At its most basic level, procurement means acquiring the materials and supplies necessary for an organization to operate, or to complete a project.
Once you dive deeper, procurement gets complicated fast. From vendor management and communication, to invoicing, payment processing, quality control, fraud prevention, and more, procurement is a nuanced and complex activity.
At its core, procurement can be separated into two categories: direct and indirect. Because both direct and indirect procurement are essential for businesses to function, gaining a deeper understanding of each aids in prioritization and optimization. Furthermore, understanding how each relates to the other can promote synergies that benefit both processes.
These synergies result in improved vendor relationships, efficient management of the complete procurement process, and better insight into potential bottlenecks and opportunities.
This article explores these very different procurement functions to help you establish a roadmap for successful spend management and supply chain strategies.
Other Names Direct Procurement Goes By: Direct Cost, Direct Spend
Summary: Direct procurement is the process of acquiring materials necessary for a business to produce the goods and services it offers to its customers. In other words, direct procurement is the act of sourcing, vetting and purchasing the raw building blocks or inputs needed to create goods and services.
“Direct procurement” refers to procuring the materials, goods and services directly required for the production of goods or services that a business provides to its customers.
Typically, these purchases of raw materials are made in bulk, and acquired from vetted and approved vendors. These vendors compete on reliability, delivery times, quality, and cost to earn the business of a direct procurement department.
The importance of a fine-tuned and frictionless direct procurement system cannot be overstated. Even minor delays in any part of the process can mean lost revenue, reputation and opportunity, as well as increased costs and missed production deadlines.
Examples of Direct Procurement:
Summary: Indirect procurement involves the sourcing and acquisition of the products, services and resources necessary for a business to operate.
“Indirect procurement,” while similar to direct procurement, is different in one key way. While direct procurement is acquiring the materials needed to make a product or service, indirect procurement means acquiring the resources, materials and services the business itself needs to operate.
In other words, indirect procurement ensures that a business has the products and services it needs to support its overall operations, not just the output of a product.
Examples of Indirect Procurement:
Apart from the unique purpose and function of each type of procurement, there are also varying functions and directives applicable to how each operates.
The Supplier Relationship
Direct procurement departments spend a significant amount of time, energy and resources on establishing, fostering and maintaining good relationships with vendors. Any impacts on delivery schedules affect continuity and production. As well, the quality of inputs affects the quality of outputs. For these reasons, relationships with vendors need to be collaborative, with a long-term focus on mutual benefit and success.
By contrast, indirect procurement places a greater focus on optimal spend management vs. supplier relationships. In this sense, the relationship with a vendor or supplier tends to be more transactional, with cost often being the determining factor.
Why the stark contrast? Supplies acquired via indirect procurement are often viewed as less essential. While they may be necessary for overall operations, the mission-critical components are those needed to produce the product or service being sold. Without them, production is delayed or halted, and nothing else matters.
Cost Management and Optimization
Direct procurement involves significant cost analysis, the data of which is used to support negotiations over deliverables. In this way, direct procurement is a planned activity, weighing cost, delivery times, quality and resilience when making a purchasing decision. It is an essential element of preventing disruptions in the supply chain.
Conversely, indirect spend teams often use “zero-based budgeting,” creating a new budget for purchases rather than basing future decisions on past buying behaviors. Such purchases are often spontaneous, or made on an ‘as-necessary’ schedule (such as stocking the office kitchen with coffee).
Due to fluctuating needs and prices, planning a budget in advance can be an inexact process, with ‘estimates’ or ‘guesstimations’ the norm. Further, because these expenses are not planned in advance, each purchase needs to be both justified and approved before it is made.
With direct procurement, inventory management typically deals with how supplies are acquired, shipped, stored and utilized. It involves forecasting needs and demand curves, and ensuring there is enough product to meet these needs. Knowing what you have, what’s coming, where it is stored, and how much you’ll need is key to a smooth production cycle and to prevent delays.
In contrast, with regards to indirect procurement, inventory management is often absent. Given that purchases aren’t usually planned, managing them on a daily basis is unnecessary.
Technology and Systems
For indirect procurement, departments often use a broad range of fragmented systems, processes, approval workflows and requirements. For example, each department within an organization may have its own unique requirements. Although technology (such as cloud procurement) is gaining traction in this space, indirect procurement has lagged behind.
Direct procurement is experiencing a revolution in technological advancements. Cloud-based procurement software is empowering teams to get more done, reduce costs, maintain or improve quality, streamline processes, foster collaboration, and more.
Organizational Hierarchy and Setup
The majority of direct procurement costs are centrally managed by supply chain or procurement teams. Within these teams, category managers are tasked with handling specific areas of spending. In this way, direct procurement is a well-organized and managed process, with clear responsibilities for each party involved.
By contrast, indirect procurement is often scattered and decentralized within organizations. More often than not, it is handled by several people throughout the company, each with their own separate budget, authorization procedures, and purchasing processes.
Understanding direct and indirect procurement and how they differ is important to getting the most out of procurement dollars for your business. Each is an essential practice for thriving companies and both can benefit from the use of new and innovative procurement technologies.
Related Reading: Introduction to Cloud Procurement for Projects