers�and�clients.�Instead�of�trying�to�average�out�the�actual�duration�of�every�AR�item�for�an�entire�year�across�the�entire�customer�base,�average�collection�period�can�be�approximated�by�dividing�the�product�of�365�days�and�the�average�accounts�payable�balance�during�a�year�by�the�total�net�credit�sales�for�the�same�year.�Obviously,�the�faster�a�distributor�collects�payment,�the�more�he�is�able�to�remain�in�control�of�his�operations�and�look�to�the�future�with�confidence.

Average�Collection�Period�

My Company

DHI�Average 69 days

days

Calculation: (365 days x average accounts payablebalance) / net total annual credit sales

Page 12: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

The�number�of�days�it�takes�a�distributor�to�payoff�purchases�he�makes�on�credit�is�called�the�accounts�payable�payment�(or�payout)�period,�and�is�most insightful when measured more than once over a period of years to determine�a�trend.�A�lengthening�payout�period�could�be�an�indication�of�a�declining�financial�condition,�whereas�a�decreasing�period�could�reflect�improvements�in�cash�flow�or�an�infusion�of�operating�capital.�In�either�case,�a�single�snapshot�of�the�payout�period�is�not�as�insightful�because�a�single�long�or�short�period�measurement�itself�can�be�a�positive�or�negative�indicator.�For�example:�a�short�period�could�mean�a�distributor�is�effectively�managing�cash�(positive),�or�it�could�mean�that�his�suppliers�don’t�trust�him�and�consider�him�a�credit�risk�(negative).�

The�AP�payment�period�is�calculated�by�first�adding�a�year’s�beginning�accounts�payable�to�that�year’s�ending�accounts�payable�and�dividing�the�result�by�two.�Then�multiply�that�figure�by�365�(days)�and�divide�the�product�by�total�COGS�for�the�same�year.�It�sounds�complicated,�but�what�you’re�really doing is simply dividing your average daily COGS into your average accounts�payable.�

DHI�does�not�supply�detailed�APPP�data,�so�we�are�not�determining�this�KPI�for�comparison�sake,�but�to�use�it�in�a�very�important�KPI�called�cash�cycle.�

Accounts�Payable�Payout�Period

My Company days

Page 13: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

The�total�number�of�days�that�pass�between�the�purchase�of�a�product�(or�the raw materials from which a product is constructed) and the collection of�that�product’s�sales�invoice�is�called�the�cash�cycle.�It�is�calculated�by�subtracting�the�accounts�payable�payout�period�from�the�combined�average�collection�period�and�inventory�holding�period.�Cash�cycle�measures�how�effectively�management�converts�cash�to�inventory�and�back�to�cash;�grouping�sales,�delivery,�and�collections�altogether�to�benchmark�the�overall�health�of�operations.�The�longer�the�cash�cycle,�the�riskier�and�more�capital�intensive�the�business.�DHI�reports�that�typical�firms�cycle�their�cash�about�every�100�days.

Cash Cycle

My Company

DHI�Average 99.2 days

days

Calculation: (average collection period + inventory holding period) - accounts payable period

Page 14: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

Expressed�as�a�percentage,�return�on�assets�represents�the�profit�generated�by�the�combined�value�of�the�cash,�inventory,�accounts�receivable,�property,�and�equipment�in�a�business;�and�is�a�simple,�effective�measurement�of�a�distributor’s�ability�to�survive�and�prosper.�Banks�and�analysts�use�ROA�to determine investment potential and company valuation, so maintaining a�high�ROA�is�very�important�when�planning�for�a�liquidity�event�or�when�seeking�investment�capital.�Because�it�is�a�simple�ratio,�there�are�two�distinct�ways�to�improve�ROA:�first,�decrease�the�total�assets�in�the�business�by�managing�cash�and�inventory�better:�and/or�second,�increase�net�sales�while�maintaining�assets�levels.�In�either�case,�ROA�is�affected�by�improving�efficiency�–�by�doing�more�with�less.�

ROA�is�calculated�by�dividing�net�profit�(pre-tax)�by�total�average�assets.�An�ROA�of�10%�indicates�that�for�every�$1.00�in�assets,�a�distributor�produces�$.10�of�pre-tax�profit.�DHI�reports�that�in�2014,�typical�distributors�maintained�a�%7�ROA

Return�on�Assets

My Company

DHI�Average 7.0%

%

Calculation: net pre-tax profit / total average assets

Page 15: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

In�many�cases,�the�processing,�filling,�delivery�and�collections�expenses�incurred�to�fulfill�a�customer�order�are�fixed�regardless�of�the�size�of�the�order.�Distributors�who�maximize�sales�per�order�more�readily�cover�costs�and�generate�profit�with�the�additional�gross�margin�dollars�generated�on�the�sale.�Sales�per�order�is�calculated�by�dividing�net�sales�by�total�number�of�shipped�orders,�and�DHI�reports�that�the�average�among�typical�distribution�firms�in�2014�was�$2,340/order.

More�customers�is�always�a�good�thing.�However,�a�distributor�who�maximizes�sales�to�existing�customers�doesn’t�constantly�need�to�find�more�of�them�to�maintain�revenue,�which�is�even�better.�Distributors�with�high sales to customer ratios effectively use delivery vehicles and other operating assets to reduce their dependence on, and cost to acquire, new customers.��A�word�of�caution,�though:�low�sales�per�customer�(which�is�usually�a�negative�indicator)�can�also�mean�that�a�firm�is�rapidly�winning�new�customers�by�expanding�into�fresh�markets�or�territories.�To�offset�the�effect�that�rapid�customer�acquisition�could�have�on�this�otherwise�insightful�KPI,�the�figures�DHI�reported�for�typical�member�distributors�in�2014�only�included�customers�who�placed�more�than�a�minimum�of�6�orders�per�year.��

Sales Revenue per Order

Sales per Customer

My Company

My Company

DHI�Average

DHI�Average

$2,340

$49,070

$

$

Calculation: net sales / total orders shipped

Calculation: nets sales / total customers (minimum 6 purchases/year)

$

Page 16: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

High�sales�per�SKU�suggests�a�distributor�is�efficiently�stocking�inventory�against�customer�demand.�Distributors�must�identify�and�keep�an�adequate�supply�of�popular�items�while�minimizing�their�supply�of�unpopular�inventory.�To�calculate�sales�per�SKU,�divide�total�net�sales�by�average�total�number�of�SKU�in�inventory�for�a�given�year.�A�SKU�is�defined�as�narrowly�as�possible�– meaning, for instance, otherwise identical items of different color are different�SKUs.�DHI�reports�typical�distribution�firms�produced�an�average�of�$8,419�per�SKU�in�2014.��

Sales�per�SKU

My Company

DHI�Average $8,419

$

Calculation: net sales / average number of distinct SKUs in inventory over the course of a year

Page 17: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

Division�8�distribution�and�manufacturing�is�a�tough�business.�

According�to�the�2014�DHI�Financial�Report,�annual�sales�for�the�

typical�distributor�increased�by�approximately�$2�Million�over�the�

preceding�5�years,�yet�he�only�pocketed�2.8%�of�those�net�sales�as�

profit.�His�average�collection�period�was�almost�70�days,�and�his�

return�on�assets�(a�key�indicator�that�many�feel�is�the�best�predictor�

of�future�growth)�is�a�modest�7%.�However,�not�every�distributor�is�

balancing�his�business�on�razor�thin�margins.�A�small�minority�of�

member�firms,�those�the�DHI�designates�as�‘high-performing’,�use�

ERP�software�to�consistently�double�industry�average�profit�margins�

and�return�on�assets.��

Page 18: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

When�compared�to�typical�firms�earning�nearly�identical�net�sales�volume,�performing�firms�are�able�to:�

•� Produce�130%�greater�operational�profit•� Spend�12%�less�on�operational�expenses•� Spend�13%�less�on�payroll�(subset�of�operational�expenses)•� Sell�39%�more�per�SKU�and�53%�more�per�order•� Maintain�33%�less�inventory�while�selling�through�it�40%�faster.•� Generate�156%�greater�return�on�assets

Among�other�things,�these�metrics�suggest�that�performing�firms�generate�more�profit�from�the�same�amount�of�work�–�they�can�do�more�with�less,�which�is�the�primary�benefit�of�operating�on�an�ERP�platform.�It�is�interesting�to�note�that�COGS�represented�69.5%�and�69%�of�total�expenses�for�typical�and�performing�firms,�respectively;�suggesting�that�it�is�only�by�introducing�operational�efficiencies,�and�not�through�price�breaks�or�volume�discounts,�that�performing�firms�were�able�to�book�substantially�greater�profits.

The�whole�point�of�ERP�is�to�enable�businesses�to�increase�profitability,�or�in�other�words,�to�drive�greater�revenue�with�fewer�resources.�Resources�can�be�capital,�equipment,�personnel,�time,�or�anything�that�translates�directly,�or�indirectly,�to�a�cost.�If�the�increase�in�profitability�exceeds�the�cost�to�implement�an�ERP�system,�then�it�would�be�wise�to�make�changes�as�soon�as�possible.�To�provide�some�perspective�on�the�possible�gains�you�could�enjoy�by�transitioning�to�an�industry-tailored�ERP�solution,�compare�your�KPIs�against�high�performing�firms’,�as�reported�in�the�DHI�financial�summary�for�2014.

The�Division�8�Profitability�Gap

When job capacity is maxed out...the

...performing firms generate more profit

from the same amount of work – they can do

more with less...

Page 19: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

As�stated�before,�net�sales�can�illustrate�performance�trends�when�figures�of�one�year�are�compared�to�another.�However,�when�net�sales�of�two�disparate�groups�are�similar,�like�they�are�for�typical�and�performing�firms�in�2014,�one�can�compare�many�other�KPIs�to�derive�otherwise�hidden�insights.�The difference in total revenue (minus returns, allowances, and discounts) between�typical�and�high�performing�firms�in�2014�was�only�a�quarter�of�a�percent;�so�each�classification’s�performance�data�can�be�compared�reliably�against�the�other.�Additionally,�because�it�is�shown�that�volume�is�not�responsible�for�profit�variation,�any�business�can�be�compared�against�performing�firms�to�accurately�asses�the�impact�of�ERP�on�its�operational�costs.�

In�other�words,�the�percentage�change�in�any�KPI,�from�typical�to�performing�can�be�applied�directly�to�any�typical�distributor

Net Sales

B.�Performing�Firm:

D.�My�Current�Net�Sales:

E.�My�Net�Sales�on�an� ERP solution:

A.�Typical�Firm:�

C.�Difference�between�Typical�� and Performing:

$16,309,393

$16,350,236

.25% greater revenue (negligible)

$_________

$_________ (1.0025 x line d )

Page 20: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

Over�the�last�5�years,�COGS�has�remained�relatively�constant�between�typical�and�performing�firms,�which�suggests�we�should�focus�our�analysis�on�other�cost�areas�to�account�for�the�substantially�greater�profits�performing�firms�booked�from�the�same�revenue�and�production�costs.�

Operating expenses are the sum of all non-production costs, and related to�profit:�when�operating�expenses�decrease�by�a�dollar,�profit�increases�by�the�same�dollar.�Performing�firms�keep�costs�to�24.2%�of�their�total�revenue,�whereas�typical�firms�pay�more�(27.5%)�to�output�the�same�volume.�Essentially, the data shows that implementing an ERP solution can result in a�12%�annual�cost�reduction.�If�you�plan�on�keeping�the�doors�open�for�years�to�come,�the�savings�are�substantial.�To�illustrate:�let’s�assume�you’re�able�to�keep�revenue�consistent�for�10�years.�Multiply�your�current�annual�operating�expenses�(the�actual�dollar�figure)�by�12%,�then�multiply�that�figure�by�10.�The�result�is�how�much�you�could�save�by�implementing�an�ERP�solution.

Gross�Margin�%

Operating�Expense�%

B.�Performing�Firm:

B.�Performing�Firm:

D.�My�company�now:

D.�My�Current�Operating�Expenses������($�figure):

E.�My�Gross�Margin�on�an� ERP Solution:

E.�10-Year�Savings�on�an� ERP Solution:

A.�Typical�Firm:�

A.�Typical�Firm:�

C.�Difference�between�Typical����� and Performing:

C.�Difference�between�Typical�������� and Performing:

30.5%

27.5%

31%

24.2%

1.6 % greater gross margin (negligible)

12 % lower operating costs

___%

$______

___% (1.0164 x line d)

$______ (.12 x line d x 10 years)

Page 21: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

Often,�factors�other�than�operational�profit�(like�interest�paid�and�interest�collected)�affect�the�net�bottom�line,�leading�to�a�profit�margin�percentage�that�is�slightly�different�than�the�difference�between�gross�margin�and�operating�expense.�When�all�factors�are�considered,�performing�firms�earn�2.5�times�more�profit�than�typical�firms�producing�the�same�net�revenue.

Profit�Margin�%

B.�Performing�Firm:

D.�My�Current�Profit�Margin:

E.�My�Profit�Margin�on�an� ERP Solution:

A.�Typical�Firm:�

C.�Difference�between�Typical�� and Performing:

2.8%

6.9%

146 % greater profit margin

___%

__% (2.46 x line d)

Page 22: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

There are many ways to decrease payroll expenses, some more

effective�in�the�long�run�than�others.��While�there�is�no�single�formula�

that�works�for�every�distributor,�it�is�interesting�to�analyze�how�

performing�distributors�manage�their�workforces�relative�to�typical�

ones.�

Payroll�Expense�%�

• Lower larger executive salaries, •� Lower�all�salaries�across�the�board,• Eliminate high-paying executive positions,• Eliminate administrative positions, or•� Staff�administrative�positions�with�less�experienced�and�cheaper�labor.�

In�2014,�performing�firms�supported�an�8%�larger�staff,�but�paid�13%�less�in�total�payroll�expense.�Furthermore,�detailed�analysis�reveals�that�performing�firms�paid�20%�more�in�sales�commissions�and�38%�less�in�administrative�wages,�meaning�they�successfully�supported�larger�(or�possibly�more�experienced)�sales�forces�with�less�experienced�service�and�support�people.�

One�of�the�chief�benefits�of�an�ERP�system�is�its�ability�to�standardize�operations,�eliminating�the�need�for�deep�industry�expertise,�long�training�programs,�and�special�skills�among�administrative�personnel.�Firms�who�have�standardized�their�processes�and�use�software�to�guide�their�employees’�work�day�see�greater�productivity,�less�negative�impact�from�employee�attrition,�and�lower�overall�employment�costs.�

B.�Performing�Firm:

D.�My�Current�Operating�Expenses������($�figure):

E.�10-Year�Savings�on�an� ERP Solution:

A.�Typical�Firm:�

C.�Difference�between�Typical�������� and Performing:

20.4%

17.8%

13% smaller payroll expense

%

% (.87 x line d)

Page 23: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

The�time-honored�adage�‘it�takes�money�to�make�money’�seems�not�to�apply�to�performing�distributors,�who�are�able�to�drive�over�twice�the�profits,�and�identical�revenues,�from�33%�less�inventory�than�their�typical�counterparts.�Modern ERP software fundamentally change rules of the game, reordering the�relationship�between�risk�and�reward,�and�enabling�distributors�to�produce�substantially�more�with�the�same,�or�even�less,�resources.��

Typically,�the�faster�cash�flows�through�a�business,�the�less�of�it�is�needed�to�keep�the�business�running�and�growing.�Inventory�turnover�is�a�fantastic�indication�of�your�business’�health�and�maturity�of�your�purchasing�motion�(stable,�established�businesses,�regardless�of�age,�operate�under�sound�assumptions�and�forecasts).

Performing�distributors�optimize�their�purchasing�and�supply�operations�to�keep�inventory�moving�40%�faster�than�their�typical�counterparts.�Effective�use of cash is a key component when seeking investment capital or when marketing�your�business�for�sale.

Inventory

Inventory�Turnover�Figure

B.�Performing�Firm:

B.�Performing�Firm:

D.�My�Current�Inventory�Investment

D.�My�Current�Inventory�Turnover

E.�My�Inventory�Investment�on�an������ ERP Solution:

E.�My�Inventory�Turnover�on�and�� ���� ERP Solution:

A.�Typical�Firm:�

A.�Typical�Firm:�

C.�Difference�between�Typical�� and Performing:

C.�Difference�between�Typical�� and Performing:

$1.8 Million

6.8

$1.2 Million

9.5

33% smaller inventory outlay

40% faster cash flow

$_____

$_____ (.67 x line d)

(1.4 x line d)

Page 24: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

Like inventory turnover, inventory supply provides insight into purchasing efficiency.�The�difference,�however,�is�that�inventory�supply�can�be�used�to�help�plan�for�growth�by�giving�owners�an�idea�of�how�much�more�inventory�to�buy�during�an�expansion�into�new�territories�or�market�segments.�Performing�distributors�move�through�inventory�faster�(as�indicated�by�their�turnover�figure),�and�so�have�an�effectively�shorter�supply�on�hand.

Effectively�collecting�on�AR�begins�long�before�an�invoice�is�issued.�Appropriately�setting�and�meeting�(or�exceeding)�customer’s�expectations�in every phase of customer interaction sets a precedent for how they are to behave�when�it�comes�time�to�pay.�Additionally,�well�managed�processes�can�help�to�identify�potential�problems�before�they�get�out�of�hand.�Performing�firms�collect�against�invoices�over�a�week�faster�that�typical�ones,�yet�they�don’t�discount�prices�to�encourage�faster�response,�nor�is�there�an�indication�that�they�service�faster�paying�customers.�This�suggests�that�customers�are�willing�and�able�to�pay,�but�typical�distributors�aren’t�organized�enough�to�speed�the�process�up�on�their�end.��

Inventory Supply Period

Average�Collection�Period�

B.�Performing�Firm:

B.�Performing�Firm:

D.�My�Current�Inventory�Supply

D.�My�Current�Inventory�Supply

E.�My�Inventory�Supply�on�and� ERP Solution:

E.�My�Inventory�Supply�on�and� ERP Solution:

A.�Typical�Firm:�

A.�Typical�Firm:�

C.�Difference�between�Typical����� and Performing:

C.�Difference�between�Typical�������� and Performing:

54 days

69 days

40 days

61 days

14% shorter

12% shorter

days

days

days (0.86 x line d)

days (.88 x line d)

Page 25: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

Performing�firms�turned�inventory�40%�faster�and�collected�against�AR�12%�faster�to�yield�an�overall�cash�cycle�that�is�23%�shorter�than�their�typical�counterparts.�Faster�cash�flow�means�less�risk�and�more�latitude�to�grow�your�business�or�adapt�to�market�challenges.�An�ERP�solution�can�accelerate�cash�flow�by�automating�the�manual�bottlenecks�and�the�eliminating�human�errors�that�derail�inventory�turnover�and�collections.

ROA�is�the�primary�indicator�of�superior�performance,�as�it�accounts�for�all�the�areas�of�the�business,�from�inventory�and�production�management,�to�staffing�and�collections.�In�fact,�the�DHI�used�ROA�figures�to�initially�identify�and�then�segregate�firms�into�the�‘performing�distributors’�category.�In�2014,�typical�distributors�generated�a�7%�return�on�the�assets�they�invested�into�their�businesses,�whereas�performing�firms�more�than�doubled�that�with�a�17.9%�return.�When�one�considers�that�net�sales�between�the�different�categories�were�similar,�it�becomes�plain�to�see�the�overall�impact�an�ERP�solution�can�have�on�an�a�business.

Cash Cycle

Return�on�Assets

B.�Performing�Firm:

B.�Performing�Firm:

D.�My�Current�Cash�Cycle:

D.�My�Current�ROA:

E.�My�Cash�Cycle�on�and� ERP Solution:

E.�My�ROA�on�and�ERP�Solution:

A.�Typical�Firm:�

A.�Typical�Firm:�

C.�Difference�between�Typical�� and Performing:

C.�Difference�between�Typical�� and Performing:

99 days

7.0%

76 days

17.9%

23% faster cash cycle

156% greater return on assets

___ days

___ %

___ days (77% x line d)

___ % (2.56 x line d)

Page 26: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

Performing�distributors�generate�53%�more�sales�per�order,�8%�

more�sales�per�customer,�and�39%�more�sales�per�SKU�then�typical�

distributors�because�they�can�identify�popular�items�and�effectively�

stock�only�the�quantities�necessary�to�meet�each�customer’s�

demand.�An�ERP�platform�that�records�and�reports�detailed�inventory�

data,�as�well�as�data�on�your�customers’�behavior,�will�enable�you�to�

identify�sales�patterns�to�similarly�manage�your�inventory.��

Return�on�Asset

Page 27: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

Sales Revenue per Order

Sales per Customer

Sales�per�SKU

B.�Performing�Firm:

B.�Performing�Firm:

B.�Performing�Firm:

D.�My�Current�Sales�Per�Order:

D.�My�Current�Sales�Per�Customer:

D.�My�Current�Sales�Per�SKU:

E.�My�Sales�Per�Order�on�and�ERP�� Solution:

E.�My�Sales�Per�Customer�on�and��� ERP Solution:

E.�My�Sales�Per�SKU�on�and�ERP������� Solution:

A.�Typical�Firm:�

A.�Typical�Firm:�

A.�Typical�Firm:�

C.�Difference�between�Typical�������� and Performing:

C.�Difference�between�Typical�������� and Performing:

C.�Difference�between�Typical�������� and Performing:

$2,340

$49,070

$8,419

$3,584

$53,025

$11,688

53% greater sales per order

8% greater sales per customer

39% greater sales per SKU

$____

$____

$____

$____ (1.53 x line d)

$____ (1.08 x line d)

$____ (1.39 x line d)

Page 28: The ROI of ERP · 2019-03-21 · Only very large corporations could afford MRP systems as they often ran upwards of $3 Million dollars create (that’s in 1960’s dollars!). However,

There�have�been�some�genuinely�positive�trends�in�the�door�and�hardware�industry�over�the�past�5�years.�Typical�distributors�saw�profit�margins�improve�from�1.4%�in�2010�to�2.8%�in�2014,�and�performing�firms�saw�profits�increase�from�4.3%�in�2010�to�7.1%�in�2012.�The�fact�that�performing�firms�were�able�to�capitalize�more�quickly�on�the�current�boom�(both�types�roughly�doubled�their�margins,�but�performers�did�it�less�than�half�the�time)�is�an�indication�of�the�valuable�role�ERP�can�play�in�growing�a�business�and�adapting�to�changing�market�conditions.�

It�is�one�thing�to�conclude�from�a�data�set�that�ERP-based�shops�can�leverage�automation�and�reporting�to�lower�costs�and�extract�more�profits�from�the�same�amount�of�work,�but�quite�another�to�determine�if�the�difference�in�profits�warrants�implementing�a�new�ERP�solution�for�your�business.�For�that,�you�must�compare�the�potential�increase�to�your�bottom�line�that�can�come�from�an�ERP�solution�against�the�cost�of�that�solution.�If�you’ve�followed�along�with�the�KPI�explanations�and�treated�them�as�exercises,�you’re�well�on�your�way�to�determining�for�yourself�how,�and�where�an�ERP�solution�will�most�positively�impact�your�operations.�

A�word�to�the�wise:�not�all�ERP�solutions�are�equal.�Your�greatest�ROI�will�come�from�an�ERP�system�that�optimizes�the�balance�between�cost�and�capability.�If�you�haven’t�already,�we�suggest�you�take�a�look�at�our�publication,�The�ABC’s�of�ERP:�An�Introduction�to�ERP�Solutions�for�the�Division�8�Industry.�In�it�we�explore�the�different�kinds�of�ERP�solutions�available�today,�and�how each is suited for the particular nuances and intricacies of division 8 manufacturing and distribution.�

Leveraging ERP to Close the Gap