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Classifying Spend: Indirect vs Direct Procurement

When it comes to spend, procurement departments—and companies as a whole—have long prioritized what is known as direct spend over its historically neglected sibling, indirect spend. In a world where raw materials and finished products dominated the landscape, this preference made a certain kind of sense (although overlooking the importance of indirect spend is a dangerous game indeed). But as the marketplace evolves and the pistons driving the economic engines of countries around the world focus increasingly on service, software, and other intangibles, the need to re-examine this paradigm becomes apparent.

Procurement strategies are shifting. Business practices are evolving. And understanding the changing roles of indirect procurement and direct procurement is essential to maximizing the efficiency and efficacy of every aspect of procurement—and building a strong bottom line for your business.

Indirect Vs. Direct Procurement

The usual definition given for indirect procurement is something along the lines of “any spend that isn’t sold to customers” or “the cost of doing business.” It’s a large umbrella, encompassing administrative costs, outsourced professional services, and all those office supplies, computers, and cubicles that a brick-and-mortar business needs to succeed.

Businesses that provide a tangible, finished product to their customers create revenue with direct procurement, and have historically lavished attention on it before making efforts to improve their indirect procurement function. Examples of direct procurement spend include:

  • Ingredients to create meals served at a restaurant
  • Materials to manufacture the latest must-have cell-phone
  • Retail goods at a popular chain store
  • High-end industrial equipment for a company that manufactures still another product

This type of procurement is focused on turning high-quality raw materials into a high-quality finished product, often sold at the highest price the market will bear.

Consequently, procurement processes at these companies tend to center on:

  • Cost avoidance. Paying the lowest price for the highest quality direct materials is the golden rule. The procurement function of these companies approaches supply chain management with an eye for cost savings, leveraging economies of scale and well-developed vendor relationships to get discounts and favorable terms.
  • Minimizing (or eliminating) risk exposure. The best materials transfer their quality to finished goods. They also help ensure products comply with all legal and industry safety standards while ensuring the consumer experience is satisfactory or, better yet, exceptional. Compliance and customer satisfaction insulate against risk and ensure the company can focus on boosting its bottom line instead of salvaging its reputation.

These priorities are valuable in managing indirect procurement as well—and, in fact, are just as essential to healthy profit margins for companies that don’t turn out a physical product.

“In a service economy, expenses that support the creative efforts behind intangible goods and services, provide strong brand support through customer service and social media, and deliver competitive advantage are the new “direct spend.”

A Fading Distinction—and a Shifting Focus

When manufacturing was the big fish in the economic pond, prioritizing direct purchasing of raw materials or goods for resale over indirect spend was the name of the game. But just as manufacturing came to eclipse agriculture in economic importance, so has the service economy come to drive manufacturing to the margins—and much more quickly. When companies are driven by virtual goods and intangible services, the indirect expenditures once dismissed as “administrative spend” suddenly become the best opportunity for cost savings, supply chain optimization, and data-rich spend analysis that feeds a smarter, leaner, more effective procurement strategy.

Consider this: a 2018 study by the World Bank found that services contributed more than 60% of total value added to the world’s economies as of 2017. In the United States, services accounted for a whopping 86% of all employment, and contributed nearly 80% of total value added to the economy. The United Kingdom has also made the shift: services accounted for 95.7% of employment, and contributed 78.6% of the total value added to the economy.

In short, while it’s always been relevant and an important variable in responsible procurement, indirect spend is drawing focus because many companies are creating revenue without manufacturing anything tangible. In a service economy, the purchases that support the creative efforts that deliver intangible goods and services, provide strong brand support through customer service and social media, and deliver competitive advantage through strategic labor practices are the new “direct spend.”

It’s Not What You Sell, But How You Manage Spend

The service economy might be changing the definition of “direct spend” for some businesses, but the core business principles that drive effective procurement still apply. A centralized procurement software solution is now an essential tool for procurement professionals around the globe.

In addition to easier supply chain management and simplified financial recording and reporting, a centralized solution makes it easy for internal stakeholders to track every aspect of every transaction, and cross-reference it with key source documents, regardless of category. Indirect procurement categories can be managed concurrently with direct ones, too.

Tail spend (also called maverick spend or rogue spending), often regarded as an inevitability in indirect procurement, can be tamed and even eliminated thanks to automated request, approval, and payment procedures.

Integrating and centralizing your procurement function means company needs are met and financial data is complete, compliant, and easily leveraged for forecasting and reporting. It’s a wise bit of indirect spending for any business that wants not just to survive, but thrive in a service-driven economy. 

A New Era for Procurement

Direct or indirect, spending money to make money is one business practice that’s probably here to stay. And whether you make old-fashioned widgets or crank out killer apps, making sure all your spend is visible, traceable, and builds value for your company is a step toward lasting success.

Manage, Classify, and Report On All Your Spend In One Place To Skip the Stress

Find Out How
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