What Generates Most Value – Direct or Indirect Procurement?

I was recently asked by Supply Management magazine to answer a reader question, asking for advice on making the switch from managing Indirect spend categories to Direct spend.  My response is below:

Your experiences in indirect procurement will position you well as you move over.

In direct procurement, you will be on the frontline. Your actions will have a measurable impact on product profitability and quality. In addition, a key aspect of your new role will be managing risks, such as ensuring continuity of supply. But you will be supported by a procurement mandate, and the items you are sourcing will be less nuanced and better defined.

Direct materials are sourced infrequently, and switching costs are high. There is often only one chance to get it right. So develop a marketplace that enables you to maximise the ROI of your supplier relationships. This will be how you spend most of your time. Success will be defined by your ability to build relationships with the internal and external players within your category ecosystem.

Information gained from these relationships will enable you to deliver high quality and value-for-money materials with a supply base that brings technical innovations to you, and not your competitors.”

It is interesting to me as I talk with fellow procurement professionals how perceptions differ on how much value is created in Direct vs. Indirect procurement, and which offers the most career opportunities.  Opinions range across the map, and it is not unusual for people to believe that the field that they are in (direct or indirect) is highly strategic and nuanced, while the other side of procurement is just a tactical or transactional.

I have experience working in both Direct and Indirect procurement.  My perspective is that both are equally as valuable to an organization.  When a company invests in procurement, the results are there to be seen regardless of whether it is in the management of Direct or Indirect spend.  Reduced cost and risk, increased performance and the building of relationships that facilitate product innovation can be applied to the suppliers or both Indirect and Direct procurement.

Where a Direct or Indirect team is only producing tactical or transactional work, it is usually because their leadership team decided not to invest in the skills, processes and technology necessary to deliver excellence.  In businesses like manufacturing firms where most third party spend affects the cost of goods sold, the majority of the procurement investment will be in Direct procurement.  On the flip side, in services firms where most costs are related to keeping the lights on, the investment will be on the Indirect side.  Others will invest in neither, and procurement will be always be transactional.  Only those that recognize the true value that procurement can bring will invest in both.

Businesses that choose not to invest in Direct, Indirect or even both typically do so due to the perception that the ROI would not justify the outlay.  Part of that is through either a  lack of understanding on the procurement value proposition, or a bad experience as a result of underinvestment. However, sometimes the math just wouldn’t add up. Under the traditional procurement delivery model specialized procurement expertise is expensive and requires significant spend in each category to generate the savings that would enable the investment.

The procurement outsourcing and as-a-service economy is finally providing access to flexible and niche expertise, on demand.  This enables companies to invest either on a pay-as-you-go or management fee basis, providing access to a broad range of expertise.  These commercial arrangements are typically risk-free, providing a significant ROI while guaranteeing cash flow neutrality as a worst case scenario.

Under these outsourcing and as-a-service delivery models, companies no longer have to decide whether to invest in Direct or Indirect.  The business case exists for an investment in both, with minimal risk.  With ROI barriers torn down, the remaining challenge for the procurement executive is convincing his or her leadership team of the benefits that can be delivered by a dynamic, proactive and strategic procurement organization.

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