In the business world, procurement divides into two categories: direct and indirect procurement. These two types of acquisitions are related, but only insofar as they both involve spending. Otherwise, they are virtually contradictory from one another. They have total autonomy, and they play very different roles in the business process.
Knowing the difference and understanding how each kind of procurement affects your business will be helpful when you develop ways to increase your company's revenue stream.
What is direct procurement?
When the average person considers procurement, direct procurement likely comes to mind first. This type of spending is directly tied to the final product or service that your business offers. It includes things such as:
- Raw materials.
- Pieces of the final product offered for sale.
- Labor needed to create your product or provide your service.
Manufacturing companies have a significant focus on direct procurement because, without this type of spending, they could not produce the items that generate their revenue. Without machinery and raw goods, there is little for a manufacturing company to do - and it would cease to function without appropriate procurement processes.
The impact of direct procurement on your revenue stream
Direct procurement is so well-known because there is an express connection between the company's bottom line for each product and the materials that go into them. It is much easier to see the tie between, for example, a five-cent drop in the cost of a needed raw material and the overall cost of a finished product. The connection between direct procurement and your revenue stream is readily apparent and it can be ascertained quickly, with very little analysis.
There is an easy-to-see, direct connection between external profits and direct procurement. Because of this visibility, it's understandable that direct procurement is often the focus of most spending concerns. However, controlling spending effectively also requires that you address indirect procurement as well.
What is indirect procurement?
Indirect procurement is often synonymous with administrative spending, but that definition is not indicative of how far-reaching indirect procurement can be.
Indirect procurement does not have the same recognizable connection to your end product or service. Instead, it is only indirectly related to what your company produces or provides to the end user. Because of the lack of direct connection with this type of spending and the end product or service, it is harder to recognize and manage indirect procurement. Visibility and having a means to efficiently track this type of spending is the first step in controlling it effectively.
There are two types of indirect procurement:
- Operating Resource Management (ORM).These resources generally include things such as office supplies, travel services, and other daily expenses. Although these expenses do not have a direct tie to the final product, they keep the company moving. Without them, you would have a hard time creating an end product for your customers.
- Maintenance, Repair, and Operating (MRO). These expenses are related to the upkeep of your equipment, building or other resources. While these expenses are not central to output, the production process tangentially consumes them.
Indirect spending can be a significant part of your budget in many types of businesses. Generally, anything that you refer to as "overhead" is likely a type of indirect spending. While indirect procurement is vital for your business, it is much harder to see the benefit to your bottom line regarding the specific connection to a product or service.
It is also challenging to track indirect spending, especially if you have more than one person who can initiate this type of process. Visibility is low and sometimes non-existent until after the fact, making controlling indirect procurement extremely difficult.
The impact of indirect procurement on your bottom line
Indirect procurement has a profound impact on your day-to-day functionality. It helps an organization run smoothly from an internal perspective, which, in turn, enables you to create an end product or service that meets your customers' needs.
Every cost will have an impact on your bottom line, but the connection is harder to see with indirect spending. Decreases in indirect procurement, for example, will not have the same dollar-for-dollar impact that a reduction in direct spending will have. It may take more time to see the subtle benefits of decreased spending on indirect procurement.
The interplay between direct and indirect procurement
You need both direct and indirect procurement to run a successful business. One is no less important than the other. Without an end product made up of raw materials and made by the workforce you pay, you would have no product to offer your clients. However, without very basic office supplies that your business needs to function, you may not have the means to create a product or provide a service, even if you have the appropriate raw materials.
If you are not managing both types of procurement proficiently, your company will not remain viable and growth may be impossible.
Negotiatus can help you monitor and control indirect spending, which has lower visibility because of its lack of direct connection to a final product or service. Our spend management platform offers you a meaningful way to track, analyze and control indirect procurement at every level in your business - no more maverick or tail spending. Are you ready to get started?