Back in the day, when factories served as the templates for developing business processes, the distinction between direct and indirect procurement spending was pretty straightforward: direct spend was focused on the things that went into your product – raw materials, components, subcontracted manufacturing services, and so on.
Indirect spend, which some have leeringly referred to as the ‘backwater’ of supply management, had to do with all the rest of it: cleaning supplies, cardboard boxes, food service, IT, etc. While the direct spend items were regarded as strategic, indirect items typically were not. However, in service industries – software, law, medicine, and so on – indirect spend constitutes just about everything. Yet in many cases, instead of being centralized and managed strategically, it is farmed out to individual departments like HR, marketing, and facilities management.
That is a huge mistake, particularly in businesses where indirect spending constitutes a major portion of the procurement dollar. Not only is it fiscally irresponsible, it ignores a world of valuable information, including data essential for risk management and supplier performance. Questions that should be posed and answered include who is the supplier? Who are its points of contact? What are the terms of their service or delivery? How much is being spent with that supplier, and for what?
Let’s look at how it works in three different types of business”
In manufacturing, the materials, components and assemblies that will be sold to customers as parts of a physical product are direct spend, while the facilities, equipment, consumable supplies and MRO are indirect.
Direct suppliers often become a company’s strategic partners because their collaborative efforts have a direct impact on innovation. They make it possible to develop products that lead to the expansion of market share and profit margin, both through their product offerings and their ideas. They sometimes participate in the R&D process, adding their IP to the company’s own.
Because of the key contributions these supply partners make to corporate performance, procurement needs to pay far more attention to risk and quality issues – whether they are present in the supplier or in their supply chain. Ensuring continuity of supply is far more critical when a supplier is a strategic partner and difficult to replace.
Most indirect supplier relationships, on the other hand, are far more transactional, although their services and deliveries still have to be dependable. Customer orders can’t be filled on time if machines don’t run, safety supplies are out of stock or facilities are poorly maintained. While Procurement might not consider these relationships strategic, they are still critical. What you want to avoid is separating your direct and indirect supplier information, risk and performance management efforts. Instead, you want to be able to look across all suppliers and spend.
One could make the case that financial services firms have no direct spend. Since salaries are beyond procurement’s purview, nothing that the company ‘buys’ is resold to customers. Even so, collecting supplier information and managing supplier relationships should still be high priority efforts. Risk and regulatory compliance requirements span nearly all categories of spend. They address global, high-profile concerns such as bribery, corruption, and data protection and privacy. Take KYC (know your customer) initiatives in banking for example. KYC has now gone beyond verifying and monitoring customers of the financial institution to include suppliers that provide IT solutions that touch the institution’s infrastructure. So a key piece of information that is often difficult to find can be critical is knowing the supplier.
Although the vast majority of a financial services company’s spend is indirect, it can still affect the top line. In the case of banks, for instance, property management is critical to securing and maintaining customer loyalty and reinforcing brand identity.
Like financial services, procurement and supply chain teams in healthcare organizations are mainly focused on indirect spend. The primary exceptions are the equipment and facilities that come into contact with patients. These indirect spend items have a direct impact on patient satisfaction. Machines must be running, supplies must be plentiful, and facilities must be spotless.
Group purchasing organizations (GPOs) are common for the balance of indirect spend, and the vast majority of such purchases are common across institutions. There are cases, however, where physicians need to have additional selection authority, often referred to as Physician’s Preference Items (PPI). Finding a qualified source and managing the cost and supply of PPI items can present a challenge. Those purchases, while indirect, justify closer and more strategic supplier relationships, similar to a direct materials supplier.
The Bottom Line
Supplier management is spend management – even though the information, risks, and relationships vary by category and industry. Procurement’s challenge is knowing which supplier relationships are strategic and deserving of additional effort and which are not, but still knowing who they are, no matter what type of spend is in question. Having strong supplier management capability and technology can serve as a solid foundation to accelerate and improve digital transformation efforts in all areas of procurement.
Vishal Patel is the VP of Product Marketing at Ivalua, a leading provider of global Spend Management Cloud solutions