3 Reasons Why a Startup Should Never Undertake an ERP Project

You probably can’t afford to risk your blooming startup business by engaging in a huge ERP project – but luckily, there are alternatives.

A startup is a company operating in a highly unknown environment and is aiming for high growth. This is precisely the kind of environment when you should not take on a long and expensive project such as Enterprise Resource Planning, ERP, implementation. When many aspects of the business are unknown long-term planning is difficult. To be prepared for frequent changes, all commitments must be evaluated in terms of flexibility. Something useful today might become obsolete tomorrow.

ERP software is a tool for operations optimization for companies producing or just handling physical goods. ERP helps to deal with large data sets, improves production planning, sales order handling, inventory management, invoicing, and so forth. In general, ERP impacts all departments of an organization. ERP is an excellent example of something that is useful but is very rigid.

ERP Projects Are Costly and Difficult

Due to the vast scope and complexity of ERPs, the implementation projects are very long. Different sources talk about lengths of 12 to 18 months. To my experience, that sounds realistic. At least it will not be shorter. The vast scope impacts the costs as well. The significant project costs consist of external human resources (setting-up of the software, customizations, guidance for internal resources for implementation, and data transfer) and license fees. The latest ERP softwares run in the cloud so hardware costs should be limited.

The scope and complexity make the project not only costly but very difficult as well. The projects are difficult for all,  not only for startups. According to a study from 2015, 70 percent of ERP project fail. One of the biggest failures made headlines in 2018 when Lidl gave up on their ERP project after spending 500 million euros on it, ouch!

What is possibly the least tangible issue and most challenging to mitigate is the fact that the project takes a lot of human resources. The issue is highlighted even further because the resources are needed from all departments, not only, e.g., from production. First of all, it is challenging to estimate the required resources and us humans; we have the tendency to be overly positive.

Secondly, undertaking the intense development project means that there can be very little other overlapping projects. Usually, starting any development project means that the people running the daily operations will now have extra work along with the day-to-day stuff. Imagine doing this for 12 to 18 months. Imagine doing this in a startup where human resources are limited, and there is restricted cash to hire outside help. Imagine not having other development projects on-going for a year or two. The case is totally different for established companies because, well, they are established. They have the capital and human resources available for them. Also, it is natural to have fewer development projects in the later stages of a company’s life.

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The 3 Reasons Why a Startup Should Never Undertake an ERP- Project

So far, we have taken a look at what makes ERP projects difficult for any organization. In this section, I list three main reasons why ERP projects are even more difficult for startups and why the project should be postponed to later stages.

1. ERP Takes Focus Away from the Most Important

An established company has the market fit and an established production. It is natural for it to look for better operational efficiency, and ERP is a crucial tool for that. A startup does not have a market fit or if it has it in the domestic market or among early adopters. In any case, the company is still to cross the chasm. Also, its production process is still developing in big leaps in a fast phase. The purpose of a manufacturing startup is to learn, not to generate profit. To start an ERP project would lead to taking focus away from development and learning to production cost optimization. This is the number one reason why an ERP project must not be undertaken.

2. ERP Takes Resources Away from More Important Projects

Unlike a large corporation, a startup cannot commit enough resources to such a massive project as ERP. The limited resources are simply used better elsewhere. Depending on the startup, major development projects that are more beneficial to take on are for example production quantity scaling, supply chain development, expansion to new markets, product development, looking for new funding, and so on. What is interesting here is that the reasons to start an ERP project are mostly production-related, but the project takes resources heavily from all departments.

To reduce the costs of the project and to add flexibility, a startup might look at stripping down the functionalities and customizations of ERP at the launching phase. Especially limiting the number of customized parts has a significant impact on the costs and the timetable. Not customizing the ERP for the needs of the specific company will lead to a situation where the best benefits of ERP are not available. This might lead to increased difficulties at launch when some aspects that the old manual or semi-automatic systems work better than the new and shiny. In such a situation, getting the buy-in from all stakeholders is challenging.

3. There is a high risk that ERP-project is a complete waste of money.

Remember the stats from earlier? Staggering 70 percent of all ERP projects fail!  Even if the startup manages to finish the long project, there is a highlighted risk of it being out of date. Due to the highly unknown environment and the long project span, likely the scope of the project is not a fit anymore. Maybe some functionalities are missing that are now considered necessary. Perhaps you spent the resources on something unnecessary. Maybe the chosen ERP software was designed for small and medium-sized companies, but now you are already becoming a large corporation?

Also, for a young company, one future scenario is being acquired by an established company. Even if the new owners would not want to completely integrate the startup to its systems (including the ERP), they at least have a process and it-infrastructure in place that can be extremely helpful. In any case, if the project is on-going in the moment of acquisition, it could be so that it must be started all over to match to updated needs and environment.

What Are the Options?

After a certain point, the amount of data becomes so big it cannot be handled with excels alone. There are a couple of options that have some of the functionalities of ERP but are significantly easier and faster to implement. One option is MRP, Materials Requirements Planning, which is a tool for production and inventory management. Small coding and optimization of spreadsheets will do a lot as well.  RPA, Robotic Process Automation, solutions are an excellent way to cut off repeatable work. One might argue that an ERP is a complex RPA- tool itself.  For example, the RPA tool Microsoft Flow could be valuable for a startup company before moving to Microsoft Dynamics- ERP later on. The presented options require more manual labor than an ERP, but that is a clearly lesser evil than undertaking an ERP implementation project at the early stages of a company.

When Is the Correct Time for ERP?

There is no question that to compete in industrial-scale against global competition, an ERP is needed eventually. The time is right for the implementation is only after you can tick the following boxes:

  • Processes are defined.
  • Production is standardized.
  • Market fit has been found.
  • Quality-system is in place.

Conclusion

In general, ERP makes standardized production run more efficiently. In a startup, there is very little standardized work because everything is new, and the company is still learning what should be standardized in the first place.

I see that production scale-up and cost optimization cannot be done at the same time. There is no question that the production scale-up would not be more critical than cost optimization. A working ERP would indeed be beneficial, and ERP is needed in high-volumes and to be able to reach healthy profit margins. But for the presented three reasons, the cons outweigh the pros for startups by a clear margin.

The author has been involved in two ERP projects as a project manager in startup companies. He has also helped startups to evaluate the feasibility of proposed ERP projects.

Introducing Lean Production Scale-Up

Lean Production Scale-Up is a four-step model designed for companies operating in untested markets with untested technology. The purpose of the model is the reduce the high capital risk that is associated especially with companies using new technology and innovations. The model enables the company to make its technology investments as soon as possible time-wise, but as late as possible in the learning curve.

I developed the model based on my experiences in production development in various startup companies both in the medical and food industries.

While the Lean Startup movement serves many types of startups, there is one aspect that has not been included in the broader public discussion. Lean Startup concentrates on finding the market fit for the untested product or service as efficiently as possible but assumes that the same level of uncertainty does not exist in the internal operations of the company. Companies like Spotify, Dropbox, and Facebook, had critical and untested assumptions regarding their business models when they started, but they did not need to doubt if the product was doable technically once market fit was confirmed.

The situation is critically different for companies that are involved in a business where the product or the production process is involving an innovation. Industries like 3D printing and food grown in bioreactors are operating in untested markets, but they are also working with unproven technology.

Build- Measure- Learn Double Loop.

Lean Startup focuses on optimizing learning by using the Build-Measure-Learn loop. For companies also having internal unknowns, a second loop is needed that is for the production process.

An Information Technology or service company must look into improving their working process for improvement as well, but in most cases, a software company is using existing coding languages, software, and hardware. When working with building new physical products with new machines and machine setups, new raw materials and so on the need for internal learning and improving the working process in the company is multiplied. Together, the two Build-Measure-Learn Loops form the Build-Measure-Learn Double Loop.

double loop

Figure 1: Build-Measure-Learn Double Loop

Lean Production Scale-Up Model

By using this model, a company with new innovation can navigate its way from an idea to full-scale production. Alternatively, in the case that innovation or the business model using it does not add value to customers or is not technically feasible, the company can identify this as soon as possible.

The Lean Production Scale-Up model consists of four steps. The model is divided into these exact four questions to maximize the efficiency of the scale-up process. Each step asks the question that the company must answer by using the Build-Measure-Learn Double Loop. The questions are answered one-by-one in the specific order.

The primary goal of the early production when working with innovation is not to generate profit for the company, and it is not to have a positive gross margin, but to reach the learning goals of each step and taking those steps as fast as possible. If you do something else than what is necessary at that step at hand, you increase your expenditure, risks, and what is worst you slow down learning and business assumption validation.

  • Step 1: Is there a demand? The question is quite similar to step 2, but asking first is there any demand at all, key assumptions can be invalidated without the need of financial commitments to production space and machinery that must be in place in step 2.
  • Step 2: Is the demand sustainable and scalable? After confirming that there is some interest comes the time to validate that the demand is not limited to too small customer segments and that the customers will turn into returning customers and advocates. Some investments are now needed, but only the ones that are necessary to collect the learnings are taken. All development ideas related to improving production efficiency are postponed.
  • Step 3: Is positive gross margin achievable? Once demand and market fit are clear, its time to confirm not only that the product can be produced on an industrial scale, but also that it can be done with a positive gross margin. At this stage when still operating with suboptimal machinery (the quick & dirty solution you have put in place so far) actually having positive gross margin is difficult, but you can collect evidence that positive gross margin can be reached. For example, changing too small warehouse to a larger one and investing in an automated packing line will improve your operational costs significantly.
  • Step 4: Continuous development. The company acquires the full-scale profit-generating production line. Learning is still essential for the young company, but the learning curve starts to slow down, and development starts to resemble established company: The development in the production process is now numerous small steps, while in the previous steps it was mostly fewer, but substantial steps. At this stage, the Lean Production Scale-Up has run its course and hands the control over to Lean Management that is specialized in continuous development.

By following the four-step model, a company with new physical innovation can navigate its way from an idea to full-scale production. Alternatively, in the case that innovation or the business model using it does not add value to customers or is not technically feasible, the company can identify this as soon as possible.

A major part of the financial risk involved in the production scale-up is associated with the relatively large upfront investments. Setting up a workshop, let alone a laboratory requires a set of tools and machines. Acquiring suitable working space and required tools is intensive investment wise. Making these investments as soon as possible time-wise, but as late as possible in the learning curve is the goal of Lean Production Scale-Up.

Avoid outsourcing

What happens throughout the Lean Production Scale-Up model is a lot of learning in two equally important sectors: From the market and customers’ needs (the market build-measure-learn loop), but also about the production process (the production build-measure-learn loop). It is tempting to outsource production or parts of it to speed up the development and reduce the need for capital investment. Subcontracting can indeed offer very tangible and tempting benefits: Facilities and supply chains are ready, no need for upfront investments or hiring production operators to name a few but looking for these benefits are not the purpose of the early stage production. If production is done by a subcontractor at an early stage, the learning will happen at the subcontractor, not internally at the company. All work must focus on optimizing the learning process that can be best achieved when the production is done in-house. When using a subcontractor in the early stages of development, the company will also find it difficult to continue to the later stages of scale-up because the subcontracting partners hold the tacit knowledge and thus the negotiation power in the developing partnership.

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Here you got a glance at what my Lean Production Scale-Up- book project is about! The idea is still fresh is only now starting to take shape. So far I have some 30 pages about the topic going more in detail how the four steps would look like in practice and what are the dos and don’ts for the starting company that is operating in the untested market with untested technology.

Edit: Second part of introducing the model can be found here: Do Not Outsource! But If You Do, Remember These 3 Things

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Your friend, Ilkka Taponen