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How Does an ERP System Work? Basics, Features and Types

ERP systems work via a central database. Users look at dashboards to view real-time data across different business units such as sales, supply chain management and personnel.

Say you're in the business assembling breadbox-sized widgets with parts from 10 suppliers. Your workers assemble them by hand, box them, and send them palette by palette to the other side of your warehouse. From there, the folks in shipping and receiving send the boxed widgets out when they get pinged from sales. All the widgets go out one or two at a time via the USPS or an overnight courier service. The business is seasonal, and widgetophiles are only buying widgets in the spring and fall. But the business is getting more competitive and widgets, while not yet a commodity, are getting more price sensitive. You need a competitive advantage.

What Does Enterprise Resource Planning Mean?

ERP -- short for enterprise resource planning -- is an integrated system of software applications that allows an organization to manage its business processes using a centralized relational database. It allows a business to see a snapshot of how efficiently its key functions -- for example, inventory levels or sales, personnel -- are working together. By doing so, it can better plan how to use its centralized resources across the enterprise -- hence, ERP.

ERP systems typically contain dashboards connected to a central database that let users look at real-time data across different business units. Depending on the sophistication of the ERP vendor, individual modules may have numerous submodules that can be added to reflect how your business operates.

Why Do You Need an ERP System?

How can an ERP system help you? Well, because multiple applications are integrated in an ERP system, the sales team taking orders over the phone can see how many widgets are left in inventory at any given minute -- even accounting for online orders that bypass customer service reps. Manufacturing is looking at the same data and knows whether or not to ramp up assembly on the line. Your trusted suppliers are automatically notified when parts are low. And shipping can account for each item being shipped and when it arrives at its destination.

It's easy to see how much faster you can work when these tasks are automated. It's also easy to see how much more cost effective it is when you're buying integrated ERP software rather than individual applications.

But many modules may not make sense for a company your size. For example, if you're operating a small- or medium-sized business, you probably don't need an application that arranges multimodal and cross-dock operations. Similarly, while you definitely need a human resource -- or human capital, as some vendors call it -- module, your needs of your 65-person company are obviously vastly different than those of a large enterprise. So, while you'll need an HR module that includes time and labor management, absence management, and expense management, you probably don't need a succession management module.

How ERP systems work
In an ERP system, information is uploaded in one module and shared to the central database, which shares the information with other modules.

Why Are ERP Systems Important?

ERP software integrates modules that once were disparate purchased applications, which reduces capital and operating expenses. The greatest benefit of an ERP system is real-time visibility of your daily operations, providing up-to-the-second information on available resources and the progress of orders and initiatives. That visibility improves operational efficiency and profitability. And that visibility can be extended so that suppliers, partners, carriers and other trusted parties can share data.

Functions that previously had to be performed manually can be done in one fell swoop in an ERP system. For example, the sales department takes an order for widgets. Rather than having to check with the warehouse separately, the sales team can see in real time how many widgets are available in the warehouse when it takes the order. Extend that to the rest of the enterprise and imagine that managers in the marketing and communication department can tell if their messaging is working. Sales managers can better forecast, and the accounting department will have less lag time in reconciliation.

An ERP system is built upon data, so data migration from existing databases is crucial. Migrated data must be purged of irrelevant, erroneous and duplicate matter.

ERP modules
Modules in an ERP system can include procurement, HR, finance and more.

Examples of ERP Modules

  • Supply chain management (SCM): SCM is the broad range of activities required to plan, control and execute a product's flow from materials, to production and then to distribution in the most efficient way. SCM integrates planning and execution of common processes. It also optimizes the flow of materials, information and capital in functions that include procurement, production, inventory management, logistics, fleet management, warehouse operations and shipping.
  • Human resources: Sometimes called human capital management (HCM), HR software can accomplish numerous tasks, such as benefits administration and payroll, by connecting submodules that traditionally would warrant their own standalone applications. Functions also typically include performance evaluations, recruitment and career development.
  • Online sales: Also known as e-commerce, the online sales module allows you see changes in prices, catalog, inventory and the supply chain, and have those changes reflected in customer-facing messaging. ERP vendors offer e-commerce applications for all sales channels, whether B2B, B2C or C2C. Ideally, this module allows you to manage both consumer and wholesale channels on a single platform. Online sales ERP applications can also let retail or wholesale partners update product information on their end.

On-Premises ERP vs. Cloud ERP

Cloud ERP is a type of enterprise resource planning software that runs on a provider's cloud computing platform, rather than on premises in an enterprise's data center. Before the concept of modern cloud computing developed in the 1990s, ERP systems ran on legacy platforms at the owner's facility.

One benefit of using a cloud-based ERP system is that you can easily update applications. Enterprise data may be safer as well if the cloud service provider stores it on redundant offsite servers. There is also a financial consideration. On-premises ERP systems are generally accounted for as capital expenses because the investment is lumped into upfront costs, while cloud ERP systems, are considered operating expenses.

On-premises ERP systems do have their advantages. If an organization has the resources -- and that's a big if -- customization and implementation can be easier, and data security can be more substantial if these tasks are handled on-premises. ERP users that want to customize their systems may use platform as a service (PaaS), a cloud computing model in which a third-party provider delivers tools needed for application development to users over the internet. A PaaS provider hosts the hardware and software on its own infrastructure. As a result, PaaS frees developers from having to install in-house hardware and software to develop or run a new application.

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