What is the difference between direct and indirect procurement?
The key difference between direct and indirect procurement is the function they address. While direct procurement focuses on securing the core supplies that are processed and delivered to your customers, indirect procurement deals with the purchasing of goods and services required to develop and maintain effective operations.
While both of these functions ultimately follow a procure-to-pay cycle, there are a handful of key differences between direct and indirect procurement processes that affect how they are managed internally.
Here are a few key areas of purchasing where the differences between direct and indirect procurement are highlighted.
Let's dive into a deeper analysis.
What is direct procurement?
Direct procurement involves the purchasing of goods, raw materials, and services directly associated with the production of products and services that a company is providing.
These purchases are generally made in large quantities, acquired from a pool of suppliers at the best possible cost, quality, and reliability.
These purchases are also made frequently and are necessary for key business outputs, here are some examples of direct procurement:
- Purchasing raw uncut steel to manufacture vehicle parts
- A plumbing company buying new fittings to be installed
- A food production company purchasing ingredients
If direct procurement stops functioning or encounters problems, companies are no longer able to manufacture and sell their products to generate revenue. The day-to-day role of direct procurement is crucial to industries such as manufacturing.
What is indirect procurement?
Indirect procurement, often referred to as indirect spend, operating costs, SG&A (Selling, General and Administrative), or MRO (Maintenance, Repairs, and Operations) costs, deals with acquiring products and services that support a business’s operations.
Indirect supplies are essential to effective operations, but they don’t exert any direct input into the finished products and services delivered to customers. Rather, they play a supporting role to ensure that the process of turning direct supplies into finished goods runs smoothly.
- Some examples of indirect supplies and services include:
- Rent and utilities
- Marketing services
- Travel and expenses
- IT-related services and SaaS subscriptions
- Stationery and office equipment
Indirect supplies are more pronounced in digital or service-oriented fields where there are no tangible goods, but mostly services rendered to customers.
Why you should care about procurement
Direct and indirect procurement are both crucial to business growth. Though they are different business functions that require unique approaches and systems, understanding the differences between the two will eventually help you plan for a successful supply chain and spend management strategy.
By understanding the approaches and differences between direct and indirect procurement, you’ll be able to build excellent supplier relationships, manage procurement efficiently, and ensure a steady flow of the goods and services you need to keep your company running smoothly. The most effective way to improve procurement efficiency is by going digital.
How direct vs indirect procurement functions differ
1. Emphasis on customer-vendor relationship
Direct procurement deals with acquiring the supplies that constitute the base of what your business offers your customers. That is to say, without the products of direct procurement, nothing works. To ensure you can guarantee a steady supply, it’s in your best interest to build long-term, sustainable relationships with your suppliers. This is where vendor performance management, strategic sourcing, minimum order quantities, etc., come in.
Under direct procurement, there’s a need to build a reliable customer-vendor relationship that can stay resilient when you need it, providing security for both sides. However, having contingencies in place are vital to plan for supply chain disruption and uncertainties around fulfillment.
Indirect procurement, on the other hand, very often doesn’t get the emphasis direct procurement receives. Rather, organizations make one-off purchases from random suppliers, whenever it’s called for, causing organizations to miss out on bulk discounts and more favorable payment terms that can be negotiated with approved and contracted suppliers.
2. Inventory management
Inventory management is all about knowing what goods you have, where they are stocked, and how much you will require.
With direct procurement, to guarantee a smooth production process and to avoid delays, goods need to be held in stock.
In contrast, indirect procurement is managed by demand; that is, purchases are made when required, so the quantities, as well as the associated costs, are lower. With more effective management of this spend, however, having the visibility and digital tools to consolidate purchase orders across teams or office locations, savings in indirect spend can also be achieved.
3. Organizational setup
In most companies, direct costs are managed by centralized procurement teams, with category managers focusing on specific areas of spend.
Indirect spend, on the other hand, tends to be decentralized and scattered, and in the hands of multiple internal stakeholders with independent budgets and spend protocols. Processes are often manual, lacking the same scrutiny and control as direct procurement, leaving money on the table. The indirect procurement process can quite easily be overseen by a finance team, if a digital system is in place to provide a reliable compliance framework for indirect purchasing.
Implementing spend management software with a centralized internal control structure such as policy and budget control frameworks for indirect procurement can improve efficiency and compliance and reduce costs, even more so in service-oriented businesses where indirect spend is high.
This structure supports a decentralized purchasing model, empowering every user to get the goods and services they need without exposing a business to the risk of unauthorized or out-of-budget spending.
4. Planned vs. spontaneous spend
Direct procurement manages the core supplies your business needs for production, and as a result, needs emphasis to ensure resilience. The essential inputs you need to keep running operations need to be planned and budgeted well in advance to avoid disruptions to your supply chain.
For indirect supplies, on the other hand, without a digital solution in place, it can be difficult to report on exact figures to estimate demand and as such, there’s little planning or budgeting for indirect procurement. Indirect supplies are often procured spontaneously as the need arises, unlike direct supplies.
How does direct and indirect procurement affect your spend management strategy?
Direct procurement has a direct impact on an organization’s bottom line as it includes revenue-generating expenditure related to products being sold, whereas indirect procurement indirectly impacts profits; the less you spend, the higher your profit margins will be. Up to 27% of total revenues may be attributed to indirect procurement. As a result, it's crucial to keep track of all business expenses, whether direct or indirect.
This leads to a key question:
What possible savings does your company lose out on by not reviewing indirect spending as closely as direct spending?
Managing your spend across the board is key to the financial growth and longevity of your company, regardless if it’s linked to direct or indirect spend. The cost saving potential of better managing indirect procurement is often grossly underestimated.
McKinsey & Company reports that, since 2011, indirect spend has been increasing globally by an estimated 7 percent every year. Therefore, accessing hidden areas of value in indirect spend should be a constant focus area to realize the most impactful cost savings in this spend category.
By implementing thoughtful indirect procurement strategies with the help of indirect procurement or spend management solutions, you can identify areas that offer immediate cost savings. Having visibility into this type of expenditure is invaluable and often uncovers just how much employees are wasting and overspending.
Providing the same level of scrutiny and control over indirect procurement as you do for direct procurement will help you see more than a marginal change to your bottom line, increasing your financial stability and allowing you to identify and allocate resources to areas that can accelerate growth.
What holistic solution is out there to help you spend smarter and save?
Introducing Fraxion, a procurement software for proactive spend management.
Indirect and direct procurement software like Fraxion can digitize your procure-to-pay process, saving valuable time and money, making it easy for your employees to obtain the goods and services needed to operate efficiently.
With more visibility and proactive controls, your team is empowered to make informed buying decisions, while the policy and budget controls guide their spending behavior. Meaning you will spend smarter and save more.
To learn more about the importance of spend management and how to build an effective strategy that will boost your bottom line, read our recent blog.