Companies have many types of spend, contracts, and supplier relationships. The procurement processes associated with each category of spend determine how it is sourced and what type of value it delivers to the organization. One of the most important divisions is between direct spend and indirect spend. Procurement teams that know the difference between direct procurement and indirect can not only better inform procurement strategy, sourcing, and supply chain management, it can set expectations for critical supplier relationships.
Direct Spend Defined
Direct spend includes all of the raw materials, components, and products that will eventually be sold to customers — even if it will be in an altered or assembled form. If your company is a bike manufacturer, direct materials may include tires and breaks; if your company is a retailer it might be the produce on grocery store shelves or the sneakers displayed in a front window. The most important thing about direct spend is that it will eventually end up in a consumer’s hands. Direct spend determines the size and health of the corporate top line. The more efficiently it is managed, the higher your gross margin — and bottom line — can be.
Direct Procurement vs. Indirect Procurement
Unlike indirect spend, which includes the products and professional services required for a company to operate but is not intended for resale to customers (such as office supplies), the cost savings and value associated with direct spend are passed along to consumers. Companies need to work closely with their suppliers to innovate and manage change, ensuring that quality standards are met and orders show up on time so production lines run as expected. In many cases, direct spend flows through an ERP system, where purchase orders from buyers meet invoices from suppliers. Because of this, the automation and business processes applied to direct spend are absolutely critical.
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The Direct Spend Difference
Speaking of purchase orders, a large number — averaging 40% — of direct spend PO lines can be expected to change before it is complete. This makes direct spend transactions harder to manage than indirect procurement ones, from the start of the process to the end. It’s harder to manage outstanding orders, get materials on time, and pay invoices. ERPs are not meant to handle this much change, so employees are often the go-between when things like delivery dates and quantities change. When change isn’t managed well, it could result in interrupted production, wasted inventory, and frustrated suppliers.
Procurement software functionality typically isn’t up to the task either, since eprocurement doesn’t usually anticipate the level of complexity that naturally accompanies direct spend.These solutions are more often geared toward indirect spending.
Supplier Relationship Management & Direct Spend
Because direct spend links a company’s suppliers and customers, effective management has always relied on strong, collaborative supplier relationships. As digital business increasingly becomes the norm, those relationships need tools to support them — tools that facilitate communication and allow the supplier relationship to be analyzed. Organizations should be able to see key metrics like how often suppliers deliver on time, how often they acknowledge new POs, and how quick they are to respond to questions or changes. This way both parties can look for ways to improve supply chain performance.
At the end of the day, suppliers should be strategic partners when it comes to managing direct spend, and any procurement solutions put in place to assist these transactions should make them feel as strategic as they are.
The success of direct spend management is usually measured and tracked in much the same way that the company’s performance as a whole is tracked; metrics like work-in-progress (WIP) inventory management and production line capacity are common because they are closely linked to competitive advantage. Poor direct spend management can lead to tied up lower profit margins, cash flow, crowded warehouses, and missed order fulfillment. No procurement function wants to be associated with processes that lead to customers being told their orders can’t be filled. And so the relationships, responsibilities, and technologies associated with direct spend are among the most important in any company.
To learn more about how SourceDay can help your business manage direct spend, talk with a member of our team today!