Indirect procurement accounts for 15 – 27% of a company's total revenue. And the total operational impact it can have on a company—either positively or negatively—can be significant.
Yet, many organizations pay the most attention to direct procurement, with indirect procurement consistently taking the back seat. This is a big mistake because indirect procurement is critical to cost-effective operations and profitability.
It's time for indirect procurement to stand up and be counted! This post will cover everything you need to know about indirect procurement.
What Is Direct Procurement?
To help you better understand indirect procurement, we first need to define direct procurement and its scope.
Direct procurement involves acquiring raw materials, components, and parts used to create a product. These are the materials that usually end up in the final product. It deals with inputs that, after processing, form the backbone of your products.
Typical examples of direct procurement include:
- A baker buying the floor for making bread
- A tech. company buying chip sets for the manufacture of mobile devices
- A construction company placing orders for the cement and clay bricks for an ongoing house project
Note: Direct procurement is sometimes referred to as "direct sourcing" or "direct spend management" and consists of a series of processes that span the entire product lifecycle.
What Is Indirect Procurement?
Indirect procurement alludes to money spent on anything other than purchasing materials involved in the direct manufacturing of goods.
All the money spent to keep the manufacturing operations running falls under indirect procurement. Simply put, indirect procurement involves the cost of items used to maintain the day-to-day operations in a manufacturing setup.
These items can include:
- Office equipment and supplies
- Rent for facilities
- Software licenses
- Outsourced services (accounting, HR, and IT)
- Marketing services
- Travel expenses
Indirect purchases don't exert any direct input into the final product you deliver to customers. However, they play a critical role in ensuring the process of turning direct suppliers into finished products goes smoothly.
Indirect Procurement vs. Direct Procurement: What's the Difference?
The difference between direct and indirect procurement is in the function they address.
While direct procurement focuses on securing the key suppliers that form part of the final product, indirect procurement deals in the supply of incidental goods. With direct procurement, you're buying items needed to manufacture the goods sold to consumers.
Indirect procurement, on the other hand, enables a company to function effectively.
With indirect purchases, you're spending on things that will facilitate the manufacture of the goods sold to the customer. Unlike direct procurement, these items don't become a part of the final product.
How Does Indirect Procurement Save You Money?
Indirect procurement account for up to 80% of a company's purchases and 27% of its revenue. Although the items are usually of lower value than direct expenses, indirect procurement transactions occur more frequently, and costs can add up quickly.
Indirect procurement occurs at all business levels and involves many suppliers and employees, meaning it deserves much attention.
So, how can indirect procurement save your business money?
If there are no indirect procurement policies in place, it will be hard to reach your business goals. Inefficient processes and practices will cost you time and money.
With no policy or controlled budgeting, overspending and unauthorized spending will likely occur, and you'll have no visibility into your company's expenditure.
But if indirect procurement is managed effectively, with sound spending and budgeting policies in place, you'll have complete visibility of your indirect costs. This can lead to significant cost savings and bottom-line growth. In fact, automating the procurement docket can create saving opportunities of up to 20%.
Indirect Procurement Best Practices
Implementing indirect procurement policies isn't just about cost savings; it also aims to improve facilities management, increase visibility, and better management of vendors.
To achieve that, organizational heads must devise strategies to steer the company towards optimal budgeting, spending, and resource allocation. Here are some indirect procurement strategies and best practices to follow.
Aim for High Spend Visibility
Many procurement processes are inefficient because they're usually implemented without comprehensive approval from the organization. When you increase visibility into your procurement processes, you're opening the door to procurement optimization.
Invest in the Right Technology
An ERP system is great for managing an organization's procurement docket. However, using an ERP system alone doesn't provide the agility and visibility required to manage:
- Buying patterns and spend analytics
- Vendor onboarding and approval
- Centralized procurement data
- Vendor, user, and department cost management
The best solution is to invest in indirect procurement technology to manage and optimize your organization's spending. Today, the market is filled with procurement software solutions that offer automated workflows, centralized records, notifications, and more.
Practice Strategic Sourcing
Start by examining your contracts to find ways to save. Then, enter into partnerships with those suppliers to ensure maximum cost savings.
Educate Staff on Indirect Procurement
Since your procurement team makes the purchases, educating them on procurement best practices is critical. They need to be aware of the steps to take to improve procurement efficiency and the pitfalls and mistakes to avoid.
As part of your accounting process, it's important to understand the procurement process. Knowing what indirect procurement is, its impact on your organization, and the best procurement strategies to adopt can lead to significant cost savings and profitability.
Want to learn more? Check out our procurement guide.