Blog Credit: Ian McCue, September 9, 2020 (What is Two-Tier ERP and How Does It Work? | NetSuite)
As a company expands, whether organically or through mergers and acquisitions, the benefits of a unified view into financial systems don’t diminish. If anything, it becomes more critical. But trying to extend a primary enterprise resource planning (ERP) system to encompass diverse business units or subsidiaries that may have entirely different reporting and compliance structures is a sure way to get mired in complexity.
Instead, look at your organizational chart for inspiration, and think in layers.
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What is Two-Tier ERP?
Two-tier ERP is an approach to enterprise resource planning technology that uses two systems to address the needs of large businesses with multiple locations and/or subsidiaries. Under this strategy, headquarters will use a Tier 1 ERP that’s highly customized and has the functionality to run a large, global company, while subsidiaries or smaller business units use a less resource-intensive Tier 2 ERP that better suits their needs.
With two-tier ERP, the business integrates the two ERP systems so information automatically flows from Tier 2 to Tier 1. This allows for master data management, or a single source of accurate data for the entire enterprise. Although the responsibilities of each system can vary, the Tier 1 software often handles core business functions like finance, human resources and procurement. The Tier 2 system manages activities, like sales, marketing or manufacturing processes, that are more specific to each subsidiary or location.
This ERP strategy became popular as vendors developed less expensive suites with more prebuilt functionality as alternatives to legacy ERP systems that burdened companies with long, expensive, and usually on-premises implementations and extensive configuration requirements. Many companies realized a two-tier approach was far more economical and less work than replacing the Tier 1 ERP or moving a new subsidiary or acquired company onto its enterprise software.
Tier 1 vs. Tier 2 ERP
There are two distinct categories of ERP systems with different capabilities, each designed for businesses of a certain size.
A Tier 1 ERP is built for the world’s largest businesses that have operations around the globe. These systems are very expensive to install, maintain and upgrade. Customizing them to meet the business’ vast requirements takes a lot of effort, which leads to long implementation times. Companies typically have an IT team dedicated to managing this software.
A Tier 2 ERP is designed for midsize companies and small enterprises. This type of ERP is usually much less expensive and easier to launch than Tier 1 software. Some solutions in this category target specific industries, like manufacturing or retail, and come with more out-of-the-box functionality for accounting, sales, human resources and supply chain (including order and inventory management). One software vendor could offer both Tier 1 and Tier 2 ERP solutions.
Let’s look at big-picture business advantages of a layered model then dig into more tactical benefits.
Two-Tier ERP Advantages
Two-tier ERP has become a popular approach for enterprises that want a powerful system at the corporate level but need a complementary solution for subsidiaries or international locations.
On a strategic level, when a company is acquired, any effort to impose a monolithic Tier 1 ERP system is likely to cause disruption—the last thing an acquirer wants. If the goal is to help the subsidiary run better and more profitably, the advantages of a lighter-weight, more customizable Tier 2 system become clear. For the parent company, there’s no compromise in terms of gaining access to data, and the IT team avoids the headache of linking (possibly very) disparate ERPs.
That’s not to say there won’t be any disruption. Perhaps the subsidiary is using a very basic system that can’t integrate with the parent company’s Tier 1 ERP, or maybe there’s no modern financial software in place at all. In that case, the IT team or integration partner would do well to sell the subsidiary on the nuts-and-bolts benefits of having its own ERP.
Benefits of Two-Tier ERP
On the ground, the benefits of a two-tier strategy include:
- Cost savings: This is perhaps the most appealing aspect of two-tier ERP, especially for companies facing other costs involved in M&A activity. Implementation, maintenance and upgrade costs tend to be reasonable, particularly if the parent company has standardized multiple subsidiaries on the same Tier 2 system. Further, since the Tier 2 system requires less attention and can share IT resources with the corporate office, the company could eliminate some IT headcount, especially due to redundant positions, or redirect that talent toward projects that benefit the business more directly.
- Meet specific business needs: A business unit within an enterprise may have software requirements different from those of the primary business because of what it sells or the industry it serves. A specialized ERP tailored to the smaller business’ needs will simply work better for finance and could drive efficiencies it wouldn’t realize with the Tier 1 system.
- Greater flexibility and control: Since a Tier 2 ERP is less complex and “lighter,” it’s faster and easier to adjust the software as necessary. This empowers these smaller segments of a large corporation to respond to changes in the market or shifts in customer behavior in a timelier manner. It also gives these units more control over their operations and processes.
- Address local requirements: A subsidiary in a different country may need a system that uses a different currency or language and must comply with local laws. There could be subtle cultural or regional disparities that affect how this office operates. A Tier 2 ERP can accommodate all of those special considerations if they are not included in the Tier 1 system.
- Better user experience: Tier 1 systems are often difficult to use and have an intimidating learning curve. A Tier 2 ERP is more likely to have a user-friendly interface and a better overall user experience. This could also cut down on training costs.
Two-Tier ERP Use Cases
Through many failed projects and blown budgets, large businesses have learned it often doesn’t make sense to migrate an acquired company or new subsidiary onto a Tier 1 ERP.
Let’s break down a few use cases where a two-tier ERP strategy makes sense:
- Subsidiaries that have a business model distinct from the larger company. For example, the main office sells computer hardware and software while the subsidiary focuses on IT services and consulting.
- Subsidiaries that sell into a different industry than the larger enterprise or serve a niche market. This could require certain features that the Tier 1 ERP doesn’t have.
- Business units or offices that operate out of a different country than headquarters. The Tier 2 ERP can not only use the local language and currency but be configured to follow that country’s tax laws and other regulations.
- Organizations that become part of another corporation through a merger or acquisition. Bringing another business’ processes and operations onto an existing ERP can be extremely time- and cost-intensive, so giving the organization a dedicated platform is often a better choice.
- An acquired company that doesn’t have a formal business management system or uses basic, introductory software.
- A company that wants to take advantage of the features and user-friendliness of a newer solution while still utilizing its legacy ERP for certain business functions or processes. This is a much faster and simpler alternative to replacing the main ERP, which could be a massive project.
Choosing an ERP System for a Two-Tier Strategy
First and foremost,companies need to find a Tier 2 ERP that will easily integrate with the Tier 1 system to enable master data management. This will ensure there is always a central, accurate source of information and prevent manual data entry and endless headaches.
The complementary system should also support standard back- and front-office functions, like accounting, supply chain, sales, marketing and operations, along with specialized needs at the company. It should display real-time data and have powerful reporting capabilities. For international locations, support for multi-currency and multi-language is essential. The Tier 2 software should be adaptable so it can not only meet the needs of but evolve with a specific business model or industry. Look for a modular setup.
Additionally, the initial cost and total cost of ownership (TCO) for a Tier 2 ERP should not be onerous. That’s part of the reason why many enterprises choose a SaaS ERP, as it’s faster to implement and requires minimal maintenance since the vendor hosts the solution on its own infrastructure and handles all upgrades and patches. SaaS ERP appeals to companies that already have to dedicate a lot of human and capital resources to keeping their Tier 1 ERP running smoothly and would prefer a turnkey option for remote sites.
When it comes to selecting a Tier 2 ERP, corporations can:
- Let a subsidiary or international location complete its own evaluation process and select any vendor. However, what analysts calls the “laissez-faire” approach could lead to integration issues with the Tier 1 system.
- Give the business unit a list of approved solutions or software providers. These could be systems the main office vetted and knows will play well with its enterprise software—preferably with prebuilt integrations—or Tier 2 solutions offered by the Tier 1 ERP vendor.