Direct vs. Indirect Procurement: What are the key differences?

The literal definition of procurement is the action of obtaining or procuring an entity or a commodity. Here, the term procurement is used in the realm of business. On the surface level, procurement might seem like it is all about acquiring supplies of an organization that needs to function daily. These include vendor management, fraud prevention, payment processing, invoice processing, quality control, etc.
However, there is more than meets the eye.

Procurement can be divided into two niches - direct and indirect procurement. While both are essential to the smooth functioning of any business, it is very important to understand their place in the business so that you can prioritize and emphasize where and how they are required.

What is direct and indirect procurement?

• Direct procurement

Direct procurement is the acquisition of raw materials and goods required for production. Such purchases are made in bulk amounts and are acquired from a supplier based on the best possible price, quality, abundance and reliability. This is necessary for the everyday functioning of a business. For example, For a chef, rice isn't just an ingredient; it's the lifeblood of countless dishes. Similarly, cement is the foundation for a builder, and metal is the backbone of the iron and steel industry. These essential commodities are more than just materials; they're the fuel that drives production and generates revenue through direct purchasing channels. Any disruption in their procurement can grind operations to a halt, sending shockwaves through entire sectors. This crucial need for consistent supply is why robust direct procurement software solutions often originate in the manufacturing industry, where even minor hiccups can have significant consequences. Ensuring a seamless flow in direct procurement processes becomes imperative to maintain the uninterrupted availability of these vital resources, underscoring the pivotal role of procurement software in sustaining essential supply chains.

•  Indirect procurement 

Indirect procurement is the purchase of services that are required to keep the business running. They do not directly influence the functioning of the business, but they do affect the outcome. It is defined as the activity directed at ordering goods and services that support your primary business but do not deliver directly to end customers. For example, in the mobile phone industry, silicon chips are a direct procurement commodity because, without them, a phone will not function, but a proper service center is an example of indirect purchasing. Would the manufacture of mobile phones get halted because of a lack of service centers? Of course not. However, would the outcome of the company as a whole be affected? Absolutely.

So, we pretty much understand the difference between the two in the basic form.

How to manage direct procurement?

Direct procurement process is one of the most overlooked yet important aspects of business operations. It is directly related to the processes involved in purchasing of the raw materials required to make a product. Managing it isn’t very easy, especially when it's across an organization with thousands of products and services.

Direct vs. Indirect Procurement

Procurement software involves the performance of two main functions. First, it is concerned with purchasing the core component of your products. Second, it is concerned with enabling you to meet your customers’ needs more effectively by granting you access to capital that will enable you to increase your inventory levels. Furthermore, this function is concerned with ensuring that the organization’s stock of raw materials has an appropriate turnover rate so as to enable not only efficient meeting of customer demands but also effective exploitation of assets. On the other hand, indirect procurement software functions are aimed at securing goods whose consumption does not have a direct effect on customers or production cycles. 

Here are three core areas of procurement where the distinctions between direct and indirect purchasing are laid-out:

1. Managing Supplier Relationships - Direct purchasing requires  suppliers to be on good terms with the company to ensure long term procurement of goods. However, in terms of indirect purchasing, companies focus mainly on expenditure. Hence, their focus is mostly on managing and reducing it. This is especially true in terms of companies that have little to no direct procurement requirements, such as software companies, digital marketing companies, etc.

2. Managing Inventory - Having the right amount of inventory on hand is essential for smooth production. It can be highly inefficient to hold large amounts of inventory if the expected demand level isn't known. Direct procurement is beneficial when you expect a constant stock level, when the purchasing process is rather traditional, when it takes time to place orders, when you deal with many suppliers and, in some cases, when dealing with very expensive and perishable goods. Indirect purchasing is more appropriate when inventory levels fluctuate dramatically in accordance with production cycles, in environments in which customization is possible and when time-to-market is required

3. Organizational Structure - In most companies, direct costs are managed by centralized procurement and supply chain teams, with category managers focusing on specific areas of spend, whereas indirect purchasing in most large organizations tends to be decentralized in nature. Organizations have multiple stakeholders with independent budgets and spend management protocols, resulting in inefficiency in the indirect procurement process. Lack of centralized structure for indirect spending leads to operational inefficiencies. A significant proportion of global Fortune 500 companies are moving to managed indirect outsourcing, saving 10–18% of their overall operating costs each year.

In a Nutshell

Inefficient procurement management directly impacts the bottom line. Without well-defined and streamlined procurement practices, businesses experience high overhead costs. The objective of procurement is to make the best purchase at the right price for the right item, at the right time and in the right quantity and quality within the organization. Businesses need to invest resources towards understanding about what differentiates direct from indirect procurement. It must be noted that it is imperative that direct and indirect purchasing go hand in hand in industries that require it. One is not more important than the other. By focusing on both direct and indirect procurement, organizations can cohesively grow by honing in on the holistic view of the procurement field.