Indirect procurement refers to the process of identifying, shortlisting, and acquiring goods and services that do not generate revenues for the business but are necessary for its operation. These goods and services do not relate directly to the goods and services sold by the company to its customers. It is important for a company as indirect procurement increases the operational efficiency of the business processes.
According to McKinsey, the share of indirect procurement in a company’s overall expenditure has increased consistently by 7% every year since 2011.
How is Indirect Procurement Different from Direct Procurement?
Direct procurement involves the acquisition of goods and services, just like indirect procurement. However, there are certain distinctions between direct and direct procurement processes.
- Direct procurement refers to the process of obtaining revenue-generating goods and services like raw materials. On the other hand, indirect procurement refers to the process of obtaining non-revenue generating goods and services like office supplies, employee training, etc.
- Direct procurement is the procurement of goods and services that are directly related to the company’s business. In contrast, indirect procurement is the procurement of goods and services not directly related to the company’s business.
- Direct procurement helps in driving profits, performance, and competitive advantage. In comparison, indirect procurement helps in maintaining day-to-day operations.
- Direct procurement emphasizes building long-term relations with the suppliers. Whereas, in indirect procurement, the company-supplier relationship is transactional in nature. Therefore, the main focus of indirect procurement is to manage and reduce costs.
- Inventory management is given due importance in direct procurement since any shortage may disrupt the entire value chain. However, in indirect procurement, inventory management is not of prime importance.
- It is seen in many companies that centralized and dedicated teams are employed for direct procurement. However, for indirect procurement, decentralized and ad-hoc teams are employed.
Indirect Procurement Categories
The categories in indirect procurement refer to the goods and services that a company requires for its day-to-day operations. There are various indirect procurement categories as listed below:
- Professional services (advisors, consultants)
- HR services (training, coaching, recruitment services)
- Marketing services (PR, digital marketing agencies, etc.)
- Capital Goods (pieces of machinery, etc.)
- IT-related equipment and services (hardware, software)
- Travel Expenses
- Facility management (furniture, cleaning, office supplies, etc.)
- Utility management (water, electricity, etc.)
- Fleet management
- Maintenance, Repair, and Operations (MRO)
Importance of Indirect Procurement
Indirect procurement is often neglected by companies as these do not relate directly to the company’s profitability. However, indirect procurement is very essential for a company. This is because of the following reasons:
- Broad Scope
Indirect procurement relates to products and services that impact almost every department of the company. It has a broad scope from utilities to marketing and financial services.
- Impact on Company’s Financial and Operational Performance
If the process of indirect procurement is neglected, the company may not establish good relations with suppliers, and they may not deliver on their promise. This affects the finances as well as the operational performance of the company.
- Impact on Company’s Viability
Any failure in the internal procurement concerning procurement, governance, and supplier management may affect the company’s viability. This shows the importance of indirect procurement for a company.
The indirect procurement, if done diligently, may add to the company’s competitive advantage by being a source of the company’s differentiation. A company can attain this through effective negotiations with the vendors and proper management of the indirect procurement process.
Challenges in Indirect Procurement
Indirect procurement is marred with the given limitations and challenges:
- Less Bargaining Power
Indirect procurement has a wide assortment of goods and services, which are needed in a limited capacity. Since indirect procurements seldom deal with bulk orders, the company does not have much bargaining power to lower the prices when dealing with the vendors or suppliers.
- Frequent Purchases
Indirect procurement involves purchasing products in low volume but frequently. This makes the indirect procurement process resource-intensive to manage.
- Un-Negotiated Process
In most cases, indirect procurement is done in the nick of time, without proper research or negotiation. This leads to the supplier dictating the terms of the procurement. Thus, the company loses the opportunity to lessen the cost.
- Poor Visibility
Indirect procurement has to deal with the challenge of poor visibility. Indirect procurement is not considered as important as direct procurement. Therefore there is no relationship building with the vendors or the suppliers. In addition, the indirect procurement process is not linked to specific bills of materials like direct procurement. This hinders the cost savings in indirect procurement.
- Lack of Planning
In most cases, indirect procurement is not planned. It is need-based. Therefore, the indirect procurement process is haphazard and ad-hoc in many companies. This affects the management of the indirect procurement process effectively.
- Lack of Centralization
Many companies employ a dedicated procurement team headed by the Chief Procurement Officer for their direct procurement. This is not the case with indirect procurement. Indirect procurement is a decentralized process marred by a lack of meaningful data and fragmented supply chains. This makes the process of indirect procurement a low-value area for the companies to manage.
- Multiple Channels and Stakeholders
It is seen that the indirect procurement process involves multiple channels and an increasing number of stakeholders that make it haphazard to manage. This leads to poor coordination and organizational efficiency suffers. This makes indirect procurement a complex and opaque process.
Indirect Procurement Strategies
It is commonly seen that while large companies neglect indirect procurement, most of the small and medium-sized companies do not frame any strategy related to indirect procurement. In recent years there has been a significant increase in the number of startups and small and medium enterprises. These organizations seldom put their efforts in chalking out any strategy pertaining to indirect procurement.
To make the process of indirect procurement effective, the companies need to modify their strategy. They must adopt new technological elements relevant for indirect procurement. This would require the companies to focus upon process optimization, adoption of digital technologies as well as responsive change management.
In addition, the companies need to have a thorough understanding of the supply chain and supplier relationships.
Organizations must know the company’s competitiveness and profitability goals. A company must be aware of the tools and techniques that can be used to streamline the entire process of indirect procurement. In this way, the process of indirect procurement may give a good return on investments for the company.
To formulate an effective indirect procurement strategy, the following priorities should be considered:
Automation is the process of indirect procurement that would lead to saving of time to complete the entire process. Process automation brings an element of ease and simplifies the whole process of indirect procurement. Automation also helps in minimizing or nullifying the chances of any human error. Companies increasingly adopt e-procurement for their indirect procurement needs. However, Robotic Process Automation is still a new area for companies to explore.
- Cost Savings
Though indirect procurement involves low-volume and low-value frequent purchases, the cost is an important consideration for any company. The cost savings made in the process of indirect procurement may lead to the company having a competitive differentiation from its contemporaries and rivals. Therefore, efforts must be given to pooling the purchases, choosing the right supplier, and having good relations with the supplier.
- Value Creation
Indirect procurement must also create value for all the stakeholders, be it suppliers, management, internal customers, etc. The process of indirect procurement must fulfill the requirements of all the stakeholders and help in the achievement of the desired goals.
Innovation is an element of priority for indirect procurement. By leveraging technologies like data analytics, intelligent spend tools, the companies can lessen the complexity involved in the process of indirect procurement. This also leads to added benefits like cost savings and increased operational efficiency in the process and the company.
- Responsible Procurement Strategy
Sustainability is an important consideration for any indirect procurement. Companies are increasingly aware of using low carbon footprint products. In addition, companies take about the origin of the product, whether child labor was used to manufacture it, and other considerations for procuring responsibly.
How to Manage Indirect Procurement?
Indirect procurement, if neglected by the companies, might be damaging as it may result in overspending, poor operations, reduced visibility, and inefficiencies in the supply chain. Therefore, the process of indirect procurement must be given its due importance and managed well.
Here are some tips on managing the process of indirect procurement well by the companies.
- Investment in the Right Technologies
The companies must invest in appropriate cloud-based technologies to streamline the process of indirect procurement. The procurement solutions help in making accurate purchases and thus save time and costs involved in the process.
Leveraging technology will also help the companies to get a big picture of the indirect procurement vis-a-vis their company. It will reflect the real-time data, which will help in planning the indirect procurement process and gauging the immediate and future requirements of the company.
- Bringing more Transparency and Visibility
One way to manage the entire process of indirect procurement is to bring transparency and visibility to the entire process. In most companies, indirect procurement is fragmented and scattered. It would do well if the companies started clubbing the purchase groups and categorizing them so that the purchase is visible.
The procurement team is mostly concerned with direct procurement. It is important to have a small team to overview the indirect procurement. The other departments must coordinate with the indirect procurement team for all their indirect procurement needs. This will bring accountability and transparency to the entire process.
- Develop an Efficient Plan
Most of the indirect procurement is last-minute, haphazard decisions with little or no planning. This strips the company of its bargaining power and adds to the extra costs. Companies must consider strategizing sourcing for indirect procurement. They must first identify the recurring procurements and the costs involved and then seek avenues to lower the costs and collaborate with the suppliers to build a strong relationship.
A company should conduct an in-depth analysis of the indirect procurement and the costs involved. This will help the company in preparing well for future procurement.
- Group Purchasing
The companies may partner with a group purchasing organization for their indirect procurement. This will increase their bargaining power and help them in saving costs. This will reduce the supplier risk and reduce the time and effort used in the indirect procurement process.
Indirect Procurement Best Practices
There are certain best practices that few front runner companies have been adopting in the process of indirect procurement. Adopting these practices would make the company procure more effectively, efficiently, and responsibly. These practices are important for everyone in the organization to understand and follow.
- Adoption of New Technologies
The adoption of cloud-based technologies helps in optimizing the process of indirect procurement accurately and efficiently. In addition, leveraging automation and Artificial Intelligence, centralized data architecture, and management leads to the effective management of the entire indirect procurement process. There must be hierarchical access to mobile devices by all the stakeholders. The real-time data must be reflected on all the employees and not just the procurement team.
- Change Management
The change management in the organization must be proactive. Educational materials must be provided so that a link is established between the new system and processes. This will help in cost savings and gaining a competitive advantage. The employees must be identified and trained properly. These employees may then train other employees and be a mentor for others to adopt the new process and technologies.
It is also important to choose the software vendor who is responsive to the needs of the organization and must be able to help the employees before, during, and after the implementation of the new systems.
- Integrate Procurement with Finance
It is valuable for the organization to have the supplier side operations integrated with the procurement. The integration of finance with procurement helps in tracking and analyzing spend data as well as performance data from internal and external sources. It helps in the development of strategic procurement plans through contextual analysis using market intelligence and understanding industry perspectives.
The Future of Indirect Procurement
Indirect procurement has been revolutionized due to the use of cutting-edge technologies like cloud computing. Blockchain, AI, and data analytics. The role of the procurement function has changed and evolved. The procurement functions have transformed into strategic partnering through a focus on strategic and sustainable value creation.
- Automated and Intelligent Spend Engines
These are the digital tools that leverage machine learning and automation to classify and categorize spending. These tools enable full transparency through automated data extraction from enterprise resource planning (ERP) and databases. They also enable automated harmonization and classification.
These tools can recognize cross-category synergies by integrating the data pool and analysis functions. These data are transformed into reports through visualization software. This enhanced transparency may drive significant bottom-line savings for the organization.
- Advanced Analytics
The advanced analytics tool may help the companies to identify their process optimization and cost-saving opportunities. This tool helps in formulating illustrative dashboards that give a close view of the overall procurement process. It helps the management and the procurement team in informed decision-making regarding the entire process of indirect procurement. These tools help the company in applying advanced category-based levers and ensuring smart workflows.
The company can use these insights to strengthen its negotiation capabilities. Functional tools like parametric clean sheets and e-Sourcing tools may help the companies in automating the entire procurement process and cut costs by around 10 to 15 percent.
- Seamless Ordering
Companies now resort to B2B ordering to increase service levels and reduce costs. Many companies have created a B2B catalog that shows all their offerings. Online marketplaces like Amazon and Alibaba are also used by businesses to evaluate and select suppliers. These platforms also help the companies with cross-category orders and improve financial traceability.
The Internet of Things-based tools may replenish the stocks in an automated manner. Thus, the technologies may be used to have a seamless ordering. In addition, the expanded assortment of product and service categories reduces the dependency of companies on a single supplier and prevents the variable flow of essential goods and services.
- Zero-Based Budgeting
Many companies use a repeatable process of stacking every expenditure starting from zero. Companies employ this zero-basing procedure to challenge every penny in the company’s annual budget. There are zero-based budgeting tools that have capabilities for indirect spend visualization, forecasting, and system integration.
To fully unlock the company’s potential, these tools include zero basing features that examine the analyses and processes, efficiency levers, and organizational structure. This tool is supported by a standardization feature that helps in budget negotiation and equips the organization to negotiate at scale.
- Procure-to-Pay Model
Gartner’s Study predicts that by 2025, over 50 percent of the organizations will have a procure-to-pay model for their procurement needs. This signifies the benefits and ease that these automated services give to the companies. The P2P models ensure supplier payment and improve the management of cash flows.
By employing machine learning, this software identifies data patterns and automates the assessment of improvement potential. This model is revolutionizing the indirect as well as direct procurement process by its easy operability and greater value creation.
- Interlinking with Finance
The interlink of procurement function and finance by the means of a software tool helps in cost management in the indirect procurement process. This software helps in providing forecasts regarding initiative implementations and projected revenues.
The company gains by improved forecasting and budget planning. This helps in improving the visibility of indirect procurement. Furthermore, the interlink between finance and indirect procurement increases the engagement of top management in the process.
- Agile Organizations
In an agile organization, the category-specific managers and teams are replaced by a multidisciplinary team with members drawn from all categories. This helps in attaining synergy and coordination. The agile operating model involves well-defined processes with clear ownership. This brings greater transparency and accountability in the indirect procurement process.
In addition, the agile model involves internal as well as external stakeholders in the indirect procurement process. Cross-functional communication among the team members is powered by strong analytics and visualization tools. This helps in making inter-departmental decisions quickly and effectively.
Indirect procurement is an important business function that has the potential of becoming a tool for competitive differentiation. Due to its broad scope, almost all the departments are influenced by the process of indirect procurement. With solutions such as that provided by the Procurement Partners, the indirect procurement process can have improved visibility, defined structure, and streamlined process.
Businesses must leverage procurement solutions to achieve cost savings and greater operational efficiency in the indirect procurement process.