Understanding the Key Differences Between Direct and Indirect Procurement
In a literal sense, procurement is defined as the action of procuring or obtaining a commodity or an entity. In this case, procurement is used as a business term. At first, procurement is seen as if it only includes acquiring supplies for an organisation that has daily operations. The functions include fraud prevention, quality control, invoice processing, vendor management, payment processing, etc.
However, it comprises more functions. Procurement is categorised into two niches: direct and indirect procurement. Although direct and indirect procurement are both crucial for a business to run smoothly, it is vital to comprehend their role in the business so that both can be prioritised and emphasised according to how and where they are required.
What is Direct Procurement?
Direct procurement consists of acquiring raw materials and goods needed for production. These are bulk purchases bought from a supplier at the best price, quality level, quantity, and reliability. This is essential for running a business. For instance, for a chef, rice is a direct procurement commodity. Similarly, for a builder, it would be cement, metal for the iron and steel industry etc.
Direct procurement is highly crucial, and its halt in functioning or any blockage can disable companies from being able to manufacture their product and generate revenue. Therefore, it is a well-known fact that the niche of procurement software originates from the manufacturing sector.
What is Indirect Procurement?
Indirect procurement means buying services needed for a business to keep running. These services do not affect the business's operations directly, but they do have an impact on the outcome. It means the activity focused on orders of goods and services that support the primary business but can't directly deliver to end customers.
For instance, silicon chips can be classified as a direct procurement commodity in the mobile phone industry, as they are a vital component in the functioning of a phone. On the other hand, an example of indirect procurement is a proper service centre. So, the manufacturing of mobile phones would not be affected due to the lack of service centres, but the company's overall outcome would be.
Managing Direct procurement
The direct procurement process is often neglected yet has a crucial role in a business's operations. It is directly related to the procedures for purchasing raw materials needed to create a product. It is not easy to manage, precisely when it consists of an organization with thousands of services and products.
Direct vs. Indirect Procurement
Direct procurement software includes the performance of two primary functions. First, it is concentrated on the purchasing of key components of products. Second, it focuses on enabling the fulfilment of the needs of consumers in a more effective way by giving access to capital that can help increase inventory levels.
Moreover, this function ensures that the stock of raw materials in an organisation has an appropriate turnover rate in order to allow the meeting of customer demands efficiently as well as effective asset exploitation. At the same time, indirect procurement software functions aim at securing goods that don't impact customers or production cycles when consumed.
The three core segments of procurement where the direct and indirect procurement differences are set up:
- Managing Supplier Relationships - Direct procurement necessities that the supplier has a good relationship with the company in order to guarantee the procurement of goods for the long term. But, in the matter of indirect procurement, expenditure is the main focus of companies. Thus, their main goal is to manage and reduce it. This is ideal in the case of companies that have minimal to no direct procurement requirements, like digital marketing companies, software companies, etc.
- Managing Inventory - In order to ensure a smooth production having an adequate amount of inventory on hand is crucial. Large amounts of inventory can be extremely inefficient if the level of expected demand is not certain. Direct procurement is practical when a constant stock level, a traditional purchasing process, excess order placing time, and dealing with many suppliers (in case of expensive and perishable goods) are anticipated. In case of fluctuating inventory levels in accordance with production cycles, in conditions where customization is possible and when time-to-market is required, Indirect procurement is ideal.
- Organizational Structure - In almost all companies, direct costs are handled by supply chain teams and centralized procurement, where category managers focus on precise areas of spending while on the other hand. In contrast, indirect procurement in large organizations is likely to be decentralized. In this process, numerous stakeholders with independent allocations and expend protocols in organizations result in an inefficient indirect procurement process. An absence of a centralized system for indirect expenditure can result in operational inefficiencies.
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