Direct vs Indirect Procurement – What’s the Difference?

From raw materials to office supplies, procurement is the backbone of any business. It involves the entire acquisition process, from identifying suppliers and negotiating contracts to managing deliveries and ensuring quality control.

But within this broad umbrella, there are two main categories: direct procurement and indirect procurement. While they both involve acquiring items a business needs, they differ significantly in what they acquire and how they are managed.

Understanding these distinctions is crucial for anyone involved in the supply chain, including engineers, as it affects everything from project costs to overall business success.

Direct Procurement

What is Direct Procurement and its role in business?

Direct procurement involves acquiring the raw materials, components and parts that are physically transformed or assembled into finished products. These are the core supplies that directly impact a company’s ability to produce and sell its offerings.

Effective direct procurement directly influences a company’s profitability and competitive advantage.

What are the common examples of Direct Procurement?

Examples of direct procurement include:

• A car manufacturer procuring various metals, tyres and engines for its vehicles.

• A clothing company buying fabric, buttons and zippers for its garments.

• A software company licencing specific software components to integrate into its own product.

• An aerospace company purchasing specialised alloys, composites and high-performance fasteners for aircraft construction.

• A medical device manufacturer directly procuring biocompatible materials, microelectronics and miniature components for their products.

What is the impact of Direct Procurement on different business factors?

Direct procurement has a significant impact on a company’s profitability and competitive advantage in several factors including the following:

• Cost savings: Negotiating favourable prices for raw materials and components directly affects production costs. Lower material costs translate to lower prices for the finished product, allowing companies to remain competitive in the market and potentially achieve higher profit margins.

• Quality control: Ensuring high-quality raw materials and components are used minimises product defects and rework which can be costly to fix. Accordingly, maintaining quality control directly influences the final product’s quality and reputation, leading to customer satisfaction and potentially reducing warranty claims.

• Supplier relationships: Building strong, reliable partnerships with direct material suppliers is crucial for securing a consistent flow of essential materials and maintaining production schedules. Delays or disruptions in the supply chain caused by unreliable suppliers can halt production and significantly impact revenue.

How is Direct Procurement managed?

When it comes to effective direct procurement management, the focus is often on three key areas:

• Strategic sourcing: Identifying and collaborating with the best suppliers who offer quality materials at competitive prices. This involves the collaboration of procurement teams with internal stakeholders like engineers to identify the best suppliers based on factors like quality, cost and reliability.

• Inventory management: Maintaining optimal stock levels of direct supplies (raw materials and components) to avoid production delays and without incurring unnecessary storage costs. This may involve company utilisation of just-in-time (JIT) inventory practices to minimise storage needs and optimise cash flow.

• Strategic suppliers relationship management: Developing strong, long-term partnerships with key suppliers for mutual benefit. Beyond price, strong supplier partnerships foster open communication to identify cost savings, improve processes and drive innovation. This might involve joint planning, early supplier involvement and shared performance metrics.

Indirect Procurement

What is Indirect Procurement and its role in business?

Indirect procurement deals with acquiring goods and services that are necessary for a company’s day-to-day operations but do not directly become part of the final product. These are often referred to as indirect spend or business expenses.

While not directly impacting the production process itself, indirect procurement significantly influences a company’s bottom line through cost optimisation.

What are the common examples of Indirect Procurement?

Examples of indirect procurement include:

• Office supplies: Paper, toner cartridges, pens and sticky notes.

• Facilities management: Cleaning, security, waste disposal, maintenance of equipment and buildings.

• Information technology (IT): Software licences, hardware purchases and IT support services.

• Marketing and advertising: Materials used for promoting a company’s products or services.

• Professional services: Consultants, lawyers, accountants and engineers.

What is the impact of Indirect Procurement on a business’s bottom line?

While not directly impacting the production activities and final product, indirect procurement significantly influences a company’s bottom line through several factors including the following:

• Cost optimisation: Indirect spend, which refers to the total expenditure on indirect goods and services, can represent a substantial portion of a company’s overall budget (15-30%). Efficient indirect spend management and finding ways to reduce spending on non-essential supplies and services, through strategies like volume discounts, tail spend optimisation, utilising multiple vendors or consolidating purchases through indirect procurement processes, can free up resources for core business activities like product development or marketing.

• Streamlined processes: Implementing standardised indirect procurement process for frequently purchased indirect goods and services can save time and reduce administrative costs associated with requisitioning, approvals and purchase orders. Streamlined processes allow employees to focus on more strategic tasks.

• Improved efficiency: Indirect procurement can impact efficiency in various areas. For example, choosing the right facilities management provider can ensure a well-maintained work environment, potentially reducing equipment downtime and improving overall operational efficiency.

How Indirect Procurement is managed differently from Direct Procurement?

The approach to indirect procurement differs from direct procurement. While direct procurement management often focuses on strategic sourcing, inventory management and key strategic supplier relationship management, indirect procurement management often focuses on cost control, streamlining processes and managing a wider range of operational suppliers.

Supplier relationships remain important, but the emphasis on indirect procurement typically shifts towards finding the most cost-effective solutions for indirect goods and services through operational suppliers rather than building long-term partnerships with strategic suppliers.

Accordingly, effective indirect procurement management mainly focuses on three major areas:

• Cost control: Collaborative forecasting by procurement teams with internal departments, like facilities, marketing or IT, to identify and source indirect needs allows for targeted cost reduction through vendor consolidation and price negotiation. It also ensures optimal inventory levels and minimises unnecessary spending on indirect goods and services.

• Processes streamlining: Indirect procurement often involves standardised procedures for purchasing frequently needed items. This may include utilising e-procurement platforms to automate routine tasks associated with indirect purchases.

• Operational suppliers relationship management: Companies may utilise a wider range of vendors for indirect goods and services compared to those used for direct procurement, hence, leveraging competition to drive down prices.

Key Differences

The following table summarises the key differences between direct and indirect2 procurement:

Best Practises

For effective direct procurement:

• Develop strong supplier relationships: Building trust and collaboration with key direct material suppliers ensures a reliable flow of high-quality materials.

• Implement strategic sourcing: Conduct thorough market research to identify the best suppliers based on factors like cost, quality and delivery times.

• Maintain optimal inventory levels: Balance having enough direct supplies to avoid production disruptions with minimising storage costs.

For efficient indirect procurement:

• Standardise processes: Implement clear procedures for requisitioning, approving and purchasing of frequently needed indirect goods and services.

• Leverage technology: Utilise procurement software to automate tasks, track spending data and identify areas for cost savings.

• Negotiate effectively: Negotiate favourable pricing and terms with vendors, especially for high-volume indirect purchases.

Real-world Examples

Tesla

Direct Procurement:

• Lithium (for batteries): A critical raw material for Tesla.

• Silicon (for semiconductors): Tesla heavily relies on semiconductors for its electric vehicles.

• Aluminium (for car bodies): Tesla uses aluminium for its lightweight car bodies.

Indirect Procurement:

• Factory equipment (e.g., robotic arms): Needed for welding and assembly operations but not directly part of the car.

• Marketing and advertising services: To promote Tesla vehicles.

• Software licences (e.g. CAD software): Used for designing and engineering Tesla products.

Boeing

Direct Procurement:

• Titanium (for aircraft structures): Provides strength and reduces weight.

• Jet engines: A crucial component of aeroplanes.

• Avionics (flight control systems): Essential for safe and efficient flight operations.

Indirect Procurement:

• Office equipment and furniture: Needed for administrative functions.

• Information technology services: To maintain Boeing’s IT infrastructure.

• Maintenance, repair and overhaul (MRO) services: For upkeep of Boeing’s aeroplanes.

Conclusion

Both direct and indirect procurement play crucial roles in a company’s success. One key difference between them is their focus. Effective direct procurement ensures a steady supply of high-quality materials for production, while efficient indirect procurement controls cost and optimises business operations.

In today’s digital age, technology plays an increasingly important role in modern procurement practises, with tools and platforms facilitating better supplier management, spend analysis, and overall process optimisation.