Every business that deals with sourcing vendors and making purchases uses the process of indirect procurement in various ways. Depending on an organization’s size and complexity of purchases, the indirect procurement process can have strong consequences on a company’s spend management and total revenue. As the use of professional services and digital software tools has risen in the past few years, the practice of optimizing indirect procurement methods is taking focus
How is indirect procurement handled? What’s the difference between direct and indirect procurement? And what can you do to ensure the highest revenue for your business without sacrificing the quality of goods and services you will be purchasing?
What is Indirect Procurement?
The indirect procurement process optimizes purchasing for goods, supplies, services, and materials not directly related to manufacturing a business’s product output. These items include anything used to maintain day to day operations, such as:
- Office supplies, hardware, and equipment
- Travel expenses
- Marketing services (e.g. advertising, writers, agencies)
- Human resources (e.g. recruitment, onboarding, and training)
- Professional services (e.g. advisors and consultants)
- Outsourced services (e.g. IT and accounting)
- Software licenses (e.g. SaaS subscriptions)
- Capital expenditure
- Rent for facilities
- Utilities, maintenance, and repairs
Indirect spend takes up only a portion of the overall procurement function (with many professionals citing 15% to 30% of total revenue coming from indirect sources). Nonetheless, its importance has increased significantly in recent years.
Indirect costs have been rising as many organizations began selling virtual goods and services over manufactured products. This trend has prompted management groups to focus more on indirect procurement optimization.
Distinguishing Direct and Indirect Procurement
The distinction between direct and indirect procurement is an important one to make since, while both work towards more cost effective spending, they still fulfill different functions.
Direct procurement teams largely deal with buying the raw materials needed to manufacture the goods sold by the firm. You’re ultimately buying items that you later sell to the end consumer after some processing. These direct materials differ immensely depending on what the company outputs. Examples of direct procurement include:
- A restaurant ordering vegetables, meats, and beverages
- A laptop manufacturer buying motherboards, hard drives, screens, and keyboards.
- A fashion brand might source cotton, silk, and fabrics.
Exact differences between direct and indirect spend are:
- Company policy. Direct purchasing typically occurs over a centralized management team and a rigid budget. Indirect purchases are often decentralized, focused on the smaller parts of the business with their own unique needs and approvers. A formal approach to indirect procurement is necessary to prevent inefficient or rogue spending.
- Inventory management. Through demand forecasting and supply chain management, mapping out direct purchases is relatively straightforward. You order just enough to avoid a costly surplus while preventing shortages. By contrast, indirect sales are naturally made on-demand and can be challenging to plan out in advance.
- Supplier relations. A company with an enduring product line is likely to use the same suppliers to manufacture those items. The vendors you make direct purchases from are thus long-term, resulting in mutual understandings regarding expectations, contract terms, and delivery schedules. By comparison, indirect transactions are short-term, and you pick suppliers based on price efficiency and short-term benefit.
- Management focus. Administrators allocate varying amounts of the budget towards direct and indirect expenses. Industries like manufacturing have most of their attention and funding on direct purchases, whereas service-based companies rely on indirect.
In the past, direct spend took up almost all the attention of administrators because it had direct implications on the bottom line. Today, however, we’re starting to see a greater focus on indirect procurement, and a mixture of the two is the best approach for real-world business processes.
Direct and indirect procurement are also starting to merge together in recent years with the advent of the service economy. Many businesses today sell as-a-Service software products or operate mostly online, which is making a lot of “indirect” purchases produce rather direct results. Either way, knowing the two types helps you better understand what indirect procurement includes and deals with.
Finance and Indirect Procurement Responsibilities
Not all companies will have a dedicated procurement team. Often, the role of procurement and making purchases falls under the finance team. Those responsible for indirect procurement must do more than just finding the lowest price. Indirect procurement functions can include reworking internal operations to lower the number of needed purchases and building strategic relationships with suppliers for more favorable contract terms.
What you generally need is an understanding of your supplier base, supply chain, and overall business goals. Combined with modern tools and eProcurement solutions, and you’ll be able to achieve a high return on investment. Aim to have the following mindsets during your journey:
- Cost control. Aiming for the lowest price isn’t always the best option. Negotiate with suppliers or even consider changing vendors entirely. You can also bundle together purchases for bulk discounts or adjust the specifications of the products you order to lower prices.
- Willingness to automate. Process automation has matured as a field in modern business, but those same companies statistically do not invest in eProcurement solutions as often as they should.
- Corporate social responsibility, CSR. This consideration requires that indirect procurement decisions face the same social responsibilities expected of the company. Doing so upholds the organization’s reputation.
Overall, expect the procurement team to create value for the internal stakeholders, whether they are internal customers, administrators, or the suppliers.
What Skills Do These Procurement Professionals Need?
With a wide variety of purchases day-by-day, indirect procurement processes can become complicated and broad. Procurement professionals should have an understanding of:
- Supplier relationship management. This can include selecting vendors, negotiating terms and conditions, and other related tasks.
- Category management, a strategy where category managers consolidate similar products and services needed throughout the company for maximum price efficiency.
- Support for multiple subsidiaries. Not only are there dozens of business units contributing to indirect expenditure, but they also might be from different nations.
For corporations operating in multiple regions, indirect procurement activities should be handled at a local level, as local professionals understand the culture, laws, and contacts relevant to the area.
How Do Indirect Procurement Processes Save You Money?
Indirect procurement processes boost revenue by:
- Reducing maverick spending. An official process will help to identify spend that’s unaccounted for and allow you to make appropriate changes.
- Consolidating purchases. Consolidating the demand for similar purchases not only simplifies bookkeeping but also might open the door for bulk discounts.
- Cleaning up the supplier base. Not all vendors will give you a positive experience. Robust supplier relationship management can weed out less reliable vendors and ensure you receive a consistent consumer experience.
- Deploying automation. Software solutions are largely replacing many of the manual aspects of procurement, reducing human error. Data collection is a benefit here, as finding savings opportunities and making informed decisions is easier when you have the right information.
The Challenges of Indirect Procurement
Working with service-based purchases is already a different process entirely from purchasing manufacturing materials, so indirect procurement teams need to have their own dedicated approach. Some possible challenges are:
- Sheer scale. From large contracts with dozens of suppliers to the hundreds of spend categories, there can be a lot on your plate at any given time.
- Low visibility. Approvers aren’t always involved from the beginning or kept in the loop throughout. This can cause bottlenecks and lead to missing information.
- Controlling spend from the start. With various purchase requesters and approvers, it can be hard to see the big picture and know where necessary spending is occurring. Streamlined processes help to create both visibility and control.
With the right preparation, any company can realize the benefits of indirect procurement, build better contracts with suppliers, and empower better purchasing environments. Let’s get into the strategies and best practices to do so.
Procurement Strategies and Best Practices
Working towards this key business process is about more than just achieving savings; it also aims to prevent overspending, increase visibility and control, improve facilities management, and better manage suppliers.
What are the key differences between a successful indirect procurement approach and an ineffective one?
Aim For High Spend Visibility
The reason so many purchasing processes are inefficient is that they’re fragmented and usually made without comprehensive approval from the organization. When you increase visibility into financial activity, you’re opening the door for procurement optimization.
Clean Up All That Data
Inconsistency is a prominent challenge for indirect spending. All that on-demand spending comes in many formats and from many different departments. In order to make sense of it all, data management practices help clear up the clutter, make data analytics more consistent, and pave the way for transparency.
Practice Strategic Sourcing
Start by looking at your contracts to find ways to save. Then, collaborate with suppliers to make those savings a reality. Align your efforts with the overall goals of your company and create your own standards to compare your performance against.
Rework Your Supplier Base
Tying into sourcing strategies, much of your work deals with negotiating new contracts, facilitating positive communication with suppliers, and monitoring vendor performance. Money should be spent ethically and sustainably.
Educate Staff on Indirect Procurement
Since employees are ultimately the ones making these purchases, the procurement team should focus on educating everyone in the company about the new policies in place. What steps are you taking to boost procurement efficiency, and how can individual employees help?
Software solutions designed for indirect spend management often have guidance and other resources for employees to train themselves on the implementation of these new policies. This process is known as “change management.”
Make your new policies clear and understandable. The more difficult it is to comply, the slower the results will be.
Working With the Finance Department
Procurement and finance have interlinking responsibilities. Spending performance can be analyzed through collected financial data to give you context for future strategic procurement practices. Life for AP is also easier when procurement and finance are synced and on the same page.
Consult a Group Purchasing Organization (GPO)
Commonly used in the healthcare industry, GPOs aggregate demand from multiple companies and use that total purchasing volume to leverage bulk discounts with distributors. They can also reduce supplier risk and save you time and effort in finding potential vendors to work with.
Take Advantage of Digital Tools
Software and automation have already empowered businesses to become more productive, and the same holds true for cloud eProcurement solutions. Automation will help you actualize your new strategy by reducing human error, creating much needed visibility, and providing you with more accurate spending data analytics.
Accessible dashboards for data analysis can show off your cost savings and beneficial partnerships to upper management, as well as giving you more direct control over your spending. Such a dashboard also makes it easier for anybody both within and outside the procurement team to contribute.
Pitfalls And Common Mistakes To Avoid
Indirect procurement optimization can’t occur when you don’t have experienced team members and a modernized software-based approach. But even with a strong foundation, avoid making these common mistakes during negotiations with suppliers.
- Don’t rush to make a decision. Vendors who know that you don’t have many other viable options will naturally raise the stakes. Make all the concessions you need from your preferred choice first before revealing your decision.
- Hide your budget. Suppliers know how to maximize their own side of the deal, so don’t reveal to them your total budget and consequently reduce your ability to negotiate more favorable terms.
- Get the timing on your side. A vendor can also use timeframes to its advantage. For instance, you might need to close a sale before the end of a current quarter. Don’t reveal this information during the meeting either to avoid giving leverage.
Reduce costs, make better deals with vendors, and gain the best competitive advantage you can get from indirect procurement today. Getting started with an eProcurement solution for internal use is a huge first step.