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A second wind

for ERP
Dorien James and Malcolm L. Wolf

Implementing enterprise resource-planning systems can be intensely painful, and once you have them up and running they may seem to interfere with the speed and nimbleness required for electronic business. Are they a waste? No, but the real benefits aren’t always obvious.

enterprise resource-planning (ERP) systems—that is, massive computer applications allowing a business to manage all of its operations (finance, requirements planning, human resources, and order fulfillment) on the basis
Dorien James is a consultant and Malcolm Wolf is a principal in McKinsey’s London office. Copyright © 2000 McKinsey & Company. All rights reserved. This article can be found on our Web site at www.mckinseyquarterly/infotech/sewi00.asp.


hroughout the 1990s, most large industrial companies installed

in hindsight it appears that EC K . which in turn generates orders for raw materials. Those companies that were able to point to them thought they could have been achieved without the help of the computer system. production schedules.” Today. painful. that didn’t exist when ERP systems were first installed. installing ERP was traumatic. What most attracted many a chief information officer was the opportunity to replace a tangle of complex. and expensive implementations. ERP promised huge improvements in efficiency— for example. Back-door gains “What we bought was sustainability. and improved customer service.” In fact. JO HN BL For many businesses. such as electronic commerce and continuous-relationship marketing (CRM).of a single. and these improvements collectively add considerable value. “Many of the benefits that we are able to achieve today could not have been predicted at the time that we started work on ERP.” said one ERP director. businesses around the world invested some $300 billion in ERP during the decade. Encouraged by these possibilities. timetables for shifts. which we could have achieved without making the IT investment. some companies had difficulty identifying any measurable benefits. integrated set of corporate data. managed to switch off 350 old systems when ERP went live. One chief information officer concluded that “80 percent of the benefit that we get from our ERP system comes from changes. and financial projections while keeping close track of inventory. monolithic ERP systems look more and more like cumbersome relics of an older IT world. lower back-office staff requirements. a manufacturer can generate the next cycle’s demand forecast. disparate. one major oil company. Yet companies shouldn’t bemoan the cost of their investment: the hard-won skills and capabilities they acquired during the ERP installation process will permit them to improve their ERP applications incrementally. Following long. such as inventory optimization. as the information technology spotlight shifts to electronic business. By entering customer and sales data in an ERP system. where “nimbleness” and “Web speed” are the buzzwords. and obsolescent applications with a single Y2K-compliant system from a reputable and stable vendor. for example. ERP can also accommodate technologies that facilitate promising developments. reduced inventory. shorter intervals between orders and payments.

At least the new processes resulting from ERP are a consequence of design rather than evolution. . The first element of this foundation is common data.102 T H E M c K I N S E Y Q U A R T E R LY 2 0 0 0 N U M B E R 2 much of the value of these large systems lay in the infrastructure foundation they created for future growth based on information technology. ERP demands standardization to reduce the number of process variants that must be supported. Standardized business processes are the second part of the foundation. The third and last part of the foundation is an organization that has been built to change continually. the initial implementation through incremental initiatives will have generated IT cost savings and process efficiencies. IT cost extend capabilities savings Think of such companies as through use of new technologies standing at the foot of a “staircase Improve business of value” (Exhibit 1). the use of different exchange rates to calculate the financial results of different plants— that must be resolved. Reaching the summit means placing applications that can support new initiatives such as e-commerce and CRM on top of ERP. The implementation of ERP gives many people their first experience of an IT project that truly changes the way a business works. globally consistent processes become essential. Competitive advantage Process effectiveness Ascending the value staircase For companies that already have ERP systems in place. The ability to execute such business initiatives is a valuable asset at a time when fast and flexible IT deployment EXHIBIT 1 has become a major success factor Climbing the staircase of value in almost all industries. Companies learn—sometimes the hard way—the need for business leadership of IT initiatives and for operating in project rather than line structures. Painful changes in even the best local traditions may be needed so that orders can be fulfilled consistently throughout a business. In most processes and capture more savings cases. When customers demand consistent global quality. To make an ERP system work in an enterprise or business unit. This discipline renders the data both transparent and easy to compare. Ascending the lower steps of the staircase requires many small adjustments that will cut IT costs and improve business processes further. the key Process problem is translating this infraefficiencies Build on ERP infrastructure and structure into bottom-line value. everyone must agree to enter information using the same vocabulary and format. exposing anomalies— for instance.

Deadline pressures probably forced the original ERP implementation team to jettison inessential but useful functions. “It was obvious in hindsight. and that value can be captured through incremental initiatives. Refining the system. Placing orders with just a few could win a substantial discount.” . Captured data. the push to deliver the original implementation punctually is likely to have left value on the table.” from different functions and sites. Look for add-ons. The key to continued success is pushing responsibility for change outward by appointing a network of “initiative owners. suppliers. service functions. but employees “needed the experience to understand why we all had to do it the same way. Extending uniformity. who understand the ERP system. finding that its different distribution processes interfered with its ability to manage its stock-control system in a number of European countries. may show that a company buys comparable products from a number of suppliers. such as electronic-ordering and -payment systems. One manufacturer. Their task should be to find the best ways to implement and sustain each of the improvements locally and to discover new opportunities for improvement. few teams that have flogged themselves to complete the initial systems. which may not be popular with employees. By analyzing all this.A SECOND WIND FOR ERP 103 The bottom steps At the beginning of the ascent. Y ou must also introduce a continuous-improvement mindset. such as accounts payable or IT operations. Information from a payment database. Sometimes the desire to optimize local operations exacts a global price. and internal processes. ERP systems capture reams of information on customers. for example. and change management work on time and on budget are keen to revisit the course. that are duplicated in different locations can be consolidated. Still. reengineering. you have to revisit the business case for ERP— or develop one for the first time—to see where further efficiencies and savings can be realized.” a manager said. “Nice-to-have” features. businesses can find opportunities to sell more or spend less. whose payback times could be very short. One implementation consultant compared installing ERP to running a marathon. For example. unified the distribution process. One such initiative involves refining the ERP system’s technical and commercial operation in order to drive out costs.

Such tools—supplied. many of which emerged after ERP began to be implemented. On the buy side. helping you cater to individual tastes and create lifelong relationships with customers. If the price exceeds the limit. attaching an e-procurement module to an ERP system can restrict purchases to preferred suppliers and cut out maverick spending by employees who have too little time to go through required procedures. It is easy to build a World Wide Web site to adver- tise products and accept credit card numbers. and InterWorld can build on existing ERP systems to offer customers high-quality service through the Internet channel. there is tremendous value in having a system that can handle not only order fulfillment but also returns. Continuous-relationship marketing. and refunds. it goes to the supplier for fulfillment. An e-procurement module allows that person to choose “computer supplies” from the procurement folder appearing on everyone’s desktop and to select the desired model from the company’s preferred supplier. Whatever advantages nimble new on-line entrants may enjoy. how much time they spent on each screen. Electronic orders yield far more infor- mation about customers than over-the-counter sales do —not only who those customers are. A range of technologies. INTERSHOP. cutting out liaison with the accounts organization. by the specialists Siebel Systems and Vantive—and by the major . you can start mounting the top steps. Electronic procurement. The four examples given here by no means exhaust the possibilities. high-volume on-line retailer. Internet commerce applications such as BroadVision. Say an accountant needs a new computer. if you care to track this.104 T H E M c K I N S E Y Q U A R T E R LY 2 0 0 0 N U M B E R 2 The top steps With these initiatives in hand. E-procurement specialists such as Ariba and Commerce One have developed such systems. including SAP and Oracle. for example. Sell-side e-commerce. a company must have world-class order fulfillment and distribution— one of the biggest challenges for electronic retailers. the order automatically circulates to all designated approvers. The clincher is that the ERP system also receives and pays the invoice electronically. and once they sign off. An add-on application can combine customer data obtained from e-commerce with information in the existing ERP system. can extend and enhance the capabilities of the original system. But to become an industrialstrength. partial shipments. which build on the ERP infrastructure. to achieve competitive advantage. as have established ERP systems vendors. but also what else they looked at and even.

collectively known as middleware. These applications can then automatically place orders with the supplier offering the best price in the right volume at the right time. middleware can integrate applications running not only within but also beyond a company’s boundaries. Applications from companies like i2 Technologies and SAP can take production schedules generated by the manufacturer’s ERP system and compare them with information about current raw-materials costs. Middleware allows application components to communicate through standardized messages. which simplify the coupling between systems. Roads to ERP The vision of snapping leading-edge functions onto ERP like Lego bricks is seductive. In the early ’90s. make it possible to track customer interactions across all sales channels. EXHIBIT 2 New technologies create new choices in enterprise resource planning Single-vendor ERP Internal user Proprietary user interface Financial-software component from Vendor A Finance Human resources Single database Inventory management Message hub Human-resources Supply-planning software component software component from Vendor C from Vendor B Open-component architecture Internal user Web browser External user Web browser Internet Order-entry software component from Vendor A Production planning Sales and distribution . indeed. so it is particularly useful in fast-moving environments where alliances. mergers. As a result. and acquisitions are routine. are eliminating the requirement that all ERP modules share the same database. this was a farsighted way to overcome inconsistency and fragmentation. but the reality is complex. today it seems monolithic and inflexible. Standard ERP systems use a single logical database shared by all ERP modules to provide a common view of an organization’s data. But a number of technologies. Supply chain optimization. Suppose that a toy manufacturer must buy lots of plastic.A SECOND WIND FOR ERP 105 ERP vendors. the integration of disparate applications becomes increasingly flexible and manageable.

percent 100% = $82 billion Reseller revenue and ecosystem software 20 5.106 T H E M c K I N S E Y Q U A R T E R LY 2 0 0 0 N U M B E R 2 What next for the big vendors? Unlike the early 1990s.5 • Baan • J. Saturation of these companies’ core industrial-market sectors— consumer products. which offer companies (on a pay-per-use basis) ERP applications running on vendor-owned and vendor-maintained computer systems.8 4. energy. 1999 was a slow year for vendors (exhibit). continuousEXHIBIT relationship marketing (CRM).9 • SAP • Other Total investment in ERP.0 1. much as the major vendor PeopleSoft did when it bought CRM specialist Vantive. and electronic procurement—is a second possible growth strategy for ERP vendors.1 5. A slow year for enterprise resource planning (ERP) Revenue of ERP software vendors. say. Although the major vendors compete in all of the main branches of business. The first is expansion into service-sector industries.7 5. Systems supplied by ASPs are particularly attractive to start-up companies that can’t reliably predict their future business volumes. put a crimp in sales. ERP vendors are now pursuing three major routes to renewed growth. The third potential growth strategy is to address the needs of small to midsize businesses.2 2. and don’t want to be continually replacing cheaper.5 1995 2.3 5. and pharmaceuticals—as well as the reluctance of many of the companies to implement big systems before the start of the new millennium.3 1.8 2.4 5. $ billion 17. that of a bank. Infact Research.4 7.3 1997 1998 19991 3.4 1996 3. manufacturing. Because it is hard to find much similarity between a manufacturer’s planning system and. less capable systems as their businesses grow. expansion here may be difficult.1 4.4 3. Source: AMR Research. Expansion into new functional areas—such as sales-side electronic commerce.5 2. can’t afford to pay for first-tier ERP systems. Edwards • Oracle • PeopleSoft Vendor revenues 21 21 Hardware 38 Implementation and consulting services 1 Estimated.2 15. The vendors could tackle this segment by serving as application service providers (ASPs). D. they have much more experience in heavy industry than in services. Pursuing it would require them either to develop proprietary offerings or to acquire companies that have complementary products.8 10. McKinsey analysis . when the use of ERP systems increased explosively.

Alternatively. ERP systems may feel like an albatross to companies that have expensively and painfully installed them. . Companies that build on existing ERP systems can stick with their original vendors. And the emergence of middleware will give companies seeking distinctive solutions greater flexibility and choice. Or they can take the bull by the horns and combine products from a number of different vendors into a suite of heterogeneous applications linked by messaging middleware. with the original vendors controlling the overall architecture. Fast-changing businesses that use middleware to manage the integration of components are likely to choose different best-of-breed vendors for each of them (Exhibit 2. have consistently extended their product ranges to compete against emerging products in “hot” functional areas. and Oracle. it is more expensive. the number-two player.A SECOND WIND FOR ERP 107 Such technical advances mean that companies enhancing their old ERP systems or buying new ones will gradually come to feel less need to get all of the elements from a single vendor (see sidebar. they constitute a valuable foundation for a wide range of new value-enhancing applications. an approach that lowers their exposure to risk but leaves them lagging. the ERP market leader. SAP. “What next for the big vendors?”). behind the state of the art. on the previous spread). Nonetheless. But an organization that has already made a big commitment to a major ERP vendor should think hard before moving toward the best of breed. Although the third approach frees a business from dependence on a single vendor. they can use third-party products to extend their ERP systems. to a certain extent.