2.1 IntroductionThis chapter looks at theoretical review, empirical review and a summary. In order to further understand the impact of ERP systems different theories will be discussed. The empirical review evaluates previous studies that relate to this study. Lastly, the main focus of this chapter, which is the summary identifies the research gap. The gap justifies the need for the current study on the relationship between Enterprise Resource Planning (ERP) and financial performance in SME’s in Kenya.2.2 Theoretical Review2.2.1 Contingency theoryThis theory originated from the organizational theory which has been utilized for the past 25 years. This theory was developed by Lawrence and Lorsch (1967). The Contingency Theory posits that organizational effectiveness (in this instance ERP effectiveness or profitability) can result from the matching of ERP characteristics with contingency factors or contextual factors such as size, culture, the structure of the SME’s. The fundamental perspective of contingency theory is that organizational effectiveness is achieved by fitting organizational characteristics to contingencies. A contingency is defined as “any variable that moderates the effect of an organizational characteristic on organizational performance” Donaldson( 2001).Forms of organizations can be different according to the external environments they are placed in. Attaining goodness of fit between a firm’s external environment and structure affects its performance significantly Parker (1995).In their strategic alignment model, Henderson and Venkatraman (1999) stressed the importance of strategic fit and functional integration. They argue that the lack of fit between business and IT strategy can make it difficult for a firm to recognize the actual value of an IT investment.Applying contingency theory in the context of ERP implementation, ERP systems can be seen to possess characteristics that relate to environmental uncertainty, i.e. organizational structure, business processes, organizational culture, IT readiness, and other organizational characteristics. The fit between organizational environments and characteristics of ERP systems has a significant role in the success of ERP implementation within organizations. Most SME’s in Kenya are adopting ERP’s that are readily available and easy to use and fail to assess the congruence between the characteristics of an ERP system and its organizational context which is critical for ERP implementation and success. Therefore, identification of a set of dimensions of organizational environments internally and externally and ERP system characteristics provides some insights into successful ERP implementation and profitability. This theory will assist in understanding the adoption of integrated systems in the smaller organizations that is based on three factors; perceived benefits, organizational readiness, and external pressure i.e. competitive pressure and trading partner power. Oliveira and Martins (2010) use this model with the Technology Organization and Environment framework to explain the adoption of e-commerce.The authors also highlighted the shortcomings in the theory; these include its limitations in explaining interactions between variables, which at best it merely describes. The theory also assumes the existence of rational actors and often researchers using it to narrow their focus to deterministic models .Due to its limitation this study will several other theories to explain aspects of organizational behavior.2.2.2 Productivity ParadoxThe concept of productivity paradox and Information Technology was first described in 1987 by economist and author Robert Solow, who stated, “You can see the computer age everywhere, but in the productivity statistics.” In particular, it asks why the rate of productivity increase appears to be slowing dramatically in the Internet age.Solow’s Paradox is defined as the “discrepancy between measures of investment in information technology and measures of output at the national level.” Essentially anything that has to do with computers and computing is some form of information technology. Therefore, whenever organizations choose to buy computers, databases, networks, software, or many other computer related materials, they are making an investment in IT. Although on the surface, this seems like a great thing, the reality is that it’s not immediately evident that investing in IT is actually profitable. This internet age has given us fast connection and great communication with peers around the world; however Information Technology has not exactly been proven to be profitable.Several authors have explained the paradox in different ways. In his original article, Brynjolfsson (1993) identified four categories to group the various explanations proposed:1. Mis-measurement of outputs and inputs,2. Lags due to learning and adjustment,3. Redistribution and dissipation of profits, and4. Mismanagement of information and technologyOne hypothesis to explain the productivity paradox is that computers are productive, yet their productive gains are realized only after a lag period, during which complementary capital investments must be developed to allow for the use of computers to their full potential Diminishing marginal returns from computers, the opposite of the time lag hypothesis, is that computers, in the form of mainframes, were used in the most productive areas, like high volume transactions of banking, accounting and airline reservations, over two decades before personal computers. Also, computers replaced a sophisticated system of data processing that used unit record equipmentBrynjolfsson (1996) found that the gross marginal profit associated with ICT investment outweighs its marginal cost. This theory will guide this research to study the average profit margin that businesses acquire from integrating their systems.2.2.3 Competitive advantage theoryThe competitive advantage theory was initially invented by Porter. It will guide the research in demonstrating the competitive advantage that the adoption of ERPs offer to the companies that adopt it. Most literature suggests that firms need to achieve strategic business and IT alignment to be competitive.Porter (1979) demonstrated a framework which uses concepts to derive forces that determine market attractiveness. They consist of those forces close to a company that affect its ability to serve its customers and make a profit. If there are any changes in any of the forces, the company is required to re-assess its marketplace. There forces are: the bargaining power of customers, the bargaining power of suppliers, the threat of substitute products and the threat of new entrants. These four forces combine with other variables to influence a fifth force, the level of competition in an industry. Hwang (2011) states that a firm needs to provide a product or service in the right place at the right time at the lowest cost and hence many firms are employing ERP solutions to respond to customers’ demands with speed and accuracy. Using ERP systems effectively is essential to stay competitive and profitable. All organizations wish to be attractive in the market in a bid to gain more customers and make profits. They look to have an extra edge that puts them at an advantage over other companies. This is where the competitive strategy comes in. Adoption of cloud-based ERPs by small and medium enterprises will help an organization achieve competitive advantage. This is achieved by better service provision to customers, better relationships with suppliers due to efficiency, reduced operating costs by better utilization of resources and accuracy in data processing and reporting. It also raises the bar in the market for organizations to improve their operations.