Understanding Indirect Procurement – How Indirect and Direct Purchasing are Different and their Impact on your Business Bottom-line
Procurement is commonly defined as a tactical, process-oriented function where not many strategic decisions are made. Traditionally procurement has been described as an essential record keeping department that ensures that the organization follows industry norms and allows the organization to be audited. Procurement can be sub-divided into two categories – Indirect procurement and direct procurement.
This blog post attempts to demystify indirect procurement, how indirect and direct purchasing are different and their impact on your business bottom-line. Further, we look at the challenges businesses face while managing indirect procurement.
What to look forward to:
• Importance of procurement as a business process
• Direct and Indirect Procurement with examples
• Is indirect procurement as valuable as direct procurement?
• The business impact of procurement on businesses
• Challenges in Indirect Procurement
• How to manage indirect procurement
Defining Indirect Procurement
Indirect procurement is the process of acquiring resources that support the ongoing existence of the business.
Example of Indirect Procurement
An organization creating smartphone apps would require little resources by way of direct procurement but may still need resources through indirect procurement like office supplies, software, systems and so on.
Defining Direct Procurement
Direct procurement is a process to acquire resources that go into building the actual product or service the business is offering.
Examples of Direct Procurement
For a smartphone manufacturing organization, direct procurement would mean acquiring the resources like chips, processors, screens and so forth that are directly related to the offering of the business.
For a product-based business, both direct and indirect procurement complement each other and create a balance for the smooth functioning of the operations.
For a service-based business, indirect procurement plays a more prominent role compared to direct procurement.
Indirect Procurement – Impact on Business
Indirect procurement requires spending on a case to case basis. Indirect procurement helps the organization for smooth functioning and gets decentralized in nature. It receives lesser visibility and a proportionately lower share of investment concerning resources. However, if indirect spends don’t get appropriately managed, it can hurt the bottom-line negatively.
Comparing indirect procurement to direct procurement, the latter requires spending upfront. Direct procurement helps the organization generate revenue, shape the consumer experience and has the power to create/damage the organization’s reputation and is centralized. It receives more visibility and a larger share of investment concerning resources.
Is indirect procurement as valuable as direct procurement?
Some professionals view spend as spend, no matter if it comes from direct procurement or indirect procurement, while others maintain that direct procurement is more valuable than indirect procurement. The point drives their rational explanation that without a successful product/service, spending in indirect procurement is of no use.
So, should you consider indirect procurement as valuable as direct procurement?
There needs to exist a certain degree of balance between direct and indirect procurement. All businesses have a certain degree of indirect procurement built-in – whether it is service based, or product based.
As an analogy, if direct procurement is a car, indirect procurement is the fuel that keeps the car running. So, to answer the question, both direct and indirect procurement complement each other. Neither type of procurement is optional anymore.
Indirect Procurement – The Main Challenges
Now that the distinction between the two types of procurement is clear, let’s look at why enterprises are not directing their prioritization towards indirect procurement.
Indirect procurement, is a complex function that involves a myriad of challenges. A study by NelsonHall found that 80% of the surveyed organizations considered indirect procurement to be delivering against expectations. But why? We need to explore the roadblocks that plague this function:
1) Large Number of Stakeholders and Commodity Groups Involved
Since indirect procurement caters to the daily functioning of the internal stakeholders, it is often decentralized to the various departments – HR will involve recruitment and training, Marketing will involve contracting with advertisement agencies and so on. This results in many internal groups involved, procuring multiple commodities across numerous categories.
2) Sporadic Buying, Maverick Spending and Poor Supplier Performance Visibility
Given the large number of stakeholders and categories involved, absence of dedicated procurement teams and mandated spend policies, there is rampant sporadic buying behavior by various business units. This sows the seeds for complex supplier relationships that do not produce any value for the organization as well as maverick spending. This also inhibits visibility into the suppliers’ performance and increases associated risks. Consequently, Zycus’ Pulse of Procurement 2018 revealed poor visibility into supplier performance as one of the major pain points for procurement professionals.
3) Lack of Visibility into Spend Data and Missed Savings Opportunities
After getting a glimpse of the sheer complexity, lack of transparency into indirect spend data is the next evident roadblock. Since this is caused by the numerous categories under which spend data need classified, we can imagine the consequence of this – it prevents procurement teams, and the organization, from identifying and increasing cost savings in indirect procurement. How do we control something we can barely identify?
Additionally, when we look at direct procurement, the transactions usually have high monetary worth. The procurement teams have powerful relationships with suppliers that allow them to negotiate for higher discounts and hence, are able to recognize considerable savings opportunities. Indirect Procurement misses this mark as volume of transactions is large and disparate with large number of stakeholders involved while the monetary worth is low.
In the backdrop, Pulse of Procurement 2018 found that 54% of the global procurement leaders consider cost savings as a top focus area.
4) Lack of Expertise
To manage the complexities that arise from indirect procurement, organizations require skilled personnel that have expertise in aspects like category and change management, contracting, managing supplier relationships and data analytics. Majority of the enterprises lack people involved in indirect procurement who will have the required skillset to effectively manage indirect procurement processes. Pulse of Procurement 2018 also revealed shortage of skilled/talented procurement workforce as one of the major 2018 pain points.
Well, this is not a pretty picture.
However, it is in the challenges where true potential lies. A study by EY on ‘Indirect Procurement Optimization’ found that by optimizing indirect procurement processes, enterprises can achieve savings up to 25%. In the current global scenario where competition is fierce and inflation levels are rising, organizations need to save wherever they can to stay afloat.
Managing Indirect Procurement – Adopting Best Practices as the Way Forward
In order for you to overcome the challenges and extract opportunities, Zycus’ whitepaper on ‘Mastering Indirect Spend – Five Keys to Success’ has listed out ways to optimize and manage indirect procurement:
1) Implement tools to identify and categorize expenditure
The Achilles Heels of indirect procurement would be the large number of unclassified, random expenditure categories that are immensely difficult to track. Add to that the number of stakeholders dispersed across the organization with no measurement systems and procurement mandates, well, it just makes it even worse. Hence, the need to implement a holistic expenditure tool to track, identify and categorize the expenditure categories is unequivocal.
It is crucial to know that while, typically, category managers working with direct materials have ownership of both the process and expenditure; indirect category managers simply execute the procurement process without having any ownership of the process and expenditure. For them to implement best practices, having and utilizing their leadership and skills to influence cost, timing and stakeholders is important. Having an integrated and well-structured expenditure tool will further aid this.
2) Building cross-functional teams
Once you have an expenditure tool in place for effective categorization, it is also important to have cross-functional or cross-business teams in place. A cross-functional team, that represents all business units in an organization, will outline the vision and mission of the procurement process, define responsibilities and accountability for each unit, identify all stakeholder needs and requirements and ensure their alignment. This will allow procurement teams to effectively manage the various indirect expenditure categories and avoid duplication of efforts and costs.
3) Build a procurement team that will minimize stakeholder apprehension
We know that, in a lot of scenarios, business units view the procurement teams as the policy policing unit that dictate adherence to the procurement process, ethical standards, etc. that simply lead to delays and unnecessary red tape in the organization. The stakeholders are apprehensive that strictly following the procurement policies can inhibit the relationships they have with their suppliers. They’d prefer to engage with suppliers on their own terms rather than competitive biddings or auction processes.
Well, that makes management of indirect procurement and achieving cost reductions in it rather difficult.
So, it is important to build a good procurement team that will not only outline the procurement processes but will also understand the stakeholders’ business needs. Reducing stakeholder apprehensiveness will motivate them to adopt best practices that will help optimize procurement of indirect materials. It will further help if the procurement teams work closely with the cross-functional teams to ensure complete optimization of indirect procurement processes.
4) Predefine savings to avoid its vaporization
It is common to see that due to the absence of pre-defined savings disposition, despite achieving savings in indirect procurement process, it is not visible in the organizations’ profit and loss statements. To put it clearly, if the procurement team saves $1,000 in the administrative budget, the admin team will spend that $1,000, on more office supplies for all business units, as it is still in their budget. To avoid vaporization of savings, prior to the indirect procurement process, all the involved stakeholders need to define and mandate what happens to the realized savings.
5) Design a governance structure to guarantee success
Leadership support forms the building blocks for assuring efficient management of indirect procurement process, or for that matter, any process in an organization. In its absence, even with optimization policies in place, it is difficult to deliver the value that the enterprise is attempting to achieve. A well-structured governance structure needs to be there invariably to set and approve strategies, targets and budgets for the business units; decide what needs to be done with the realized savings, assess projects and remove related roadblocks. One can imagine that in the absence of top management support, stakeholders can lose priority and participating in implementing any of the best practices and simply adhere to what they feel is best.
If you still want to gain more in-depth insights on managing indirect procurement, visit Zycus’ on-demand webinar featuring Bill Michels, CEO, Aripart Consulting.
In a Nutshell
In conclusion, it is important to understand what differentiates indirect procurement from direct procurement – it shows us why it is time to invest organizations’ resources towards identifying the challenges and adopting best practices to manage the phenomenon that is indirect procurement. It can clearly not be ignored, especially if you want to compete in the current global as well as local scenario. It goes without saying that enterprises still need to focus on their direct procurement processes and continue their path of optimizing the same. The need of the hour is to get indirect procurement on the path as well.
Food for Thought
After reading this, are you questioning the very dichotomy of procurement? Are you wondering if it’s still relevant to differentiate procurement processes the way we have done for the longest of times? After all, this bifurcation held true and relevant for manufacturing organizations where the lines between direct and indirect procurement were distinct. But in the current scenario, where majority of the economies are service-led, and the lines are blurring, is it still useful, or even beneficial, for organizations to perceive and execute procurement the way we have seen?
Let us know your thoughts in the comments section below.
– Written by Jijnyasa Patowary & Viral Doshi