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ERP Application Erosion and the Cost Curve

Posted on 1 December 2015 by Alistair Brough

alistair_application_erosion_and_the_cost_curve.jpgHow many of you remember the cost curve?

All economics students are taught the cost curve at university – it’s a very useful tool for planning and optimizing production. To be honest, the cost curve’s message haunted me for weeks until I had my ‘Eureka!’ moment – a little too late for the final exam, but not too late to be of value in my job here at SYSPRO.

As Wikipedia informs us: ‘...a cost curve is a graph of the costs of production as a function of total quantity produced.’ The typical short-run cost curve is ‘U’-shaped. As initial output increases the company enjoys economies of scale and the cost of producing each unit goes down. At a later date, cost per unit goes up, typically due to the need for additional labor, and the curve begins to ascend.

Imagine, for example, a small factory making widgets. At a certain point the company has lowered the cost of each widget and is making money hand over fist. In order to increase production and make even more money, additional workers are hired. But this is where the rot sets in – not only does additional labor add extra wages to the cost of production, it puts additional strain on almost every stage of the process, from logistics to distribution. The simple fact of having more bodies on the assembly line, elbows bumping against elbows, tends to slow down the average rate of production, thus increasing the cost per unit.

Application erosion will also drive up the cost curve by lowering the productivity of labor. Imagine a new, under-trained employee who decides that the ERP’s Bill of Materials is out of her comfort zone. At her old job she ran the production floor with a spreadsheet, and that’s what she decides to do now. This is application erosion in action! What used to take three minutes using the ERP is now a full-day job in Excel. Not only does this decrease the value of the ERP, it shortens the desirable downward descent of the cost curve and points it prematurely upwards as your cost per item of output rises.

If the cost curve argument doesn’t clear things up for you, here’s another way of looking at it. Let’s compare an integrated ERP to a network of different systems:

  • OPTION A: you have one system – your ERP – that costs (for ease of argument) $5,100 to license.
  • OPTION B: Forget about ERP – you can run your whole business on five smaller systems that cost $1000 each to license. At first glance, this leads to a $100 savings over the ERP, and every dollar counts at the end of the day.

Or does it?

Let’s imagine that maintenance will cost $100 per system. The cost of Option A, the ERP, is now up to $5200 – but the cost of Option B soars to $5500. Let’s add training into the equation, and the fact that running multiple interfaces usually requires translation between systems, which requires additional development. Suddenly the cost of Option B far outstrips the cost of a well-maintained ERP.

While the above discussion doesn’t describe application erosion per se, it does give a hint of what can happen at the financial level once application erosion has ‘dis-integrated’ your ERP.

 

Topics: ERP and Financial Management, Owning or (Running) ERP


Alistair Brough

Al Brough is an Analyst at SYSPRO Asia. Before entering the world of ERP, Al worked extensively in the sugar and timber manufacturing industry.

With an undergraduate degree in Marketing and Human Resource Management, Al uses his broad knowledge base and pragmatic nature to find the perfect solution for every problem. His personal life is perfectly balanced by his lovely wife, an energetic Jack Russell, anything to do with trains and a slow-growing bonsai.

 

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