Lastly, and perhaps more importantly, the difference between direct and indirect procurement lies in how they affect the company’s A business will not survive without creating solid relationships with third-party suppliers. As a business grows, so do the responsibilities and transactions that are needed to keep operations going. This can be a complex matter in procurement, where internal units forge relationships with outside suppliers in deals that can directly impact a company’s profits and reputation. In this article, we will take a look at indirect spend, another side of procurement that many industry professionals often underestimate and take for granted.
What is indirect procurement?
Indirect procurement pertains to the purchase of supplies and services to keep a company’s daily operations going. Also called indirect spending, this type of procurement ensures that your company is running smoothly through expenses covering fixtures, travels, office equipment/supplies, building utilities, HR functions, technology, marketing, and outsourced services. Indirect procurement does not directly contribute to the company’s bottomline, but it is necessary to support the existence of the said company. Spending under this category is a case-to-case basis, which means goods and services are procured based on current needs. On average, indirect spending accounts for 15% to 30% of a company’s total revenue.
Direct procurement versus indirect procurement
Direct procurement is the process of obtaining goods, services, raw materials, and other resources for production. These resources are essential to building a company’s products or services that will directly go to its end-users or customers. These purchases are typically on a large scale and are conducted frequently. Also called direct spending or direct cost, this type of procurement includes raw materials, products for resale, machineries, and subcontracted labor, to name a few. Direct procurement is closely tied to manufacturing because it covers operation performance, product quality, and consumer experience.
Although direct procurement and indirect procurement are both essential to keep a business running, they are widely different from each other and knowing their differences is important when creating spending strategies. Let us examine their key differences.First, direct procurement purchases goods in larger quantities than indirect procurement and are sourced from a pool of vendors at the best rates. Purchases are also done more frequently in direct procurement since the raw materials being acquired are essential to making their end-products or goods for resale (GFR). On the other hand, purchases under indirectprocurement are on an ad hoc basis, which means goods or services are only procured when there is a demand for them.bottom line or net income. Direct spend ultimately impacts the bottom line, while indirect procurement does not. The former contributes immediately to the company’s revenue, has more transparency, and receives wider visibility.To illustrate, let us look at a manufacturer of smartphones as an example. Their direct spend includes microchips, sensors, batteries, and modems, all of which are essential to build a smartphone that they can sell to their customers. But running a smartphone company is not only limited to the actual production of the smartphones. It also requires spending on renting the factory where the smartphones are produced, as well as marketing-related services to ensure that the products reach their target buyers.
Why indirect procurement is important?
Having accurate and complete information is key to creating a sound financial plan.You cannot strategize around something that you do not fully see and failing to take into account these factors could impact your decisions. Having so-called invisible spends could also disrupt your cash flow as it creates an illusion that you possess more working capital than what you actually have. Procurement leaders must gain full visibility over their indirect spend as this could pave the way to more cost-saving solutions. A 2014 study by London-based professional services provider EY found that optimizing indirect spend can cut costs by as much as 25%, including an estimated 5% to 25% spending optimization in hardware and software.However, paying attention to indirect procurement is not all about cutting costs. It can also boost your business’ operations, improve how you deliver your products or services to your clients, and minimize risk exposure.
Challenges of indirect procurement
While it does not contribute to the bottom line, indirect procurement impacts the company’s overall operation. But many profits-driven companies tend to overlook this area as a result of its complex nature. In a survey, outsourcing analyst firm NelsonHall found that about 80% of respondents advised that indirect procurement was delivering against expectations, reflecting the roadblocks plaguing this function.Let us examine the challenges of indirect procurement.
Lack of visibility
Indirect procurement is often treated as less important as it does not have immediate impact on profits nor end-products and services unlike direct spend. This often leads to one-off transactions with no negotiated contracts, making them vulnerable to mismanagement. Indirect spend also usually relies on various business divisions, meaning there is no central mandate overseeing it. This makes it hard to identify which specific department is responsible for the policies. For example, HR is responsible for training, marketing for advertising agencies, IT for software, and so on. This results in having many internal departments involved, and spending on different goods and services across various categories.
Having multiple suppliers
Another major roadblock to indirect procurement is having to deal with multiple suppliers at once. Since indirect spending covers the overall operations of the company, it often requires volume buying. But since some companies do not have centralized policies for indirect procurement, this sometimes results in maverick spend (also called tail spend or rogue spend), which refers to unchecked expenses that could ruin a business. This type of spend can account for 80% of spending of a company that does not have a centralized indirect procurement process. Having too many vendors at an already jam-packed table is a problem waiting to happen. It can lead to contract lapses, which in turn results in compliance risks. Unlike its counterpart, indirect procurement also does always rely on preferred suppliers, meaning the procured goods and services do not match the approved vendors’ quality and price.
Lack of skills
Companies need skilled professionals to handle the complex nature of indirect procurement. These skills include data analytics, category and supplier management, and contracting. But many organizations fail to appoint qualified professionals to handle indirect procurement simply because they do not realize the importance of this function.
Talent shortage has been haunting the procurement segment for years. According to an annual research on procurement trends by Zycus, a cloud-based procurement solution provider, nearly 3 in 10 respondents identified lack of skills as the major pain point facing the segment. This was underpinned by the retirement of baby boomers, absence of university graduates feeding directly into procurement roles, and increased competition against higher-paying jobs.
Underinvestment
Indirect procurement is susceptible to underinvestment because of its lack of immediate impact on profits. Zycus’ study found that 7 in 10 respondents considered outdated technology as the segment’s biggest pain point. It also found that about 30% of companies have yet to spend on procurement technologies. Additionally, younger, tech-adept procurement professionals said their present companies’ tools fall short of the user standards that they are used to. For example, having vendor management systems (VMS) and inventory management tools are not usually a priority in indirect spending, which decentralizes the handling of expenses that fall under it across different business units. Organizations need to realize the importance of investing in indirect procurement given the cost-savings solutions that they can get out of it.
Risk mitigation
The procurement process is also vulnerable to supply risks. This includes market and delivery risks, as well as frauds.This is caused by employing unqualified participants and favoring informal decision policies. Procurement can likewise lead to compliance risks such as policy adherence and anti-corruption.
Tips for better indirect procurement
Indirect procurement is a nuanced function that largely depends on the requirements of a company. But how do you get started on something so complex? Here are some tips and best practices to get the most out of indirect procurement.
Set priorities
A well-established indirect procurement process can yield cost savings. To start planning, you need to identify which spending areas are likely to bring the best benefits. You should prioritize items that account for the largest portion of your indirect spend, as well as those that have the biggest impact on how you deliver your goods and services to your clients. In technology companies, this can cover contingent workforce; in manufacturing, this often includes maintenance and repair; and in healthcare companies, this usually involves insurance risks, IT, and staffing services. You can leverage various cloud-based data analytics tools to identify these areas. Once you have done so, you can review those items that do not meet industry standards or yield value for your money.
Focus on the fine print
Indirectly procured goods and services tend to involve contracts that did not go through thorough assessment. They sometimes have unexpected restrictions, which in turn push up costs. Contracts are also often written and prepared by the vendors, meaning their terms are likely to be favorable to them than you. When reviewing your vendor contracts always keep an eye on automatic price hikes, termination charges, and automatic renewals. If you are not satisfied with your vendor’s output, go back to the contract if said vendor is meeting their commitments as per agreement. If not, you can always renegotiate the terms or find another vendor. Keep in mind, however, that while the latter is an option, it is not always the first course of action when you want to find ways to minimize costs from indirect procurement.
Renegotiate
Now that you have identified the areas where you can cut costs, it is time to renegotiate with your vendors. Renegotiation is not uncommon in procurement. One area to look at is the payment term. A vendor would often insist payments made in 30 days but you can always ask to extend it to between 60 days and 120 days. You can also request a price freeze or stabilization mechanism in the contract that would allow for either yearly or incremental price increases based on industry standard instead of a fixed percentage.
Adopt tools and technologies
Another best practice in procurement–be it direct or indirect, is the adoption of new technologies. These tools will help you gain transparency, improve the category management of your spend, generate insights into market trends, and adopt a more efficient relation with your suppliers. You can use various data analytics tools to do away with unclassified and random expenses and keep track of them in an organized manner. Data may include supplier catalogs, purchasing records, and costs.
Create an indirect procurement team
The responsibility of managing indirect expenses should fall under a specific unit and not spread across various departments. You can start by having cross-functional teams who will represent every unit in an organization. This team of representatives must have a vision of the entire procurement process, define the responsibilities of every department, set expectations and accountabilities, and identify all the stakeholders.
Conclusion
Despite its lack of immediate impact on profits, indirect procurement can affect the company’s overall growth. Many businesses tend to reduce indirect procurement to mere record keeping without realizing the potential cost-savings solutions it can bring. If done properly, indirect spend can open ways for a company to reduce its random, maverick spending. It can also impact the company’s branding and relationship with vendors and third-party suppliers. While direct procurement has an obvious impact on the company’s bottomline, business leaders should not take indirect procurement for granted. After all, how can you spend on finished products and services if there is no company that exists in the first place?
