What Is direct procurement?
Learn what direct procurement is, how it's different from indirect procurement, and the importance of vendor management strategy in direct procurement.
As your business processes scale and become more complex, it’s important to understand the distinction between two very different kinds of procurement:
- Direct procurement
- Indirect procurement
These two types of procurement have very different impacts on day-to-day business operations. They should be approached with a different mindset and, in many cases, different processes.
In this guide, we’ll explore what direct procurement is, how it's different from indirect procurement, and the role and importance of a vendor management strategy in direct procurement.
What is direct procurement?
Direct procurement is the acquisition of goods or services that relate directly to the production of the thing your business sells.
Examples of direct procurement include:
- Raw materials (e.g., fiberglass for boat building)
- Parts and components (e.g., CPU chips for computer manufacturing)
- Certain professional services, if they go directly into production (e.g., architectural design services for a property development firm)
- Some software purchases (e.g., design software for a graphic design firm)
The key to understanding what defines a purchase as direct procurement is analyzing whether the purchase is essential to the production of a good or service.
For instance, a computer manufacturer can’t build computers without CPUs, and a graphic design agency can’t produce graphics without a design tool.
The intricacies of direct procurement are best understood when compared to its counterpart, indirect procurement.
How is direct procurement different from indirect procurement?
Indirect procurement is the process of acquiring goods and services that, while important, don’t go directly into the production of your goods or services.
Let’s say your company is a clothing retailer, and you manufacture your own garments. The direct materials that go into producing your apparel (fabric, for example) would be considered direct purchasing.
Examples of indirect procurement include:
- Office supplies for the administration department
- Rent at your physical stores
- Your ecommerce platform subscription
Each of these expenses is important but incidental to the direct production of your garments.
Direct vs. indirect procurement: Categorizing software expenditure
For some purchases, it’s obvious whether they should be considered direct or indirect procurement.
Categorizing expenditure becomes a little more difficult when we consider software purchasing, especially in the case of companies that sell a service rather than a product.
Consider a digital marketing agency. A marketing agency doesn’t manufacture a physical product. There are no components or raw materials required.
However, certain software purchases are critical to the production of their services, for instance:
- Digital advertising platforms
- Marketing automation software
- Email marketing tools
The marketing agency can’t sell digital advertising as a service without the software required to do so, so this purchase would be considered direct procurement.
On the other hand, they’ll also use software tools that don’t go directly into the product of their services, such as a project management platform or internal communications tools. These would be categorized as indirect procurement.
In determining whether a purchase should be categorized as direct or indirect procurement, the question to ask is, “Does this product go directly into the production of our good or service?”
If the answer is yes, it’s direct procurement. If it’s no, then it's indirect procurement.
Vendor management’s importance in direct procurement
Effective management of supplier relationships is a crucial element of the direct procurement process. The products these vendors provide are essential to your business needs. Without them, you can’t make the thing you sell.
Vendor risk management is of particular importance. Shortages and disruptions to the supply chain can damage your production workflows and ultimately impact your bottom line.
If, as a marketing agency, your marketing automation platform experiences significant downtime, this impacts your ability to deliver on your contractual agreements with clients.
As a clothing manufacturer, the durability of your garments may be a key differentiator, which is affected by the raw materials you use. Should a strategic supplier go out of business, you’ll need to source a new vendor, which will change the physical makeup of your product.
Relationships with direct vendors are also often key to your competitive advantage. Without that direct input into production, your product or service offering may fundamentally change.
Procurement teams should focus on strategic supplier relationship management by:
- Using supplier relationship management software to maintain real-time performance visibility and gain insights into vendor spending and cost-saving opportunities
- Developing vendor KPIs and expectations, as well as holding regular supplier performance review meetings
- Regularly analyzing risk across multiple dimensions, including operational, financial, and market risk
Vendor management’s importance in indirect procurement
For indirect suppliers, vendor relationship management is just as important as it is for direct procurement.
When developing your vendor management strategy, be cautious not to exclude indirect suppliers simply because they are categorized as indirect. Ask, “If this vendor disappeared off the face of the earth today, would it cause a significant impact on operations?”
If the answer is yes, protecting that supplier relationship should be a priority.
Learn more about the vendor relationship management process in our guide: Vendor relationship management: What it is and why it matters.
What are the challenges in direct procurement?
Strategic sourcing and procurement teams face three key challenges in managing a direct procurement strategy:
1. Complex processes
RFX requirements, IT compliance conditions, and purchasing approval workflows are all necessary. Unfortunately, they often slow down the direct procurement process. Procurement software can assist by automating approval pathways.
2. Risk management
Entering into a relationship with a supplier always involves some degree of risk (security risk, for instance, is always present in SaaS purchasing), but this risk is heightened when sourcing direct suppliers.
For example, if, as a marketing agency, your digital advertising platform experiences significant downtime as a result of a cyberattack on your supplier’s servers, this could halt your ability to deliver advertising services to clients.
As a clothing manufacturer, if your fabric supplier experiences a supply shortage, you may have to reduce production of certain garments.
Discover how to assess and reduce vendor risk in our guide, Vendor risk management: What to watch for and best practices.
3. Balancing cost and value
Cost reduction is often a concern when sourcing new suppliers — you want a software solution that provides the maximum value for your budget.
However, choosing the vendor that offers the lowest price isn’t always the best path forward. Low prices can often mean compromises when it comes to quality assurance and risk management, and poor attention to either can be detrimental to your business operations.
Adopt three strategies for solving the challenge of balancing cost and value:
- Decide early in the procurement process whether the key concern is minimizing cost or maximizing value. For example, you might decide that when buying certain office equipment, you’ll choose the lowest cost vendor, regardless of quality. When procuring an email marketing platform, you may be happy to go with a higher-cost vendor if the feature set they provide offers more value.
- Use price benchmarking data to improve your contract negotiations and ensure you get the best price possible.
- Engage in cost avoidance strategies like monitoring software usage to avoid overage fees.
Vendr is your secret weapon for managing SaaS buying
Vendr is the SaaS buying platform that optimizes the direct procurement of software, helping you to:
- Pay less. We’ve got the largest set of SaaS buying transaction data around and an experienced team to help you negotiate a great deal.
- Manage relationships. Visualize all your vendor relationships in a central hub, monitor contract renewals, track cost savings, and identify areas of overlapping spend.
- Stay compliant. Automate purchase approval workflows and feel confident that department heads are making purchases compliant with internal regulations.
Discover just how much you could reduce your SaaS expenditure today with our free cost savings analysis.