A Framework for Evaluating ERP Acquisition Within SMEs

A framework for evaluating ERP acquisition within SMEs Aurelio RAVARINI Research Assistant Cattaneo University - LIUC Corso Matteotti, 22 – 21053 Castellanza (VA) – ITALY Phone: +39 331 572 327 [email protected] Abstract Recently, external factors such as the year 2000 issue and the adoption of the new European currency have been stimulating companies of any size to radically rethink their information systems. It is necessary to rapidly decide whether to modify existing applications according to the new requirements or to completely redesign the information system. In any case, this process often implies unexpected costs and allocation of resources. As a result, the need to change or renew software applications could be exploited as the chance to redesign the critical business processes as well as to implement an ERP system, in order to more effectively manage business information. The introduction of ERP systems often requires the evolution from the traditional company structure, built on business functions, to an organization based on business processes. This change usually involves significant impacts from both organizational and cultural points of view, which are rarely compatible with the peculiarities of small and medium enterprises (SMEs). Nonetheless, experiences from larger companies have shown the strategic and competitive advantages ERP systems can provide. Therefore, in order to allow SMEs to correctly evaluate the acquisition of ERP systems, it is necessary to consider also solutions implying lower organizational and financial impacts. According to the identification and analysis of a set of business indicators related to technological and organizational innovation, this paper presents a framework supporting the evaluation of ERP system acquisition within SMEs. Key-words : ERP (Enterprise resource planning) SMEs (Small-medium enterprises) IS acquisition Business complexity Business transformation Marco TAGLIAVINI Research Assistant Cattaneo University - LIUC Corso Matteotti, 22 – 21053 Castellanza (VA) – ITALY Phone: +39 331 572 226 [email protected] Federico PIGNI Research Assistant Cattaneo University - LIUC Corso Matteotti, 22 – 21053 Castellanza (VA) – ITALY Phone: +39 331 572 329 [email protected] Donatella Sciuto Full Professor Politecnico di Milano Piazza Leonardo da Vinci, 32 – 20133 Milano – ITALY Phone: +39 02 2399 3662 [email protected] A framework for evaluating ERP acquisition within SMEs Aurelio RAVARINI, Marco TAGLIAVINI, Federico PIGNI, Donatella SCIUTO Introduction The evaluation of the contribution of Enterprise Resource Planning (ERP) systems to the company value creation process has always been a difficult task. Since these systems aim at supporting the management of the company as a whole, their implementation often leads to radical organizational changes (Willcocks et al., 1998; Shtub, 1999; Lozinsky, 1999). Consequently, although the potential of integrated information systems is widely accepted, it is very difficult to isolate the ERP system contribution in the company value creation process. Experiences on the field show that, especially for small and medium enterprises (SMEs), it is hard to recognize the economic and organizational impacts related to ERP systems use, making it difficult to take advantage of the related investments (Brynjolfsson et al., 1996; Kirchmer, 1998; Welti, 1999). On the other hand, since most of large enterprises already make use of ERP systems, producers and distributors are now shifting their competitive focus towards SMEs (Amigoni et al., 1998). As a consequence, SMEs have to assess the different solutions offered by vendors often without adequate knowledge. Starting from a cross analysis between the procedures of implementation of ERP systems and SME peculiarities, this paper suggests a simple approach that, given the strategic choices of the company, supports the acquisition of ERP systems within SMEs. 1. Obstacles to the adoption of ERP systems ERP systems, traditionally designed for large companies application, are characterized by very high costs, that rarely can be met by SMEs because of their strict financial constraints (Palvia, 1994; Burns, 1996). Because of the virtual saturation of the market, ERP vendors have recently moved their attention toward SMEs, by offering simplified and cheaper solutions (Kirchmer, 1998). Nevertheless, although the price of ERP packages has been lowering, the whole investment is still very high, because of high costs of staff training and external consultancy (Shtub, 1999; Lozinsky, 1999). Furthermore, it is necessary to verify the suitability of ERP systems to SME peculiarities: within these companies, the decision to rethink the information system is often determined by exogenous factors, such as the year 2000 issue or the adoption of new European currency (Barelli, 1997; Leggio, 1998). In fact, SMEs rarely make use of formal business strategies: as a consequence, they spend very little time in checking up IS related strategic choices, and IS management is often approached in a non formalized way (Zinatelli et al., 1995; Cragg et al., 1995). As a consequence, the IS is often unable to effectively support business processes because of cultural problems, unsuited hardware platforms, as well as too rigid software applications (Burns et al., 1996; Julien, 1998). Riboldazzi (1998) found that most of the administrative systems currently used by SMEs are characterized by a very high degree of customization and that, on average, the corresponding investments are very low (in 34% of the sample it is lower than 5.000 USD). Other research have highlighted that SMEs typically attach low strategic importance to ICT potential applications (Occhini, 1997; Ravarini et al., 1998). On the other hand, the obsolete software applications currently used by SMEs could turn out to be an enabler of a radical change, that SMEs are increasingly requested to carry out because of the evolution of markets and technologies. In this sense ERP systems seem to be the right choice whenever it is considered strategic to: • take advantage of IT advances; • model software applications on business processes, rather than adjusting business processes according to software constraints; • pursue internationalization; • integrate information flows with customers and suppliers; • redesign and formalize business processes. 2. BPR as a prerequisite for ERP implementation? It is generally accepted that, whenever implementing a new IS like an ERP, companies should reengineer their business processes according to their actual requirements, in order to effectively exploit the benefits of IT (Davenport, 1993; Hammer, 1995; Whitman, 1996; Bloomfield, 1997). Nevertheless, it is questionable whether SME peculiarities and constraints could justify a different approach: SMEs could implement a ERP system delaying the possible process reengineering to a later step (figure 1). Next sections will describe the basic issues of both approaches. A framework for evaluating ERP acquisition within SMEs Aurelio RAVARINI, Marco TAGLIAVINI, Federico PIGNI, Donatella SCIUTO Traditional approach Approaches Business Process Reengineering E RP acquisition Simplified approach Analysis and D esign Implementation Startup Time Acquisition life cycle Figure 1. Two approaches to the acquisition of an ERP system 2.1.The traditional approach: BPR as a prerequisite of ERP implementation Business Process Reengineering (BPR) aims at improving the performance of business processes, according to their actual requirements rather than to software restrictions (Davenport, 1993; Hammer, 1995). The reengineered processes should drive the customization of software modules, to better exploit the potential of the ERP system. Reengineering the business processes implies relevant organizational impacts, since it often involves changes in the way people work, in the distribution of decisionmaking power, in the strategic importance of business functions. Therefore, this approach requires specific skills on process design and reengineering, as well as the ability to administer both managerial and organizational issues (Kirchmer, 1998; Shtub, 1999). These changes can dramatically affect SME organizations, where such competencies are usually not developed, the entrepreneur is often the only one having decision making power and where long term planning is very rarely performed (Burns, 1996; Julien, 1998). As a consequence, the adoption of an ERP system has a challenging impact on the overall organization and the financial constraints of an SME. For these reasons, it could be worth taking into account a simpler and less radical approach that considers BPR merely a possible activity, following the implementation of an ERP system. 2.2.A simplified approach: ERP implementation without BPR This alternative approach requires, in the first place, that the company adapts its processes according to the ERP system requirements. As a consequence, the time requested for the implementation of the system can be shortened, while possible reengineering of critical business processes could be postponed. From the technological point of view, the effectiveness of this solution depends on the IS flexibility. If the existing information system makes use of standard communication protocols, without being tied up to customized solutions, the adoption process of an ERP system will be easier and cheaper. From the organizational point of view, this approach has a lower impact on SME structure: it implies less structural changes, a short-term impact and lower financial resources. Nevertheless, the simple automation and integration of business processes could imply a too limited performance enhancement. In that case, the company could take into account a partial redesign of its processes: thus, the ERP system should be flexible enough to map its procedures on the reengineered processes, through the adjustment of its parameters values. 3. Evaluation of ERP system acquisition The simplified approach potentially allows the application of ERP systems within a wider set of SMEs: it relaxes constraints that have always been critical for smaller companies, such as financial limitations, organizational resistance to change and skill shortage. However, from the entrepreneur’s point of view, taking into account a new approach means increasing the complexity of the evaluation. For this reason the proposal of the new approach should be introduced together with a more general framework, supporting the entrepreneur in evaluating ERP system acquisition. As a matter of fact, the objective of such a framework belongs to the wider field of the “management of technological and organizational innovations”. Therefore, the framework should assist the entrepreneur in exploring both these dimensions, in order to make explicit the aims that can lead her or him to consider the acquisition of an ERP system. A framework for evaluating ERP acquisition within SMEs Aurelio RAVARINI, Marco TAGLIAVINI, Federico PIGNI, Donatella SCIUTO Because of the typical constraints characterizing SMEs, a procedure driving such an assessment should be fast, cheap, and as simple as possible, thus referring to a limited number of easily measurable business variables. Basing on these assumptions, the framework presented in this paper has been developed according to a bi-dimensional matrix structure, that require to assess the value of one indicator for each of the above-mentioned dimension (Figure 2): • flows: the more its value is high, the more the company will need to adopt complex IT solutions, hence, it could be used to estimate the intensity of technological change required by the company; • business complexity can be a meaningful indicator of the complexity of business information business transformation can be used to assess the level of organizational innovation (Venkatraman, 1994), i.e. the intensity of organizational change that the entrepreneur wish to achieve, also by means of the adoption of a new IT solution. Technological innovation H igh Radical Business com plexity L ow Increm ental Increm ental Local Automation Internal Integration Radical BPR O rganizational innovation Business Redefinition Network of Company Redesign Boundaries Business transform ation Figure 1. The indicators used to evaluate the intensity of technological and organizational innovation 3.1.Assessing technological innovation: factors affecting business complexity It can be assumed that organizational complexity is positively related to the need for coordination and control of organizational activities and therefore to the complexity of the information system (Grinyer et al., 1986; Lorange, 1980; Vancil and Lorange, 1975). An empirical confirmation of this statement is represented by the cited relationship between the use of ERP systems and the business size (that is a typical business complexity index). Previous research (Grinyer et al., 1986, Yasai-Ardekani and Haug, 1997) has developed measures of organizational complexity essentially based on size, diversification, and divisionalization of the company. Nevertheless, since the consistency of this indicator is essential for the theoretical validity of the whole framework, a detailed analysis of the literature has been performed in order to identify a set of business variables that show a meaningful relationship with business complexity. 3.1.1. Growth and development objectives A review of literature (Delmar, 1997, Weinzimmer et al. 1998) showed that there is little agreement on what fac- tors affect growth and how growth should be measured. This works show that the choice of absolute vs. relative growth criteria has a substantial impact on results: some factors positively affecting absolute growth were unrelated or even negatively related to growth in relative terms. The same pattern was also exposed while examining growth in sales and growth in numbers of employees: the factors affecting sales were not the same as those affecting the number of employees. Moreover, most studies were cross-sectional and relied on relatively small samples. These limitations lead to fractional insights into the reality of high-growth businesses. Murphy, Trailer and Hill (1996) studied different measures of performance in the research literature and obtained a similar conclusion: there is little consistency in performance measures across studies and comparisons are difficult or even impossible (cf. also Storey, 1994, p. 125). A recent study of managers found sales growth to be the most commonly identified measure of overall organizational performance (Hubbard and Bromiley, 1995). Of course, managers can choose from a bewildering array of performance measures, including accounting-based return rates such as ROI, various stockmarket measures, cash flows, and growth rates. Researchers confront similar A framework for evaluating ERP acquisition within SMEs Aurelio RAVARINI, Marco TAGLIAVINI, Federico PIGNI, Donatella SCIUTO choices concerning how to operationalize performance. Studies have considered numerous variations in performance measures (Lenz, 1981; Steers, 1975; Venkatraman and Ramanujam, 1986). Thus, this index could be evaluated through quantitative variables related to the business growth, such as the comparison of turnover and/or market share values with respect to previous years. Other indicators of growth are the production capacity or the acquisition of other companies. Therefore, the estimation of growth and development objectives requires the involvement of people managing the company expansion prospects, thus the company board. 3.1.2. Internationalization level The business complexity is directly proportional to the company degree of internationalization, mostly because of different legal and cultural issues that should be managed (Hamel and Prahalad, 1994; Prahalad, 1990; Sanders and Carpenter, 1998). The complexity arising from internationalization is typically associated with two factors (Westhead et al. 1998). First, as a firm expands beyond its domestic markets, it is likely to enact a greater diversity of cultures (GomezMejia and Palich, 1997), customers, competitors, and regulations (Brahm, 1994). Often, such diversity is at odds with the domestic managerial mindset of the top team (Ohmae, 1989) and puts pressure on the team to geographically fragment its attention (Ghoshal and Nohria, 1989; Kim and Mauborgne, 1991). Second, there are tremendous competitive pressures for international firms to extract synergies across product, geographic, and other markets (Bartlett and Ghoshal, 1989; Roth and O'Donnell, 1996; Rumelt, 1974). Researchers have generally focused upon two measures of internationalization. The first is the dichotomous dependent variable whether a firm exports sales abroad or not (Cavusgil, 1984; Westhead, 1995). Second, an export intensity dependent variable (i.e., the proportion of sales exported abroad) has been explored (Bloodgood et al., 1996; McDougall, 1989). In particular, SMEs could be classified into three classes according to the percentage of turnover (or investments) related to international operations: national companies export companies and international companies, the latter including only those companies producing and/or selling in foreign countries. 3.1.3. Diversification of product, market, technology The degree of diversification is related to the number and variety of business products and markets the company refers to, even from the technological point of view. The characteristics and the number of different products (as well as batch versus built to order productions) should imply different levels of complexity: the higher is the number of different products, the higher should the business complexity be. Moreover, companies could be classified considering those based on only one business unit, on more interrelated units, on dissimilar units. The extent to which the business units are related could generate a higher or lower level of business complexity. Evidently, non related business units imply higher values of business complexity. Furthermore, a company with geographically distributed branch offices has probably a higher complexity, in terms of logistic management and information flows. The extent of diversification and divisionalization have been used in many studies of strategy - structure relationships and have been shown to be robust (Grinyer and Yasai-Ardekani, 1980, 1981; Keats and Hitt, 1988; Montgomery, 1982). In related-diversified firms, an increase in the number of businesses adds to information-processing demands by increasing business-unit interdependencies (Hill and Hoskisson, 1987; Kerr, 1985; Michel and Hambrick, 1992; Pitts and Hopkins, 1982). In unrelated-diversifiers, as the number of businesses increases, the informationprocessing requirements associated with maintaining efficient internal capital markets also increase (Jones and Hill, 1988). Moreover, there are tremendous competitive pressures for international firms to extract synergies across product, geographic, and other markets (Bartlett and Ghoshal, 1989; Roth and O'Donnell, 1996; Rumelt, 1974). Indeed, theorists and practitioners have asserted that internationalization requires a firm to place a premium on swift and internationally coordinated action, to have the capacity to reconcile system and subsystem priorities, and to have the ability to develop and sustain a sense of community within the organization's global web of subsidiaries (Bartlett and Ghoshal, 1989; Sanders and Carpenter, 1998). Taken together, the factors discussed above serve to compound the complexity of a top team's tasks. 3.1.4. Diversification of product, market, technology The degree of diversification is related to the number and variety of business products and markets the company refers to, even from the technological point of view. The characteristics and the number of different products (as well as batch versus built to order productions) should imply different levels of complexity: the higher is the number of different products, the higher should the business complexity be. 3.1.5. Number of employees Although group size has been shown to be positively associated with information-processing capability (Haleblian and Finkelstein, 1994), research on work groups also suggest that large groups can become quite unwieldy (Gladstein, 1984). This remark raises an interesting ques- A framework for evaluating ERP acquisition within SMEs Aurelio RAVARINI, Marco TAGLIAVINI, Federico PIGNI, Donatella SCIUTO tion about board structure in complex environments, especially a highly international environment. That is, if board size increases to accommodate the complexity of internationalization, how will a firm avoid succumbing to the dysfunctional supervision and information-processing traits characterizing large groups (Finkelstein and Hambrick, 1996)? In such situations it is particularly important for a board's composition to be more balanced with insiders (Sanders and Carpenter, 1998). 3.1.6. H igh Redefinition of com pany boundaries Business netw ork redesign Business process reengineering Level of business transformation Degree of vertical integration Vertical integration requires executives to devote considerable time and attention to coordinating the operating interdependencies associated with long-linked chains of activities (Fry, 1982; Michel and Hambrick, 1992). As the number of sequential dependencies among various activities increases (which is the case in a long-linked chain of activities), the knowledge and skill required to coordinate them also increases (Wood, 1986). Moreover, as knowledge and skill requirements increase, information-processing demands also rise (Campbell, 1988; Henderson and Fredrickson, 1996). 3.1.7. and organizational structure (Venkatraman, 1994). As a result, it is possible to identify five strategies characterized by very different organizational impacts and potential benefits (Figure 3). Degree of functional extension There are companies considering certain business functions trivial: the degree of functional extension refers to the number of strategic functions directly managed within the company. This index should be directly related to the complexity of the organizational structure as well as the organizational coordination. A very simple estimation of the business complexity could be achieved by assigning to each variable a value ranging from 0 to 5: the amount of business complexity will then be expressed as a value ranging from 0 to 30. Such a procedure does not provide a precise estimation of the business complexity, but aims at developing awareness about the reasons motivating organizational changes, as well as the formalization of this choice through qualitative evaluations. Next paragraphs will explain how to correlate the business complexity to other strategic parameters in order to evaluate the acquisition of an ERP system. Internalintegration L ow L ow As above mentioned, the acquisition and use of an ERP system can not only improve business process performance but may revise the way of doing business. In fact, the use of IT ranges from the simple improvement of procedure efficiency (automation) to the business process reengineering (transformation), until the overcoming of company boundaries, through the creation and management of inter-organizational relationships that can effectively be supported by IT (joint ventures, long term contracts, licensing agreements, etc). Hence, the acquisition of an ERP system could affect the company structure at different levels, regarding both operating procedures Potential performance improvement H igh Figure 2. Levels of business transformation related to technological innovation 3.2.1. Local automation This strategy is pursued only for automation of local, independent procedures. It requires minimal efforts and expected results involve just enhancements in business process performance. Benefits coming from this strategy are easily duplicable, as most of standardized solutions. Therefore, it is unlikely to get competitive advantage by simply automating existing procedures. 3.2.2. Internal integration Internal integration aims at integrating the business processes and the company IS in order to create competitive advantage. The required integration has to be pursued both at the technological and organizational level: whenever necessary, people belonging to different business functions have to cooperate to reach common objectives. Together with the necessary automation effort, this strategy requires an integration effort; however, in both cases the business process structures remain unchanged. 3.2.3. Business process reengineering This strategy involves the partial or complete redesign of business processes. As stated before, this means a change affecting not only the company procedures, but also its organizational structure. 3.2.4. 3.2.Business transformation levels Localautom ation Business network redesign In this case changes overcome company boundaries and affect the entire network of external relationships. The interaction with its partners is not only through EDI, but implies the business process integration, through a continuous information exchange and competence sharing. This scenario allows each partner to exploit the competencies of the business network without involving expensive solutions of vertical integration. 3.2.5. Redefinition of company boundaries IT allows the redefinition of the competitive environment through the creation of strong inter-organizational relationships. A framework for evaluating ERP acquisition within SMEs Aurelio RAVARINI, Marco TAGLIAVINI, Federico PIGNI, Donatella SCIUTO The choice of the most suitable transformation level should derive from a detailed cost/benefit analysis, taking into consideration the significant impact of IT acquisition and use on organization. A cross analysis between the business complexity and transformation levels leads to the definition of a two dimensional matrix which aims at supporting the evaluation of ERP system acquisition within SMEs. Each of the main indicators can assume two values, thus identifying four possible situations (Figure 4). 3.3.A framework for the evaluation 1 H igh 2 Sim plified Approach Traditional Approach Business Com plexity L ow 3 4 Inform ation System Check-up BPR A utomation Strategies Local Automation Internal Integration Transformation Strategies Business Business Network Process Reengineering Redesign Redefinition of Company Boundaries Business Tranform ation Levels Figure 3. A framework for evaluating ERP acquisition within SMEs Each position of the matrix corresponds to specific business innovation requirements, which specify the opportunity of acquiring an ERP system. Furthermore, according to the previous remarks on the need of business process redesign before implementing an ERP system, the model identifies the most suitable organizational choices according to the levels of business complexity and transformation. Next paragraphs will outline the interpretation of each position into the matrix. 3.3.1. Position 1: simplified approach Although the high business complexity may justify the acquisition of an ERP system, the company does not want to be subject to the organizational impacts related to business process reengineering. This is the most suitable situation to apply the simplified approach, i.e. the acquisition of an ERP system without redesigning the business processes. 3.3.2. Position 2: traditional approach The company is characterized by high values of business complexity and is ready to redesign its organizations (or at least its processes). Therefore, the traditional approach seems to be the most appropriate choice. Since this solution implies higher investments and organizational impacts, the company will have to be ready to face such problems. 3.3.3. Position 3: check-up information system The low business complexity, together with the resistance to organizational impact, does not justify the acquisition of an ERP system. The company will have to focus on its existing applications, by verifying the effectiveness of their support to the company strategic objectives. By using open architectures, standard communication protocols and avoiding any kind of customization, the IT manager will avoid a possible dependence on the software suppliers. 3.3.4. Position 4: business process redesign Companies positioned in this area are characterized by low business complexity, but nevertheless feel the need to redesign their organizational structure. Therefore, it could be useful to start redesigning the business processes and verifying the coverage level of existing software applications with respect to the new processes. If the coverage level is too low, the company should seriously take into account the acquisition of an ERP system, possibly comparing this analysis with the purchase of software application that could better support each business procedure. A framework for evaluating ERP acquisition within SMEs Aurelio RAVARINI, Marco TAGLIAVINI, Federico PIGNI, Donatella SCIUTO 4. Conclusions The acquisition of an ERP system implies technological, organizational and cultural impacts. Because of their peculiarities, SMEs often give up the introduction of technological innovations requiring important organizational changes. Therefore, smaller companies need to consider alternative solutions characterized by lower organizational and financial impacts. This paper suggests a simple framework for evaluating the acquisition of ERP systems according to the level of business complexity and the extent of organizational change the company plans to achieve. 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