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Calculating the EDI Benefit

thumb EDI CostsWith the maturity and prevalence of technology in the market today, the benefits of migrating from a paper based system to communicating business documents via some electronic platform are well documented. Gains in the order to cash cycle, keying accuracy, as well as the ability to seamlessly communicate with your supplier/customer communities are just some of the points regularly mentioned when asked about the benefits of EDI.

 

At a high level, these are all important to the overall business, but the question still remains of how will EDI impact the bottom line? I have seen (and have myself) EDI managers answer this question by comparing manual order entry to EDI processing per transaction based on some generic time study, but this does not tell the whole story.

In order to get closer to the real value EDI provides, defining the points listed below may give us a better overall picture.


EDI Costs


1. Average personnel cost of entering one manual order versus cost of one EDI transaction.

2. Error rates of both manual and EDI orders.

3. Overall costs of order entry staff versus EDI infrastructure.

4. Number of orders needed to receive in order to outweigh the setup fees.

5. What will be the effect on company's goodwill in market if EDI isn't implemented?

While each point is a piece of the puzzle, it is important to remember to evaluate each individually, then collectively to gain proper perspective.

To illustrate this, I have pulled together the hypothetical analysis below incorporating points 1,2, and 4 (3 and 5 have been left out purposefully because each could vary greatly based on the particular circumstance of each company). In the example, we receive a request from customer A to implement EDI. The first thing we should do is find out how many orders and what sales value this customer provides us on a yearly basis. In this case we receive 100 orders totaling $150,000 from this customer annually. We then estimate that on average it takes an order entry clerk making $15.00 per hour, 15 minutes to enter each order we can then get a manual processing cost (an annual pay increase of 2.5% was added to years 2-5). Then we can take that value minus the cost per transaction if received via EDI and get a processing savings.

Since keying errors most definitely affects the bottom line, we should also understand how the potential error rates will affect us. For this case I used the published error rates of .3% manual, and 0.006% electronic which were published in the2007 book Purchase Order Management Best Practices by Sabri, Gupta, and Beitter. Calculating the impact versus overall sales shows that EDI will save us an additional $441 annually in lost inventory from keying errors, not including the cost of returns and reships
 

             
Entry Costs

           


  Year 1

Year 2

Year 3

Year 4

Year 5

Manual

  $375

$384

$394

$404

$414

EDI

TP Setup

$250











Mapping

$100











Transaction/Translation

$10

$10

$10

$10

$10



Total

$360

$10

$10

$10

$10

Entry ROI



$15

$374

$384

$394

$404

             
Error Rate (% of Sales)

           


  Year 1

Year 2

Year 3

Year 4

Year 5

Manual

0.3%

$450

$450

$450

$450

$450

EDI

0.006%

$9

$9

$9

$9

$9

             
Total Cost

           


  Year 1

Year 2

Year 3

Year 4

Year 5

Manual

  $825

$834

$844

$854

$864

EDI

  $369

$19

$19

$19

$19

Total ROI

  $456

$815

$825

$835

$845

Gross Profit % Gain



0.30%

0.54%

0.55%

0.56%

0.56%

 



If we look at only the bottom corner of a painting, we cannot appreciate the entire beauty of the work. As with art, by looking at each piece of cost associated with manual to electronic order processing, we can get a clearer picture of how EDI can effect profitability. In the case of the example given, 100 orders annually would quickly become beneficial, but what if we only receive 10 per year? That is when we have to break out our crystal ball and incorporate the value of goodwill in the market and potential for future growth to determine if the implementation will be worth the cost.

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