What's the difference between Direct and Indirect Procurement?

TLDR:

• Direct Procurement: things a company buys to put into a product it sells to customer
• Indirect Procurement: things a company buys to consume itself.

Direct procurement is the purchasing of goods used in the core product of a given business. The goods and services bought through direct procurement ultimately find their way to the end customer or client.

Using Tesla as an example, Direct Procurement would be buying:

• car parts
• lithium and cobalt for battery cells
• seats, to be installed in the vehicle
• and arguably even software licenses for infotainment

It's direct because the parts are going directly into the core product, the electric vehicles, and would eventually make it into the hands of end-user customers.

By contrast, Indirect Procurement is the purchasing of materials and services that the business uses itself. Looking again at Tesla as an example, indirect procurement would be when Tesla buys: office chairs, employee computers, soap, fire extinguishers, pencils, etc. These items (while still essential for the operation of the business) are simply not part of the core product, nor will they end up in the hands of consumers.

Depending on the type of business, what is considered direct versus indirect can vary. Items that are classically indirect, like office supplies, would be categorized as direct for companies like Staples, Office Depot, or Grainger.

The simple question to differentiate is: "will these goods end up in the hands of our customers?" If so, it's direct, otherwise indirect.

Difference in Approaches and Roles

With different categories, come different category strategies.

Teams working with large volume direct purchasing need to invest heavily in supplier relationship management. Direct teams invest an enormous amount of effort into finding the right supplier partners and working collaboratively with them (See our blog post on Supplier Partnership Hierarchy). Suppliers are often selected based on both cost and capability.

These tightly integrated relationships are important for maintaining timelines, quality, and credibility. They tend to last longer than their indirect counterparts, and they have greater strategic importance to the firm.

In indirect, the emphasis is far less on who and more on how much. With many of the goods being effectively interchangeable, vendor relationships are more transactional, with cost competitiveness at the forefront.

Now, this largely describes the state of the industry. There are wholly valid arguments to be made that if a business has a large portion of indirect category spend, they probably should think about which indirect supplier or vendors could be strategic partners as well.

Cost Modeling

Another distinction between the two categories is in the way that costs are tracked and managed.

Within direct, often "budgets" are actually based on targets, at the part-level, assembly-level, or full-product level. To set these targets, the best-in-class teams will use should-costing methodlogy, as described here..

Indirect certainly has cost-objectives to hit as well. One best-practice here is something called "zero-based budgeting." In this method, procurement managers draw up the budget from scratch (zero-based), rather than basing it on prior years or quarters. This forces folks to justify all expenses, not just incremental ones, and is a first-principles way to reduce the propagation of waste year-over-year.

Digital Tools

Surprise, surprise -- I'm about to recommend LightSource.

Software technologies and e-procurement solutions are extremely important to the top-performing procurement teams -- both in the direct as well as indirect arenas. Humans are... well, only human. So software like LightSource is an extension of the mind's capabilities, helping give procurement managers superpowers and do things that would normally take months in a matter of minutes.

Digital tools can help on a number of fronts (and with the best tools, all of them at once), including: transparency, cost-reduction, executive visibility, supplier relationships and discovery, and frankly overall procurement team happiness.

Software has this special ability to take the boring transactional tasks off peoples' plates and free up their time and attention to focus on the hard strategic or relationship questions that procurement professionals just love.

If you have any questions about LightSource or want to chit-chat on procurement generally, don't hesitate to reach out at: contact@lightsource.ai