In our last blogs, we have discussed the pros and cons to a decentralized and to a centralized approach.
However, rarely is either extreme the optimum. Instead, managers are often called upon to think globally and act locally. In other words, we should somehow marry the best aspects of centralization and decentralization. While this may sound like a paradox, in this blog we will discuss specific use cases in ERP of how global and local, or central and de-central, can be combined for an optimal result. Thanks to modern developments such as Service Oriented Architectures (SOA), cloud computing and orchestration, multinationals today are able to deploy ERP strategies which harness the advantages of both centralization and decentralization in real time.
So today, we explore how technology can enable a synthesis of the two strategies preserving many of the strengths and minimizing the weaknesses of each extreme.
Industry analysts often refer to the concept of two or more ERP system each optimized for either global or local needs as two-tier ERP. Alternatively, the term hub and spoke is used where the global ERP system forms the hub and the local ERP system or systems are connected via spokes. The previous sections focus on the advantages of global ERP systems versus decentralized ERP systems. This section focuses on how the so-called spokes allow companies to think globally and act locally. In effect, the spokes refer to the connections between the ERP systems like the connections between the hub and rim of a bicycle tire.
The word “integration” is used to describe “spokes” so different in character as to provide little insight into how two applications communicate with one another. On one extreme, each individual transaction can be mapped via web services (SOA) where well defined exits in system A correspond to well defined on ramps in system B providing seamless integration. On the other extreme, large quantities of data such as a subsidiary’s entire financial records for a quarter can be aggregated in an income statement and balance sheet, downloaded into a simple flat file like an Excel spreadsheet and imported into the hub system in a simple batch process.
The term “orchestration” is more helpful in describing how hub and spoke ERP systems work together since this concept goes well beyond describing how data is transferred. Orchestration takes the discussion up a level to discuss how the end-to-end process flows across applications over time. Furthermore, orchestration addresses such issues as master data management, lifecycle management and identity management.
The important point to take away from this section is that the degree of orchestration that can be achieved between two applications is a function of the variance in the two designs. Therefore, in the next section regarding use cases, we will distinguish between heterogeneous ERP environments i.e. applications, which are developed independently of one another and homogeneous environments where applications are designed in parallel.
Heterogeneous environments are often limited to crude unidirectional batch integrations such as a month’s end flat file transfer of a subsidiary’s financial information. Harmonized environments, on the other hand, can more easily support bi-directional exchanges of information in real time.
At the most fundamental level, large enterprises with subsidiaries must prepare consolidated financial statements for one or more tax authorities. Typically, these same companies are active in one or more capital markets which place additional financial disclosure requirements on the consolidated financial data. These requirements can be met at the most basic level with simple batch transfers of aggregated data as infrequently as once per quarter. While such automated processes can save time and money compared to manual financial consolidation, they don’t provide the value associated with real time information.
Homogeneous environments, on the other hand, can provide potentially all of the advantages listed under centralization: Buy side and sell side power, standard processes and governance risk and compliance. Let’s take one example to illustrate the point: the cash account. The cash balance in the quarterly consolidated financial reports is of virtually no value to the treasurer. If he or she wants to know this value at any point of time they need only call the bank. Of far greater value is the forecasted future cash balance based upon projected cash flows. This allows the treasurer to both minimize the cost of capital and maximize security.
Forecasted future cash balances help minimize the cost of capital since it gives the treasurer time to acquire cash using the optimal instrument at the optimal time. If, for example, issuing ten-year bonds in a dedicated country is the optimal natural hedge, the treasurer needs time to meet the necessary regulatory requirements and potentially shop around for the best deal. With respect to security, the treasurer could set up alerts to his or her mobile device. As soon as the variance between forecasted and actual cash balances in any subsidiary exceeds certain tolerances, they could receive an alert. Such checks and balances may not eliminate the risk of embezzlement; however, they provide the treasurers with more powerful tools to execute their fiduciary responsibilities.
Another core use case for two-tier ERP consists in linking foreign sales offices with the corporate hub. As discussed earlier in the pharmaceutical example, the production of medication in country A involves fundamentally different core processes to the selling of medication in country B. One business object potentially linking all subsidiaries within a multi-national is the customer. For a company to be able to offer “one face to the customer”, numerous integration scenrios are necessary. To begin with, all of the legal entities under which the customer operates need to be associated with one another. When one of these legal entities requests a price quote, the sales office responsible needs access to a central repository of terms and conditions to know what, if any, price discounts have already been negotiated.
Let’s round out the discussion of typical Two-tier ERP use cases with an example of a multinational involved in manufacturing. In this scenario, it is common to transfer goods, at various levels of completion, between legal entities. Local tax authorities will insist upon arms length exchanges to ensure they receive their fair share of taxes on the value added to the product in their jurisdiction. The multi-national, on the other hand, will want to limit inefficiencies associated with internal transfers. By integrating the business object “material item”, a lot of expensive manual steps can be avoided. Once material numbers and related processes are synchronized, it is conceivable that a simple bar code scan at the shipping or receiving dock is sufficient to trigger all of the ERP processes necessary to move inventory from one legal entity to another including inventory transfers, quality inspection, accounts receivable and of course provisions for taxes payable.
No matter how harmonized the landscapes, there are always opportunity costs associated with any integration. Even a single global instance of an ERP application has to deal with issues such as potential interruptions in connectivity.
In the ideal world, corporate officers would have visibility into every single transaction, financial or material, happening at every corner of the world in real time. The costs; however, have traditionally outweighed the potential benefits….even in a single global ERP instance. When processes are orchestrated across two or more ERP systems the Total Cost of Ownership rises significantly. The concept of TCO is important here because buying a custom integration is like buying a helicopter. You need to factor in an hour of maintenance per hour of flight to appreciate what this form of transportation really costs. In software, there is a rule of thumb for customization costs: If the coding costs you 1, all of the surrounding implementation services such as documentation, consulting and testing will cost you 10 and maintaining the customization over its life time will cost you 100.
Some vendors of homogenous environments though offer specific orchestrated processes “out of the box”. The TCO for each individual customer, in such cases, is quite low for multiple reasons. To begin with, homogenous environments avoid much of the waste associated with heterogynous environments such as the two solutions evolving independent of one another. Furthermore, the vendor is able to amortize the costs that do arise across a larger target market…potentially its entire installed base.
Despite the high TCO of custom integrations, large enterprises with two-tier ERP strategies have traditionally engaged in such integrations… sometimes of highly sophisticated nature… because of the tremendous value they can deliver. For example, we could discuss how complicated it can be to orchestrate the ATP (availability to promise) transaction across two or more ERP systems. When such transactions are necessary to protect valuable customer relationships… and proceeds from such sales cover the TCO… the integration makes perfect business sense. Going forward, large enterprises may have little choice but to integrate a much broader range of data and processes in real time just to remain competitive.
Large enterprises with subsidiaries around the world face global and local challenges. Some challenges, such as speed of innovation, are increasing. Depending upon the nature of the business, it may make sense to have a more centralized or decentralized ERP strategy.
Rarely, however, is either extreme optimal. Two-tier ERP is a compelling option for many multinationals striving to balance both global and local needs. Depending upon whether the ERP systems are developed independently of one another (heterogeneous) or in parallel (homogeneous) will determine what level of global co-ordination is practical. Ultimately, a cost benefit analysis needs to be made to determine which integrations are practical. As a rule of thumb, the more homogeneous the ERP systems the more centralization benefits a customer can practically achieve at a reasonable cost in reasonable time. The trend is towards deeper integrations in real time.
Even though this post marks the final part of our first series regarding 2 Tier ERP, we will continue to further explore the topic and are looking forward to your feedback.
Let us know what your thoughts are – 2Tier ERP, respective subsidiaries scenario will be a big focus for us in 2012.
John Hunt and Sven Denecken