Direct vs Indirect Spend: How Your Procurement Strategies Should Differ

July 28, 2021

Indirect spend is getting bigger, and that’s becoming a problem for procurement teams. McKinsey calculates that globally, indirect spend is growing around 7% per year. When indirect procurement costs rise, profit margins fall. Procurement teams are good at lowering direct procurement costs—but they can always do better. Now is the time to curb direct and indirect spend at the same time. 

Yet direct and indirect spend management require different strategies. Companies that understand the difference and strategize accordingly can streamline costs, run more efficiently, and are in a better position to grow their profit margin. Here’s how to improve your direct vs. indirect procurement strategies.

What is indirect spend?

Direct spend is easy to define—managed by the procurement team, it’s the goods and services a company purchases that directly relate to the creation or manufacture of their own product or service.

Indirect spend is a little harder to define. Essentially, it’s the goods and services purchased that are incidental or subsequent to the product or service a company is offering—think of safety goggles, office supplies or janitorial services; they’re essential to help the company function, but they don’t directly contribute to the manufacture of a product.

Indirect spend is a normal—and vital—cost of doing business, and it has a direct impact on a company’s bottom line. Yet many companies struggle to manage indirect spend. McKinsey says indirect spend can often be fragmented among multiple locations, business units, and categories, which makes it hard for the procurement team to identify. As a result, capturing enterprise-wide savings opportunities becomes difficult. Leaders of indirect-procurement functions will often “lack sufficient clout within the organization” to obtain the technology and talent they need to manage indirect spend. The result, says McKinsey, is that most companies don’t have mechanisms or tools to monitor indirect categories and effect positive change to the company’s financial health.

But indirect spend can be curbed and managed effectively. All it takes is time, effort, and a good plan. Here’s five steps for managing indirect spend better:

Conduct a spend analysis: The first step is working out what you’re spending your money and who is spending it. Identify the key suppliers you use and try to identify potential savings opportunities.

Consolidate spend categories: If you can simplify your indirect spend categories, you can better manage your spend. Category consolidation is a crucial step toward making your supply chain more efficient.

Get buy-in from management: No plan will work without support from your company’s leaders. Ensure this support and create spend management champions by including the C-Suite in decision-making and explaining to them the benefit of an indirect spend management plan.

Identify KPIs and create a plan: Develop key performance indicators designed to help you reduce risk and expense that come with non-compliant or underperforming vendors.

Invest in the right software: True spend management and analysis requires tools fit for purpose. Ensure your plan is a success by selecting procurement tools that incorporate indirect spend management. 

Direct spend vs. indirect spend

Because direct spend feeds straight into your company’s production of goods or services, it requires a different type of management than indirect spend. Direct spend is mission critical. It often requires strict supply schedules, because continuity of supply and the quality and quantity of materials directly impacts production, the company’s reputation, and its ability to provide a product or service. 

Here’s four steps for managing direct spend better: 

Build long-term, healthy relationships with your suppliers: Supplier relationship management is all important for direct spend. When you have close relationships with your suppliers you can work with them to innovate better solutions and identify potential problems early. Working in close partnership with your direct spend suppliers will keep the production lines running.

Ensure strong inventory management: For direct spend items, you need to know what materials you have, where they are, and how much you need at all times. Strong inventory management, where the right quantity of materials is always held in stock, is a must for making sure your company has a pain-free production process with minimal risk of delays.

Centralize procurement: To build good supplier relationships and ensure appropriate inventory management, it’s vital that direct spend items are purchased and monitored centrally. Indirect spend is often best handled by multiple buyers around the business (with procurement monitoring the spend) but direct spend items must be centralized to ensure orders are timely and to spec.

Use the right technology: Much like indirect spend, direct spend requires the appropriate tools. Select software that helps you manage your suppliers, talk to your inventory management systems, and streamline your request for proposal (RFP) processes.

How should direct spend vs indirect spend strategies differ?

When your procurement team is managing indirect spend, it needs the right combination of technology and strategy. Oftentimes it isn’t members of the procurement team who are actually making the purchases that mount up to indirect spend. For this reason, technology is vitally important for tracking, analyzing, and automating various parts of indirect procurement. Easy-to-use procurement tools are more likely to be used by the buyers around your company, making the process easier to comply with and more efficient.

Direct procurement, on the other hand, requires a greater focus on the relationship between vendors and buyers. Supplier relationship management is an important part of managing direct spend. Procurement teams that can build long-term, mutually beneficial relationships with their suppliers are in a better position to innovate, mitigate risk, and save money.

Fairmarkit’s platform helps procurement teams achieve both outcomes of these outcomes by digitizing and automating the procurement process for indirect spend, and providing a platform for better supplier management for direct spend. 

The differences between managing direct and indirect spend are important to understand but the ideal outcome is the same: a procurement process that runs efficiently, saves money, and provides visibility into your company’s spend. Tools like Fairmarkit can help bring clarity to your procurement process and build better partnerships with your suppliers.

For more advice on managing direct procurement and indirect procurement, check out Fairmarkit’s blog, The Source.

Expert procurement and supply-chain tips sent straight to your inbox.