Let's explore the world of procurement. Understand the key differences between direct and indirect procurement and how they impact your business...
There is no doubt a business needs robust processes and strategic relationships with goods and service providers to survive the competitive marketplace. Unfortunately, although most companies focus on direct procurement, they fail to manage indirect procurement, or the purchasing for their day-to-day business operations.
This is a mistake as indirect procurement is essential to cost-effective operations and ultimately, profitability.
In this post, we’ll cover everything you need to know about indirect procurement strategies, including:
- The difference between direct and indirect procurement
- How indirect procurement contributes to business profitability
- 5 indirect procurement best practices
- Indirect procurement KPIs
- 3 Indirect procurement strategy mistakes to avoid
Keep reading on to get all the tips and tricks for optimizing this often underestimated procurement category.
What is indirect procurement?
Indirect procurement is the process of purchasing goods and services that are critical to the day-to-day operations of a business but not directly linked to the production of goods or delivery of services.
Indirect procurement enables a company to function effectively, is driven by employee demand, and indirectly affects a company’s profitability. Failure to recognize it as a major cost-reduction driver is a missed opportunity to capture sustainable savings.
There are several categories of indirect procurement, some examples include:
- Office supplies
- IT-related services
- Marketing-related services
- Capital expenditure
- HR-related services, including recruitment and training
- Travel management services
- Professional or outsourced services such as consultants and advisers
- Facilities, maintenance repair, and operations
- Utilities like water, gas, and electricity
Indirect procurement involves purchasing goods and services essential for daily operations but not directly tied to production. It's driven by employee demand and indirectly affects profitability. Overlooking it can miss cost-reduction opportunities.
Some indirect purchasing examples include rent, office supplies, IT services, marketing services, capital expenditure, HR services, travel management, professional services, facilities maintenance, and utilities.
What is the difference between direct and indirect procurement?
Direct procurement is the acquisition of raw materials to produce goods or services that a business is providing. For example, a fabric manufacturer can contract directly with a cotton or silk supplier to acquire the raw materials needed to produce apparel. Typically, direct procurement has an ongoing, direct impact on business profitability.
The balance between direct and indirect procurement varies across industries. Manufacturing industries heavily rely on direct procurement, while service providers depend on indirect procurement. However, all organizations can get a competitive advantage and boost profits by implementing an effective indirect procurement strategy.
Keep reading about this essential topic in our comprehensive blog: Direct vs Indirect Procurement: A Deep Dive into Their Key Differences
How does indirect procurement contribute to business profitability?
Indirect procurement accounts for up to 80% of an organization’s purchases and 27% of its total revenue. And its impact is rising: since 2011, indirect procurement has grown globally by 7% every year.
Although purchases are often lower-value than direct procurement transactions, indirect procurement transactions occur frequently, at all business levels with costs that add up quickly if processes are inefficient. It is also a category of procurement that involves many employees and suppliers, meaning it requires a lot of attention from your procurement department.
So what is the impact of indirect purchasing on profitability?
If there is no indirect procurement strategy in place, your spend management goals are harder to reach: inefficient processes will cost time and money. With no policy or budget controls in place, unauthorized spending and overspending will almost certainly occur and you’ll have no visibility into 80% of your organization’s purchases and expenses.
Alternatively, if managed effectively, this spend category has the potential to generate significant cost savings and bottom-line growth. Digital solutions can create savings opportunities of 15 to 20%.
5 indirect procurement best practices
Indirect procurement can be a complex process to manage. It typically involves many stakeholders, categories, contracts to negotiate, and relationships to nurture. However, with careful planning and monitoring, you can establish a proactive indirect procurement process that saves time and costs while boosting productivity and employee experience.
Here are a few tips to help you get started:
- Invest in the right technology
- Streamline your processes
- Track your spending
- Encourage responsible spending
- Review all indirect spend contracts
1. Invest in the right technology
Many organizations find that they aren’t generating the indirect spend savings they desire, and there’s a reason for it. They’re solely relying on an ERP system to manage a diverse indirect procurement operation.
Although ERP solutions are a great supplemental resource to integrate with an indirect procurement solution, using one alone doesn’t offer the agility or visibility required to manage:
- User, supplier, department, or cost-center-based spend management
- Vendor onboarding and approvals
- Buying patterns and spend analytics
- Centralized procurement data
- Internal and vendor PunchOut catalog procurement
Your first line of business should be implementing an indirect procurement solution that can manage and optimize your organization’s spend. Modern solutions offer a digital procure-to-pay process with automated workflows, notifications, centralized records, and controls at every approval and transaction life cycle stage.
You minimize time-consuming manual processes that are prone to human error. Meanwhile, you gain comprehensive visibility into your organization’s indirect spend with:
- Detailed audit trails
- Budget insight at decision points
- Spend analytics
- Risk analytics
With a transparent indirect procurement process and accessible data, you gain the insights to partner with high-performing, cost-effective suppliers. From there, you can consolidate purchase orders and purchase in bulk to yield better financial value for your organization.
Read about the benefits of an e-procurement system here: The top 8 benefits of transitioning to an e-Procurement system
2. Streamline your processes
The automated process efficiency that procurement tools enable is key to the successful management of indirect procurement.
Admin-intensive and repetitive procurement tasks such as supplier onboarding can be streamlined, while frequent or monthly purchases can be templatized to save time and minimize errors. With automated workflows, you can achieve greater visibility over purchasing activities and maximize efficiency and workforce productivity.
3. Track your spending
Indirect procurement is renowned for operating outside of procurement's purview. Too often purchases occur without being tracked or approved against a project, department, or budget.
How much money is being spent, or worse yet, wasted on unnecessary items? Who are your employees purchasing goods and services from? To improve transparency and control, you need to track indirect procurement with the same level of scrutiny used to monitor spending on direct supplies required for production.
An indirect procurement solution can streamline and track employee spending with automated:
- Purchase requests
- Expense requests
- Approval workflows
These features all channel spend to contracted vendors, boosting your purchasing power and helping you negotiate more favorable terms to reduce costs.
4. Encourage responsible spending
A significant issue with indirect procurement is that non-procurement professionals carry out a significant portion of it when purchasing day-to-day goods and services for and on behalf of a business. This leads to a low compliance rate, resulting in wasteful spending, risks of fraud, and higher costs for the business.
Therefore, it is essential to educate the entire company on the need to follow procurement procedures and implement the necessary framework to guide their purchasing decisions.
Take control of your indirect spending by leveraging your solution to ensure approvals and spending policy compliance, maintain budgets, and eliminate rogue spend. Nurture a responsible spend culture by providing a user-friendly indirect procurement solution that ensures accountability while making it easy to request, approve and make informed purchasing decisions on any device, from any location.
5. Review all indirect spend contracts
Indirect procurement is often fragmented, with contracts spread across different departments and locations. Centralize your contracts and review them for opportunistic terms like the evergreen clauses that keep contracts in perpetual renewal year in and year out.
You should assess service contracts to ensure the materials or services being procured are still relevant to the organization. Where necessary, renegotiate those contracts regularly.
5 Indirect procurement KPIs
Track your progress and fine-tune your strategy by monitoring key indirect procurement KPIs.
Digital procurement software will enable you to gain complete visibility into spending behavior. By analyzing and reporting on spend by category you’ll gain the insight you need to understand how your business spends, which suppliers are providing the best value, and where more budget and cost control measures need to be applied.
Some critical indirect procurement KPIs you should be monitoring include:
- Cycle times and costs
- The savings and cost reductions you generate
- Cost avoidance
- Procurement ROI
- Vendor-related metrics like spend by supplier, price variations, and contract compliance (directly linked to reducing rogue spending)
You’ll be able to assess where your organization’s procurement platform is excelling, and where it’s underperforming. With this information, you can pave the best path forward, either by optimizing and driving the adoption of your current platform or evaluating alternate digital procurement software.
Read more about procurement KPIs here: 8 Procurement KPIs you should be tracking
3 indirect procurement strategy mistakes to avoid
If you lack seasoned procurement teams with years of negotiation experience, or a modern procurement solution to help you optimize the entire process, you can easily make procurement mistakes.
Below are some of the common mistakes to avoid:
- Revealing the budget amount
- Making quick decisions on purchase calendar
- Announcing the shortlisted selection
1. Don't reveal the budget amount
Vendors typically are trained to spot opportunities for maximizing their profits. Essentially, they will be keen to establish the availability of funds for indirect procurement with your company.
For this reason, under no circumstances should you or your stakeholder reveal available funds. Doing so will compromise your team's ability to get as many concessions as possible to match your current budget.
2. Don't make quick decisions on the purchase calendar
Vendors will also be eager to close the sale as soon as possible and within the current quarter of the purchase calendar. Sharing your purchase timeline can compromise your team's ability to negotiate a fair deal.
3. Don't announce the shortlisted selection
Suppose the vendors establish they are the only alternative for your indirect procurement spend. In that case, they will raise the stakes for your negotiation team.
To avoid this scenario, don’t announce your final selection too soon before your team secures the most concessions from your preferred vendor. Additionally, strive to engage more vendors to make sure you have a great representation of all the options available to you.
We can help you optimize your indirect procurement strategy with technology
If you’re looking to improve your indirect procurement processes, create value, enhance efficiency, and boost your organization’s bottom line, investing in a digital procurement solution like Fraxion can fast-track your strategic objectives and path to success.
Click here to find out more about how your indirect procurement strategy can positively impact business profitability.