Behind every successful business is a strong procurement strategy focused on quality materials and intentional spending. Successfully navigating vendor relationships, managing supply chains and ensuring raw materials for your products are key tasks relating to direct procurement. Making sure your marketing spend, office leases and other types of operational architecture are properly allocated are important steps in indirect procurement. Both types are critical to the health of any business.
But you can’t have a successful procurement strategy without managing both types of procurement, and understand their respective roles in a successful business.
We’ll cover the key differences of direct vs indirect procurement, their common pitfalls and solutions, and how you and your team can learn procurement management strategies from real-life examples.
What is direct procurement?
Direct procurement is the strategic acquisition of goods or services that make up a business’s product or are key to its production. Direct procurement involves purchasing raw materials, machinery, wholesale goods, software or services that serve a key role in the production of an end product or service.
Some examples of direct procurement include:
- A marketing agency paying wages to staff writers
- A construction company purchasing steel and concrete for building production
- A robotics company purchasing processors and gears for its latest iteration of robotic products
The overarching objective in direct procurement is acquiring lynchpin goods and/or services for the creation of a product or service. This is done through maintaining and creating vendor relationships, sourcing proper materials to ensure quality, or buying goods in bulk in order to cost-save effectively.
What is indirect procurement?
Indirect procurement is the purchasing and management of goods and services that are necessary to operate a business, and does not include any products or services used directly in offer creation. Put another way, indirect procurement purchases generally do not contribute to a company’s revenue, unlike direct procurement purchases.
Some examples of indirect procurement are:
- Purchasing office supplies such as staplers, computers desks and chairs
- Paying for utilities for an office building such as heating, water, gas, and electricity
- Bringing in external consultants for team-building exercises or professional development programs
Successful indirect procurement relies on good processes and measurement tracking, such as using technology like SAP’s Ariba to track spending through detailed dashboards. Doing so prevents unwanted spending crawl and supplies information for better decision making. A core focus of indirect procurement is finding balance between business efficiency and operational costs—one outweighing the other results in a financial bottleneck or operational stagnation.
Direct vs indirect procurement: what are the differences?
The core difference between direct and indirect procurement is whether the product or service purchased is directly tied to creation of your product. If it is, that would be implementing a direct procurement strategy. If the purchase is an essential one not directly tied to the creation of an offering, that’s indirect procurement.
Simply put, indirect vs direct procurement comes down to revenue generation. If a purchase generates revenue through your service of product creation, it’s direct procurement. If the purchase is necessary for operations, but does not contribute to your bottom line, it’s indirect procurement.
Direct procurement is most applicable when coming up with a new product or service idea or creating cost-efficiencies with an existing offering.
Consider a marketing agency startup. Stakeholders want to find website development software that is reliable, functional, cost-effective, and fits in with the long term goals of the business. The type of software the startup purchases is a reflection of its direct procurement strategy and business objectives.
Indirect procurement, on the other hand, is more relevant to operational spending. Using the same marketing agency as an example, deciding on which email provider to use for communications is a core indirect procurement decision. Decisions focused on improving the efficiency of a business—or reducing internal, non-production costs—is where indirect procurement is most effective.
What are the benefits of direct and indirect procurement?
Improving a business’ overall financial health and operational efficiency is a key metric of success for both direct and indirect procurement. After all, both functions deal with costs of doing business. That said, there are key benefits to each procurement type procurement managers and other supply team members should be aware of.
Benefits of direct procurement
- Improve supplier relationships: Direct procurement is closely tied to suppliers, as they are the life of your product’s components that make it successful. As a result of direct procurement, your business may develop close relationships with suppliers, allowing you to innovate together and be aware of potential supply chain issues early on due to enhanced communication.
- Increase profit margins: Using a cost-driven direct procurement strategy by pricing your product based on the cost to produce an offering, companies can seek out suppliers with better material prices through direct procurement. This results in production cost savings which, in turn, lead to higher profit margins.
- Elevate business reputation: Direct procurement can be leveraged to create strategic partnerships that improve the reputation of your business overall. Consider a carpentry company that partners with a timber supplier known for its replanting efforts, rather than using a less sustainable solution. Customers that are aware of this partnership may have more appreciation for the carpentry company’s products going forward.
Benefits of indirect procurement
- Improve operational efficiency: Lack of operational supplies such as computers for new hires, for example, can stagnate operational efficiency quickly—preventing business growth. Indirect procurement, when implemented right, can solve necessary supply issues and keep your business running smoothly year-round.
- Increase cost savings: By implementing proper indirect procurement strategies, companies can reduce their operational spend by approximately 15% to 17%, according to a report from McKinsey & Company. Reviewing quarterly reports for maverick spending can alleviate financial pressures throughout the year, for example.
- Free up working capital: By capturing indirect spending that is unnecessary and reallocating it, companies can use these newly acquired funds to further innovate products and services.
Challenges and solutions in direct and indirect procurement
While both these procurement types offer key benefits for intentional procurement teams and businesses, there are challenges to go along with each spending type. Thankfully, there are well-known solutions as well. Here are some of the most common for each procurement type.
Challenges in direct procurement
- Working with suppliers of any caliber brings risk to a business, including delivery timing, product quality, financial health of the vendor and access to inventory to create your product reliably.
- Direct procurement is complex, involving many complex processes and stakeholders. Ensuring your product blueprint is correct, material orders are checked, and your team has visibility of inventory, are no small tasks.
- Working with multiple suppliers to ensure you have components for product creation involves large swaths of data. Key information can be bottlenecked between supply heads and team members, or across multiple teams—depending on the size of your organization.
Solutions for direct procurement issues
- Establishing and maintaining strong, transparent relationships with vendors allows for more communication about business issues. This allows potential problems to come to the forefront to be dealt with quickly. Conducting regular supplier due diligence and financial health reviews of suppliers can also mitigate risk.
- Ensuring all team members involved in direct procurement are well-trained, up to speed with best practices and have access to viable communication networks, all reduce information slippage between teams.
- Using a centralized procurement program—such as Ramp’s software—lets for all parties to view the end-to-end direct procurement process. This keeps information flowing between team members so nothing is missed and product creation continues to operate smoothly.
Challenges in indirect procurement
- With fewer touchpoints than direct spending, unmanaged indirect procurement can lead to large amounts of ad hoc spending, hurting cost-retention efforts.
- Because indirect spending can be done in small, variable batches that add up quickly (e.g. hotel stays for out-of-state sales members), managing purchasing records can be very time-intensive.
- Multiple departments have indirect procurement processes, from legal to marketing, each with their own procedures, needs and goals. Because indirect procurement is done across an organization, coordination can suffer.
Solutions for indirect procurement issues
- Setting up centralized roles or teams to manage indirect spending across an organization can reduce ad hoc spending, as requests are always processed by the same set of individuals. Reviewing this data monthly can also help overcome maverick spending.
- Use enterprise-wide purchase orders, rather than small batches, to provide more context for indirect procurement. This gives accounting and reconciliation-focused departments more information to streamline the reconciliation process.
- Use spend analytics to track department-based indirect spending and use it when training procurement staff and other employees. This gives each department similar processes and procedures instead of a disjointed approach.
An example of direct procurement in action
Plumbing fixture specialists Hansgrohe, based out of the Black Forest, supplies its customers with design-orientated fixtures and fittings for showers and bathrooms. Because of the technical nature of their products used in their industry, the direct procurement of parts for their products was complex. With the demand for high-quality fittings and showerheads not slowing, the company needed to find a way to shorten lead times on their products to get them to market faster.
Their current request process for customized parts needed to be shortened to meet market demand.
After partnering with JAGGEAR, an e procurement provider, Hansgrohe was able to import their supply systems and documentation processes into a digital platform. This severely reduced supplier and back-and-forth compared to when email or mail was the standard mode of communication. Using a digital solution that had greater data visibility and better communication with suppliers meant this manufacturer saved time by reducing data entry processes. What’s more, their response times for offers were reduced by two to three days.
An example of indirect procurement in action
Viking Well Services, a oil and gas company established in Lore City, Ohio, had multiple high-ticket indirect purchases every month. These purchases could be for parts on their machines, repair costs, or back office software—purchases that were necessary to keep the business operational. However, their indirect procurement process wasn’t clear: ““People were just going out and buying what they needed, and they would have a purchase order number,” Senior Controller Chris Lowdermilk told Ramp.
This process bottlenecked efficiencies in the finance department, and led to a lack of financial transparency as well.
Viking chose to use Ramp’s procurement software to increase efficiencies and reduce financial opacity. Ramp’s platform allowed Viiking to have all their PO’s and bills in one centralized location for better viewability and understanding of where money was going and how much was left on a PO, for instance. Adopting a more transparent indirect procurement approach gave Viking more time: their controller reported time savings of two-to-three days each week, and their month-end closing time was eight days faster on average.
Wrapping up
To recap, the distinction between direct vs indirect procurement comes down to how vital is to the creation of a product or service. Direct procurement involves purchases that directly support your product or service, where indirect procurement relates to purchases needed to run business operations.
Even though direct procurement can immediately reflect in profit margin changes, learning to manage both procurement types is essential to running a long-lasting business. Why? Both affect the cost of creating your offer or running your business, so if either type of spending gets out of hand, you could face financial bottlenecking.
Ramp’s procurement software can streamline your procurement process across the board, from automating bill processes to incorporating multi-level payment approvals for better financial decision making. Interested in saving time and money? Learn more about Ramp’s procurement technology.
