Direct vs. Indirect Procurement: What are the key differences?

direct-and-indirect-procurement
blog dateDec 02, 2021 | 5 min read | views 489

The literal definition of procurement is the action of obtaining or procuring an entity or a commodity. Here, the term procurement is used in the realm of business. On the surface level, procurement might seem like it is all about acquiring supplies of an organization that needs to function daily. These include vendor management, fraud prevention, payment processing, invoice processing, quality control, etc.
However, there is more than which meets the eye.

Procurement can be divided into two niches - direct and indirect procurement. While both direct and indirect procurement are essential to the smooth functioning of any business, it is very important to understand their place in the business so that you can prioritize and emphasize where and how they are required.

What is direct procurement?

Direct procurement is the acquisition of raw materials and goods required for production. Such purchases are made in bulk amounts and are acquired from a supplier based on the best possible price, quality, abundance and reliability. This is necessary for the everyday functioning of a business. For example, rice is a direct procurement commodity for someone who works as a chef. Cement is a direct procurement commodity for a builder, metal is for the iron and steel industry and so on. Direct procurement is so essential that if it stops functioning or encounters any kind of blockage, companies will no longer be able to manufacture their product and generate revenue. Hence, it can be said this niche of the procurement software stems from the manufacturing sector.

What is indirect procurement? 

Indirect procurement is the purchase of services that are required to keep the business running. They do not directly influence the functioning of the business, but they do affect the outcome. It is defined as the activity directed at ordering goods and services that support your primary business, but do not deliver directly to end customers. For example, in the mobile phone industry, silicon chips are a direct procurement commodity, because without them, a phone will not function, but a proper service center is an example of indirect procurement. Would the manufacture of mobile phones get halted because of a lack of service centers? Of course not. However, would the outcome of the company as a whole be affected? Absolutely.

So, we pretty much understand the difference between the two in the basic form.

How to manage direct procurement?

Direct procurement process is one of the most overlooked yet important aspects of business operations. It is directly related to the processes involved in purchasing of the raw materials required to make a product. Managing it isn’t very easy, especially when it's across an organization with thousands of products and services.

Direct vs. Indirect Procurement

Direct procurement software involves the performance of two main functions. First, it is concerned with purchasing the core component of your products. Second, it is concerned with enabling you to meet your customers’ needs more effectively by granting you access to capital that will enable you to increase your inventory levels. Furthermore, this function is concerned with ensuring that the organization’s stock of raw materials has an appropriate turnover rate, so as to enable not only efficient meeting of customer demands but also effective exploitation of assets. On the other hand, indirect procurement software functions are aimed at securing goods whose consumption does not have a direct effect on customers or production cycles. 

Here are three core areas of procurement where the distinctions between direct and indirect procurement are laid-out:

direct-vs-indirect-procurement

  1. Managing Supplier Relationships - Direct procurement requires  suppliers need to be on good terms with the company to ensure long term procurement of goods. However in terms of indirect procurement, companies focus mainly on expenditure. Hence their focus is mostly on managing and reducing the same. This is especially true in terms of companies that have little to no direct procurement requirements such as software companies, digital marketing companies etc.

  2. Managing Inventory - Having the right amount of inventory on hand is essential for smooth production. It can be highly inefficient to hold large amounts of inventory if the expected demand level isn't known. Direct procurement is beneficial when you expect a constant stock level, when the purchasing process is rather traditional, when it takes time to place orders, when you deal with many suppliers and in some cases when dealing with very expensive and perishable goods. Indirect procurement is more appropriate when the inventory levels fluctuate dramatically in accordance with production cycles, in environments in which customization is possible and when time-to-market is required

  3. Organizational Structure - In most companies, direct costs are managed by centralized procurement and supply chain teams, with category managers focusing on specific areas of spend whereas indirect procurement in most large organizations tends to be decentralized in nature. Organizations have multiple stakeholders with independent budgets and spend protocols, resulting in inefficiency in the indirect procurement process. Lack of centralized structure for indirect spending leads to operational inefficiencies. A significant proportion of global Fortune 500 companies are moving to managed indirect outsourcing, saving 10-18% of their overall operating costs each year.

In a Nutshell

Inefficient procurement management directly impacts the bottom line. Without well-defined and streamlined procurement practices, businesses experience high overhead costs. The objective of procurement is to make the best purchase at the right price for the right item, at the right time and in the right quantity and quality within the organization. Businesses need to invest resources towards understanding about what differentiates direct from indirect procuring. It must be noted that it is imperative that direct and indirect procurement goes hand in hand in industries that require it. One is not more important than the other. By focusing on both, organizations can cohesively grow by honing in on the holistic view of the procurement field.

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