Quarterly Journal on Management
From the publishers of THE HINDU BUSINESS LINE
Vol. 2 :: Iss. 3 :: February 1999
Enterprise Resource Planning software -- what it can do, and what it cannot.
Information technology can make or break a company in the present ultra-competitive environment. The pressure that this environment can apply on companies is huge: for instance, in a span of about 10 years, it has forced companies in India to shift from being profit-driven to being customer-driven.
At the cutting edge of information technology (IT) for enterprises are the Enterprise Resource Planning (ERP) Packages that help manage the functions and processes of the entire organisation, right from the planning and policy making stages to distribution and marketing.
Many fundamental changes are taking place businesses. Organisations have been forced to shift from mass production - making a lot of the same kind of things - to mass customisation - making a lot of different kinds of things. This means that companies will have to possess a repertoire of designs and stop their production line frequently for tooling changes. Every such stoppage and change has associated costs: design costs, testing costs, and most important, idle time costs. This switching from one process to another can be made more efficient by the speed at which information about new trends can be collected, and excellent logistics (in terms of inventory control, machine scheduling etc.), which is assured by IT. Employees have been forced to shift from being skill-driven to being knowledge-driven, and the cause and enabler of this shift is IT itself. Automation (in terms of expert systems in manufacturing) has made many skilled and semi-skilled people redundant. They have to be retrained to adapt to new systems and processes. The retraining is effectively done with the help of information technology (internet, intranets, Computer Based Training etc.).
With respect to ERP implementations, the number of people required just as a medium of communication has been cut down drastically. This is happening especially in the non-production areas. For instance, Roots Industries Ltd, a Rs 20 crore, Coimbatore-based, horn manufacturing company, has just three people managing its entire accounting function. The need for lower-middle and staff level people in the supporting areas is now almost non-existent.
Managers, too, have been forced to shift focus from purely operating for maximum profits and least costs of their own divisions, to a more complete perspective of the whole organisation. In an organisation that is run as a cluster of Strategic Business Units (SBUs), focussing on each and every SBU and its cost and profit functions may not be as gainful as looking at each SBU's costs and profits in relation to the other SBUs. Functions have to be optimised at the enterprise level, which may mean that some divisions/ departments have to operate below par.
Promise or Peril?
Most ERP packages are skewed towards manufacturing and production processes because this is where most of the perfectly identifiable cost activities take place. Most managers are attracted by what is promised by an ERP solution as a cost reduction solution in terms of productivity and co-ordination.
Although productivity is a key parameter for manufacturing companies, another reality is that even when high productivity is achieved, it does not automatically translate into competitive advantage. Competitive advantage comes from delivering what customers value, and from doing so in a way that cannot be easily copied. Because productivity is typically construed to involve a narrow focus on reducing costs and increasing throughput, it diverts attention from areas like customer service, quality, and timeliness. These areas are not as easy to quantify, but they are often places where IT can have the biggest impact.
The right focus/ purpose has to be identified when opting for an ERP package. Coimbatore-based Revathi-CP Equipments Ltd, is looking for an ERP solution. S. Hariharan, General Manager - Finance, Revathi CP Equipment Ltd, hits the nail on the head when he says: " We are not looking at an ERP solution as a cost reduction package; we are looking at it as a means of streamlining operations to offer better customer service. Cost reduction is incidental... it happens when you streamline activity."
The right direction is required because the price of a mistake is very high: anywhere around Rs. 30 lakhs to a couple of crores, just for the ERP solution, not considering other changes that are made in terms of process reengineering and the like. It pays to know what to expect, and what not to expect from an ERP solution. It pays better to know which of those expectations are realistic, and which ones are not.
Manufacturing companies can benefit from an ERP implementation in just one major area: reduction in cycle time. The rest of the benefits are up to the management to identify, and utilise. In the process of reducing cycle time, the ERP package will look at the key variables that affect cycle time: Raw material, Processing, and Scheduling.
ERP solutions are invaluable when an organisation has a whole range of products requiring different input components. For instance, Roots Industries Ltd makes about 30 different kinds of horns. Each horn has about 120 components, of which quite a few are also used for other finished products. In effect, the company has to maintain stocks of almost 2,000 different items. To complicate this further, a single order may consist upto 15 or 20 different Stock Keeping Units. Roots uses MRP II, a scaled down version of a full-fledged ERP solution.
O. A. Balasubramaniam, Senior Manager - Systems, Roots Industries Ltd, who handled the implementation says that the solution has done wonders for the company. He says: "It will tell us when to order what items, when to give the order to sub-contractors, it takes care of the scheduling and tells us when to process which order." The main advantage has been that the average cycle time has been reduced by 30 per cent, and he is hopeful that it can be cut further, as managers start realising the full potential (the solution has been operational since April 1998). He adds: "Reduction of cycle time means that we can promise faster delivery."
With respect to handling raw material, the key concepts are reorder levels for different components/inputs, the Economic Order Quantity (EOQ), and the co-ordination of the orders. With respect to processing, just before implementing an ERP solution, the organisation may have to reengineer some processes to make them more effective. By far the most important variable in cycle time, scheduling, comes next. The raw material has to be processed at the right time and different processes that can take place simultaneously have to be set in motion. The process scheduling has to be done in such a way that there is least work-in-progress, and least finished goods inventory at the stores.
The optimisation of the order quantity leads to a decrease in raw material costs. Streamlining of the process in terms of better reorder levels, and co-ordination of ordering results in reduced inventory costs. Processing costs also decrease because of better quality control - both in terms of product quality, and process quality. Taken together, these little savings here and there add up to quite a tidy saving in total costs.
ERP has further impacts on cost. Apart from being an information system that generates reports, ERP also helps in decision making by allowing specific queries. For instance, it can tell the organisation which vendors offer the best credit terms, which vendors deliver on schedule, which vendors have the capacity to match which kind of order, etc. For instance, it can name vendor A as the best vendor for ordering 1000-1200 units of a part, to be delivered within 20 days, but when the delivery period is stretched to 30 days, vendor B is better. This reduces costs and simultaneously helps to identify vendors for partnering.
Costs, Costs, Costs! What about Revenues?
The reduced cycle time gives the organisation two choices: One, to pass on the cost reductions to the customer; and/or, two, to utilise the cost savings for investment in research and development. Both these choices will enable the organisation to retain its customers as well as attract new ones. In the first case, the company is going to attract customers with a very basic proposition: same product at a lesser price; in the second case, the proposition is a better product at the same price.
The reduced cycle time's advantage of reduced cost will be short lived, in the sense that once the implementation is complete, including programming the new parameters into the decision support system, the cost reductions will no longer be very attractive. Managers will view the savings in costs as a matter of course. Besides, once the competition implements an ERP solution, the advantage of reduced cost is going to be wiped out.
In this context, it is better for a company to look at an ERP solution as a complete solution, rather than as a cost saving device. The potential of the solution to improve revenues has a much more important role to play.
Any ERP implementation will have an impact if and only if the decisions are made on the basis of what the package tells you. That raises another question: The reliability of the control parameters that have been programmed for the ERP. It also raises the question of the reliability of data that has been fed into the system. One has to keep in mind the fundamental truth about any system, let alone information systems: Garbage In, Garbage Out (in IT parlance, GIGO).
Control parameters need to be properly and thoroughly analysed before being incorporated in the system. It is the classic case of knowing what to measure rather than how to measure. It is very easy to measure all the wrong things, and it is also very easy to get stuck trying to figure out how to measure some performance.
For instance, one CIO, in response to a query on the result of ERP implementation, said that the effect is all not measurable as the company has realised a lot of customer goodwill, but that is not measurable. Wrong! At the individual client level, it can be measured by looking at what percent of the customer's requirement the company satisfies; and, the number of repeat orders (a measure of customer retention). At a larger level, we could also compare customer retention rates before and after ERP implementation.
Further, the data that is fed into the system has to be above suspicion. In this regard, the author found a problem which is probably peculiar to developing countries. Companies keep the ERP solution off-line, in the sense that basic production data is fed by machine/shift supervisors rather than by the machines themselves. Also, only a few companies use automatic inventory control systems in terms of bar coding and scanning; most still have store clerks feeding the system with store data.
Feeding data manually into the system raises two problems: One, the person entering the data might make a mistake (for instance, type in 100 instead of 1,000); and two, persons might enter the wrong data intentionally. Identifying the second problem, in the long run, may be easy. The first problem, however, is something that is bound to happen every now and then.
Does a company that uses machines incapable of transferring data really need an information system that is most particular about each and every unit/paisa that comes in or goes out of the company? Implementing a real-time information system - and paying lots of money for it to enable decision-making at all levels - when the actual processes involve machinery that do not have the requisite finesse in information transfer, is very much like putting the cart before the horse.
In Roots' case, where the ERP solution is held off-line and data is input manually, the company is planning to implement a bar-coding system for stores and work-in-progress in the near future. This is bound to bring in more reliable data faster, and the company is looking at automatic data acquisition systems for the future.
Indian companies face a major problem in exploiting the potential of ERP solutions simply because the infrastructure in India does not allow for the kind of fine tuning that ERP solutions suggest. For instance, if a company located in Coimbatore orders some components from Cochin, the actual time taken for the delivery, normally, is about four hours. But just-in-time is not possible because the truck would have to stop at the Kerala-Tamilnadu border, and nobody knows how long it would be held up there. Therefore, to be on the safe side, the company orders in such a way that the supplies arrive about 3-4 days in advance. Now, that is reducing the company's savings from what it could actually save.
Another peculiar problem that Indian companies face is the fact that the ERP package does not really help in fulfilling bureaucratic formalities for excise, customs etc. The company would still have to have a separate system to handle that aspect of business. The best computer technologies will always add unnecessary costs to a poorly managed firm. For instance, they may just make a non-productive process more productive when, in reality, the management should have got rid of the process. The problem, then, is not with the capabilities of the technologies, but with the managerial inability to use them effectively. Gartner group researchers allege that "70 per cent of IT projects have not delivered their expected benefits because they have failed to integrate the results into work processes."
The true test of the decision making process is to determine whether it makes the best use of the information available, and whether the knowledge of how to use the information is better than the competitor's.
There is a point at which the cost of producing better information becomes prohibitive; for instance, the marginal value of 98 per cent accuracy versus 97 per cent may not be worth the cost. At this point, it is better to conserve resources (here, capital) and continue with the current system that provides reasonably reliable and fast information. This is not saying that an ERP is not a valuable tool; just that "If a thing ain't broke, don't try fixing it."
What eventually happens in some Indian companies is that the whole ERP solution is held off-line for some reason or the other - usually the ones discussed above - and the output from decision support modules is generally used as a benchmark for performance, as it happens in Elgi Equipments and Roots.
Harjeet Singh Wahan, Executive Director, Elgi Equipments Ltd, says: "We are fine tuning our internal performance to the fullest potential. We use the solution's output as a benchmark for performance, and we are looking at incremental improvement towards what the solution says we could achieve." Roots' Balasubramaniam says: "We are continuously experimenting with the parameters and deriving ourselves."
Although this seems to be a good practice, considering the environmental hurdles, the question of whether companies need expensive ERP solutions just to use as modelling algorithms or performance simulators is something that has to deeply thought about.
In the final analysis, any project, at some stage, has to go through a cost-benefit analysis. This analysis is based on projections, estimates, and expectations. In terms of ERP implementations, there is a great danger of overlooking certain simple constraints. An ERP solution promises a lot of genuine improvement, and in return, requires certain preconditions to perform to its potential. An analysis of what a company could achieve after taking into consideration the preconditions that are required would go a long way in the company reaping the benefits and being satisfied with its new solution.