In recent years, procurement has become a key business function in many organizations. Without procurement, many organizations would not be able to operate. But what exactly is procurement? Procurement involves making sure that all goods and services required for business purposes are properly acquired. This could be anything from raw materials to office supplies to advertising.
Over time, two overlapping disciplines have emerged within procurement: indirect and direct procurement.
In this blog, we explain the difference between direct and indirect procurement. But first, let’s clarify the roles that direct procurement and indirect procurement play within an organization.
What is direct procurement?
Direct procurement involves acquiring the raw materials, parts, or components that are used to create a product. These are the materials that often end up in the final product for customers. 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 made frequently and are necessary for key business practices, such as a baker acquiring flour to produce bread.
If direct procurement stops functioning or encounters problems, companies are no longer able to manufacture their product and create revenue.
Direct procurement is often related to manufacturing operations where raw materials are turned into physical products.
What is indirect procurement?
Indirect procurement involves purchasing goods and services, supplies, and materials that are required to keep the day-to-day business running. One way of classifying indirect procurement is that it doesn’t add to a business’s bottom line. Indirect procurement may include purchases such as repairing equipment, buying office supplies, maintenance, travel, or other services.
Without indirect procurement functions, businesses wouldn’t be able to operate effectively. Typically, indirect procurement includes somewhere from 15-27% of a company’s total revenue.
Indirect procurement strategies
Managing indirect procurement can be challenging. It requires careful planning and monitoring. Here are some strategies to help you manage indirect procurement.
1. Track spending
Often times, indirect procurement spending isn’t tracked the same way as as direct procurement. Individuals or departments are often given a budget to work with and can purchase what they want when they need it. However, it’s a good idea to keep an eye on employee spending so finance and accounting teams know exactly what teams are spending money on.
2. Be strategic with your sourcing
Assess your suppliers and entire supply chain and look for opportunities for savings. Build relationships and collaborate with your vendors to rework your supply base if needed so everyone can get the benefits of the savings.
3. Use technology to stay informed
There are many technologies and tools that organizations can use to gain insight and visibility into their procurement process and operations. These technologies include data analytics software, automation technology, and market research tools.
4. Build relationships internally
There are often many departments involved in indirect procurement to some extent, whether it’s purchasing office supplies, setting up advertising budgets, or reconciling invoices. It’s important that everyone is on the same page when it comes to company spending and indirect procurement so you can better predict future needs and shifts.
Indirect procurement categories
Did you know that indirect procurement categories can make up about 40 percent of a company’s total spend? It’s also harder to draw a direct connection between indirect spending and the company’s profitability.
These are some of the most common indirect procurement categories:
- Human resources (ie. training, hiring, professional development, etc.)
- Utilities (ie. water, electricity, gas, and rent)
- Office supplies (ie. office furniture, stationery, cleaning supplies, etc.)
- IT/Technology purchases (ie. computer hardware and software)
Direct vs indirect procurement: what are the differences between the two?
Direct procurement is spending on services, goods, and materials that drive profit, performance, and competitive advantage. Whereas indirect procurement is expenditure on the maintenance, goods, and services needed for day-to-day operations, which do not directly contribute to a company’s bottom line.
While both of these functions ultimately follow the procure-to-pay cycle (see below), there are a handful of key differences between direct and indirect procurement that affect how they are managed internally.
Managing supplier relationships
To drive quality and improve efficiencies over time, direct procurement teams tend to foster long-term, collaborative relationships with their suppliers. Hence, more time is spent on developing and managing supplier relationships.
Indirect procurement teams are predominantly focused on managing company spending, hence they tend to have more of a transactional relationship with suppliers than their direct procurement counterparts. Thus, their focus is more on managing and reducing expenditure.
It’s important to note that vendor management can still benefit companies with indirect procurement requirements. Hotels and companies with multiple locations can often negotiate better deals and discounts when they centralize relationships with their vendors, thus reducing their overall expenditure.
Similarly, software companies with little to no need for direct procurement (e.g. purchasing of raw materials, transportation costs, etc) can also reduce their overhead costs with strategic vendor management of suppliers that support indirect procurement activities.
To avoid delays, effective inventory management is critical to direct procurement. If a supplier runs out of stock, it can cause problems for the entire supply chain (and have devastating consequences for a company’s bottom line).
Typically, inventory management is less of a priority for indirect procurement teams. However, this will always depend on the nature and needs of the company.
Because direct procurement has a “make or break” impact on a company’s revenue, it’s typical for direct spending to be managed by a dedicated, centralized procurement team.
Companies don’t typically take the same approach for indirect spending, which tends to be a decentralized function haphazardly delegated to a variety of stakeholders across multiple departments.
Examples of direct procurement vs indirect procurement
Here are some real-world examples of direct procurement and indirect procurement.
- Raw materials
- Machinery and manufacturing equipment and parts
- Ingredients for food products
- Subcontracted labor
- Maintenance and repairs to manufacturing or office equipment
- Utilities (gas, electric, water)
- Office furniture, stationery, and other office supplies
- Employee management and development costs (training sessions, human resources costs)
- Consultants and professional services (speakers, advisers, coaches, consultants)
- Computer hardware and software
- Workplace and facilities management (toilet paper, cleaning supplies)
- Marketing costs
This isn’t an exhaustive list. As always, a company’s business model and the services and products it sells will determine its involvement with direct and indirect procurement.
Direct and indirect procurement, and spend management
Direct and indirect procurement are both part of an organization’s overall spend management strategy. Both of these types of procurement impact the organization’s financials in different ways. Direct procurement has a direct impact on an organization’s bottom line whereas indirect procurement doesn’t. Therefore, it’s important to track all company spending, whether it’s direct or indirect procurement.
Spend management software like Procurify can digitize your procure-to-pay process, saving valuable time and money and making it easy for your organization and employees to obtain the goods and services needed to operate.
Editor's note Original publish date: 25 Sept 2013 Original author: Kenneth Loi We've since updated and republished this blog post with new content.