What is Direct Procurement?
Direct procurement is perhaps the most important function of a procurement team, given its impact on the business’ success. And while many organizations ignore indirect procurement to their detriment, focusing on direct procurement in times of crisis is a sound business strategy. If you can’t find ways to reduce risk and control costs for your direct spending, there’s a serious flaw in your operations.
Direct procurement is not a monolith: depending on your particular industry or market, there are different strategies to direct procurement that can build value for your organization. This guide will provide a deeper insight into direct procurement and ways to make your spending work for you.
What is direct procurement?
Direct procurement, sometimes known as direct spend, is defined as the purchase of goods or materials directly related to the creation of a manufactured good. These raw materials, resources, services, and other inputs are core to the offering that a business delivers to the end-user or customer. For instance, a car manufacturer’s direct procurement would be steel, electronics, and other parts that will end up in the vehicles they sell.
Direct procurement is often the first priority for procurement teams. Ideally, this spending category should enjoy maximum cost savings with minimal risk, a tricky balance to strike. It’s for this reason that procurement teams often invest more time and energy into supplier relationship management and process optimization for goods and services that fall under direct spend, placing indirect spend at a lower priority.
Why is direct procurement so important?
Direct procurement impacts (and is impacted by) many other aspects of running a business, including inventory management, cost management, supplier relationship management, and internal communication. How well a procurement team is able to manage direct procurement presents challenges and opportunities in each of these areas.
A direct procurement strategy is often viewed in simplistic terms: reduce risk and lower costs. However, direct procurement has many other facets. Organizations that are able to shift from a cost-savings mindset to one of building value, efficiency, and performance through direct procurement benefits more in the long-run. This approach requires breaking direct procurement into three subcategories.
Cost-driven direct procurement
Cost-driven direct procurement is a strategy specifically for companies that price their goods or services as determined by the cost to produce each item. For instance, food manufacturers and construction companies often use cost-driven direct procurement.
Market-driven direct procurement
Companies that price their goods or services based on the market price — e.g., the price charged by their competitors — use market-driven direct procurement. Any company that has a tight margin and faces steep competition for their product or service will use this direct procurement approach.
Value-driven direct procurement
Companies that price their goods and services based on a calculation of benefit (“value”) to a customer, with additional consideration of the way procurement builds value for the company, will use this approach. For instance, software firms will use this procurement strategy for direct purchasing as well as pricing.
A value-driven approach to direct procurement is the approach flexible enough to be used across industries. No matter which strategy a procurement team takes toward direct procurement, sourcing software and automation can inform how much time, effort, and resources a team should use to optimize this spend category.
How to manage direct spend
No matter what approach you take to direct procurement, there are ways to manage your direct spend and ensure you are getting the most bang for your buck.
Supplier relationship management is central to direct spend. This is one area in which building close relationships with your supply chain partners is mission-critical. Building close, long-term relationships allows procurement teams to innovate better solutions and identify potential problems early.
Along with managing your supplier relationships comes inventory management. Costs related to poor inventory management pile up quickly. Bad planning in the retail industry led to $300 billion in lost revenues due to markdowns, one report found. Another report found that out-of-stock orders cause $634.1 billion in annual losses for retailers. For direct spend items, keeping the right quantity of materials in stock is a must for making sure your company has a pain-free production process with minimal risk of delays.
How can you achieve strong supplier relationships and inventory management? Start by centrally organizing your direct procurement function. The right software can bring together your direct spend for better visibility, help you manage your suppliers, talk to your inventory management systems, and streamline your request for proposal (RFP) processes.
For more advice on optimizing the procurement process, check out Fairmarkit’s blog, The Source.