Father of the Portfolio Purchasing Model, Peter Kraljic, a former McKinsey & Co. director is heralded as being the first to propose that enterprises should regard purchasing as a separate operation in supply chain management.
Kraljic argued that efficient, cost-effective production and operations were possible if procurement wasn’t seen as a mere tactic function but rather a strategic one.
The adoption of Kraljic’s Purchasing Model would forever revolutionize procurement strategy. And today, the purchasing process can be subdivided into two major disciplines: direct vs indirect procurement. Let’s explore what constitutes each discipline.
Direct Procurement Defined
Direct procurement is the business of sourcing and purchasing the necessary raw materials goods, and services required by a company for the manufacturing process. Goods are bought in bulk to optimize spend and are sourced from a qualified list of vendors.
Vendors must meet minimum order quantities, desired quality, various industry standards, and provide raw materials at cost-effective prices. When approved, contracts are signed, and purchasing cycles are established to ensure timely delivery of goods.
A breakdown in the direct procurement operation will result in enterprises failing to produce goods and this will, in turn, affect the entire value chain. This is one of the reasons it is imperative that procurement teams are furnished with procurement software that allows them to properly do their job.
Examples of direct procurement include the purchase of machinery, raw materials, subcontracted labor, and products for resale.
Indirect Procurement Explained
Indirect procurement is the process of acquiring goods and services needed in-house for daily operation. From a financial point of view, indirect procurement has no bearing on a company’s bottom line but instead should be budgeted for as part of expenditure taking up to 30% of company revenue.
Indirect procurement cannot be sidelined because, without proper execution, enterprises will struggle with efficient operation. Examples of indirect procurement include utilities, office and equipment maintenance costs, professional consultations, marketing expenditure, and purchase of office hardware such as computers, phones, printers, and furniture.
Direct vs Indirect Procurement
When we consider direct vs indirect procurement, we see that direct procurement is linked to acquiring goods, materials, and services that serve to improve profit, competitive advantage, and the company’s performance. While indirect procurement is tied to the purchase of goods and services that are used internally and any costs associated with maintenance that allow day-to-day activities to continue unabated.
The differences between these two disciplines however are best seen when we study:
· How supplier relationships are managed
· How inventory is handled and,
· The overall business procurement structures
i) Vendor Relationship Management
The manner in which relationships with suppliers are managed is a tell-tale of which procurement discipline is being employed. For example, when sourcing for direct procurement, buyers generally want to foster long-term relationships so the emphasis here would be on building trust and solidifying the synergistic relationship.
Procurement teams understand the importance of a reliable supplier for direct procurement. When a transactional relationship has been established, it is easier to negotiate discounts and more favorable terms and conditions.
With indirect procurement, the major focus is on keeping the company’s spend at a minimum. So, at this level, sourcing teams would rather not be locked into tight contracts preferring the freedom of being able to change suppliers if they find better offers. The goods being sourced here will not disrupt the bottom line and hence the ability to easily switch vendors.
ii) Inventory Management
When it comes to inventory management, the manner in which this issue is handled reflects a core difference between direct vs indirect procurement. With direct procurement, teams take time to find suitable vendors because an unreliable vendor can cause serious problems if raw materials cannot be delivered on time. An unsuitable supplier can wreak havoc on a business’s bottom line.
This attitude is a little bit relaxed in indirect procurement. Here procurement teams can pick a vendor from their list of qualified suppliers and get the necessary inventory as and when it’s needed. Here inventory management is more tactical and less strategic.
iii) Business Procurement Structure
Businesses tend to have a consolidated sourcing and procurement team for matters related to direct procurement because of the importance of this operation on the company’s net income.
However, the same cannot be said of indirect investment. Here enterprises tend to have a decentralized procurement process. The process is not as strictly monitored and managed as the direct procurement one.
Invest in Robust Procurement Solutions
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