The literal definition of procurement is the action of acquiring or purchasing an entity or good. Here, the term purchase is used in business. On the superficial level, it might seem like it’s all about getting supplies for an organization that needs to work every day. These include vendor management, fraud prevention, payment processing, invoice processing, quality control, etc.
However, there is more than meets the eye.
Procurement can be divided into two areas – direct and indirect purchasing. While both direct and indirect purchases are essential to the smooth running of any business, it is very important to understand where they are in the business so you can prioritize and emphasize where and how.
Direct purchase is the acquisition of raw materials and goods needed for production. These purchases are made in bulk and are sourced from a supplier based on the best possible price, quality, availability and reliability. This is necessary for the daily functioning of work. For example, rice is a direct purchase commodity for someone who works as a chef. Cement direct purchases commodity to constructor, minerals for iron and steel industry and so on. Direct purchase is so essential that if it goes out of business or faces any kind of blockage, companies will not be able to manufacture their products and generate revenue. Hence, it can be said that the niche of these procurement programs stems from the manufacturing sector.
What is indirect purchase?
Indirect procurement is the purchase of services required to keep a business going. They do not directly affect the workflow, but affect the result. It is defined as the activity directed at ordering goods and services that support your core business, but are not delivered directly to end customers. For example, in the mobile phone industry, silicon chips are a direct purchase commodity, because without them, the phone will not work, but the appropriate service center is an example of indirect purchase. Will the manufacture of mobile phones stop due to the lack of service centers? of course not. However, will the result of the company as a whole be affected? definitely.
So, we fully understand the difference between the two in the basic picture.
How do you manage direct purchases?
Direct purchasing is one of the most overlooked but important aspects of business operations. It is directly related to the processes involved in purchasing the raw materials needed to make a product. Managing it is not very easy, especially when you are across an organization with thousands of products and services.
Direct purchase vs. indirect purchase
The direct purchase program includes the performance of two main functions. First, it’s about purchasing the core component of your products. Second, it is about enabling you to meet the needs of your customers more effectively by giving you access to capital that will enable you to increase your inventory levels. Further, this function is concerned with ensuring that the organization’s stock of raw materials has an adequate turnover, so as to enable not only the efficient fulfillment of customer orders but also the efficient exploitation of assets. On the other hand, the functions of indirect procurement programs are aimed at securing goods whose consumption does not have a direct impact on customers or production cycles.
The following are three basic areas of procurement in which the differences between direct and indirect procurement are identified:
Supplier Relationship Management Direct procurement requires suppliers to have a good relationship with the company to ensure long-term purchase of goods. But with regard to indirect purchases, firms mainly focus on spending. Hence their focus is mostly on managing and minimizing the same. This is especially true for companies that have few direct purchase requirements such as software companies, digital marketing companies, etc.
Inventory Management Having the right amount of inventory on hand is essential for smooth production. Holding large quantities of inventory may be very inefficient if the expected level of demand is not known. Direct buying is useful when you expect a stable stock level, when the buying process is more or less traditional, when it takes time to place orders, when you deal with multiple suppliers, and in some cases when dealing with expensive and perishable items. Indirect purchasing is most appropriate when inventory levels fluctuate significantly according to production cycles, in environments where customization is possible and when time to market is required.
Organizational Chart In most companies, direct costs are managed by centralized procurement and supply chain teams, with category managers focusing on specific areas of spending while in most large organizations indirect procurement tends to be decentralized. Organizations have multiple stakeholders with independent budgets and spending protocols, which leads to inefficiencies in the indirect procurement process. The lack of a centralized structure for indirect spending leads to operational deficiencies. A large proportion of global Fortune 500 companies are moving to indirect managed outsourcing, saving 10-18% of total operating costs each year.
Ineffective procurement management directly affects the bottom line. Without simplified and well-defined purchasing practices, companies face high overhead costs. The objective of purchasing is to make the best purchase at the right price for the right item, at the right time and in the right quantity and quality within the organisation. Businesses need to invest resources in order to understand what distinguishes direct purchase from indirect purchase. It should be noted that it is essential that direct and indirect procurement go hand in hand in industries that require it. One is not more important than the other. By focusing on both, organizations can grow coherently by honing the overall view of the procurement field.