ROI, or Return on Investment, is essential to making the right decision about enterprise software. In simple terms, ROI is the percentage return you are realizing on the money you spent on the software.
ROI = ($ benefits per year minus additional yearly costs from the application) divided by the costs of implementing the new system.
If you spend $2 million up front for an application and another $400,000 per year to maintain it, and the benefits produced amount to $700,000 per year, the ROI would be ($700,000 minus $400,000) divided by $2 million, or 15%.
What ROI should you get from a successful system investment? That depends on your company’s strategy and overall approach to these types of projects. But I would say 30% to 40% should be a minimum. That’s because an annual rate of return in this range would “pay back” the original investment in about three years, which is about the timeframe within which better software options may exist in the market.
Payback is another way to quickly assess the relative attractiveness of a system implementation. In simple terms, payback is the number of months or years it takes for the financial benefits to “pay back” the original investment.
In the example above, the upfront cost was $2 million and the net annual savings were $300,000. So how many years would it take to pay back the $2 million? The answer is $2 million divided by $300,000, or almost seven years. Using the three year payback guideline, this particular example would be a loser.
Where do the benefits come from? Benefits don’t come from the software – but from what you do with the software. If a new system is integrated in your company but nothing else changes you will get – zero – benefits.
You are a manufacturer but you track all of your costs on spreadsheets. A shop floor application and standard costing system would show you where you are wasting money and which products cost the most to produce and why. If you know these things you can cut the waste and consider different pricing for more expensive-to-produce products.