Procurement 101

Direct vs. Indirect Procurement: Key Differences Demystified

Reading time:

6 minutes

Written by

Gabriel Swain

A light bulb on a blue background to represent the thought process needed to distinguish between direct and indirect procurement.

Running a business is like operating a machine: all parts must move in unison for it to function properly. If one gear breaks, the whole machine stops. Similarly, when a single business function breaks down, it can impact the entire business.

Internal inventory (e.g., printer paper) and service contracts (e.g., office wif) must be monitored to prevent that from happening. That’s called indirect procurement.

This might not be what you think of when you hear the word procurement, but it’s just as important as direct procurement. Below we break down the differences between direct vs. indirect procurement and provide answers to commonly asked questions about these two sides of the procurement coin. Off we go!

What is Direct Procurement?

Direct procurement (DP) is what most people think of when they think of procurement, so we’ll start here. DP involves acquiring goods and services essential to a product or service's production or delivery. It's a vital link in the supply chain, ensuring businesses have the necessary resources to produce what they sell.

Key DP activities include negotiating contracts, identifying suppliers, strategically sourcing materials,  managing vendor relationships, ensuring quality control, and managing costs. The goods and services procured through DP form part of the value chain and directly influence the final product or service.

A straight road through snowy trees to represent direct paths from A to B to help distinguish between direct and indirect procurement.

What is Indirect Procurement?

While direct procurement focuses on goods and services required for product creation, indirect procurement (IP) ensures the acquisition of everything else essential for company functioning.

Picture an office without stationery or a manufacturing plant without maintenance services - it's inefficient. This is where IP steps in, managing necessary acquisitions from office supplies to software services, cleaning services, and utilities. Without IP, businesses would struggle to maintain day-to-day operations.

A winding road through a snowy forest to represent indirect paths from A to B to help distinguish between direct and indirect procurement.

Direct vs. Indirect Procurement: The Key Differences

The main difference between these two lies in their end goals. Direct procurement fuels your product by providing necessary materials and services for its creation, directly impacting product and service quality and sales.

Indirect procurement maintains operational efficiency. It's the unsung hero keeping the lights on, computers running, and the workplace clean. While it doesn't directly impact your product, poor IP management can disrupt operations, impacting productivity and the bottom line just as quickly as direct procurement can.

Indirect Sourcing, Purchasing, and Procurement: Clearing up Confusion

Let’s pause to clarify some often-misunderstood terms. Although procurement, purchasing, and sourcing are often used interchangeably, they are distinct processes.

Direct and Indirect Purchase Orders

Direct purchase orders are usually raw materials purchased to make the end product for the customers. Meanwhile, indirect purchase orders are referred to as overhead expenses. These are goods and services that are not directly related to production. 

For instance, if you are making chairs then your direct purchase orders will include materials such as wood. Indirect purchase materials can be computers to 3D model the design of the chairs.

What is Indirect Sourcing?

Indirect Sourcing involves identifying and evaluating potential suppliers for indirect goods and services. This involves market research, supplier capability analysis, and financial stability assessment. It helps companies identify potential suppliers offering the best price, quality, and delivery time.

Direct vs Indirect Sourcing

The main difference between direct and indirect sourcing is that with direct sourcing businesses search for suppliers to get the direct goods and services necessary for the final production. The direct sourcing process involves supplier selection, quality assurance, cost analysis, and negotiations.

What is Indirect Purchasing?

Indirect Purchasing entails placing orders, tracking deliveries, and managing invoices for indirect goods and services. Procurement professionals ensure timely delivery, quality standards, and the best prices.

These distinct stages combine to form the overall procurement process. Understanding these differences can help companies optimize their procurement processes and achieve better results.

From Cost Reduction to Value Creation: The Future of Indirect Procurement

By adopting a strategic approach, indirect procurement can shift from a cost-reduction role to a value-creation role, improving efficiency, reducing supply chain risk, and increasing innovation. Here are some strategies:

  1. Collaborate with Internal Stakeholders: IP professionals can work with internal stakeholders to identify value-creation opportunities beyond cost savings.
  2. Focus on Supplier Relationships: By working closely with suppliers to identify new opportunities and innovations, procurement can improve product quality, delivery times, and overall supplier performance.
  3. Leverage Data Analytics: By analyzing spend data, IP can identify areas for process improvements, supplier consolidation, or innovation to create value beyond cost savings.
  4. Emphasize Risk Management: IP can help reduce risk and protect the organization's reputation by ensuring suppliers' reliability and regulatory compliance.
  5. Consider Sustainability: Indirect procurement can contribute to sustainability efforts by sourcing environmentally friendly products and services. 

PRO TIP: If you’re not incorporating sustainability into your procurement and supply chain strategies, today is the day to start. According to a recent McKinsey study, the shift toward achieving net zero emissions could generate up to more than $12 trillion (USD) of new annual sales by 2030. 

An older gentleman in glasses with money falling on him to represent value creation in procurement

Common Questions Answered

Direct spend is tied to the goods or services comprising what you sell, while indirect spend relates to operational expenses that keep your business functional.

Direct vs Indirect Spend

Direct spend refers to business expenses that are necessary for manufacturing and production of the end product for the customer (e.g., raw materials). Indirect spend refers to business expenses that are not directly related to the production of the end product but are necessary for the overall business process (e.g., computers, office supplies, etc.).

How does indirect procurement support business operations?

Indirect procurement functions like a backstage crew in a theater production, ensuring everything is in place for the "performance" - your day-to-day operations. It manages the acquisition of necessary goods and services that enable your employees to perform their tasks efficiently.

Why is direct procurement crucial to the production process?

Direct procurement sources the materials and services that go directly into your product. Efficient direct procurement leads to high-quality products, timely production, and ultimately, satisfied customers.

What are the steps in the direct procurement process?

The direct procurement process begins with identifying the need for materials, sourcing and negotiating with suppliers, issuing a purchase order, scheduling delivery, and settling the invoice upon receipt.

What are the steps in the indirect procurement process?

Indirect procurement shares some steps with its direct counterpart, including identifying needs, sourcing suppliers, and settling invoices. However, it also involves managing inventory for items like office supplies and evaluating supplier performance to ensure quality services.

Can the same strategies be used to manage both direct and indirect procurement?

While there are overlaps, each requires a unique approach. Both need strategic sourcing, evaluating supplier performance, and effective negotiation. However, direct procurement often requires a stronger emphasis on long-term supplier relationships due to the direct impact on product quality.

How does direct procurement impact a company's bottom line?

Direct procurement directly influences the cost of goods sold (COGS). Efficient direct procurement can lower these costs, thereby increasing profit margins.

How does indirect procurement impact a company's operational efficiency?

Streamlined indirect procurement ensures smooth day-to-day operations. It helps avoid downtime that can occur due to a lack of necessary supplies or services, thereby enhancing overall productivity.

How can a company balance its direct and indirect procurement strategies?

Striking the right balance involves realizing cost savings through effective direct procurement and achieving operational efficiency through well-managed indirect procurement. It's like juggling – it requires practice, agility, and a keen eye on all the balls in the air.

Conclusion

The distinctions between direct and indirect procurement are subtle yet significant, and understanding these can provide your business with a competitive advantage. Direct procurement, the star of the show, fuels your product by sourcing the necessary materials and services that go into its creation. On the other hand, indirect procurement, the unsung hero, ensures the operational efficiency of your business. This dual approach enables your business to produce high-quality products while ensuring smooth and efficient operations.

However, the power of indirect procurement extends beyond mere operational support. It can evolve from a cost-cutting function to a value-creating role. By adopting a strategic approach that transcends cost reduction, indirect procurement can contribute meaningfully to the organization's overall success. Through collaboration with internal stakeholders, building robust supplier relationships, leveraging data analytics, emphasizing risk management, and considering sustainability, indirect procurement can unlock potential value beyond mere cost savings.

In the end, effective procurement isn't just about getting the best prices; it's about optimizing processes, building strong relationships, mitigating risks, and making strategic decisions that drive long-term growth and sustainability. By appreciating and leveraging the strengths of both direct and indirect procurement, organizations can create a more resilient, efficient, and competitive business model.

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