A Cross-Industry Look At Direct vs Indirect Spend

Vishal Patel explores the difference between direct and indirect spend across three different industries…

The most fundamental spend categorisation in procurement is the line between direct and indirect spend, but one effort that transcends this split is supplier management. This includes supplier information management, supply chain risk management/mitigation, and supplier performance management.

Whether spend is direct or indirect, supplier information should be maintained centrally and with a high level of accuracy. Who is the supplier, who are the points of contract, what are the terms of service or delivery? How much spend does the company have with the supplier and for what? As long as indirect suppliers are meeting expectations, they are doing what is required. Direct spend suppliers, on the other hand, must deliver a different level of ROI. Meeting expectations is the foundation for strategic partnership and collaboration.

Manufacturing

In manufacturing, materials, components and assemblies that will be sold to customers are direct spend while facilities, equipment, consumable supplies and MRO are indirect.

Direct suppliers often become strategic partners because the company’s collaborative efforts with them have a direct impact on innovative potential. 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 are far more transactional, although 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 critical nonetheless. What you don’t necessarily want to do is separate your direct and indirect supplier information, risk and performance management efforts, ideally, you want to be able to look across all suppliers and spend.

Financial Services

One could make the case that financial services firms have no direct spend. Since salaries are beyond procurement’s purview, nothing the company ‘buys’ is resold to customers. That said, supplier information and relationship management are still high priority efforts. Risk and regulatory compliance requirements span nearly all categories of spend, and address global, high-profile concerns such as bribery, corruption, and data protection and privacy. We’ve all heard of KYC (know your customer) initiatives in banking for example. KYC has now gone beyond verifying and monitoring customers of the financial institution and now also often includes suppliers that provide IT solutions that touch the FI’s infrastructure (and thus their customers) called know-your-suppliers (KYS). For instance, a key piece of information that is often difficult to find but critical is knowing the ultimate parent of a 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. The remainder of indirect spend includes the ‘usual suspects’ like office supplies, travel and IT/telecom but often with a heavy services procurement need

Healthcare

Not unlike financial services, procurement teams in healthcare organisations are predominantly focused on indirect spend. The primary exceptions are the equipment and facilities that patients come into contact with. These indirect spend items have a direct impact on patient satisfaction despite not being resold. Machines must be running, supplies must be plentiful, and facilities must be spotless.

For the rest of indirect spend, Group Purchasing Organizations (GPOs) are common, based on the fact that the vast majority of transactional purchases are common across institutions. There are cases, however, where physicians need to have additional selection authority. These non-standard items, often referred to as Physician’s Preference Items (PPI), can present a challenge in terms of finding a qualified source and managing the cost and supply of the items. Those purchases, while indirect, do justify closer and more strategic supplier relationships, similar to a direct materials supplier

Supplier management is spend management – although 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) – regardless of the type of spend in question. Overall, having a strong supplier management capability and technology can work as a solid foundation to accelerate and improve digitisation and transformation efforts in all areas of procurement.

Ivalua is sponsoring the upcoming Procurious London CPO roundtable on 29th May. If you’re a CPO and would like to attend one of our roundtables in person please contact Olga Luscombe via [email protected] to request an invitation.