What is direct and indirect purchase?

Direct and indirect procurement are both crucial in business growth. Though they are different functions that require unique approaches and systems, understanding the similarities and differences between the two will eventually help you plan for a successful supply chain and spend management policies.

Direct procurement involves the purchasing of goods, materials, and services directly associated with the production of goods and services that a company is providing. Whereas, indirect spend refers to expenses incurred for materials, services, and maintenance required to operate the business. Both are important for a business, and one can’t exist without the other. But, the approaches are different for both processes.

We present four key areas of purchasing where the differences between direct and indirect spend are highlighted:

Supplier Relationship Management

One of the main differences in approach has to do with supplier relationship management. Direct purchasing teams invest a lot of time and effort into developing and maintaining relationships with suppliers. Delivery schedules and continuity directly affect production; the quality of raw materials impacts the quality of the final product, and thus the organization’s reputation and credibility. The relationships with suppliers are usually long-term and collaborative in this process.

In indirect procurement, the focus is mainly on spend management, not vendor relationship benefits. The collaboration with suppliers is transactional, with competitive costs being the focal point.

Investing in strategic rather than intentional relationships and developing better supplier relationships is something indirect spend teams can learn from the direct procurement teams. Also, streamlining supplier relationship management, as direct procurement does, will create better savings opportunities for indirect spend.

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 stocks, as well as the associated costs, are lower.

Indirect procurement can learn inventory management best practices from the direct procurement team to achieve the right balance between supply and demand activities.

Company Setup

In most organizations, direct costs are managed by centralized procurement teams, with category managers focusing on specific areas of spend. Indirect spend, alternatively, tends to be decentralized and scattered, and in the hands of various internal stakeholders with independent budgets and spend protocols.

Configuring a centralized structure and categories for indirect procurement will enhance efficiency and compliance and reduce costs.

Indirect procurement teams can learn valuable lessons from the direct procurement team in soft skills that are so essential for handling a large number of requirements, internal stakeholders, and vendors.

Use of Technology

Indirect procurement usually has diverse, uneven requirements often generated by a large number of users from a company’s non-procurement functions. To streamline the process, indirect procurement teams are focused on creating an uncomplicated buying experience through easy-to-use technology.

Businesses have begun to realize that upgrading direct procurement systems can help streamline processes, cut risks, maintain quality, and reduce costs. Yet, many teams continue to face problems with decentralized systems that have a non-intuitive user interface. Cumbersome processes negatively impact compliance and productivity.

The best solution for businesses is to invest in an intuitive, end-to-end e-procurement system that serves all procurement needs.

Tags: Direct and Indirect Procurement, procurement management software, Procurement Software Solution, Procurement software solutions

Direct and indirect procurement may seem like two very similar processes. However, within the procurement and sourcing process, these two categories serve very different purposes. Companies that understand the difference in these types of procurement are better able to manage inventory, create an efficient supply chain, and grow sustainably. Here’s what the difference is between direct vs indirect spend in procurement — and why it’s important. 

What is direct procurement? 

Direct procurement refers to the process of buying raw materials and goods for production. If your company makes sneakers, for instance, direct procurement would relate to the acquisition of shoe leather, laces, rubber for the soles, and thread for stitching. 

Direct procurement generally relates to product-based businesses, rather than service-based ones. Another way that many entrepreneurs think about direct procurement is as the Cost of Goods Sold (COGS). Items purchase via direct procurement are absolutely necessary for any future sale to happen. If, for some reason, direct procurement fails, the company would be forced to stop selling. 

What is indirect procurement?

Indirect procurement relates to purchasing services or supplies required to keep the day-to-day business running. Returning to the example of the shoe company, this could be the electric bill at the office or factory, the cost to ship the product to distributors, or paying models to wear the sneakers in a marketing campaign.

Indirect spend is still a crucial part of operating a business. Though direct procurement is central to producing goods, indirect procurement must be appropriately managed to keep profit margins healthy. Ideally, experts recommend that a company’s indirect procurement is no more than 15-27% of a company’s total revenue. 

Managing direct vs indirect procurement 

Analysis by McKinsey found that globally, indirect spend has been growing by an estimated 7% per year. As indirect procurement costs go up, profit margins shrink — but too often, procurement teams focus on lowering direct procurement costs in order to protect profit. 

Why are so few organizations able to get a handle on indirect procurement? McKinsey experts argue, “Spending is often fragmented among multiple locations, business units, and categories, making it hard to identify and capture enterprise-wide savings opportunities. Leaders of indirect-procurement functions typically lack sufficient clout within the organization to obtain the technology and talent they need. And most companies do not have mechanisms to monitor indirect categories and reflect their performance on financial statements.” 

[Read more: 3 indirect procurement challenges] 

Managing indirect procurement requires a combination of technology and strategy. There are platforms that can track analyze, and automate parts of indirect procurement, making the process more efficient. For instance, platforms like Fairmarkit can help procurement teams achieve a greater number of RFQs — resulting in a more competitive process and transparent prices. 

Managing direct procurement is a slightly different story. While indirect spend demands teams focus on budgeting from the company perspective, direct spend is all about building supplier relationships. Supplier relationship management can play a big role in managing direct spend: businesses that are able to build long-term, mutually-beneficial supplier relationships will save money. 

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