EDI Costs to Benefits

Introduction

Benefits of Electronic Data Interchange

• Improved Customer Service
• Lower Inventory Carrying Costs
• Decreased Procurement Costs

Costs of Electronic Data Interchange

• Personnel
• Training
• Software
• Communications

Intangible Benefits of Electronic Data Interchange

Intangible Costs of Electronic Data Interchange

Summary

Introduction

Over the past few years, the EDI landscape has changed. The knowledge and skills needed to implement EDI have increased along with the number of EDI transaction sets and their complexity. However, the costs of implementing EDI have decreased. The telecommunications industry has developed Value Added Networks (VANs) to assist with EDI communications. Software vendors have created comprehensive, user-friendly EDI software translation packages and many consulting firms offer EDI development, maintenance, and training services.

Benefits of Electronic Data Interchange

The major benefits of implementing EDI falls into three broad categories: improved customer service, lower inventory carrying costs, and decreased procurement costs.

Improved Customer Service

Customer service is the package of activities provided by a supplier, which creates time, place, and form utility for a customer. Three components of customer service affected by EDI are pre-sale information, product availability, and data entry.

Pre-Sale Information. EDI partners at the beginning of the EDI relationship usually agree upon products, specifications, and prices. EDI orders are usually for standard frequently ordered products. In many businesses standard products, with volume business partners, account for 75 percent of total sales. Since the EDI purchase process is automated, the specifications, item prices, and estimated order volume for the orders transmitted over EDI are often agreed upon as part of the relationship.

Product Availability. Product availability is the supplier's ability to ship a finished product in a timely manner required by the purchaser. The benefits in product availability created by EDI are measured by the reduction in customer service staff time, lost sales, lost customer good-will, back orders, partial shipments, and expedites.

An EDI partnership is a close binding of two companies. EDI creates a "virtual link" between the customer's Retail Requirements System for a wholesaler or retailer or Material Requirement Planning (MRP) System for a manufacturer, and the supplier's Master Production Schedule (MPS) System. Often this linkage is formalized between two EDI trading partners by a blanket order to purchase a large number of goods in a year. In addition, EDI customers often share sales and forecasting information with the supplier to streamline the manufacturing process and to improve manufacturing capacity planning decisions.

This virtual linkage decreases the amount of time needed to process an order. No longer are requirements generated, vendors evaluated, purchase orders created, mailed, entered, and then processed. The unnecessary steps are left out and the remaining steps are automated through the EDI relationship. This fast reaction time, and shared sales and forecasting information gives the supplier a longer manufacturing lead-time. With a longer lead-time, the supplier can better determine manufacturing requirements and allocate manufacturing capacity to meet these requirements. When more manufacturing requirements can be covered, lost sales and related lost customer goodwill will be reduced.

While increasing the lead-time of the supplier, EDI can also decrease the order cycle-time of the customer. Order cycle-time is the time period from when a customer releases an order until the customer receives a shipment on that order from the supplier.

Companies try to shorten the order cycle time to decrease inventory-carrying costs, shrinkage costs, and improve cash flow. In a Just-In-Time (JIT) environment the requested receiving date by the customer is often no longer than the manufacturing time of the supplier and product shipment time. By helping manage a customer's inventory through decreased cycle time, a supplier can greatly improve customer goodwill and achieve volume business from that customer.

Back Orders, partial shipments, and expedites are often caused by an error in ordering process. A study by the Gartner Group (Evans-Correia, K., "EDI: the Future Frontier", Purchasing, February 1989, pp. 44-49) found that correcting an ordering mistake costs between 10 to 15 times as much as processing an accurate order. Since there will be few human errors in an automated EDI process there will be fewer costs of back-ordering, partial shipments, or expedites due to ordering mistakes.

Data Entry. Since EDI is the direct transmittal of business documents between computers, the printing of orders and invoices by customers and the subsequent entry of these documents by the suppliers are eliminated. While not all business partners, especially small ones, will become EDI ready, a company can drastically decrease the amount of data entry when large customers send documents through EDI.

Customer Service Benefit

• Decreased lost sales
• Decreased back orders, partial shipments, & expedites
• Decreased overtime
• Increased customer good will
• Decreased data entry costs

Lower Inventory Carrying Costs

Inventory carrying costs result from storing or holding goods for a period of time. The components of carrying costs are capital, space, inventory service, and inventory risk. Inventory carrying costs are proportional to the amount of inventory on hand.

The amount of inventory on hand is a function of product demand during order cycle time and the variability of that demand. EDI decreases the order cycle-time and its variability, which decreases the required amount of inventory on hand. This decreased inventory level decreases the costs of carrying inventory. The reduction of inventory by EDI is the number of days, which the orders cycle-time is decreased multiplied by the amount of inventory on hand. Major types of inventory costs include: capital costs, space costs, service costs, and risk costs.

Capital Costs. Capital costs are the costs incurred by keeping money tied up in inventory. Capital costs are reduced by using EDI because less inventory on hand is required due to shorter order cycle times.

Space Costs. Space costs include physical space, materials moving equipment, and inventory personnel time. Physical space costs are reduced by EDI with decreased inventory on hand. The savings in material moving equipment results from the reduction of material moving equipment required to handle the storage and retrieval of the inventory. The savings in inventory personnel time results from the reduction of time to move and administer the inventory.

Inventory Service Costs. Inventory service costs are the costs associated with insurance and taxes. With a decrease in the level of inventory, there is a corresponding decrease in the cost of insurance and taxes.

Inventory Risk Costs. Inventory risk costs are the costs associated with deterioration, damage, or obsolescence of inventory. These costs decrease in a direct relationship with a decrease in the quantity of inventory on hand.

Inventory Carrying Benefit

• Decreased capital costs
• Decreased space costs
• Decreased inventory service costs
• Decreased inventory risk costs

Decreased Procurement Costs

Procurement costs are the costs associated with the acquisition of goods for the replenishment of raw materials inventories. The elements of procurement costs are processing, transmitting, purchase, and receiving.

Processing, Transmitting, and Purchasing. EDI improves the procurement cost elements of processing, transmitting, and purchasing by providing an automated method for standardized procurement. In many organizations, standardized procurement is 75 percent of total procurement. Since the majority of total procurement can be automatically performed by EDI, the purchasing staff will need to spend less time on creating and administering purchase orders. The purchasing staff will be able to concentrate more on vendor searches and evaluations. Better vendors can help to improve the quality and costs of all procured products.

Receiving. EDI improves receiving by refilling the scheduling of resources in a customer's receiving area. When the suppliers sends a customer's order, it also sends an EDI Advance Ship Notice (ASN) which includes the items shipped, the carrier name, and expected delivery date. The customer receives this information before the shipment and uses it to schedule people, equipment, and a receiving dock for that order. This improves the scheduling of the receiving area resources, which decreases the need for excess people and equipment.

Procurement Benefit

• Decreased procurement administration
• Increased time for vendor evaluations
• Decreased receiving personnel and equipment

Costs of Electronic Data Interchange

The costs of implementing Electronic Data Interchange fall into the broad classifications of personnel, training, software, and communication.

Personnel

Implementing EDI in an organization requires support and training staff. At least one full-time EDI Coordinator is needed to answer user questions and perform maintenance on the EDI system. At least one temporary trainer is needed to initially train management and users about the theory of EDI and how to use the EDI system.

Estimates of the cost of the EDI Coordinator can be obtained from human resources or by speaking with recruiting firms. The trainer could be an internal person who either understands EDI or is willing to learn it, or an external consultant who specializes in training about Electronic Data Interchange.

Personnel Costs

• EDI Coordinator
• EDI Trainer

Training

Training costs are the costs associated with the lost work hours of the personnel being trained, training materials, and the training environment. Training is probably the most important aspect of EDI. Often problems with Electronic Data Interchange are less hardware and software related and more system usage related. People need to become comfortable with a new system. Training is a good way to make new systems and procedures seem less intimidating and to make users more productive when utilizing the new EDI systems.

Training Costs

• Lost work hours
• Training materials
• Training environment

Software

When implementing EDI, new software is purchased or developed and existing business application software is changed. The software components of implementing EDI are communication, translation, and application interface.

Communication Software. Communication software handles the transfer of information between the organizations using EDI. The information may be transferred through a third party Value Added Network (VAN) or directly to a trading partner's computer through just about any standard communications link. The functions of communication software are standardized. The communication software is often included with the EDI translation software or can be purchased from the EDI translation software vendor for a nominal charge.

Translation Software. The translation software converts Business Application information into an EDI information standard. The most common standard in the United States is the ANSI X.12 EDI format. Usually translation software is purchased from an EDI software vendor. A Popular EDI communication and translation software vendor for the Mainframe, AS/400, Unix and Windows platform is the Gentran Server by Sterling Commerce.

The application interface software is purchased, or developed internally by information systems staff or by EDI consultants. Usually packaged interface software cannot be purchased and when it can be purchased it will often need modification to fit the information needs of the company and its EDI trading partners. Estimates of the costs for development varies depending on the scope of the EDI project. An examination of similar systems, request of bids from consulting firms and an approximation of the costs from the EDI software vendor can be used to estimate the cost of the application interface.

The total software costs vary widely and can range from $2000 for a basic software with limited functionality, to the $100,000 plus software package that runs on a Mainframe and will completely automate your Just in Time (JIT) procurement process.

Software Costs

• Communication
• Translation
• Application Interface

Communication

The communication costs are the costs associated with the installation and maintenance of a connection between the organization and its EDI trading partners. The components of communication costs are installation, monthly service, and communication equipment.

Installation. The communication links can be a dial-up or leased line between the organization and a Value Added Network (VAN) or the EDI trading partners. In the past it was normally a dial-up line to a VAN, but in today's market leased line seem to be the preferred mode of communications for many business processes. For a Value Added Network connection, there is an initial EDI electronic mailbox setup charge and an initial charge for links to each trading partner's mailbox.

Monthly Service. Monthly service costs are charged by your local telephone service company or leased line provider. The value added network normally charges by the number of lines or characters in each EDI communication.

Communication Equipment. The communication equipment translates data from a format which is understood by the computer into a format which can be transmitted to the VAN or EDI trading partner. Communication Equipment costs will range widely based on the mode of transmission, a modem may cost less than $100 as where the hardware for a leased line may cost upwards of a few thousand dollars.

Communication Costs

• Installation
• Monthly telephone and/or leased line connection charges
• Monthly VAN connection
• Modem and/or leased line hardware

INTANGIBLE BENEFITS OF ELECTRONIC DATA INTERCHANGE

There are many intangible benefits to implementing Electronic Data Interchange including: faster response to market needs, faster customer response time, improved trading partner relationships through mutual commitment, gained or maintained competitive position, facilitating Just In Time (JIT) production, improved audit trails, superior service, and improved cash flow.

Another benefit of implementing EDI is the ability to retain and expand business. Many organizations are decreasing the number of suppliers that they work with. The business environment is changing from competitive priced procurement where bids are requested from many organizations, to target pricing where costs and acceptable profit are analyzed with one or two suppliers who are long term business partners. As the number of suppliers' decrease, sales volume often increases for the remaining suppliers. Fully functional EDI capabilities are often a prerequisite for suppliers who become these business partners.

INTANGIBLE COSTS OF ELECTRONIC DATA INTERCHANGE

There are also intangible costs of implementing EDI. EDI causes a re-design of the organizational structure and its work processes. These changes create costly behavioral and organizational transformations. Instead of increasing productivity, after initial EDI implementation productivity usually decreases until personnel in the organization become accustomed to the EDI system and how to use it effectively.

SUMMARY

In the next ten years the number of companies using Electronic Data Interchange (EDI) will dramatically increase. It's even been noted by some experts that estimate 95% of all business transactions will be completely computerized, from negotiations to payments. While this percentage may be aggressive, I think it is safe to say that many business transactions are moving to automation through EDI.

The knowledge, software, and communication cost requirements of implementing EDI are decreasing. Mid-size and small organizations are beginning to develop EDI systems. Many large organizations are requiring their business partners, even the small organizations, to use EDI. Every manufacturing, distribution, and retail-related organization should consider implementing EDI.

Since the EDI X.12 standards keep changing, the EDI software system will need periodic maintenance. However, if properly implemented a company can probably go one to two years between EDI software upgrades.

This article created a framework for determining the measurable costs and benefits of implementing EDI. An EDI project is a major cost expenditure. In some organizations the costs of implementing EDI might outweigh the financial benefits. The costs and benefits of implementing electronic data interchange should be carefully weighed before starting an EDI project.

Special Note:

EDI Associates believe in giving credit were credit is due and Richard Hornback deserves the credit for this fantastic case study which he posted on ecworld.com's web site in 1995. Outside of a few modifications to reflect the changes in technology, Richard Hornbacks case study is as true today as it was at the time of its writing.