Can Direct and Indirect Procurement Work Together?
- Traditional lines of demarcation between direct and indirect procurement are vanishing
- Indirect procurement has streamlined processes with the help of technology
- Monitoring both categories in tandem on a unified platform can help a business realize strategic goals
June 26, 2021 | Procurement Software 4 minutes read
For many businesses struggling to deal with growing uncertainty amid the COVID-19 pandemic, streamlining the procurement function has become top priority.
What does this mean for their direct and indirect procurement teams? How should they be managing spend to deliver on cost savings in this new normal? Are usual approaches still as effective?
Let’s dive deep to find out.
Direct vs. indirect procurement
Direct procurement, also called direct spend, is the process of purchasing or obtaining raw materials, resources and goods and services that are utilized in the core operations of a business.
The goods and services bought through the process of direct procurement ultimately find their way to the end customer or client of the business.
For example, a car manufacturer requires specific kinds of steel, plastic and electronics that will eventually be a part of the vehicles it produces. The process of procuring these materials comes under the gamut of direct procurement.
Indirect procurement refers to the purchasing of services, supplies, materials and goods required to support the ongoing existence of the business. In other words, it includes purchases of goods and services that do not become a part of what a business sells to its customers.
These supplies are essential for day-to-day operations, but they do not have an obvious or immediate impact on the company’s bottom line. Examples of indirect procurement can include computers and office hardware, software, maintenance, utilities, logistics, travel expenses, etc.
Indirect Spend | Direct Spend | |
|---|---|---|
| Spend | Low: 20-30% of spend | High: 70-80% of spend |
| Purchase volume | Varies by category but lower than direct categories | Bulk purchases in high quantity |
| Number of spend categories | High | Low |
| Quality control | Moderate | Strict |
| Number of suppliers | High: 70-80% of suppliers | Medium: 20-30% of suppliers |
| Transaction volumes | High | Low |
| Average transaction value | Low | High |
| Drivers | Efficient operations | Top line and margin |
| Criticality | Medium: Affects productivity and smooth operations | High: Affects finished product, market reputation, sales, and revenue |
| Impacts | Affects bottom line | Affects both top and bottom lines |
| Stakeholders involved | Multiple | Limited |
| Business risks | High | High |
| Consumer | Internal stakeholders | External clients |
Is one segment of procurement more important than the other?
Direct procurement, where the bulk of the money is spent, is traditionally seen as more integral to the business. It is where a business looks to make a profit and derive competitive advantage.
According to a financial analysis of 2,800 global companies by S&P Capital IQ in 2017, direct spend can account for 67% of a company’s revenue.
No wonder, procurement’s endeavor to realize cost efficiencies has historically focused on direct spend.
Often, enterprises have made significant investments and spent considerable time establishing processes around direct spend. Any transition from established procedures is considered risky.
However, despite being considered vital, direct spend continues to face obstacles.
Partly because many enterprises consider direct spend to be a core function and are reluctant to make any significant changes. They continue to rely on traditional methods of direct procurement, with planning based on material requirement over a period.
In contrast, indirect spend has made good use of technology. Advanced technology has enabled indirect spend teams to effectively collaborate with suppliers and mitigate risk. In this way, indirect procurement has also succeeded in reducing maverick spend.
Merging direct and indirect procurement
As procurement teams turn to technology to make the function more agile, they are unsure if the traditional distinction between direct and indirect procurement is still relevant.
Talking about the insignificance of this distinction, Krish Vengat, vice president of consulting at GEP, says: “If you’re looking at the business from the standpoint of a CEO or CFO, a spend is a spend. Their interest in the distinction between direct and indirect spending might only stretch as far as wondering why some of the tools that have made indirect procurement so much more efficient are not being used more widely to manage direct spend.”
Clearly, from a business perspective, it is more important to determine how to monitor and manage both these spends effectively. Instead of bifurcating procurement into direct and indirect, there is a need to combine, and effectively monitor, the overall spend.
In fact, many of the technological tools developed to make indirect spend more efficient can also be applied to direct spend. These include e-auctions, e-catalogs, purchasing cards and invoice automation.
Conclusion
There are several benefits of doing away with the traditional demarcation between direct and indirect procurement. By sharing resources, information and insights, indirect and direct spend teams can break down silos and build a more constructive relationship that benefits the procurement function as well as other stakeholders and the business at large.
ALSO READ: DIFFERENCES BETWEEN DIRECT AND INDIRECT PROCUREMENT
Frequently Asked Questions
Direct materials are components that go into a manufactured product. For example, components such as the screen, integrated circuits, camera modules and buttons are the direct materials involved in the production of a smartphone.
This stands in contrast to indirect materials, which are items that are involved in the overall manufacturing process but don’t end up in the final product.
Direct materials procurement is considered high stakes as it critically impacts supply chain efficiency, customer sales, and ultimately, the top and bottom lines of a company. And in today’s highly dynamic, globalized supply chains, managing direct materials expenses is way more than a business priority; it’s also a way to gain strategic competitive advantage.
Indirect materials are goods that, while part of the overall manufacturing process, are not integrated into the final product. For example, disposable gloves, personal protective equipment, tape, etc., may be essential to a production line, but they are not part of the actual product created on that line.
When cost savings take priority, it’s important to control spending and compliance by using a unified source-to-pay (S2P) platform for indirect materials.
Among S2P platforms, cloud-native ones offer the best functionality: they are easy to set up, deploy, learn and use, and they offer real-time, end-to-end visibility.
Unlike indirect materials, direct materials are components that are integrated into a manufactured product. For example, chips in a mobile phone are direct materials in mobile phone production.