We often get asked by people not familiar with our industry the difference between indirect and direct spend or, more specifically, the difference between an indirect procurement management system and a direct procurement management system and how the two impact a business.
The generally accepted difference between direct and indirect spend is that direct spend goes into the raw materials and goods (or COGS-Cost of Goods Sold) that allow a company to produce and sell products or buy and sell products to end customers, while indirect spend is ‘back office’ purchases for the operations of the business.
From accounting transactions to the overall business, direct and indirect spend are vastly different. It should come as no surprise that managing them require different skill sets and tools. We often tell our clients that direct spend is about supplier management and performance while indirect spend is about spend management.
Why is it important to know the difference?
Direct spend has a direct impact on the top and bottom lines. The lack of parts and supplies can shut down factories and businesses, cause stock outages and drive up labor costs, hindering business goals. Issues involving direct spend hit the company’s customers – and therefore the financial statements. Real-world examples of this are the recent shutdown of a Ford plant this year and KFC stores closing in the UK due to a chicken shortage.
A hiccup with indirect spend could mean employees at the head office are disrupted or inconvenienced but production is rarely stopped due to incomplete or unreceived purchases.
So how does this tie into the evolution of procurement management technology? There are some unique business pain points associated with direct spend that indirect procurement management solutions do not solve. Here are some common pain points and how each solution manages them:
Changes in Purchase Orders: When dealing with direct spend one thing is constant – change. Change is pervasive for factories and distributors and happens on the purchaser side or on the supplier side. Ignoring changes and even reacting slowly to change could mean production downtime, increased inventory levels, and customer satisfaction risks. Direct procurement systems are built to manage change giving all parties the ability to quickly communicate and take near real-time action.
Many indirect management systems don’t handle the volume of change that regularly occurs in direct spend. For example, if it takes four weeks to get a new desk and chairs as opposed to two weeks, a business isn’t likely going to suffer. Therefore, most indirect spend systems focus on managing the spend and not managing the change. Indirect management systems don’t handle the volume of change that regularly occurs in direct spend.
Focusing on the User: Direct spend procurement teams and buyers are uniquely skilled compared to indirect buyers. Direct spend buyers understand the complexities of ERP/MRP systems. They are trained to read inventory reports and production schedules. Just in time (JIT), inventory turns, cycle counts, quality and return material authorizations (RMAs) are all a part of the day in the life for direct spent buyers. As such, direct spend buyers require specialized procurement solutions that automate their tactical work freeing them to focus on strategic parts of the business. From the shopfloor foreman to the CEO, direct spend management impacts the entire organization. This means having one source for communication and tracking, and maintaining communication on both the buyer and supplier side of the purchase. For most indirect buyers, purchasing isn’t their day job.
Changing Behavior: When looking at the difference between direct and indirect management solutions you need to think about whose behavior you’re trying to change. With indirect most of the time you are trying to change the buyers’ spending behavior within your organization. Most organizations want to standardize process internally and have staff who are not regular buyers follow a certain protocol.
In direct procurement, you’re trying to change the supplier behavior. A stronger buyer/supplier relationship is key, so most businesses need to direct suppliers on how to service your business by providing them a way to be proactive in communication and to your needs.
Despite the differences between direct and indirect spend, procurement still has an important role to play in all organizations. If an organization is moving toward automation, it’s important to know the differences between the two, and what business pain points a company is trying to solve.