Procurement, in the simplest terms, is all the steps involved in sourcing and securing the materials and services needed to support a business’s daily operations and production. When it comes to procurement, there are two main methods: direct and indirect.
At first glance, one might assume that the differences between the two are minimal. Both involve shopping around with various vendors, negotiating terms, managing relationships, approving invoices, and keeping records. However, the processes for direct versus indirect procurement are different. While both may be important, depending on the industry or product, one may have greater importance to your business.
Regardless of which method receives priority at your company, it’s essential to understand the nuances of both. So let’s dive into the definitions of direct and indirect procurement, examine some examples of both, and finally, compare the implications of direct versus indirect procurement.
Direct procurement, which is more prominent in industries that produce physical products, is the optimization of the purchasing process for all aspects related to the manufacturing process. This can include anything from services to raw materials, but they must have a direct connection to the business’s core operations.
Also referred to as direct spend, the products and services procured are processed before making their way to customers or clients. When problems arise in direct procurement, it can affect the manufacturing of products, which is a huge issue for businesses.
While the most obvious example of direct procurement tends to be the raw materials that go towards manufacturing a product, there are other aspects as well. For example, any material or service that helps create what your business is offering or selling is considered a direct purchase. These components are absolutely essential; without them, there would be no product. Some examples include:
Indirect procurement, which is more prominent in businesses that provide services, is the optimization of the purchasing process for non-essential supplies and services that don’t have a direct role in the manufacturing process. Indirect sourcing typically focuses on support services and office supplies.
These items or actions are necessary for the day-to-day running of an organization. However, they are not directly connected to the product a company offers. Instead, indirect purchases help an organization operate functionally, ranging from post-it notes to customer relationship management software. Businesses frequently benefit from outsourcing indirect procurement. Companies like P3 Cost Analysts bring market knowledge and expertise to companies that lack the necessary capabilities to fully optimize direct spend.
Many of the things acquired through indirect sourcing are intangible, but not all of them. They cover the technology, overhead, and services that are used to run the business.
The core difference between direct and indirect procurement is the connection to the final product. Direct purchases are used directly in the production of the final product, whereas indirect purchasing is more related to support. While this distinction in function might not seem that significant at first glance, where we really start to see the difference is how businesses operate direct versus indirect procurement.
The importance of direct procurement for companies means there is a big emphasis for organizations to foster positive, long-term relationships with their suppliers. Direct procurement supplies are the basis of the business, so a steady supply chain is of the utmost importance. By nurturing relationships with vendors, firms can develop a mutual understanding that results in sustainable relationships with on-time deliveries and strong communication.
However, indirect procurement doesn’t require such a strong connection between a company and its suppliers. In fact, most companies will create a sense of competition among vendors in order to secure better pricing or contract conditions. Because these supplies are deemed non-essential, there is more wiggle room to shop around and bounce from one supplier to another. Third-party companies like P3 already have years of experience working with various suppliers and, more importantly, have thousands of benchmark data points around the country to know exactly what the vendors are charging others. Between this, and their industry expertise, they can easily leverage competition to secure your company the best rates.
Because managing direct spending is absolutely vital to a business’s bottom line, organizations will typically have an entire team dedicated to the task. Any breaks in the supply chain can cost delays in production as well as affect profits. Because of this, direct procurement is very thoroughly budgeted for and planned.
When comparing direct versus indirect spend, the latter is a little bit more relaxed. Responsibilities are often split across different teams in the company. Also, due to the unpredictable nature and low priority, indirect procurement is a bit more flexible. A team may only purchase indirect supplies once the need for them arises. Because those who are often in charge of making these decisions are not experts in procurement, and more importantly are not experts in each expense category, utilizing a third party like P3 can ensure that the best strategies are implemented.
As direct procurement has the greatest impact on a business’s bottom line, it’s usually purchased in large quantities. This also allows organizations to secure the best pricing. It’s also imperative that direct purchases are readily available when they’re needed for production. The team in charge of direct procurement must have a long-term strategy for acquiring and storing inventory to ensure there are no delays or shortages.
Meanwhile, indirect sourcing comes when there is a specific need for a product. The demand for supplies can be challenging to estimate, and running out of inventory won’t have as much of an effect on production. Materials are purchased in much smaller quantities, and there is no need to have a large inventory on hand.
While direct procurement is oftentimes kept in-house, there are experts out there who specialize in helping businesses save money via indirect procurement. Outsourcing procurement to a third-party company is often the easiest way to save money in multiple business areas. In addition, this gives an organization access to professionals with certain areas of expertise that they likely won’t have on staff.
P3 Cost Analysts, for example, is a cost reduction firm that has saved its clients millions through the years. Our job is to find areas where vendors are overcharging your company and help you source contracts that are more beneficial for your business. Our expert analysts know exactly where to look, and we often save our clients 20 to 40 percent through our full cost reduction audits.
First, our team of expert analysts will look through your vendor contracts and invoices to ensure you’re not overcharged. When your contracts are up, we’ll help you through the indirect procurement process to help you find the right vendors for your business. We can help your company save money across the board with expense audits and procurement help in telecom, utilities, waste management, vendor payment solutions, and more.
Understanding the differences between direct and indirect procurement is the first step toward making the most cost-effective decisions for your business. By examining some examples of both types of procurement, the difference between the two becomes more clear. When it comes down to it, the contrast between the two is most obvious when examining how businesses address direct versus indirect spend.
While there are ways to cut costs for both types of procurement, there is much more wiggle room in indirect purchasing. Because indirect procurement isn’t as essential to the final product of a business, it’s the perfect area to outbound to an expert to help you find savings.
If you’re ready to start cutting costs with indirect sourcing, schedule a free call with P3 Cost Analysts and talk with one of our cost reduction experts today.