Approaches to cost estimation and risks of the ERP project

What can implementation "threaten" with?

Though possibilities of ERP systems are known, and their positive business impact of the companies using them is conventional, there is a number of factors which can limit a possibility of award enforcement of such class. One of them is the high implementation cost and maintenances of the ERP system. As other such factor serves duration of ERP projects and quite essential time log between start of a system in operation and obtaining positive effect.

Besides, implementation of ERP, as a rule, means reorganization of business processes of the enterprise that at the initial stage can lead to an exit even on lower economic indicators, than were before implementation. Also, there is a need of training and additional motivation of personnel which is followed by risk of loss of the valuable specialists who were "incompatible" with the ERP system.

At the same time any project including on ERP system implementation, it is integrated to risk of an exit out of limits of the planned cost and terms of its implementation or even its total failure. The share of successful ERP projects is estimated by experts approximately at 60%, respectively, in remained 40% (2 of 5) cases are implemented these or those project risks.

What it is necessary to understand?

So that to implement a resource management system of the enterprise, it is necessary to go to quite serious costs, business reorganization, advanced training of personnel with risk of loss of its part and also to agree with decrease in production efficiency for quite long period of implementation and the subsequent adaptation of the enterprise to the ERP system taking into account risk of rise in price and/or prolongation of the project and also to understand that the effect of implementation of methodology and an information system will be shown during a year and a half after (successful) completion of work of implementers.

In this context there is a problem of assessment of real need of implementation of the ERP system and also potential effect which will bring its use. It is logical that more the solution of this task depends not so much on the choice of the ERP solution (though this moment is very important), how many on a status of the enterprise, its market provision and financial opportunities, readiness of an organizational management system, managers of all levels and linear personnel to transition to methodology of ERP. Similar assessment can be executed in several directions, in particular, on those that correspond to negative factors of implementation of ERP. Let's consider them in a vista shot.

Costs for implementation

The order of costs for implementation of the ERP system can be estimated, knowing future number of the automated jobs which are at the same time working in the system of users or licenses which are going to be purchased. Practically for all leading ERP systems there are estimates of their cost counting on one user / the automated workplace. If such estimates are unavailable, it is possible to use an empirical ratio:

_ZERP = _SLITs x 1.5,

where _ZERP are the total costs of ERP, and _SLITs – the total cost of the purchased licenses.

It is necessary to add hardware costs (the server(s) and workstations), creation or updating of data networks to the received amount, on the system software (OS, DBMS, development tools), on hiring of specialists in DBMS and the ERP system or for additional training of staff of own IT service and the subsequent payment of their services and also for training in work with the ERP system of end users.

Project risks

Besides, it is necessary to estimate the risk connected with project implementation also. For this purpose in the simplest case mathematical expectation of the losses connected with "missing" in terms or the estimate of the project or in general with a total failure of the project is defined. The value of losses and probability of approach of each of failures are estimated in the expert way. As for determination as such of mathematical expectation, it, as we know, is equal to assessment of effects of approach of an event increased by the probability of its approach. However in this case several options are possible, how at the enterprise perceive a possibility of problems at accomplishment of the ERP project.

In particular, if to consider that failure to meet time constraints of the project, exceeding of its estimate and a total failure do not depend from each other (really, the project can fail also because of incorrectly effective objectives, and because of errors in motivation of participants and for a number of other reasons), then it is possible to estimate separately three scenarios: two moderately optimistic (failure to meet time constraints and exceeding of the estimate) and one pessimistic (total failure of the project). At the same time it is possible to add mathematical expectation of the most real to the total cost of ERP, according to representatives of the enterprise, from three options of negative succession of events.

On the other hand, it is possible to consider these three events interconnected and being in certain dependence. For example, failure to meet time constraints of the project often leads to exceeding of its estimate, and both of these events together can lead to a project failure in general. Or it is possible to consider failure to meet time constraints and exceeding of the estimate as the project failure reasons independent from each other. In both cases it is necessary to define a conditional probability of a failure of the project at approach of events "failure to meet time constraints of the project" and/or "exceeding of the estimate of the project". If to adhere to the first of two points of view stated slightly above (exceeding of the estimate – result of failure to meet time constraints of the project), then the conditional probability of a failure of the project when exceeding the estimate will be calculated on a formula:

P (_software|_PRSM) = P (_software ∩ _PRSM) / _{P (PRSM)},

where _software – a failure of the project, _PRSM – exceeding of the estimate, P (_software ∩ _PRSM) – project failure probability without exceeding of the estimate, and _{P (PRSM)} – the probability of exceeding of the estimate which, in turn, is a conditional probability and is calculated at dip condition of terms of the project on a formula:

P (_PRSM|_SSR) = P (_PRSM ∩ _SSR) / P _(SSR),

where _SSR – failure to meet time constraints of the project, P (_PRSM ∩ _SSR) – the probability of exceeding of the estimate without failure to meet time constraints, and P _(SSR) – the probability of failure to meet time constraints of the project determined in the expert way.

If to consider, failure to meet time constraints and exceeding of the estimate of the project events independent from each other, then the conditional probability of a failure of the project at their joint approach will be calculated as follows:

P (_software|_SSR + _PRSM) = P (_software ∩ _SSR + _PRSM) / P (_SSR + _PRSM),

where _{PRSM CCP+} – joint approach of failure to meet time constraints and exceeding of the estimate of the project, P (_software ∩ _{PRSM CCP+}) – project failure probability without failure to meet time constraints and exceeding of the estimate, and P (_{PRSM CCP+}) – the probability of joint approach of failure to meet time constraints and exceeding of the estimate of the project equal to the work of probabilities of these events – P _(SSR) x _{P (PRSM)}.

Anyway, mathematical expectation of implementation of the risks connected with the project needs to be added to the amount of already revealed costs. As a result the amount of "direct costs" of ERP system implementation will turn out. It needs to be compared with the planned project deadlines and to define whether "the enterprise can dare" to incur costs in this volume.

Decrease in business performance

Assessment of this parameter depends, first of all, on what will be the general approach to implementation and also transition to productive operation of the ERP system. If at the level of the general approach gradual replacement of the existing control blocks with the enterprise with the Enterprise resource planning functions is planned, decrease in business performance, most likely, will be smaller, than at simultaneous implementation of the ERP system in all guidance loops. Similarly, if the functionality of the ERP system in parallel with the management tools used earlier by the enterprise is going to use some time, the effective management of the company (because of duplication of functions) will fall slightly, but, most likely, to longer term, than upon "shock" one-time transition to ERP.

Estimate what of options for the enterprise is more acceptable and "how many it will cost" follows, proceeding from a reality of data domain, an expert way or if at present there is a change of the ERP system and the similar project was already carried out earlier, analytically, taking into account the changes which happened at the enterprise by means of adjusting factors.

Besides, on the speed of adaptation to methodology of ERP and the specific system implementing it, the orderliness of business processes, efficiency of the organization of enterprise management, existence of a system of internal regulating documents (standards, regulations, instructions, etc.), loyalty and qualification of a managerial and linear personnel, its acquaintance to information technologies, perfection of technology production processes of products, etc. has significant effect.

These factors in many respects determine that term for which the enterprise will return, in ERP system terms of use, to economic indicators which it had prior to the beginning of an implementation project, and will begin to increase them due to advantages of methodology of ERP. Today the author does not know of existence of formal techniques of similar assessment, respectively, the main tool should be considered examination here.

As a result assessment of future losses because of decrease in business performance should be received during project implementation and the period of adaptation of the enterprise to ERP. The received value of losses should be compared with the period in which they will have to arise therefore the position of the company concerning whether such losses and what measures are acceptable should be developed (including, not connected with ERP) can be accepted for their decrease or compensation.

General "liability" of the project and decision-making

At the same time losses owing to decrease in business performance should be estimated also and in total with certain earlier total costs of implementation of the ERP project taking into account the corresponding risks. If the total amount of the "liabilities" connected with implementation of the Enterprise resource planning and adaptation of the enterprise to it is acceptable (or it can be somehow compensated), the enterprise is ready to transition to ERP. Otherwise it is necessary to analyze factors of formation of costs/losses. If their most part belongs to the ERP system, perhaps, it makes sense to pay attention to more "budget" solutions in this class, to take measures for implementation reduction in cost (perhaps due to use of own IT personnel), or to estimate opportunities and effect of "scrappy" automation. If the factors connected with the enterprise, most likely, are problem it not absolutely "grew" to ERP. In that case it is necessary to make efforts on increase in transparency and simplification of the organization of company management, formalization, streamlining and business process optimization, to take a number of organizational measures for increase in business performance, to optimize technology production processes of products (for example, to use methods of financial value analysis of production). After it it is possible to return to consideration of a possibility of implementation of the ERP system.

At the same time, the situation, external in relation to the enterprise, can develop in such a way that transition to ERP will be a necessary condition of preserving of business competitiveness and, respectively, its survival. In this case, all estimates described above should be treated not as the cutting restrictions defining to implement the ERP system or not and as target functions which values need to be minimized.