ERP System at Whirlpool Europe: An Investment Decision
Case Report
Executive Summary In 1999 Whirlpool’s CFO and Vice President of Logistics are trying to make a decision on investing in an enterprise resource planning (ERP) system, named Project Atlantic.
A successful implementation of this system would result in massive cost
savings for Whirlpool Europe through improved operating efficiency and effectiveness. The current logistical model has various different inventory systems and was occasionally unable to meet customer demands. Although the cost is high, analysis detailed in the following report results in a positive net present value (NPV) of the project. In the following analysis, Whirlpool Europe’s assumptions and projections are used to form revenue and cost estimates for the cash flows of investing in an ERP. Estimated benefits and costs are described and analyzed. These estimates are then applied to a value analysis. The resulting NPV is $2.13 million. Other profitability ratios lead to a conclusion that the project would derive positive net benefit from inception in 1999 through 2007. As a result of this analysis, it is recommended that Whirlpool Europe’s senior management team take on this project and proceed with the acquisition and implementation of an ERP system.
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Brief Background of Whirlpool Europe Whirlpool Corporation expanded into the European market by purchasing a 53% share of the appliance division of Philips-Electronics for $470 million in 1989. Shortly thereafter, in 1991, Whirlpool purchased the remaining 47% for $600 million. Whirlpool created several European brands, with brands both spanning all of Europe and just smaller regional brands. Currently, Whirlpool Europe operates eleven manufacturing plants, two central distribution centers, and twelve regional distribution centers. Orders flow through the distribution chain in that order. There were many different inventory systems in use, with little consistency or compatibility, causing extraordinary inefficiencies amongst many functional parts of the organization, including sales, operations and logistics, and finance. Often information was “inconsistent and irreconcilable.” Whirlpool had two main customer bases in Europe: “consumers who purchased stand-alone appliances for their homes and contractors who purchased built-in appliances for new home construction or kitchen remodeling.”
Demands of these
customers at times did not fit with the current operations and logistics model of Whirlpool Europe, causing a loss of potential sales. Project Atlantic Goals The goal of Project Atlantic is “to design and implement an enterprise resource planning (ERP) system that would allow Whirlpool Europe to better serve its consumer market for stand-alone appliances and contract market for built-in appliances and, at the same time, reduce its inventory by 12 days of sales.” In short, Whirlpool Europe wants an ERP to improve operating efficiencies and effectiveness. Whirlpool Europe would like to be able to provide customers with customized solutions, available when the customer wants it, while maintaining lower levels of inventory and standardizing inventory management across the organization. Implementation Plan Implementation of the ERP is planned to start in May of 1999 and be completed in August 2002. Whirlpool Europe plans to roll-out the ERP in geographical groupings, Page 3 of 7
called Waves. It plans to start with the “West Wave” consisting of Belgium, France, the Netherland, and the Warehouse Management and Physical Distribution, followed by the South Wave, Central Wave, then completing implementation with the North Wave. The implementation time is expected to decrease with each wave. According to Exhibit 3 of the case study, the West Wave sold significantly more units in 1997 (the baseline year) than any of the other Waves, at 2.27 million units sold compared to the next highest of 1.44 million. Also, the West Wave has the lowest product availability, at 73.5%. Therefore, implementation of an ERP will have the most significant impact with this Wave. Implementing in the West Wave first will provide an immediate benefit to the organization and will jump start the returns of the project. The implementation costs include the cost of 50 Whirlpool Europe employees for each Wave, Consulting, and a Compliance Task Force. Capital equipment for the ERP total $23.9 million over four years, from 1999 to 2002. Along with the capital equipment, software licenses of $900,000 are to be purchased in the first two years, at $600,000 in 1999 and $300,000 in 2000.
Capital Expenditures and Implementation Costs are
outlined in detail in Exhibit 6. Expected Benefits Improved operating and logistical efficiencies from the ERP is expected to result in a great deal of cost savings to Whirlpool Europe. Savings include reduction in FTEs from the order desk and finance department, less warehouse space, reduced bad debts expense, and elimination of the expense of the current information systems. These cost savings result in $22.3 million in savings over eight years from 2000 to 2007. Meeting the goal of reducing days sales of inventories (DSI) by 12 days in each Wave results in a total reduction in inventory of approximately $30 million by the end of 2005 (total Whirlpool Europe DSI improvements shown in Exhibit 5). This will result in significant warehousing cost savings of $1.6 million in eight years (2000-2007). Because of the inefficiencies and inconsistencies of the various inventory systems currently in place, there are a large number of customer returns (3% of units purchased). These returns cost Whirlpool Europe approximately $30 per return. The ERP is expected to reduce the number of returns. The amount of reduction, however, is unknown.
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Revenue and Gross Margin are expected to increase due to higher product availability. Whirlpool Europe set its target for product availability at 92%, substantially better than the current product availability amongst Waves. This improvement was expected to increase unit sales by 25% of the improvement on product availability. Detailed calculations for revenue and gross margin increases are found in Exhibits 1-5, outlining the increases for each wave and the total net effect. The total change in Revenue and Margin through 2007 is estimated to be approximately $356 million and $71 million, respectively (see Exhibit 5). Full implementation and derived benefit of the West Wave by 2002 is estimated to result in a total increase in revenue of $60 million, with the future sustained additional revenue of $31.5 million annually. Gross Margins from the West Wave are estimated to contribute an additional $5 million annually with the ERP system once implementation is complete and all estimated benefits are recognized (See Exhibit 1).
This Wave
obviously had the largest impact to the organization. The other Waves combined are estimated to result in a total sustained annual increase to revenues and gross margin of $26.5 million and $6.5 million, respectively (See Exhibits 2-4). Expected Costs Estimated costs of an ERP system include capital expenditures, implementation costs, and on-going operational costs. Exhibit 6 outlines each of the costs associated with the proposed ERP system. The cost of capital equipment totals $23.9 million over the first four years (1999-2002). Software licenses of $900,000 will also be purchased in the first two years. Implementation costs, previously discussed in the Implementation section above, are estimated at a total of $15.7 million during the implementation phase (1999-2004) and include costs such as consulting support, compliance task force, and Whirlpool FTE support. On-going Operational Costs of the ERP system are estimated to be $6.6 million (total) in the first four years (1999-2002), then $3.4 million annually for each following year of use. The total estimated operational cost from 1999 until 2007 is $23.6 million. Some of the cost estimates may vary once the project is executed.
Capital
expenditures can vary with the system chosen. However, since Whirlpool Europe is
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planning on using an off-the-shelf system, the cost estimate for the capital expenditures should be reasonable and have little variance. Implementation costs are where I see the greatest possibility for a significant variance from the estimate. These types of costs are often very hard to estimate.
Because there are many process changes and
employee acceptance of the change is so critical to the success of this project, training expenses may vary considerably. Valuation and Recommendation Exhibit 7 shows the value analysis of the benefits and costs of the proposed ERP project. The total Net Investment is $23.9 million over the first four years (1999-2002). The total change in Net Income after taxes, at a tax rate of 40%, is $17.4 million from 1999 to 2007. When considering the project period as 1999-2007, the Net Operating Cash Flow is $41.3 million and the Net Cash Flow from the project is $17.4 million. Considering Whirlpool Europe’s cost of capital at 9%, the Net Present Value (NPV) of the project (1999-2007) is more than positive $2.13 million. This positive NPV encourages investment in this project. The Internal Rate of Return (IRR) and Modified Internal Rate of Return (MIRR) are 10.93% and 10.18%. Both of these rates of return are higher than Whirlpool Europe’s current cost of capital, suggesting that the project will yield higher returns than the cost of capital. Since the returns of the project are higher than the cost of capital, this is a profitable project for the company.
The
profitability index is 1.291. Any project yielding a profitability index of greater than 1 is a profitable project. Therefore, by the profitability index assessment, investment in an ERP system would be a profitable decision for Whirlpool Europe. If we were to assume that the ERP system would continue to be used beyond 2007, several cash flows would continue. Increased revenue of $58 million per year would continue. Estimated cost savings of $3.57 million annually would continue from FTE reductions and warehousing, bad debts, and information systems expense reductions. On-going operational expenses associated with the system would continue at $3.4 million annually. Also, additional Cost of Goods Sold would remain at $46.4 million annually. There may be other additional costs with continued use, such as
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license renewals, that are unknown. Depreciation expense is complete in 2007 (5 years after completion of capital expenditures). With the known continued cash flows, and Whirlpool Europe’s tax rate of 40%, the annual change in net income after taxes would be approximately $7.1 million. Because there is no depreciation expense beyond 2007, the net cash flow from the project is also $7.1 million for each year after 2007. Continuing use of the ERP system beyond 2007 would only increase the positive returns and profitability of the project. Each of the four value indicators analyzed (NPV, IRR, MIRR, and the profitability index) prove an ERP system to be a profitable investment decision for Whirlpool Europe. Given the current state of disarray in inventory management and logistics, it is recommended that Whirlpool Europe invest in an ERP system to realize the cost efficiency opportunities.
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