Direct vs Indirect Procurement: The Differences That Actually Change How You Buy

Direct and indirect procurement are distinguished by whether the purchased products constitute the outputs of the company’s production processes. Thus, the former category includes all goods that are used to produce the company’s products, such as raw materials, components, and packaging materials. The latter category covers all needs of the organization except for direct purchases.

Key highlights

• Direct spend is driven by production forecasts, while indirect spend is demand-driven.
• Direct spend failures pose an immediate threat to the production process, while indirect ones are often silent wastes.
• Most of the savings in indirect spend result from improved visibility and compliance with contracts rather than tough negotiations.
• Direct spend purchases usually go into the cost of goods sold and indirect spend purchases are recorded as operating expenses.
• The finance function gets a unified view of both spend categories without the need for standardized procedures.

What Is Direct and Indirect Procurement?

Direct procurement is purchasing goods and services that become part of the finished product. Indirect procurement is purchasing goods and services that support the core operations but are not part of the final product.

Direct procurement

A furniture manufacturer buying wood, fabric, and hardware falls under this category of procurement. These items are integrated into the final product, so they affect the cost of goods sold. In addition, they determine the quality of products and the production process’s continuity. For example, delayed delivery or poor quality of materials leads to interruptions in the manufacturing process and, consequently, lost revenues.

Indirect procurement

Meanwhile, the same furniture manufacturer purchases software licenses for its marketing department and cleaning services for its facilities, which fall under indirect procurement. Indirect procurement typically includes IT and software, professional services, travel and entertainment, marketing expenses, facilities, and MRO (maintenance, repair, and operating supplies).

The gray areas

The line between direct and indirect procurement is sometimes blurred because freight is often classified as either direct cost or indirect cost depending on the company’s accounting policies. Similarly, services purchased from external organizations can be ambiguous in some cases. One way to distinguish between direct and indirect procurement is to define whether the spend disappears into the final product (direct) or the company’s operations (indirect). Services procurement is sometimes separated as a third category, including consultants, agencies, and contractors. In any case, it is essential to document the coding rules to avoid misclassifications that undermine spend analysis.

Direct vs Indirect Procurement: Key Differences

The difference between direct and indirect procurement shows up in five places: how you plan purchases, how you treat suppliers, what failure costs, how you account for the spend, and who owns the buying decision.

Planning rhythm

Direct purchases follow the build schedule, thus they are forecast driven and planned, while indirect purchases are request driven and ad hoc, which changes the tooling, as direct buying needs ERP and material planning with bill-of-materials tracking, while indirect buying is guided buying and budget control focused.

Supplier relationships

Direct procurement typically uses fewer suppliers and has longer-term relationships, while indirect procurement has a broader range of vendors with more transactional interactions. Supplier relationships drive benefits such as better pricing, priority during shortages, and risk sharing for direct spend.

Risk and failure

Failure of a direct supplier is visible on the factory floor the same day, while the impact of an indirect supplier failure such as an over-billing agency or slow software vendor has a delayed, diffused impact, and therefore less likely to cause urgent action. Indirect spend has traditionally been under-invested compared to its value.

Accounting and financial impact

Direct spend is recorded as a cost of goods sold and indirect spend is recorded as an operating expense, which has implications for budgeting, cost accounting, and margin analysis.

Organizations that strategically manage indirect procurement achieve cost savings 20-30% higher than those focusing solely on direct procurement.

– Gartner, Procurement Strategy Insights

Direct and indirect purchase orders

Purchase orders (PO) are different for direct and indirect, and where teams feel the difference most is in their day-to-day work. The phrase ‘direct purchase order’ could be interpreted as a purchase from a direct supplier, but the interesting contrast is the behavior of purchase orders by spend type.

Direct and indirect purchase orders

Direct purchase orders

Direct purchase orders are created from forecasts and planned demand, recurring direct purchase orders can be automated, and forecasts can be shared with suppliers to help them plan their resources. Higher risk categories may have blanket agreements with lead time commitments and penalty clauses.

Indirect purchase orders

Indirect purchase orders originate from requisitions from requesters who may not have interacted with procurement before. The key control for indirect purchase orders is the catalog: approved suppliers and prices, thus a request is compliant if it is within catalog parameters without any additional approvals.

Non-PO indirect invoices

Non-PO indirect invoices are the weakest link in the indirect procurement process: when a department hires a consultant on a non-PO basis, the invoice is sent to the company with no contractual documentation or evidence of approval.

Advantages of Direct Procurement

Direct procurement offers several advantages over indirect methods. The main benefits of direct procurement include improved supply chain management and reduced risks of disruptions or delays in the production process.

With a more stable supply of materials and components, the production process becomes more predictable. In addition, direct procurement allows for greater control over the quality of purchased components and materials. Buying directly from suppliers also provides opportunities for cost savings through economies of scale.

Direct procurement helps in developing forecasts for the purchase of materials and components with a specific focus on the needs of the production process. This, in turn, reduces the need for emergency purchases or purchases of surplus materials. Moreover, direct procurement opens up the opportunity for collaborative innovation and the development of new materials and components.

Disadvantages of direct procurement

Firstly, using this type of procurement, organizations become dependent on the suppliers from whom they purchase components and materials.

Secondly, direct procurement requires more effort and time to organize compared to indirect procurement. In addition, working with direct suppliers often means losing visibility over the supply chain, as most companies do not have an overview of their second-tier suppliers.

According to a survey, while 95% of organizations have an overview of their first-tier suppliers, only 42% have an overview of their second-tier suppliers.

Although many companies understand the importance of procurement, the role of procurement managers is still underestimated.

Many organizations have procurement functions at the stage of finalizing the prototype or just designing the product, which is short-sighted since 70-80% of the costs are determined at the design stage.

Thus, the main advantage of direct procurement is not the opportunity to negotiate prices but the ability to become involved in the process early enough to influence the design and specification.

Where Indirect Spend Leaks Money?

Indirect spend leaks money mainly through poor visibility and off-contract buying, not through bad negotiation. Contracts get signed, then employees buy elsewhere.

The scale of the blind spot

Indirect spend typically accounts for 20 to 30% of revenue. Its share of total company spend varies sharply by industry:

Visibility is a critical challenge. Just 19% of CPOs and CFOs at large European companies report having full visibility of their indirect spend and 85% of senior leaders say more than a quarter of this spend has no financial oversight. According to data from McKinsey cited by Zycus, indirect spending at these businesses has grown by around 7% per year since 2011.

Off-contract buying

The Hackett Group found that nearly 30% of the indirect spend was off contract, and that these maverick purchases typically cost 15 to 27% more than on-contract equivalents. Nearly 55% of the organizations studied have a decentralized buying structure to buy indirect materials and other supplies.

A worked example

Here is an illustrative calculation. If you negotiate a 12% discount on $5 million of annual indirect demand, which promises $600,000 in savings, and 30% of your purchasing is off-contract at list price, just $3.5 million is purchased on contract at the discounted price. The total bill becomes $4.58 million, and your realized savings drop to $420,000. That is a $180,000 leak.

This generalizes as a rule of thumb: the percentage of your spend that goes off-contract is the percentage of your negotiated savings that disappear. Other practitioner analysis reaches the same conclusion, noting that this calculation ignores the additional lost rebates and higher-than-necessary processing costs.

Ardent Partners data shows the average organization has a maverick spend rate of nearly 30%, compared to just under 10% for best-in-class indirect spend organizations.

Why does it happen?

Your employees aren’t trying to be non-compliant; the reason they slip off the reservation is that the right way is slower, more complex, or just harder to find. The correct response is to remove friction and enforce compliance:

• Make the catalog the easiest way to buy.
• Fix catalog gaps driving people to look elsewhere.
• Require a PO to make a payment.
• Give budget owners a view of off-contract spend.
• Running Both With One System

Direct and indirect spend require different control sets, but benefit from a shared data foundation. Organizations that treat the two types of spending as separate verticals often end up with visibility gaps between the two, and more complexity and cost due to duplicated processes.

There is a four-step approach to operating a single system for direct and indirect spend:

• Use a consistent classification system. Develop common rules and guidelines, including for gray areas like freight.
• Adapt control sets to the risk of each category. Apply heavier processes and controls to categories where errors or fraud carry the highest cost.
• Measure what matters. Define performance metrics appropriate to each type of spend. Time to delivery and quality metrics like perfect order rate may be most important for direct spend, while maverick spend rate and PO compliance are more relevant for indirect spend. (Targets cited by practitioners: maverick spend under 10%, PO compliance over 95%)
• Enable the end-to-end process. The purchase request, approval, PO, receipt, and invoice should be integrated into a single workflow in a single system, rather than four separate systems.

This is where Zapro AI can help. Its procurement platform includes request, approval, PO, vendor management, contract, invoice, and AP automation in a single application. For direct buying it includes inventory management across warehouses, RFQ sourcing, and alerts when inventory is running low. For indirect buying, it offers purchase request automation, approval routing, and an embedded Amazon Business catalog with over 100 million items.

We offer a flat-rate per-user plan starting at $699/month, simplifying budgeting for smaller teams. It also claims that manual three-way matching takes about 11 minutes per invoice, versus less than two minutes for its automated three-way match.

This is an area where a single invoice can be a useful test: take a sample invoice and see what happens if it doesn’t match the PO and receipt. Most systems will require manual input at some point during the process.

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FAQ

1. What is the difference between direct and indirect procurement?

Direct procurement refers to purchasing goods and services that are used in manufacturing products. Indirect procurement refers to purchasing products and services that are not used directly in manufacturing. These procurement types differ in purchasing process, sourcing strategy, risk management, and accounting.

2. What is a simple explanation of direct and indirect procurement?

An example of direct procurement can be orders of flour, sugar, and boxes for a Bakery. An example of indirect procurement can be oven repairs, accounting software, and advertising services.

3. What percentage of spend is indirect?

The indirect spend percentage varies depending on the company type, for example, for manufacturing companies, it is 20% – 40%, and for service, technology, or health care corporations, it can be 60% – 80%.

4. Is direct or indirect spend easier to control?

Direct spend is easier to control since it is derived from the bill of materials, whereas indirect spend is more challenging to regulate since it comes from various sources that purchase on behalf of the company.

5. What is the difference between a direct and indirect purchase order?

Direct purchase orders are created based on forecasts and are often repetitive. In contrast, indirect purchase orders originate from department requisitions and are controlled by catalogs and approvals.

References

• Esker: What Is Maverick Spend?
• Zoho Procurement: Maverick spend in procurement
• Indirectix (LinkedIn): Maverick Spending Control in Indirect Procurement
• Zapro AI: Procurement Software
• Zapro AI: Home
• Zapro AI: Pricing
• Zapro AI: Procurement Software Demo
• Amazon Business: Introducing Zapro
• Precoro: Maverick Spend
• Procurement Academy: Maverick Spend
• Zycus: Guide to Indirect Procurement
• Ivalua: Direct vs. Indirect Spend
• Aavenir: Advantages of Direct Procurement
• ProcurementAIAgents: Procurement Categories List
• Varisource: Indirect Spend Benchmark
• Spendflo: Advantages of Direct Procurement
• Ramp: Direct Procurement Guide
• ProcurementAIAgents: What Is Indirect Procurement?
• Verdantis: Indirect Procurement Category Strategy
• PM Study Circle: Direct Procurement