Fed Warms Up to ERP Spending, but Will Contractors and Their ERP Vendors Comply? Part Two: Challenges and User Recommendations

Challenges

It appears that the federal market's hunger for enterprise resource planning (ERP) systems will not subside any time soon. Namely, driven by system consolidation at the Department of Homeland Security and Administration management mandates, the federal market for ERP products and services will hit $7.7 billion (USD) in fiscal 2009, a 37 percent increase over fiscal 2004 spending of $5.6 billion(USD), according to a report released at the end of August by INPUT (www.input.com), the leading provider of government market intelligence based in Chantilly, Virginia (US).

Further, with the General Accounting Office's assessment that a third or so of all federal employees will retire over the next few years, upgraded ERP applications appear to be a convenient way to prevent civic paralysis. Commercially available business applications can replace the inefficiencies and liabilities of legacy islands of information that only the retiring federal employees understood and maintained. On the other hand, the more efficient processes may require fewer job replacements, both in terms of technical and customer-facing personnel. Additionally, with commercially available business applications, the product development costs are spread among a large user population. This large installed base also allows for a greater aggregated vendors' experience, resulting thereby in higher-quality tried-and-true products.

Based on the analysis in Part One of this note and our familiarity with most leading vendors' capabilities, there is a strong feeling that only a minority of all ERP vendors properly support the engineer-to-order (ETO) and project-based manufacturing environments. This brings us to the so called "fatal flaws", which are missing functions that may make it extremely difficult if not impossible for the application software to run the physical business. For more details, see Find the Software's Fatal Flaws to Avoid Failure.

A number of these ETO fatal flaws or showstoppers are close engineering, manufacturing, and purchasing collaboration and management as to collapse product lifecycles; project management and scheduling capability; the ability to compare actual and estimated or budgeted costs; revenue recognition and progressive billing by milestones; management of an immense number of engineering changes; strong estimating and quotation capabilities that include freight and duty; support for subcontracting (or the nowadays less popular word "outsourcing"); part numbering flexibility (to such a degree that bills of material [BOM] can be created even without part numbers); handling shipment straight from work-in-progress (WIP) and without posting to inventory; ability to attribute costs to projects as to financially quantify modifications upon a customer request that varies from the original specification; visibility of proposals, open orders, and materials (including the estimated-to-complete), and so on..

To further complicate the matter, neophytes will find dealing with the Federal Government perplexing, since the customer in case will act very differently than its commercial counterparts. Also, the additional regulatory requirements impact how eligible contractors are selected, monitored, and paid, and may require the aspiring contracting company to revise internal procedures or enhance its back-office or ERP system. In other words, the chosen provider must constantly prove to the federal customer that it did not cheat on the project, which mandates the use of the accurate cost and schedule data. Federal contracts can often be fraught with legal snares for the unseasoned providers. Thus, many project-oriented organizations do provide products and services under government contracts, but project accounting for these organizations often requires the use of sophisticated methodologies for allocating and computing project costs and revenues. There are many different types of contracts the government is using and within each of those there are dozens or more variations, whereby each variation will drive its own type of billings, revenue recognition, and requirements for reporting back to the government customer.

The government requires its contractors to collect and allocate cost in certain ways; for example, according to the Defense Contract Audit Agency (DCAA) rules, labor costs must be recorded daily. Also, a contractor is required to keep track of several contracts simultaneously, meeting the rules for different types of contracts and being consistent in accounting for a number of indirect costs. To this end, government contractors have long been using earned value measurement (EVM), as it satisfies the government's requirement that contractors hold onto a stringent cheat-proof system that can be validated and audited, and because the method produces accurate cost and schedule information.

The primary difference between EVM and traditional budget versus actual' cost tracking systems is that the first one can quantify schedule and cost variances separately (e.g., cost variances can be compared directly against the planned cost of the work without distortions in cost variance data that production delays can cause). Also, the cost of an increment of work is identified when it is accomplished in terms of both cost and schedule. Therefore, EVM's royal capability is early detection and identification of trends and variances to the plan, which enables analysis and decision making while there is time to take corrective actions (or at least to be aware of the situations if the time does not permit corrections). As another benefit, instead of merely reporting actual costs, the EVM system predicts them.

Consequently, the defense and other federal markets are particularly complex, as requirements like EVM reporting provide high barriers to entry, and the first step before attempting doing business with the government should be a sensible self-assessment for any contracting provider. The government requires that all eligible contractors are technically and fiscally capable of completing the entrusted job. Thus, before any contract is awarded, the government will have to be convinced that the contractor has the technical expertise to produce the goods and services for which it is bidding to provide, that it has a back-office ERP or accounting system able to segregate costs by contract, and that is financially viable.

It is logical that as the contract risk increases and familiarity with the goods and services provided decreases (e.g., for the first-time attempted, custom built ones), potential contractors are scrutinized more closely and are compensated in different ways. Another crucial evaluation factor is the ability of the ERP software in use to identify and accumulate costs by contract and work breakdown structure (WBS), which is a product-oriented division of tasks that accumulates cost and schedule data, while in APICS' words, "WBS is a hierarchical description of a project in which each lower level is more detailed".

Consequently, companies that are not already offering the above capabilities will likely not be able to tap the recent surge in the federal and defense markets.

This is Part Two of a two-part note.

Part One covered the event and began a discussion of the market impact.

The Potentially Successful Vendors

Those vendors and their users—government contractors—who can deliver comprehensive solutions that satisfy the exacting, stringent requirements of federal agencies are in the driver's seat to capture that market segment. Increased federal adoption of ERP systems may imply that these have been increasingly offering a government endemic functionality. As an example, leading ERP vendors provide procurement software that works with pertinent laws and regulations, such as Code of Federal Regulations (CFR), DoD Contacting Regulations, General Services Administration (GSA), Federal Acquisition Regulations (FAR), Federal Supply Schedules (FSS), etc. Also, they provide human resources (HR) systems that align with military or general schedule pay rates, and financial systems that comply with Joint Financial Management Improvement Program practices for government financial systems. Further, the tax and revenue management module within some ERP suites provides federal, state, and local government agencies tools to automate the tax collection process by enabling constituents to conduct and view financial transactions. A records management module provides these agencies, along with colleges and universities, school districts, and healthcare providers, with the ability to define records and cases, workflow execution and monitoring, and electronic signature and information retrieval capability.

Deltek Systems, SAP, Oracle, PeopleSoft, American Management Systems (AMS), Lawson Software and, to a degree, Geac, Best Software, Microsoft Business Solutions (MBS), and others all have been busy delivering or have already delivered similar capabilities. Provision of CRM and additional analytic and reporting requirements are other crucial issues. Each of these players will have to bet on creating an offering addressing e-government with a strong backbone ERP component—or, at least, an easy integration to major ERP systems in the case of niche, point solutions providers.

Many customers require weekly progress reports and may be comfortable with the Microsoft Project format, but the product on its own cannot give the visibility and scheduling over a great number of concurrent projects, and that is where products like Relevant Business Systems, IFS, MAPICS, Encompix, Lilly Software, Epicor Software, Cincom Systems, and so on come into picture within the mid-market manufacturing segment and even for smaller defense contractors. Some of these vendors offer a unique combination of deep engineering and manufacturing capabilities with high compliance reporting requirements. Meeting the public sector's needs will also require vendors to improve ease of installation, return on investment (ROI), interoperability, and service and support networks.

Now that the federal ERP market is becoming sounder, greater penetration of the midsize market is necessary if e-government data-sharing initiatives are to gather momentum. After all, federal agencies regularly contract with small or disadvantaged businesses and rely on state and local government for much of their information and program implementation. Consequently, for vendors to fully implement ERP and e-government systems at the highest levels, they will have to offer compatible products for smaller entities.

Incidentally, states are another sector where ERP is reportedly experiencing significant growth. Taxpayers are demanding the same rich functionality and streamlined performance that for-profit, e-commerce sites provide from their own state and local government. This demand is crucial in driving ERP needs, as ERP often provides the foundation for the customer-facing service delivery systems.

What an ERP system does for a business is as important nowadays as it has always been, despite the fact that the term ERP may have fallen out of favor at some stage. It sets the infrastructure an organization needs to do business and to communicate with internal and external users and other organizations. To this end, the public sector has realized the compelling need to modernize its back-office systems under the umbrella of e-government, namely, to provide constituents access via the Internet to internal public agencies, processes, and systems. This combination does not obsolete ERP systems. Quite the contrary, ERP functionality remains as critical as ever. Any business needs good inventory control, planning, purchasing, financial accounting, and all the rest of the nitty-gritty. Therefore, based on the experiences of earlier e-commerce and e-government initiatives, CRM and SCM only function well when backed up by the solid internal transactional system that ERP provides.

User Recommendations

The moral of the story is not that ERP is alive and kicking—it has become a hackneyed story by now. More important, while users in the public sector are in the driver's seat, the task of selecting the right provider is nonetheless grueling. There is a cutthroat competition among well-known viable brand names with no clear market winner in the offing. Since government agencies need a reliable back-office system in place in order to conduct their e-government business or client relationship management, we encourage them to actively inform themselves about vendors' latest product offerings and vigorously negotiate contract terms.

The importance of a thorough, well-structured software selection process is of utmost importance given the fact that mere nuances will determine a winner. Overlooking any crucial business applications evaluation criteria (e.g., product functionality, product technology, product cost, corporate service and support, corporate viability, corporate strategy, etc.) may result in a selection with disastrous consequences.

Agencies should therefore seek assistance in the selection process from unbiased service providers, preferably with experience in the public sector or similar industries, and base their decisions only on the existing functionality that the vendors are able to demonstrate during scripted scenario sessions. They should put vendors' software through its paces during scripted scenario demonstrations (detailed sequences of near real-life business processes), in order to further distinguish between the vendors who made the short list (see Demonstration Post-Mortem: Why Vendors Lose Deals). A best-of-breed strategy may not necessarily be a bad option. However, 'bolt-ons' should be selected only from certified official business partners of the primary ERP vendor. The 64,000-dollar question is how functionality-rich these new 'e-gov' modules are, and how seamlessly they have been integrated with the back-office. Alternatively, how feasible would the integration with third-party products be?

While many of the required functionalities may appear to be offered by many vendors as supported' when responding to requests for information (RFI), subsequent product demonstration often reveals the need for some tweaking or even a major modification in order to satisfy stringent customer requirements. The devil is always in the details. As an example, some ERP systems will allow users to estimate and quote an overall project using time or dollar "buckets", which concept enables enterprises to perform actual rollups. In other words, companies can track orders and projects and compare their progress to the original estimate, as well as to previous iterative changes, all in the "bucket" form (e.g., total engineering hours or total dollars). Yet, most systems that are ETO-oriented can only track the current iteration.

According to the Small Business Administration Pro-NET sourcing service database, there are tens of thousands of small and minority-owned companies that are doing business with the federal government. With the new emphasis on improving homeland security and expanding antiterrorism operations around the world, many of these firms will likely experience a significantly greater demand for their services and rapid growth over the next several years. Many of these businesses will meet many of the governmental standards, but, for those that are in doubt, hiring a consultant familiar with government regulations in terms of top-notch accounting, manufacturing, and contracting abilities, might be the safest and fastest way to compliance. This is especially so because federal contracts have several tricky clauses that should be intimately understood, as they differ tremendously from typical commercial contracts, while their consequences can be grave for an uninformed new contractor. Although they are referred to by their FAR number and title (and often without their actual "fine print" text appearing in the contract), they can affect such contract terms as the amount the government will pay for the work performed or whether the contract can be cancelled.

On a more general note, companies who are project manufacturers, ETO, BTO, jobbing shops, or defense contract manufacturers should think carefully when selecting an ERP system. Given the maturity of the ERP market, its ongoing consolidation, and that fact that competitive advantage is hard enough for manufacturers to find, they should not compromise on their requirements. Especially small- and mid-size enterprises should ask hard questions about the scope of an ERP system, and how it supports project based idiosyncrasies. After all, a new system should always be about improving the business and not a mere technology initiative.

The vendor that listens to your needs instead of telling you what "cool things" its software can or cannot do, and which speaks your language and uses your terminology and vernacular is a good candidate to be a vendor that understands your business. Still, as a sort of a litmus test, prod each vendor to tell you what percentage of its sales would belong to your industry. Vertical focus indicates that software contains industry-specific features and that ERP vendors have certain industry expertise. Also, in implementing an industry-specific application, it is important to ensure that the application provider's implementation team includes members with in-depth knowledge and experience in that industry. Vendors geared toward certain industries should have solid integration skills or strong relationships with systems integrators that have industry-related expertise. This should significantly streamline implementation time by eliminating a lengthy vendor or integrator learning curve.