Key Terms & Definitions

Direct vs Indirect Spend: What's the Difference and Why Does It Matter?

    Organizational spend is often categorized into two types: direct spend and indirect spend. Read on ahead to learn how each affects your business.
Direct vs Indirect Spend: What's the Difference and Why Does It Matter?

Companies need to purchase goods or services on a relatively large scale to ensure that their business runs smoothly and that company goals are met. Procurement professionals differentiate between the two key types of spending that all businesses do: direct and indirect spending.

Direct spend

Direct spend refers to all the purchases of goods and services that are directly involved in the manufacturing of a product. Consider a company that makes and sells refrigerators, Coldchain Auto. To build refrigerators, Coldchain Auto needs a lot of raw materials. Everything from steel metal and plastics to make the refrigerator cabinets, doors, and fixtures, to the components of the cooling system including compressors, screws and coils. All the raw materials, components and hardware used to make a refrigerator are part of Coldchain Auto's direct spend.

Indirect spend

Indirect spend refers to every purchase that is not used to directly manufacture a product. To make and sell their refrigerators, Coldchain Auto requires a whole ecosystem of support from manufacturing to sales and marketing to IT and HR. All of these teams will require items to function, such as office supplies, cafeteria supplies, janitorial services, office furniture, travel etc. All of this is important to allow the company to perform its core function of making and selling refrigerators and it is covered under a company's indirect spend.

Why does it matter?

The process of procurement will vary depending on the type of good or service the company needs. The process of procuring raw materials and goods used to make the product is called direct procurement. Similarly, the process of procuring all other goods and services that are used to run the business itself is called indirect procurement.

Direct Procurement vs Indirect procurement

One of the primary goals of every business is to keep costs as low as possible and boost profits. Knowing what the company is spending on is the first step, and here is where the distinction becomes useful and is used to first classify how much a company is spending on what, and second, to analyze this information to prepare procurement strategies for cost savings and sourcing.

With indirect procurement, costs saving is easier. You can buy a cheaper coffee maker for the break room, for example. With direct procurement, on the other hand, where a company cannot switch to cheaper raw materials or a different product machine, for example, the drive to saving costs comes down to managing relationships with vendors and finding ways to make the process of procuring their goods more efficient and in cutting down on costly inefficiencies.

For example, when Coldchain Auto places an order with an unreliable supplier, materials may be delivered late, which means the company can't meet its orders on time, which would lead to a loss of revenue. Similar problems can arise as a result of placing incorrect orders or by providing incomplete information to suppliers.

One of the ways businesses have started doing this is by investing in comprehensive e-procurement solutions and strategies. Find out how you can save time and money using Proqura's e-procurement solution here.

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