Procurement functions are famous for slicing and dicing spend to bring it under management, but perhaps no ‘slice’ is quite as common as the division between direct spend and indirect spend, or not for resale goods. Direct spend includes all of the raw materials and components that will eventually be sold to the company’s customers, and indirect spend is pretty much everything else in the supply chain – excluding salaries, fees, and taxes.
While direct spend plays a large role in determining the size of a company’s top line, efforts made by procurement when sourcing indirect spend are relied upon to streamline operational consumption and defend the bottom line. Indirect spend management preserves net profit margin and the organization’s overall profitability.
Defining Indirect Spend v. Direct Materials
All companies have both direct and indirect spend, but depending on what kind of company you work for, your direct spend or direct procurement might be another company’s indirect spend and vice versa – it is a very contextualized categorization. The ownership structure of managing the spend may vary as well, with procurement professionals in retail companies usually getting their start in indirect and the exact opposite happening in the automotive industry.
For manufacturers, indirect spend usually includes all of their maintenance, repair, and operations spend, commonly known as MRO. For retailers, indirect spend includes shelving, office supplies, corporate travel, and location-based and corporate professional services (such as window washing and janitorial). Here’s a fun twist since we mentioned how contextual these spend categories are: for a manufacturer, property maintenance is usually considered indirect spend, while for a bank with teller locations it is often considered direct procurement because it affects consumer perceptions.
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Indirect Procurement in Practice
Indirect spend is predominantly driven by employee demand, compared to the consumer or sales-driven demand addressed by direct spend management. For years, indirect procurement teams and category managers have not only worked to put cost effective contracts in place, they have responded to internal stakeholder demand for procurement process automation to more closely resemble the B2C ecommerce experience – with more freedom and convenience. And the same efficient inventory management principles apply in both direct and indirect categories.
While indirect spend management is usually considered a bottom-line issue, it can absolutely have top line implications. Let’s say you work for a toy manufacturer and your business unit is packing up pallets of programmable robots for shipment to a wholesaler or retailer. The plastic film that will be wrapped around those robots prior to shipment is indirect spend. If in the process of determining the specifications for that film procurement underestimates how thick it needs to be, and some of them are damaged in shipping, you’re going to have a very unhappy customer. Strategic sourcing may lead to cost reductions on plastic film, but it could still cost you sales, or even a contract.
This is just one example, but every indirect product or service has to be available and function properly for related business processes to maintain continuity. Indirect spend may only affect competitive advantage indirectly, but it affects it all the same.
Indirect vs. Direct Supplier Relationship Management
Just like the differences between direct and indirect spend management, there can also be differences in the associated supplier relationships. In many cases, indirect spend management is all about cost savings, but it is unwise to oversimplify and assume that all indirect spend is transactional. Savings opportunities have to be weighed against the impact to the operation and customer.
Let’s go back to our toy robots and the plastic pallet film. Depending on how much your company spends with that film supplier, they might just approach you to help pilot a new film that is not only lighter weight and just as strong as what you are currently using, it either costs less or requires less per pallet to achieve the same level of stability. That would be a strategic opportunity, wouldn’t it?
Yet while indirect procurement can play a strategic role within an organization, companies that produce or distribute physical products must manage significantly more detail with direct spend. Not only is the majority of their spending direct, but managing a complex supply chain brings with it a large amount of change. Working with dozens or hundreds of suppliers to get the right parts on the floor at the right time means that orders are constantly shifting, supply is not always readily available, and supplier delays have domino effects on operations. We estimate that an average of 40% of purchase orders will change by the time the order has been delivered.
So while indirect procurement teams focus heavily on cost savings in their supplier relationships, direct procurement teams focus more on supply chain performance, or making sure their suppliers can provide the right materials at the right time.
All spend can potentially be strategic spend, whether your customer buys it from you or just comes into contact with it incidentally. The best procurement teams are big-picture thinkers and see opportunities to keep the end users (whether employees or customers) happy while protecting that all-important bottom line.
To learn more about how SourceDay can help your business manage indirect spend, talk with a member of our team today!