Direct procurement is responsible for making sure you have all the “linchpin” ingredients for making the core things that your company produces. Indirect procurement, on the other hand, includes everything else that is essential to keeping the lights on and keeping your business running smoothly and efficiently.

Direct procurement activities involve bigger budgets and may be more centrally and strategically managed. But what so often gets overlooked is that in many businesses, indirect procurement costs can still make up a significant portion of procurement-related expenses. Despite this, indirect procurement is often decentralized and inconsistently managed, with enormous potential for improvement. Today’s best technologies and spend management practices help you take a more unified and holistic approach to all your spend management processes—ensuring that your teams, your data, and your systems are integrated smoothly and are working well together.

What is direct procurement?

Direct procurement refers to the process of purchasing raw materials, components, and labor that are directly utilized in the production of the goods or services that your company sells.

This spend activity is very closely tied to your primary business operations. It supplies your production line and affects the quality of the final product you offer to your customers. An example would be a car manufacturer sourcing and purchasing steel and tires. Another way of looking at direct procurement is the immediacy of its proximity to your core operations. Without office supplies, an auto manufacturer could still make cars. But without metal or rubber, the primary operation grinds to a halt.

Good direct practices often leverage e-procurement solutions and tools including spend analytics, strategic sourcing, and material requirements planning (MRP). This helps companies ensure that they have reliable suppliers and efficient systems to manage these relationships—leading ideally to more efficient and resilient operations.

What is indirect procurement?

Indirect procurement involves the acquisition of goods and services that are important to keep your company running but do not directly go into the production of your core products or services. This spend category includes maintenance, repair, and operations (MRO) as well as IT services and software-as-a- service (SaaS) subscriptions, marketing, real estate, outsourced professionals, and much more.

And while the definition of indirect procurement hasn’t really changed in 50 years, today’s digital transformation has seen a marked shift in how both companies—and their customers—do business. Certain indirect expenses are timeless, such as janitorial services or office supplies. But what has shifted enormously is our reliance on SaaS solutions, cybersecurity, and increasingly powerful and specialized software. Today’s spend management teams are often spending less on stationery, advertising services, and even real estate. But that’s got more to do with a shift toward digitalization, self-serve marketing tools, and remote work than with a reduction in indirect expenses in general. As companies and manufacturers become increasingly digitalized, they are finding that despite spending less on some “hard” business expenses, they are seeing a rising need for other types of tools and solutions to help them grow and compete.

Direct vs. indirect procurement: What are the differences?

The main difference between these two procurement models is not how they are undertaken, but why they are needed and what they are needed for. Best practices—from sourcing to payment—should be rigorously applied to all your acquisition activities whether they are direct or indirect.

• Business continuity and strategic importance: Direct procurement activities are immediately critical to business continuity. A disruption in the supply of raw materials can halt production, affecting sales and the bottom line. Indirect procurement has less of an immediate impact upon the business; however, the cumulative effect of managing this spend category effectively tends to have a significant impact on overall business health.
• Budget size and contract length: Direct procurement often involves larger budget allocations and longer contract durations. In contrast, indirect procurement might involve smaller, more variable spending amounts with shorter contract terms, focusing on operational needs that may vary from year to year (or even day to day).
• Planned vs. spontaneous spend: Direct procurement requires rigorous planning and forecasting to align with production schedules and market demand. With indirect procurement, there is often a bit more room for flexibility, with purchases made as needed, based on more immediate operational requirements.
• Importance of supplier relationships: Supplier relationship management (SRM) in direct procurement is typically more strategic, involving long-term partnerships to ensure compliance, access supplier expertise and suggestions, and enable consistent supply and quality. In indirect procurement, the focus is to encourage people to make purchases from these approved suppliers in order to capitalize on volume discounts, enhance quality control, and comply with guidelines and regulations.
• Inventory management: Inventory management in direct procurement is a strategic activity aimed at balancing cost with production needs to avoid overstocking or stockouts. Indirect procurement may not be as vulnerable to shortage and surplus risks, depending on the nature of the goods or services procured.
• Organizational setup: Direct procurement has traditionally been managed by a specific procurement team, with clear budgets and KPIs, whereas indirect procurement is often less rigorously controlled or monitored. And while this has been a distinction between direct and indirect in the past, it’s important to note that today’s best spend management professionals manage indirect procurement in a more connected and systematic way.

Common challenges with direct procurement

Many of the challenges for this spend category can originate outside your company. To grapple with these kinds of issues, it’s essential to have good collaboration among your teams and your suppliers—and that you ensure your direct spend activities are data-driven and centralized.

• Supply chain volatility: As the past few years have shown us, “never say never” is a good axiom to live by in today’s business world. From weather events to political unrest, a complex (and growing) range of global events can disrupt your supply chain. It’s more important than ever for direct procurement teams to collaborate with supply chain management and to leverage and analyze resilience-building data from across the business.
• Quality control: Even with the best of intentions, your suppliers can let you down on the quality front. Good SRM tactics and constant monitoring of global and regional market trends can help you anticipate quality problems and pivot as needed.
• Commodity price fluctuations: Depending upon your sector, you may be particularly vulnerable to shifts in the price and availability of the raw materials you need for your core manufacturing. Again, by staying on top of market intelligence and building buffers into your budgets, you can be more prepared for such eventualities.
• Supplier dependency: When you find a great supplier, it’s tempting to get complacent. But, through no fault of their own, a supply partner may suddenly fail to deliver. Without some other vetted and available options, you can find yourself in a scary spot.
• Regulatory compliance and sustainability: Your direct procurement spend is typically bigger and may include raw materials, long-distance shipping, foreign labor forces, and other complex components. Direct procurement teams need to be on top of both local and global compliance when it comes to environmental, social, and governance (ESG), legal, and myriad other regulations that typically don’t have as significant an impact upon indirect procurement activities.

Common challenges with indirect procurement

Indirect procurement challenges often originate within your organization. This is bad news and good news. Bad news if you continue to tolerate silos and outdated tools and practices. But good news if you’re ready to tackle these issues because—unlike politics and weather events—these kinds of challenges are within your control.

• Poor spend visibility: Even if departments follow the right protocols, if this spend is not captured and integrated with your other expenses, you may lose the opportunity to subject it to centralized scrutiny. This means a reduced ability to identify cost-saving opportunities or eliminate wasteful spending.
• Maverick spend: Most maverick spending is well-intentioned and only happens due to the perceived slowness of going through “official” channels or the absence of solutions that automate compliance with buying protocols and policies. Yet is can cause significant damage, increasing costs and escalating the risk of purchases that don’t meet organizational or regulatory requirements.
• Data hoarders and disparate data: Indirect expense and sourcing data needs to be collected, standardized, and analyzed along with all other critical business data. If you do not have a strict policy and practice of capturing and centralizing this information, you will lose its benefits—including more accurate forecasting and reduced costs.
• Surpluses and redundancies: Indirect procurement often results in surplus supplies or redundant services due to poor coordination and planning. Enhanced visibility provided by automated solutions helps you free up this excess capital that could be better utilized elsewhere in the business.
• Company culture: Old habits die hard. In many companies, there hasn’t been much concerted strategy put into indirect procurement. Integrating indirect spend into your centralized processes takes more than good software. It requires transparent communication and clarity regarding the importance of visibility and silo-smashing across your business.

The impact of direct and indirect procurement on spend management

Direct spend, while comprising a significant portion of total costs, offers opportunities for economies of scale and volume discounts that can effectively keep inventory costs in check. Conversely, while indirect spend does not have the same impact upon the cost of goods sold, it is increasingly critical to business success as inefficiencies can drive up expenses and lead to operational delays and disruptions. Holistic spend management, therefore, becomes essential in balancing these (and all) spend categories, ensuring that each contributes as much as possible to the overall financial health, growth, and operational fluidity of your organization.

What to look for in direct / indirect procurement software

As you progress on your digital transformation journey, choose software with features that will boost your ability to integrate, customize, and automate your spend management activities, including:

1. Comprehensive integration capabilities: Integration across your ERP and spend management systems ensures that procurement data aligns with production and operational needs, which is essential for establishing a balance between direct and indirect procurement.
2. Advanced analytics and reporting: Given the differing focuses and impacts of direct and indirect procurement, analytics are vital to distinguish and manage the unique challenges and opportunities of each.
3. User-friendly interface: Any tool is only as good as your teams’ willingness and ability to use it. Look for an interface and dashboard that are intuitive and straightforward.
4. Automated workflow management: Automation streamlines processes, reduces manual tasks, and improves accuracy and speed. This allows your teams to focus on strategic matters, confident that the manual tasks are being consistently monitored.
5. Robust vendor management tools: Regardless of what services or goods a vendor is providing, standardized and reliable vendor management features are essential for maintaining quality and reliability in both direct and indirect procurement.
6. Flexible customization options: From reports to workflows and automated processes, customization helps ensure that your teams can adapt to the unique needs and challenges associated with each supplier, vendor, or operational activity.
7. Security and compliance features: When it comes to regulatory compliance and the protection of sensitive transactional data, powerful AI-driven security features are beyond essential to protect your reputation, your customers, your suppliers, and your team members.
8. Mobile-optimized solutions: As your procurement activities become more precise and better integrated across your entire business, you’ll want to be sure your spend management solutions support flexible usage—whether at a desktop or on a mobile device.