Direct vs indirect spend: key differences & how they’re managed
Most company expenses fall under two categories: direct or indirect spend. Also known as direct and indirect procurement, each is distinct yet closely related.
Common business expenses include everything from SaaS tools and marketing campaigns, to employee wages and office rent. For organizations big and small, strategic sourcing is a significant business expenditure which directly affects growth and profitability.
In most companies, the procurement and supply chain teams categorize and track direct versus indirect spend. This helps finance teams optimize budget allocations and greater spending behaviors.
Whether or not companies have dedicated roles for managing direct and indirect spend, effective purchasing strategies require a full understanding of both types of procurement costs.
In this article, we’ll dig into the key differences between these two kinds of spending, and take a deeper look at how each is managed.
What is direct spend?
Also known as direct procurement or direct cost, direct spend sources the raw materials or supplies needed to manufacture or assemble the end product sold to customers. This cost is considered part of the cost of goods sold, or COGS, in the company’s financial reporting.
D2C (direct-to-consumer) brands and companies that sell physical products often have high volumes of direct spend.
Take for example, a brand that sells water bottles both online and in stores. Direct costs would include all materials and services that make up different components of the bottle, its design, product labeling and packaging, and transporting these elements to the manufacturing warehouse for assembly.
This type of procurement directly impacts a business’s top-line revenue and sales. Case in point: if there are shipping delays on these commodities, the business is unable to move forward with timely production and delivery of their final products to customers.
Supply chain logistics have a major part in direct spend management, as well as identifying and building relationships with key suppliers on a long-term basis. The goal is to achieve smooth operations and protect the brand’s reputation by collaborating with vendors that ensure consistent and reliable delivery and service.
What is indirect spend?
Indirect spend, or indirect cost, refers to expenses that keep the business running “behind the scenes”. Indirect procurement focuses on internal resources like office supplies and equipment, shipping fees, wages, and other costs that support daily operations, team processes, and workflows within the company.
Using the same water bottle brand example, indirect spend would include rent for the retail store, POS systems, SaaS tools for managing multiple streams of business operations, hosting and server fees for the brand website, and much more.
Without essential goods and services that help employees and business owners do their jobs effectively, a company would struggle to grow. Quite simply, a company’s workforce cannot function without indirect spend.
The different priorities of direct vs indirect spend
Direct and indirect spend are equally important in successful business ventures, yet how they’re managed and executed can vary greatly. A company’s industry, size, funding, and even its stakeholders can influence its procurement strategy and subsequent processes.
A key difference between direct and indirect procurement is how supplier relationships are managed and prioritized. This determines how teams interact with their key suppliers, and what goals they set for the collaboration.
Direct procurement focuses more on:
Building and nurturing strong long-term partnerships
Creating a stable, consistent supply chain and production process
Collaborating with the highest quality suppliers possible
Indirect procurement focuses more on:
Effective spend management and spend analysis
Identifying opportunities for cost savings without sacrificing quality
Consolidating and optimizing indirect spend categories
How procurement teams manage direct vs indirect spend
Strong supply chain management and clear expense policies help ensure better product quality, protect the brand’s reputation, and prevent maverick spend.
Well-designed procurement strategies also help other departments in the company operate more smoothly. These are several functions that benefit from targeted strategies for direct versus indirect spending.
1. Better inventory management
Inventory management keeps track of the quantity and type of materials and goods a company has in stock, and which need to be replenished throughout the year.
Strong inventory management takes a proactive approach to direct spend by ensuring the company always has enough supplies to support and execute a timely production process. Maintaining backup inventory volumes helps teams avoid major delays in the event of supply chain issues.
Indirect spend in inventory management is more reactive in execution. Supplies and goods are only ordered as necessary. Regular assessment of indirect costs can help companies determine when and what are the essential minimum level of supplies needed. This reduces excess or redundant expenses and identifies new cost savings opportunities throughout the year.
2. Effective cost management
In cost management, direct procurement experts frequently use strategies like should-cost analysis to negotiate vendor pricing. This strategy estimates the supplier’s final pricing by estimating the total costs the supplier needs to spend to produce or deliver the final goods.
Conversely, many indirect procurement teams prefer starting each new budgeting period from scratch using zero-based budgeting. Here every dollar counts, and each expense needs to be reassessed and justified for the next fiscal period to be approved. This helps eliminate redundant spend and prevents companies from wasting budget on expenses that aren’t actively supporting growth in the business.
For example, this could be subscriptions to multiple softwares that provide the same features, or excess supplies that weren’t used in the previous quarter.
3. Centralized e-procurement solutions
Indirect spend professionals frequently work with and receive requests from non-procurement teams. And traditionally, manual procurement requests can be slow to process in high volumes. This makes it highly beneficial to implement an intuitive e-procurement solution that is easily accessible to all employees who often need to outsource goods and services in their role.
Direct spend teams also benefit from process automation and digitalization. Using a specialized platform for direct procurement optimizes everyday supply chain logistics and communications, while reducing the risk of human error. For example, comprehensive ERP systems can automatically notify when new purchase orders are needed for production materials from key suppliers.
To maximize operational efficiency and accuracy, some companies can aim for automation tools that can streamline both direct and indirect procurement processes within the same platform.
Smarter procurement starts with smarter spend management
To wrap it up, there are clear distinctions between direct and indirect spend–and the company’s business model determines how big the differences are between these two procurement categories.
In manufacturing, distribution, and direct-to-consumer industries especially, direct procurement strategies should be managed with special care, to guarantee the quality of materials and the end product. On the other hand, indirect spend often prioritizes getting the best price and optimizing budgets.
Spend management softwares like Spendesk enable businesses to track all company purchases in real time, giving finance teams more visibility and control. In-depth spend data helps businesses identify new opportunities for cost savings in procurement, employee expenses, and more.
Want to see how it works? Take Spendesk for a spin, right now.