Procurement is a critical business function for organizations; without it, many would not be able to operate. It's essential for workflows to run smoothly, strengthen supplier relationships, and streamline inventory management.
Over time, procurement has split into two overlapping disciplines that have emerged, known as indirect and direct procurement.
In this article, we'll define procurement, compare direct vs. indirect processes, list key examples, answer your top questions, and talk about the industry's future.
To fully understand the difference between direct and indirect procurement, you must first understand the key term both share: "procurement."
Procurement can be responsible for up to 70% of an organization's revenue and includes the buying of goods and services, as well as the management of contracts and supplier relationships, in order for a business to run ethically and profitably.
To reach success in both direct and indirect procurement strategies, there are four core phases of value creation, which are:
60 to 70% of procurement teams are now focused on strategic pursuits. Understanding the key differences between indirect and direct procurement helps businesses prioritize tasks and optimize necessary functions.
Direct procurement is acquiring goods, raw materials, supplies, products, parts, components, and services needed to operate your core business activities. These essential items make their way to end customers with some processing. In other words, these materials end up in the final product.
Direct procurement purchases are typically made in large quantities and acquired from a carefully chosen pool of suppliers, at the best possible cost and quality. These purchases are made frequently and are necessary for critical business functions.
If direct procurement encounters problems, a business can no longer manufacture its product and create revenue. Thus, it is often related to companies in the manufacturing industry, where raw materials are transformed into physical products.
Indirect procurement involves purchasing goods, services, and supplies that support a company's operations in a non-essential role. This can include everything from paper clips to decorations, travel, maintenance, equipment repair, etc.
Although these items are still essential to your organization, they exert no direct input into the finished products or services you deliver to customers. Instead, indirect procurement plays a supporting role to ensure the process of converting direct supplies into processed goods runs smoothly.
Indirect procurement will not add to a company's bottom line, only the top one. However, without it, a business would not be able to run efficiently.
The main difference between indirect and direct procurement has to do with function. While direct procurement focuses on core materials that are processed and sold to the customer, indirect procurement is related to supplying spontaneous goods when needed.
The difference in function means both methods will operate uniquely.
42% of CPOs recently surveyed have said that supplier relationship management will be one of their main focuses.
Direct procurement creates long-term relationships with suppliers, minimizing the risk of disruption in the supply chain. These are basic materials needed to operate the business, and they cannot get stuck in shipping. Thus, building long-term, sustainable relationships with suppliers is in your best interest.
Vendor management, minimum order quantities, and contracts are all ways to create a sound and lasting business relationship. In addition, there's a need to develop a feeling of security and reliability for both sides. A great way to start this is with a well-developed plan for strategic sourcing.
Since indirect procurement deals with non-essential materials and supplies, it does not get the same emphasis as direct procurement. This extends to supplier relationships. Things happen a lot quicker with indirect procurement, and services are used whenever called for.
Vendors are typically shortlisted, and there is less of a sense of loyalty. If someone has a better deal on pens for the office, you will likely go with that brand. No harm, no foul to the supply chain. There is little effort to retain services for the long term, and both parties understand that.
Direct procurement and indirect procurement also differ when it comes to spending.
While direct procurement manages core supplies, this supply chain must be emphasized to ensure business resilience. These essential inputs need to be carefully planned and strategically sourced. The budget should be laid out well in advance to avoid any disruptions.
Indirect procurement deals with spontaneous spend. Things are purchased precisely when needed, in an effort to support the greater good, and keep things moving. There is little planning or budgeting for indirect procurement, and everything is purchased as the need arises.
Managing inventory deals with acquiring, storing, and planning for items, which is performed differently depending on the method of procurement you are using.
More often than not, inventory management is more exclusive to direct procurement, given the risk and reward associated with managing the entire supply chain for direct inputs.
There is no long-term strategy for indirect procurement regarding inventory management. It's more along the lines of a "first-come-first-serve" basis. In addition, these purchases are typically unplanned, so no long-term strategy can exist.
As a result, managing inventory for indirect procurement can be challenging. Ensuring quality and keeping suppliers compliant with your company standards can prove difficult. This makes inventory management less of a priority for indirect procurement.
When it comes to how procurement is structured, direct and indirect differ significantly.
Since direct procurement involves a "make-or-break" mentality, there needs to be more than one person making a decision. Therefore, it usually involves a team that manages the direct costs centrally. In other words, the supply chain is centralized, the budget is strict, and they focus on specific areas of spend.
Businesses take a different approach to indirect procurement. This method of spending is haphazard, and the function is decentralized across various stakeholders and departments. It makes sense. One department will not know that another is out of staples. In this case, the budget is less rigid and addresses more unique needs.
Measuring the success of these two types of spending also requires a different process.
The main task of direct spend is to fulfill customer orders on time. In this case, cost savings are just as significant as inventory management and delivery KPIs.
For example, unused inventory leads to ongoing costs that take up storage space and tie up cash flow. Meanwhile, delivery delays and poor supplier management lead to an inability to satisfy the customer's order. All of this can seriously damage a company's bottom line.
Indirect procurement looks at cost metrics to gauge performance. It focuses on controlling expenses and ensuring there's no redundant spending. KPIs usually include cost-savings, cost avoidance, and cost-reduction metrics.
The influence of direct and indirect procurement can also differ by industry.
Direct procurement far outweighs indirect procurement in industries where the materials procured directly affect the end product. This includes manufacturing, construction, and retail.
Companies that provide professional services typically prioritize indirect spend. This can include IT companies, recruitment agencies, and consultants.
It's clear now that indirect and direct procurement involves two distinct processes, goals, functions, strategies, and stakeholders. Thus, a separate approach must be developed for each one.
Here are a few ways to increase the value of procurement processes within your organization:
It’s also critical to embrace technology around every turn and don’t shy away from a digital transformation. This will help to achieve responsible sourcing and sustainable procurement processes.
One way to manage the entire operation is through procurement automation. In fact, the digital transformation rate in procurement is expected to reach 72% by 2025. So, chances are your competition is already shopping around.
Procurement tools provide direct and indirect procurement teams with the 360-degree visibility needed to effectively maintain supplier relationships, manage inventory, and identify opportunities to reduce costs and improve sourcing.
Many e-procurement systems come with features that enable market research, sourcing tasks, and other data-relevant work that is important for procurement success.
Zip is a platform that enables procurement to focus more on strategic sourcing by automating workflows and reducing cycle times. Enable procurement to focus on more strategic sourcing and reduce redundant vendors with advanced categorization features.
Liberate procurement from tracking approvals manually across sectors like security, finance, legal, and IT. Spend less time fielding questions about the status from a requester and grant crisp visibility to all stakeholders.
The main difference between indirect procurement and direct procurement is who and how they serve. The functions and goals are entirely different.
While direct procurement deals with purchasing goods and materials you need to operate the business, indirect procurement deals with all the finer things. Both are necessary to keep a well-oiled machine running.
Just as a car manufacturer needs parts to build the car, they also need water to keep employees hydrated. Every need must be met in one way or another, and how that need is met defines the two strategies.
Zip is reinventing the way companies manage their B2B spend. Ready to see Zip in action? Click here for a free 15-minute demo.
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