Debunking Procurement Terminology: Indirect Procurement and its Importance to Your Organisation
Whilst most companies divert much of their procurement efforts and budget to direct spend, their attention to indirect spend often falls short. An often costly mistake because indirect spend is essential to cost effective operations and has a larger impact on the bottom line than many business leaders might think. So where does the difference between the way these two functions operate lie and why is it a mistake to neglect indirect procurement?
What is indirect procurement?
Indirect procurement can be defined as the sourcing of goods or services which are not related to manufacturing, yet are still necessary for a company to operate successfully. These goods or services are often purchased to be used by internal employees and stakeholders rather than for the eventual sale to customers. Indirect procurement spans a wide range of categories, with anything from IT-related products (e.g. laptops) and office equipment (e.g. furniture, lighting) or even hiring an agency falling under the umbrella term.
Whilst indirect procurement might be deemed ‘non-essential’ to the production of consumer products, inefficient management of indirect spending can still have far-reaching impacts on operations as a whole. Effective indirect procurement can have a significant role in a company’s success. This is namely because, without the necessary equipment, employees cannot succeed in their role, which subsequently leads to time wastage. Likewise, indirect procurement still makes up over 20% of spending!
It’s clear: efficient indirect procurement processes can help keep costs low whilst ensuring high-quality goods from suppliers, ultimately leading to strengthened organisational operations. Yet, this potential is often neglected by corporations of all sizes and industries.
How does indirect procurement differ from direct procurement?
Alternatively, direct procurement, also referred to as ‘direct spend management’ or ‘direct sourcing’, refers to securing ‘core supplies’ which are required for the production of the product sold by the company to consumers. This is an end-to-end process that, taking manufacturing as an example, begins with the process of the new product introduction (NPI) and follows through right until the product’s end-of-life. In the vast majority of cases, direct procurement is also deemed strategic in nature and the term is often used synonymously.
Direct procurement involves many internal and external departments, including but not limited to engineering, logistics, suppliers, and procurement teams.
The greatest distinguishing feature between indirect and direct procurement lies in the functions each addresses. Because they operate in different ways and thus, necessitate their own dedicated approaches. After all, the procurement of service-based purchases is already an entirely different process from purchasing manufacturing material.
See the table below for an overview of the differences between direct and indirect procurement…
What are the Challenges of Indirect Procurement?
Indirect procurement is multi-faceted and incorporates many challenges. A study undertaken by NelsonHall concluded that the large majority of senior executives consider indirect procurement processes to be underperforming. In fact, this figure amounted to as high as 80%, with 55% stating that the function was inefficient in driving business performance in their company (Strafford, 2012). What are the biggest contributing factors, then, to so many procurement professionals being dissatisfied with their indirect procurement processes?
The main challenges can be broken down into the 4 following categories:
1. Decentralisation
The sheer scale of indirect procurement positions decentralisation as a major challenge. Indirect procurement encompasses hundreds of spending categories and deals with countless contracts and suppliers. Equally, the nature of indirect procurement, as a set of processes that caters to the daily functions of many internal stakeholders, means that it is often decentralised to different departments. It is precisely when this occurs that cost-saving opportunities are overlooked and time is wasted.
2. Poor transparency
Poor visibility of data, specifically in terms of supplier availability and performance, or past purchase requisitions, often occurs on account of decentralisation and is one of the major pain points for procurement professionals. This lack of visibility can lead to [Maverick buying] (https://www.lhotse.de/en/blog/5-types-of-maverick-spend) which is, in essence, a purchase that occurs in an organisation without the involvement of the procurement department. Not collating information or excluding approvers from procurement processes has negative repercussions. Doing so can lead to inconsistent supplier management, as well as bottlenecks and time delays.
3. Untapped potential for cost savings
The sheer complexity of indirect spend, coupled with the lacking spend transparency can lead to substantial cost savings remaining untapped. For this reason, it can be difficult to see the bigger picture. To minimise this risk, processes must be streamlined and spend adequately controlled. Yet, it is only after [cost savings] (https://www.lhotse.de/en/blog/a-recession-is-coming-save-costs-through-procurement) opportunities have been identified and recognised that this can occur.
Research done in 2018 found that 54% of global procurement leaders consider cost savings as a top focus area (Dedhia, 2018). Because direct procurement deals with transactions that are high in monetary value, procurement teams tend to hold strong supplier relationships enabling the negotiation of higher discounts and cost savings. Yet, indirect procurement often does not meet up to the same standards due to the large number of transactions involving many different stakeholders.
4. Lacking expertise
Skilled employees with experience in procurement can offer expertise when it comes to strategic activities such as data analytics as well as contract and supplier relationship management. However, most businesses are lacking in trained professionals whose main role is to manage indirect procurement processes.
Yet, with easy-to-use AI software that takes the hard work out of procurement, this becomes less of a challenge. With the help of software specifically tailored to your company’s indirect procurement needs, your organisation can realise benefits, establish, and maintain better contracts with suppliers. Ultimately, the aim is to empower everyone in the organisation to procure like experts.
Ways to Optimise Indirect Procurement
Since the average organisation spends anywhere between 20% or more of its total turnover on indirect procurement, optimising the associated processes should be a top priority of any business. After all: savings in indirect procurement are not just short-term quick fixes, they hold longevity.
But what exactly does a successful indirect procurement approach entail, and how can ineffective purchasing be prevented?
1. Use AI software to increase spending visibility
A large cause of inefficiency stems from the fact that purchasing processes are often still manual and fragmented. Equally, they often occur without approval from the organisation. By taking advantage of digital tools, you can streamline procurement processes and enable better compliance and less time wastage.
With Lhotse, your company can become empowered to become more strategic in your purchasing, through added visibility and more accurate spend analytics. For example, by using Lhotse [FUNKE] (https://www.lhotse.de/en/blog/a-recession-is-coming-save-costs-through-procurement) was able to do all this whilst simultaneously bringing in **3x more supplier offers at 20% lower prices. **
Ultimately: eProcurement solutions increase productivity and give your company more control of its spending.
2. Rework your supplier base and contracts
Managing indirect spend is not a static process and necessitates ongoing attention, specifically regarding supplier contracts. [Re-negotiating] (https://www.lhotse.de/blog/negotiations-in-times-of-crisis-insights-from-the-experts) existing contracts and collaborating with suppliers to realise savings is a great way to overcome one of the greatest indirect procurement challenges.
Reworking your supplier base is also an excellent opportunity to ensure that your contracts with suppliers mirror and align with your company values. In so doing, your company can be certain that they are spending money in a cost efficient manner that is also ethical and sustainable.
3. Educate your employees about indirect procurement
The distinction between indirect and direct procurement is one not all employees are aware of. Since it is precisely the business users who are involved in the purchasing processes, adequate education regarding new policies can be instrumental. Ensuring these policies and processes are easy to understand can also help speed up and improve results.
Often eProcurement solutions provide guidance not only through their onboarding procedures but also in the form of resources that train employees. In the procurement sector, this is known as ‘change management’.
Alternatively, other software solutions pride themselves on their user-friendly interface. Take Lhotse, for example, our platform is easy to use without any previous procurement expertise!
4. Collaborate
Collaboration can take many forms and can be crucial in improving the efficiency of procurement processes. Due to the nature of the procurement function, procurement teams must already work closely with other departments.
Let’s take for example the finance department. Concentrating more effort on collaborations and working in concert with your finance colleagues can bring many advantages. This specific collaboration can help your team to analyse spending performance through financial data which can improve future strategic pursuits. After all, the finance and procurement departments in a company have a variety of responsibilities in common so collaboration is always mutually beneficial.
Summary
Studies show that a mere 5% reduction in indirect spend can approximately translate to a 2% reduction on the bottom line (Erdner, 2022). The high number of stakeholders and suppliers causes indirect spend to be highly complex and yet, despite this, commonly overlooked.
However, optimising indirect spend requires a specific skill set. Whilst supplier management and negotiations are crucial, in the modern age the ability to harness technological innovation is a must. AI-software solutions, such as Lhotse, offer a user-friendly method of streamlining manual processes and enabling spending.
Developing these skills, as well as following the four outlined steps in this blog, ensures the optimisation of indirect spend so that neither money nor time is wasted!
If you wish to find out more about how Lhotse can help you to improve your procurement processes, book a demo with us today!
Bibliography
Erdner, P. (2022, June 16). Increase Your Bottom Line by Managing Indirect Spend. Apexanalytix - Ultimate Supplier Management. https://www.apexanalytix.com/resources/reports/increase-your-bottom-line-by-managing-indirect-spend/
Dedhia, A (2018). Pulse of Procurement 2018. Zycus. https://res.cloudinary.com/zycus-com/image/upload/v1531134099/Files/PDF/Zycus_POP_2018_Part_1.pdf
Patowarya, J. (2022, September 20). You Didn’t Know these 7 Steps of an Effective Procurement Process. Zycus Procurement Blog. https://www.zycus.com/blog/procurement-technology/you-didnt-know-these-7-steps-of-an-effective-procurement-process.html
Strafford, G. (2012). https://cdn2.hubspot.net/hub/28326/file-330611712-pdf/docs/Proxima-current-perceptions-part-1-whitepaper-final.pdf. Proxima.
