What are direct and indirect procurement?
The typical definition of procurement is that it is a tactical, process-oriented function with few strategic decisions. The procurement department has traditionally been referred to as a crucial record-keeping unit that makes sure the business complies with industry standards and enables audits. Procurement can be sub-divided into two categories – Indirect procurement and direct procurement.
Indirect procurement, how indirect and direct purchasing differ, and their effects on your company’s bottom line are all topics that this blog post aims to demystify. We also examine the difficulties companies have in controlling indirect procurement.
Please continue reading for more information on direct and indirect procurement.
What Does The Term Procurement Mean?
The procurement function of an organization is in charge of managing spend, which includes both the purchases of goods and services that go into the creation of the goods that are sold to customers as well as those that are necessary for the day-to-day operations of the company.
However, this oversimplifies a bit what the best in class modern procurement organizations do for the larger company or organization.
For the larger organization, procurement can and should be a significant value creator. In fact, there are various stages of procurement value creation that relate to the Source-to-Pay process:
- Identifying Value, is where procurement teams leverage spend data and spend analysis to understand trends in spend and identify opportunities and develop category management strategies.
- Creating Value occurs when sourcing and procurement uses relevant sourcing processes and tools to engage and select the best fit supplier. However, just creating value isn’t enough; it also needs to be captured.
- Capturing Value occurs when a contract has been established that governs the responsibilities and obligations of both supplier and buyer, and well as when the organization has the right To guarantee adherence to those contracts, products, services, and prices, procure-to-pay procedures have been put in place.
- Monitoring and measuring value is where the procurement organization takes a holistic view of the Process from source to pay and relationships with suppliers.
Naturally, it is crucial for procurement teams to do this across all spend categories, including direct and indirect spend, which at a high or simplistic level breaks down all of an organization’s spend. Each of these is necessary for a business to succeed. But it’s crucial to comprehend the distinctions and varying levels of emphasis between direct and indirect spend in sourcing and procurement.
Your procurement team must possess superior knowledge of contract management, sourcing, and supplier relationship management in order to be successful. They also need to have the ability to effectively manage procurement costs as they benefit the company. They will need to comprehend both internal and external forces, and they will need to become increasingly adept at juggling cost savings with stable supplier relationships.
The Definition Of Direct Procurement
The process of acquiring the goods, services, and supplies you require for your primary business activity is known as direct procurement.
Essentially, direct procurement is the acquisition of those necessary goods and services that, after some processing, are delivered directly to your final clients.
It deals with the components that make up the core of the services your organization provides.
Direct purchasing, as an illustration:
- a baker buying the flour for making bread
- a construction company making an order for the cement and blocks for an ongoing project
- a fabric factory ordering textiles and cloth materials for processing and sewing down the line
Note: Direct purchasing is primarily used in physical manufacturing sectors, where direct raw materials are transformed into physical products.
Indirect Procurement: What Is It?
Purchasing goods and services that, albeit in a non-essential capacity, aid a company’s operations is known as indirect procurement. Office supplies, stationery, decorations, and other items are among these indirect supplies.
In their own unique ways, indirect supplies continue to be vital to your company. But they have no direct influence over the final goods and services you provide to your clients.
Instead, they serve as a supplementary function to guarantee the efficient conversion of direct supplies into finished goods.
Indirect supplies include things like:
- A SaaS subscription, such as Slack, Asana, Kissflow
- employee development resources, e.g. books
- office decorations,
- office equipment such as laptops & personal computers.
In digital fields where there are primarily services provided to customers rather than tangible goods, indirect supplies are more noticeable.
Indirect Procurement Strategies
It can be difficult to manage indirect procurement. Planning and oversight must be very careful. Here are some tactics to manage indirect procurement.
Track Spending
When compared to direct procurement, indirect procurement spending is frequently not tracked in the same way. A budget is frequently provided so that people or departments can buy what they want when they need it. To ensure that the finance and accounting teams are aware of exactly what teams are spending money on, it is a good idea to monitor employee spending.
Be Strategic With Your Sourcing
Search for cost-saving opportunities by evaluating your suppliers and the entire supply chain. Establish communication channels and work together with your suppliers to restructure your supply chain as necessary so that everyone can benefit from the cost savings.
Use Technology To Stay Informed
Organizations can use a wide range of technologies and tools to gain visibility and understanding of their operations and procurement process. Software for data analytics, automation, and market research tools are some of these technologies.
Build Relationships Internally
When it comes to purchasing office supplies, creating advertising budgets, or reconciling invoices, many departments are frequently involved in indirect procurement to some degree. In order to better anticipate future needs and shifts, it is crucial that everyone is on the same page when it comes to corporate spending and indirect procurement.
Indirect Procurement – The Main Challenges
Let’s examine why businesses do not prioritize indirect procurement now that the differences between the two types of procurement are clear.
One of the most challenging aspects of indirect procurement is how complex it is. According to a NelsonHall study, 80% of the surveyed organizations thought indirect procurement was meeting expectations. We need to investigate the obstacles that impede this function, which include the following:
Stakeholders And Commodity Groups Involved
Since indirect procurement supports the daily operations of internal stakeholders, it is frequently decentralized to the various departments; for example, human resources will handle hiring and training, marketing will handle contracts with ad agencies, and so on. This involves a large number of internal groups in the procurement of numerous commodities across numerous categories.
Sporadic Buying, Maverick Spending & Poor Supplier Performance Visibility
Numerous business units engage in frequent sporadic buying due to the numerous stakeholders and categories involved, the lack of dedicated procurement teams, and the mandated spend policies. This plants the seeds for complicated supplier relationships that don’t benefit the company and for irrational spending. Additionally, this reduces the ability to monitor the performance of the suppliers and raises the risks involved. Poor visibility into supplier performance was thus identified as one of the main sources of pain for procurement professionals in Zycus’ Pulse of Procurement 2018 research.
Lack Of Visibility Into Spend Data & Missed Savings Opportunities
The next obvious barrier is a lack of transparency in the data on indirect spending, which can be seen as a result of the sheer complexity. We can imagine the effect of this, which prevents procurement teams and the organization from identifying and increasing cost savings in indirect procurement, given that this is caused by the numerous categories under which spend data must be classified. How can we manage something that is so difficult for us to name?
Additionally, when we examine direct procurement, the transactions typically have high monetary values. The procurement teams are able to negotiate for higher discounts thanks to their strong relationships with suppliers, and as a result, they are able to spot significant cost-saving opportunities. The volume of transactions is high and diverse, with a large number of stakeholders involved and a low monetary value, so indirect procurement falls short in this regard.
In the backdrop, Pulse of Procurement 2018 found that 54% of the global procurement leaders consider cost savings as a top focus area.
Lack Of Expertise
Organizations need skilled staff with knowledge of topics like category and change management, contracting, managing supplier relationships, and data analytics to manage the complexity that results from indirect procurement. In the majority of businesses, there aren’t enough employees working in indirect procurement with the necessary skills to run the processes well. The lack of talented and skilled procurement workers was also identified as one of the year’s major pain points in the Pulse of Procurement 2018 report.
It’s clear that this situation is not pleasant.
True potential, though, can only be found in the challenges. According to a study by EY on “Indirect Procurement Optimization,” businesses can save up to 25% by streamlining their indirect procurement procedures. Organizations must find every opportunity to save money in the current global environment of fierce competition and rising inflation rates.
Read about: What Is Profitability Analysis
Indirect Procurement Categories
Did you know that up to 40% of a company’s total spending may be allocated to indirect procurement categories? Additionally, there is less of a direct correlation between indirect spending and business profitability.
The following are some of the most typical categories for indirect procurement:
- Human resources, which include hiring, training, and other aspects of professional growth)
- Marketing
- Utilities (ie. water, electricity, gas, and rent)
- Office supplies, such as furniture, stationery, and cleaning products)
- Travel
- IT/technology purchases (i.e. computer hardware and software)
Direct Vs Indirect Procurement
Naturally, the products you actually create and market to your clients are crucial, and this is where direct procurement plays a crucial role in the excellence, innovation, and profitability of those goods. It requires a variety of skills to get it right, such as having the proper strategic sourcing procedures in place, being aware of your supply chain strategy, and increasingly integrating ESG principles into your company through sustainable procurement and responsible sourcing.
To ensure that your company is in the best possible position to innovate with your key suppliers, direct procurement is both crucial and complex, and it increasingly depends on having really solid and strategic supplier relationships. We are still dealing with the COVID-19’s ongoing effects on global supply chains, so simply getting the goods is not enough. An illustration of how procurement teams are being forced to think creatively is how some businesses are handling the chip shortage. According to Sundar Kamak of Ivalua, “Each year, millions of devices and pieces of equipment containing chips are discarded or scrapped; the UN estimated that 53.6 million metric tonnes of e-waste were generated globally in 2019; only 17% of that waste was recycled.” According to him, businesses that use direct procurement and strategic suppliers have a chance to cut costs, make up the difference, and even reach some ESG goals along the way.
Whereas direct procurement is essential for the creation of products, indirect procurement is typically not necessary for the creation of what your business sells. However, if your employees cannot access the equipment they require, whether it be laptops or, as people return to the office, cleaning supplies and services, this will have an effect on your business’ operations.
A competitive advantage shared by best-in-class procurement teams is their use of Source-to-Pay systems and other digital procurement technologies.
Use Kissflow To Supercharge Your Procurement
Indirect spend is completely handled by Kissflow Procurement Cloud. It has features like:
- Product catalogs for easy ordering
- Vendor management, from sourcing suppliers to payments
- Multiple payment options that accommodate different suppliers
- Advanced security protocols that protect your data
- Customizable workflows and processes that streamline operations
- A simple learning curve your entire team can navigate in hours, not weeks
You can manage your budget even better and make more informed purchases with Kissflow’s offer of the procurement gauntlet’s missing infinity stone.
Final Words
Are you now doubting the procurement dichotomy itself after reading this? Are you unsure if it’s still necessary to differentiate procurement processes the way we have for so long? Because the lines between direct and indirect procurement were clearly defined in manufacturing organizations, this division was valid and applicable. Is it still useful or even advantageous for organizations to perceive and carry out procurement in the manner we have in the current environment, where the majority of economies are service-led and the lines are blurring?
The article’s main topic was procurement, both direct and indirect. Please leave a comment if you’re interested in learning more about direct and indirect procurement. Have a good day and thanks for reading.
