5 Differences Between Direct and Indirect Spend
Direct and indirect procurement are both critical to businesses. However, they are very different functions that require very different approaches and tools. Understanding the similarities and differences between direct and indirect spend will ultimately help you plan the roadmap for successful supply chain and spend management strategies.
What is direct procurement?
Direct procurement — or direct spend, or direct cost — involves the procurement of goods, materials and services directly related to the production of goods and/or services that a business is offering.
What is indirect procurement?
Indirect spend refers to expenses incurred for materials, services and maintenance required to operate the business. Both are equally essential to the running of a company, and one cannot exist without the other. But while both teams essentially procure, their approaches and responses are dramatically different.
Here are five core areas of procurement where the distinctions between direct and indirect spend are highlighted:
Supplier relationship management
One of the key differences in approach has to do with supplier relationship management. Direct procurement teams invest a lot of time, effort and energy into building and maintaining relationships with suppliers. Supply schedules and continuity directly affect production; the quality of raw materials impacts the quality of the end product, and thus the company’s reputation and credibility. Here, relationships with suppliers are usually long-term and collaborative.
In indirect procurement, the focus is on spend management, not supplier collaboration benefits. The relationship with suppliers is transactional, with competitive costs being the key focus.
Investing in strategic rather than tactical relationships and building strong supplier relationships is something indirect spend teams can learn from their counterparts. Also, streamlining suppliers and pooling volumes, as direct procurement does, will create better savings opportunities for indirect spend.
In direct procurement, should-cost analysis — analysis conducted by a client of the expenses incurred by the supplier in delivering a product or service, to guide negotiations — is a much-used cost management practice. For indirect spend teams, zero-based budgeting is a best practice. A method of drawing up the budget from scratch instead of basing it on the previous budget, it requires that every expense be justified before it is added to the budget; its aim is to reduce costs as much as possible.
Both teams can learn and gain from applying each other’s tools to their key spend categories.
Inventory management is knowing what materials you have, where they’re stocked, and how much you’ll need.
With direct procurement, to ensure a smooth production process and to prevent delays, materials need to be held in stock. In contrast, indirect procurement is governed by demand; that is, purchases are made when required, so the stockpile as well as the associated costs are lower.
Direct procurement can offer useful lessons in inventory management best practices, which can help the indirect spend function strike the right balance between supply and demand activities.
Use of technology
Indirect spend typically has diverse, fragmented requirements often generated by a large number of users from an organization’s internal, non-procurement functions. To streamline and simplify the process, when selecting e-procurement solutions, indirect procurement teams are focused on creating an uncomplicated buying experience through easy-to-use indirect procurement technology.
Companies have begun to realize that upgrading direct procurement technologies can help to streamline processes, cut risks, maintain quality and trim costs. Nevertheless, many teams continue to be bogged down by unwieldy systems that may be feature-rich but have non-intuitive user interfaces linked to the organization’s legacy ERP systems. Cumbersome processes negatively impact compliance and productivity.
To stand up to the challenges in direct spend, it would be sensible to learn from indirect procurement’s focus on user experience. The most effective strategy would be for businesses to invest in intuitive, end-to-end single-platform systems that both functions can use.
In most companies, direct costs are managed by centralized procurement and supply chain 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.
Creating a centralized structure and categories for indirect procurement will improve efficiency and compliance and reduce costs, even more so in service-oriented businesses where indirect spend is high.
Direct spend teams can look to their counterparts for valuable lessons in soft skills that are so essential for handling the large number of requirements, internal stakeholders and vendors, all of which make indirect procurement so complex.