Knowing your indirect and direct spend procurement and why it matters

Did you know that every time you make a purchase for your business, it falls into one of two categories? Direct spend and indirect spend are different ways to categorize the purchases you make for your business. Read on ahead to learn how each affects your business.

When it comes to spending, there’s often a lot of different ways to slice the pie.

At the same time, it's also important to manage and analyze costs and maximize profit as well as understand the purpose of each purchase. To achieve this, organizational spend is often broken down into two categories: direct and indirect spend. You may have heard these terms before but might not know exactly what they mean or how they differ from one another.

In this blog, we'll take a look at what makes these two types of spend different from each other. Then, we’ll talk about the strategies that come into play for managing each type effectively.

What Does Procurement Mean?

Procurement is the management of spend.

In other words, procurement means buying goods and services used to make the products an organization sells to its customers and running an organization on a daily basis.

However, the modern procurement function has evolved beyond the traditional role of buying goods and services for the organization.

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This is particularly true in organizations where the procurement function has been elevated to the status of a strategic contributor within the organization.

Procurement professionals are now considered critical contributors to an organization's success and are expected to develop relationships with internal stakeholders and suppliers that help drive out costs, improve quality and delivery times, reduce risk, and deliver value to all parties involved.

And to do so, procurement teams need to manage spend across categories, including direct and indirect spend.
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Direct and indirect procurement are both important and essential to the success of every business. But they're also very different and require varying levels of focus in procurement and sourcing.

What is Direct Procurement?

Direct procurement deals with goods or services that directly impact your company's production of a product or service for sale.

It's a term you may have heard thrown around a lot at your organization, but do you know what it actually means?

Direct Procurement is the end-to-end process organizations follow to manage the procurement of direct materials – in other words, any materials, parts, or services used to make a product. It's made up of a series of related processes that span the full product lifecycle and includes internal and external stakeholders.

You may also hear this concept referred to as direct spend management or direct sourcing.

In simple terms, direct spend is the cash you shell out to produce your products.

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Think of it as the raw materials your business needs to make its products—like the metal, plastic, screws, processing chips, and so on that go into a smartphone, or the fabric and sewing supplies needed to stitch together clothes.

Basically, direct spend is any positive expense that keeps you in business—and it's not just limited to physical items. For example, if you run a marketing agency, your direct spend might include pay-per-click advertising campaigns on Google or Facebook.

Confused by the jargon? Get it straight with this procurement glossary. From A to Z, we've got all the definitions you need to know.

What is Indirect Procurement

Indirect spend refers to any purchase made by a company that isn't directly related to its product.

To understand the concept better, think about an electronics company that makes headphones. The money they spend on the materials to make the headphones would be considered a direct spend. But the things they pay for that aren't directly related to making the headphones are indirect costs, including marketing software, office furniture, cleaning services, and data storage. In short, all the expenses a business incurs to operate.

Indirect Vs. Direct Procurement

Let's start with the most important part: What you make and sell to your customers. Is it what you really want to be making? Is it the right quality? The right price?

Direct procurement is critical to getting all those things right. But to do so, more than ever, procurement teams have to think out of the box. Take the ongoing auto-industry struggle, from the COVID shutdown to the disastrous shortage of chips and other raw materials due to the Russia-Ukraine war. Many automobile companies are working directly with their strategic suppliers to fill the shortfall and meet some of their cost and ESG targets along the way.

Costs are always a concern in business, and procurement is no exception. Whether you're purchasing goods directly or indirectly, it's important to save money where you can.

At the same time, we know it's not always easy to save costs at an organization, especially when it comes to procurement.

With indirect procurement, the easiest way to save is by buying cheaper products. For example, you could choose a less expensive printer for your office.

However, in direct procurement, companies have more control over their costs through supplier management. A company can't simply change raw materials to save money—what they actually can do is manage relationships with their suppliers and take advantage of savings opportunities. They also tend to have more control over their supply chain and make the process of sourcing more efficient.

Based on the specifics of managing lies the biggest difference between the two types of spending: which is usually cost-saving for indirect procurement and cost savings plus supplier management, business impact, or performance management, etc., for direct procurement.
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Let's take a deeper look into each of these specifics to understand the difference between direct and indirect procurement better:

1. Spend Management

Spend management is all about the profit impact of direct and indirect spending.

If a business spends less, its profits will be higher. Indirect spend is more open to spend management tools because the practice of indirect procurement can be wasteful. Hence, controlling indirect spend can positively impact the bottom line.

At the same time, for direct spend, the impact on the company's top and the bottom line is all the more significant. For instance, if products and services are delayed, a company can't ship its products. And if it can't ship those items, customers won't receive them.

And if customers don't receive the merchandise they've paid for, those orders may not be filled, and revenue losses could be high.

2. Supplier Management

A crucial difference between direct and indirect spend is that the former creates long-term, recurring, and purposeful relationships with its suppliers. This makes supplier relationship management essential to companies.

Naturally, when direct-spend supply is disrupted, it can have a devastating effect on organizations. Building relationships with suppliers can help you manage your indirect costs too.

While full-time interaction may no longer be a necessity, periodic evaluations of vendor performance can help you control costs and maximize value.

3. Performance Measurement

The things that make procurement most valuable to a business are different in the direct and indirect areas.

If you're trying to determine the value of procurement in your business, it might help to think about the differences between direct and indirect spending.

With indirect procurement, organizations measure success by reduced costs. On the other hand, for direct spending, customer satisfaction is the most important factor.

Additionally, organizations must have materials on hand when they're needed. If materials aren't available in time for production, then production can be delayed—which can mean lower revenue for an organization.

4. Business Impact

Direct and indirect spend are two different ways to analyze where your money is going, but depending on the industry you work in, one may have a more noticeable impact than the other.

In an industry reliant heavily on direct spending, like manufacturing, distribution, or retail, direct spend has an outsized impact compared to indirect spend—and controlling it is critical to keeping a business in good shape.

5. Technology

When it comes to technology for procurement, there are multiple solutions for managing direct and indirect spend. The former focuses on the logistics of purchasing, while the latter offers tools for strategic sourcing.

When you need to source or buy direct materials, you want to move fast to make sure you can get them when and where you need them. Yet in most cases, e-procurement solutions and procurement software aren't tailored to these needs.

Companies with large direct spend needs often have to rely on spreadsheets and email to communicate with suppliers because software tailored to their specific needs is hard to come by. We'd bet they'd prefer an easier, faster way of doing things, one that can really deliver on speed and simplicity.

Conclusion

At Ignite, we believe that the future of procurement is here, and the old way of doing things just doesn't cut it anymore. If you're still relying on spreadsheets and legacy ERP systems, you're missing out on a lot of time and money that can be saved with a modern solution.

To solve this issue, Ignite offers a full range of procurement analytics, strategic sourcing, contract management, and source-to-contract capabilities. Our solution can be tailored to fit to your needs and transform your existing procurement organization.

To be successful in both direct and indirect procurement, Ignite focuses on the following core pillars of value creation:

Leveraging spend data to identify trends, uncover opportunities, and develop strategies to cut costs and increase revenue.
Sourcing responsibly and connecting with the best suppliers.
Having a clear view of all the contracts between you and your suppliers to ensure compliance
Gaining a holistic view of the entire source-to-contract process and supplier relationships to optimize performance and profitability.

To learn more about how Ignite can help your business manage indirect and direct spend, contact us today!