ERP costs: When does the investment pay off?

What does an ERP system cost? A cost overview

The cost of an ERP solution is made up of several parts: license fees, implementation, and long-term maintenance. To put the investment in perspective, you should understand total cost of ownership (TCO).

TCO is the sum of all costs tied to the investment: not only the initial purchase price, but also every direct and indirect operating cost over the system’s full useful life.

License costs: A major part of total cost of ownership

License costs for an ERP system are the direct costs of buying or licensing the system. They are often the first and most visible cost factor, but their structure and amount vary depending on which licensing model you choose. To choose well, you need to understand how different licensing models work and what long-term effects they can have on total cost.

One-time license fee (on-premises)

In this model, the company pays a one-time fee for the right to use the ERP software and receives a perpetual license installed and run on its own servers. On-premises licensing usually involves higher upfront investment because you buy the software outright. Additional costs for hardware, IT support, and regular updates are also typical.

Subscription model (cloud-based)

With a cloud ERP solution, companies pay a monthly or annual usage fee for access to the ERP system. Those subscription fees typically cover maintenance, updates, and in some cases support. This model does not require a large upfront investment; instead, it spreads license costs over the system’s full useful life. Cloud-based ERP systems often offer greater flexibility because you can add users or modules as needed.

User-based licensing

Some ERP vendors set license costs based on the number of users who access the software. Companies then pay a fee per user, either one-time (on-premises) or recurring (cloud ERP). This model suits companies that want to start with a small user base and buy additional licenses only as demand grows. However, TCO rises in proportion to the number of users, so the model can become expensive over time as the user base expands.

Modular licensing

Some ERP vendors offer modular licenses, where the company pays only for the functions and modules it needs. Purchasing, inventory management, and finance, for example, can be licensed as separate modules, so you pay only for the areas you actually use. That can lower TCO for companies with specific requirements.

Costs of implementing an ERP system

Implementing ERP software is the second-largest cost item after licensing. Implementation costs vary significantly from company to company and depend on several factors, including company size, process complexity, and specific requirements.

These are the costs you should expect when implementing an ERP system:

Data migration and integration

A major share of the effort comes from migrating historical data into the new ERP software. Integration costs also arise when the ERP system needs to connect to third-party solutions such as CRM, accounting, or logistics software. Those interfaces (APIs) often need specific customization, which increases effort and cost.

Customization

Every company has its own processes and requirements that often call for changes to the standard ERP. Industry- or company-specific customization ensures that the software is a strong fit for your organization, but it adds extra work.

Hidden implementation costs

Unexpected costs can appear during implementation, for example for additional hardware or software to support data migration.

Ongoing costs for maintenance and updates

Ongoing costs after implementation make up an important part of total cost and differ significantly by model. As a business owner, you need to keep ongoing costs in mind and plan for maintenance, service, and security early. Here is how on-premises and cloud ERP systems differ:

On-premises ERP systems

• Maintenance and updates: With on-premises solutions, you install software updates and security patches yourself. Those processes can be resource-intensive and require an experienced IT team or support contracts with external providers.
• Hardware and infrastructure costs: Because the full IT infrastructure is managed locally, hardware and network components also need regular maintenance and replacement.
• Security and backup solutions: Security measures such as firewalls and encryption systems, plus regular data backups, have to be managed in-house. That can be costly because it requires additional hardware, software, and IT resources.

Cloud solutions, using Dynamics 365 Business Central as an example

• Ongoing license fees: With Dynamics 365 Business Central, the company pays monthly or annual fees that already include maintenance, updates, and security.
• Support and service-level agreements (SLAs): Cloud ERP vendors such as Microsoft offer a range of support packages, from free base support to premium options with 24/7 support and the highest service levels.
• Security solutions and backups: Cloud infrastructure often includes built-in security, automatic backups, and a high level of data encryption.

Employee costs for the transition and training

You can only use the new ERP system successfully if users receive enough training. Do not underestimate training and onboarding for your team: they directly affect how the system is used and how efficiently you operate. Costs include the following:

• Training costs: Training costs include several components, such as basic and advanced training on the ERP system’s general functions, plus module-specific training for the modules your company uses.
• Key user training: Key users receive more intensive training and then serve as internal points of contact. They can pass on their knowledge and train new employees, which saves money over the long term.
• Productivity losses: During the rollout, expect a temporary drop in productivity as employees get used to the new ERP system. That can indirectly raise implementation costs.

When is an ERP system worth it?

You may already be adding up license, implementation, and training costs in your head and wondering whether the investment is worth it at all. The answer is straightforward: ERP software pays off when the benefits you gain clearly outweigh your initial and ongoing costs.

You can assess the cost-benefit ratio of ERP solutions through return on investment (ROI) and the payback period. A high ROI and a short payback period are clear signs that the ERP system supports your long-term business goals.

Assessing ERP costs using payback period and ROI

In an ERP context, the payback period answers a simple question: How long does it take for efficiency gains, lower error rates, and streamlined processes to offset the purchase costs and ongoing expenses?

The term is closely linked to return on investment (ROI), which describes how profitable an investment is. ROI compares the return generated with the amount invested and shows how strongly the investment contributes to creating value for the company.

So the payback period tells you when an ERP system’s costs have been recovered, while ROI assesses overall profitability beyond that point.

How do you run a payback and ROI analysis?

A payback and ROI analysis helps you assess the economic viability of an ERP system. The process includes these steps:

1. Cost analysis: Determine the upfront investment for the ERP system, including license costs, implementation, training, and hardware. Also capture ongoing maintenance and support costs.
2. Estimate potential savings: Calculate how much you can save each year by using the ERP system. Typical savings come from higher productivity, lower inventory levels, more efficient purchasing, and fewer errors in production and administration.
3. Calculate the payback period and ROI: You can calculate the payback period and ROI as follows:
   • Payback period = Total costs / Annual savings
   • ROI = ((Savings - Investment costs) / Investment costs) × 100
   • The ROI figure expresses the profitability of the ERP investment as a percentage.
4. Factor in risks and uncertainties: Consider unforeseen costs or potential risks, and adjust the calculation if needed so you get a more realistic payback period and a more conservative ROI.

Sample calculation for an SME

Suppose an SME decides to implement an ERP system and expects the following costs and savings:

• Initial investment (including licenses, implementation, and training): CHF 80,000
• Annual maintenance and support costs: CHF 10,000
• Estimated annual savings (for example from efficiency gains and lower inventory): CHF 30,000

Payback period and ROI calculation:

• Total costs for the first year: CHF 80,000 (initial costs) + CHF 10,000 (maintenance costs) = CHF 90,000
• Annual savings: CHF 30,000
• Payback period = CHF 90,000 / CHF 30,000 (per year) = 3 years
• Return on investment (ROI) = ((30,000 × 3) - 90,000) / 90,000 × 100 = 0 percent

After the payback period (3 years), annual ROI is then about 33 percent of the cost savings relative to the original investment (CHF 90,000).

This means that after about three years, the SME has recovered the investment costs through savings, and from that point on the ERP system continues to increase the company’s ROI.

Tips to keep costs down

Every phase of an ERP project, from choosing a licensing model to training employees, offers room to cut costs. Here are some field-tested approaches to reduce total cost and shorten the payback period:

• Choose the right licensing model: Compare on-premises and cloud options carefully. Cloud-based models need less capital up front and spread costs over the useful life. With on-premises, one-time costs can be more economical in the long run if you need extensive customizations over time and user counts keep rising.
• Use modular licensing: If you only need specific ERP functions, choose a modular application such as Dynamics 365. The advantage is that you only have to license the modules you need.
• Keep integrations to a minimum: When integrating additional applications, focus on what is necessary. Integrations cost money not only up front, but also through ongoing maintenance. A consolidated system landscape can lower those costs over the long term.
• Develop an efficient maintenance strategy: Plan updates and maintenance so they are carried out on a regular basis and you avoid emergency or ad-hoc costs.