Tackling the opportunity cost of projects and maintaining cash efficiency is key to upholding profit margins. But sometimes, you can’t tie spending to projects or billable activities. This is called indirect spend, and it has just as significant an impact on your business.
To truly get the most opportunity out of every dollar, you need to control both direct and indirect buying. But curbing indirect buying is easier said than done. Often, organizations put out a general mandate to “cut spending” and hope for the best.
But there are better ways to achieve cash optimization in every category of spend. It requires the right policies and processes for stakeholders, well-managed vendor relationships, and strong spend management tools.
This article covers everything you need to know about direct and indirect forms of spend:
The differences between direct and indirect buying
Direct spend refers to purchasing goods or services directly related to production, manufacturing, or billable work. Examples of direct procurement include products, raw materials, and services needed to drive production.
Indirect buying—sometimes called overhead expenses or tail spend—involves buying goods or services that are not directly necessary for manufacturing a product but are needed for running day-to-day operations. These purchases may be transactional or managed through a well-negotiated contract.
Indirect buying often refers to smaller sum, less individually impactful purchases, such as:
- Office and administrative supplies
- Consumables for store locations (e.g., cleaning supplies)
- Facilities management costs
- Professional services
- Travel and hospitality
- Incidental expenses
- Small, one-time purchases and "spot buys"
The key differences between direct procurement vs. indirect procurement have implications for procurement managers. Knowing which category a particular item falls into ensures purchasing decisions are strategically aligned with organizational objectives. With direct buying, it is important to analyze risk factors such as delivery times and pricing structures. Alternatively, with indirect buying, it’s more important to ensure cost-effectiveness.
Organizations need to manage both categories of spending effectively to maximize value. For example, certain methods, such as reverse auctions, can lower costs on direct items by reducing prices through competitive bidding. On the other hand, volume-based purchasing or pre-negotiated contracts reduce costs on high-volume repetitive purchases of indirect items like office supplies.
Indirect procurement is more challenging to manage, but the strategic value of doing so is significant. Addressing the individual challenges of indirect spend helps organizations balance risk and efficiency.
Common challenges in indirect buying management
Although indirect buying deals with low-dollar purchases, it often makes up a large portion of the total expenses in a company. It’s also the category of spending that offers the most opportunity for improving cost controls.
Several common factors make it more difficult to implement good spend strategy and strategic sourcing. By their very nature, these costs are more likely to slip through the cracks when they occur, only to show up as an unwelcome surprise on month-end or quarterly close reports. Fortunately, for every challenge in tracking and curbing unnecessary spend, there are solutions to make the process easier and deliver favorable results.
Procurement professionals face five significant challenges when it comes to reducing indirect costs.
No indirect procurement policy
Without proper spending policies in place, businesses quickly see indirect buying get out of control. Optimizing budgets is more difficult, and redundant spending, inaccurate or incomplete contracts, and poorly negotiated prices are more likely. Without formal policies, it becomes difficult to track, monitor, and implement corrective measures to ensure that indirect buying stays reasonable.
Companies that craft well-defined spending policies manage both direct and indirect costs more easily. The best policy blends flexibility with oversight, creating safeguards to guide acceptable costs. At the same time, it offers internal buyers autonomy to review and select the items and tools that work best for them.
Poor spend visibility
Transparency in the procurement processes is essential to managing spend. Without visibility into indirect buying, companies lose a significant portion of their budgets to inefficient or unnecessary purchases. Visibility into procurement and indirect buying is essential to properly manage expenditures and reduce costs throughout the organization.
Lack of visibility also decreases compliance practices. Without visibility, there’s no way to ensure that employees follow the company policies and regulations mentioned above. Since these potential pitfalls can seriously affect the bottom line, initiating measures to increase the level of spend visibility within your procurement practice is vital. Using technology to centralize procurement transactions allows finance and accounting to capture all relevant data and eliminate blind spots in the procurement process.
The practice of sourcing goods outside the standard procurement process poses a considerable challenge for organizations looking to keep costs down. Without knowledge of all procurement decisions, businesses invite unnecessary third-party risks and make it more likely departments will exceed budgets.
Unregulated spend leads to decreased oversight of expenditures and diminished transparency into the rationale behind purchasing decisions. It makes tracking spending and ensuring employees adhere to spending policies challenging.
Ultimately, uncontrolled maverick spend costs businesses leverage. When organizations fail to operate within their allocated budgets, it becomes harder to weather unexpected financial scenarios. It also reduces borrowing power, interferes with supplier relationship management, and creates uncertainty in financial reporting. Building a well-documented procurement process, implementing approvals, and creating spend visibility helps curb maverick spend, so every transaction complies with spend policy.
Inadequate spend analytics
Without spend analytics, businesses miss out on opportunities to improve cash flow and reduce indirect buying. Spend analytics allow companies to gain insight into the full scope of their purchasing activities, such as the types of products they buy, the partnerships in their supply chain, and the contract performance of those relationships. The info generated through spend analysis enables businesses to assess their financial health better and create more accurate forecasts for future spending.
Effective spend reporting increases cost transparency across the business— improving cost management and procurement decision-making. It allows companies to identify areas where ROI and cost savings could be improved. Implementing stronger systems for capturing and analyzing all aspects of the company’s spending activities enables greater control over budgeting and ensures operations stay competitive and compliant.
Lack of procurement KPIs
Establishing key performance indicators (KPIs) is essential to effective procurement and cost management. Without tracking spending metrics, companies are at greater risk of overspending or missing out on savings opportunities.
By establishing clear and measurable objectives with specific KPIs, businesses better evaluate their purchasing practices against a predetermined set of criteria, highlighting areas where they can improve. This data is integral for developing strategies that maximize value and procurement performance while managing costs.
Properly executed KPIs create an environment for continuous improvement within an organization’s procurement process, which drives process efficiencies across the entire enterprise. By leveraging KPIs as part of a comprehensive cost management strategy, businesses enjoy greater visibility into past trends and financial health over time to ensure that resources are always allocated effectively and efficiently.
How procurement software improves indirect buying management
Visibility is often the most difficult challenge in managing indirect buying. Procurement software like Order.co uses automation to bring every purchase into focus and make compliant spending and approval easy.
Spend management software allows procurement teams to support internal stakeholders while gaining control of the buying process. It creates a functional, end-to-end procurement process that includes sourcing the right products from key suppliers, automation workflows to streamline approvals, and reporting for trends and key metrics like cost savings, cost reduction, and category management.
Using Order.co, procurement professionals implement a well-supported procurement strategy with advanced features, such as:
- Role-based guidelines and limits for each buyer based on category, department, location, and job role
- Automatic line-level coding for more accurate reporting of both direct and indirect buying
- Strategic sourcing through preferred suppliers using a curated, dynamic catalog
- Centralized purchase order creation, order processing, contract information, and payments to reduce errors and duplication
Order.co makes it easier than ever to gain and maintain visibility into your spending, even as your procurement function scales. To see the platform in action, schedule a demo of Order.co today.