What Is Direct And Indirect Spend In Procurement?
Direct and indirect procurement may seem like two very similar processes. However, within the procurement and sourcing process, these two categories serve very different purposes. Companies that understand the difference in these types of procurement are better able to manage inventory, create an efficient supply chain, and grow sustainably. Here’s what the difference is between direct vs indirect spend in procurement — and why it’s important.
What is direct procurement?
Direct procurement refers to the process of buying raw materials and goods for production. If your company makes sneakers, for instance, direct procurement would relate to the acquisition of shoe leather, laces, rubber for the soles, and thread for stitching.
Direct procurement generally relates to product-based businesses, rather than service-based ones. Another way that many entrepreneurs think about direct procurement is as the Cost of Goods Sold (COGS). Items purchase via direct procurement are absolutely necessary for any future sale to happen. If, for some reason, direct procurement fails, the company would be forced to stop selling.
What is indirect procurement?
Indirect procurement relates to purchasing services or supplies required to keep the day-to-day business running. Returning to the example of the shoe company, this could be the electric bill at the office or factory, the cost to ship the product to distributors, or paying models to wear the sneakers in a marketing campaign.
Indirect spend is still a crucial part of operating a business. Though direct procurement is central to producing goods, indirect procurement must be appropriately managed to keep profit margins healthy. Ideally, experts recommend that a company’s indirect procurement is no more than 15-27% of a company’s total revenue.
Managing direct vs indirect procurement
Analysis by McKinsey found that globally, indirect spend has been growing by an estimated 7% per year. As indirect procurement costs go up, profit margins shrink — but too often, procurement teams focus on lowering direct procurement costs in order to protect profit.
Why are so few organizations able to get a handle on indirect procurement? McKinsey experts argue, “Spending is often fragmented among multiple locations, business units, and categories, making it hard to identify and capture enterprise-wide savings opportunities. Leaders of indirect-procurement functions typically lack sufficient clout within the organization to obtain the technology and talent they need. And most companies do not have mechanisms to monitor indirect categories and reflect their performance on financial statements.”
[Read more: 3 indirect procurement challenges]
Managing indirect procurement requires a combination of technology and strategy. There are platforms that can track analyze, and automate parts of indirect procurement, making the process more efficient. For instance, platforms like Fairmarkit can help procurement teams achieve a greater number of RFQs — resulting in a more competitive process and transparent prices.
Managing direct procurement is a slightly different story. While indirect spend demands teams focus on budgeting from the company perspective, direct spend is all about building supplier relationships. Supplier relationship management can play a big role in managing direct spend: businesses that are able to build long-term, mutually-beneficial supplier relationships will save money.
What about direct vs indirect sourcing?
To add another layer of complexity, direct sourcing and indirect sourcing are different from direct procurement and indirect procurement. Direct sourcing refers to the process of purchasing a good or service straight from the source. With indirect sourcing, a company works with a third-party to facilitate the ordering process. Direct and indirect sourcing is common in the recruitment industry.
Fairmarkit has a range of tools that can help you manage your direct and indirect procurement strategies. For more ways to improve your sourcing and procurement processes, check out Fairmarkit’s blog, The Source.