Is ERP outsourcing viable?

SAP ERP - costs per named user

Outsourcing the business applications is attracting increasing interest in IT organisations. The step is not, however, always worthwhile – an optimally structured and highly efficient internal IT department can absolutely offer the same service as a provider at a lower price.

The outsourcing of applications is widely assumed to pay off for customers: pay less for more service and delegate work, responsibility and hassle to boot – who doesn’t want this? The sticking point in the supplier‘s traditional cost argument (“reduction of IT operating costs by more than 50% possible!”), however, is that the market is not transparent nor are the prices stable. This applies not only to outsourced services, but also to IT services provided internally. And anyone who is not familiar with their own costs will find it difficult to negotiate with suppliers and legitimise well-founded decisions.

On the other hand, it is perfectly possible that the provider’s calculations will add up in favour of the customer. If the user is planning to use a new ERP solution “on a greenfield site”, service providers can exploit the full advantages of this approach. The full (financial) benefits of service providers are also revealed in a comparison with ERP environments with a below-average level of efficiency.

Unknown quantities

There are, however, unknown quantities that mean that the project no longer pays off. The quotation price usually seems lower on paper than the costs of internal operations, as the service provider simply distributes financial advantages expected for the future over the term of the contract. He tries to offset this by extending the term and keeping the annual reduction as flat as possible in order ultimately to break even. This means that the financial cost of the provision models is offset in the medium term.

The chart (see above) shows the typical trends in the costs and prices for named users of SAP ERP, using the example here of a fictitious outsourcing agreement with a term of four years based on real and current benchmarking data. In the first instance, outsourcing the services is cheaper, but the costs offset this over the years. While the service provider tries to finance itself over the term of the contract with relatively stable prices, the costs of internal IT fall more quickly. There are various reasons for this, such as more efficient use of the hardware through, for example, increased virtualisation, the standardisation of procedures for managing the systems, more mature processes or the effects of synergy. 2012 marks the end of the fictitious contract. The service provider can adjust its prices to the market conditions in a new quotation and the race starts all over again.

Further costs

The services requested in the tenders are often offered cheaply in order to get a foot in the door. The supplier seeks to deliver additional services. These then become a test bench for the business case for outsourcing if they have not already been agreed contractually in advance. A service provider will find that the expense really pays off. Further costs are incurred through the retained organisation for controlling the provider.

In conclusion, our benchmarking data shows that ERP outsourcing is generally cheaper than internal operations at the standard level. If, however, internal IT is in good condition, with an ERP environment that has been streamlined for efficiency and is “best in the class” - this can still be financially competitive. On the other hand, it is also necessary to constantly work on the infrastructure and modernise it. Slackening the reins inevitably results in higher costs. This does of course also apply to outsourcing agreements. IT managers can therefore influence whether outsourcing of the ERP environment is worthwhile or whether inhouse operation can be more economical.

Timo Kopp, Senior Consultant, Maturity

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