Direct vs. Indirect Spend Explained (+ How to Manage Both)
Colby Ezell / Cost Reduction / December 15, 2022
Managing your business’s spending habits is one of the main focuses of procurement teams. It’s their job to control spending by sourcing, negotiating, and contracting with third-party vendors. They’re also typically in charge of monitoring these suppliers’ billing and performance to maximize profits.
When it comes to spend management, there are two main types — direct spend and indirect spend. Understanding the difference between direct vs. indirect spend can help business owners and procurement teams make more informed decisions when it comes to handling their finances.
In short, direct spend is money that goes directly towards products or services, while indirect spend refers to costs associated with running a business. Let’s break down what each type of spend is and how you can manage both effectively.
Direct spend is money that goes straight toward products or services that your company provides. Because these items and services are absolutely vital to the final product, direct spend procurement must be managed in a specific manner. Any expense associated with producing the goods or services your company sells should be categorized as direct spend.
Examples of direct spend include:
Traditionally, direct spend made up a majority of the budget for most businesses. But today, many companies are experiencing significant growth in indirect spend.
Indirect spend encompasses all the other expenses necessary for running a business that doesn’t tie directly to a business’s final product. All these expenses are essential for the functioning of your business but don’t contribute directly to the production of goods or services you provide.
Examples of indirect spend include:
While spend is the amount of money that a business or organization puts towards certain costs, such as goods, services, or staff, procurement is the act of finding the best provider for your specific needs. While the terms are sometimes used interchangeably, there is a subtle difference.
Procurement is the process of acquiring goods or services. This includes everything from identifying and selecting vendors to negotiating contracts and ensuring that purchased products meet quality standards. In other words, procurement is the process of securing items or services that are needed, while spend is the money that is actually used to purchase those items or services.
While the two concepts are closely related, it is important to understand the difference between procurement and spend. After all, companies need to carefully manage both to ensure that they are getting the best value for their money. By understanding the distinction between these two terms, businesses can more effectively manage their operations and make sure that they are getting the most bang for their buck.
Are the nuances between spend and procurement confusing to you? What about the differences between direct and indirect spend? If so, a simple option is to seek guidance from a third-party company with extensive market knowledge and expertise, such as P3 Cost Analysts.
While the difference between indirect and direct spending might seem minimal for now, we start to see a more apparent distinction when considering how to manage them. First, let’s look at their similarities. Managing both types of spending requires transparency across platforms, careful tracking and analysis, and efficiency within the organization.
For example, if you want to reduce indirect spending on technology licenses, you need to identify which licenses are no longer being used by your team and cancel them accordingly. Similarly, if you want to reduce direct spending on raw materials, you need to analyze which materials are being used in bulk to help get better rates from your suppliers.
Tracking both types of spending also helps determine where exactly money is being spent to create more efficient budgeting strategies going forward. However, the methods and strategies to do that differ greatly for direct vs indirect spend.
Direct spend tends to be more predictable, budgeted for, and planned ahead of time. Because any issues in the supply chain can bring production to a halt, profits will be directly and negatively affected. This guides the specifics of the management process for direct spending.
Direct spend supplies are absolutely critical to final production, so maintaining a steady and reliable supply chain is of utmost importance. Because of this, companies put a big emphasis on maintaining strong relationships with their vendors. These connections help develop sustainable relationships, encouraging on-time deliveries and solid communication between organizations.
Direct spending usually involves thorough budgeting and strict planning to prevent production delays which can have devastating effects on profits. Because of this, companies often have an entire team dedicated to direct spend.
Direct spend purchases are typically purchased in large quantities to secure the best pricing and guarantee available when needed. Inventory management involves a long-term strategy to ensure production continues as scheduled.
Indirect spend is often managed across more than one department, with indirect procurement handled on an as-needed basis. Because of this, indirect spend management is a bit more flexible, with much more room to cut costs. Third-party companies like P3 Cost Analysts specialize in handling indirect spend procurement for other businesses to help with cost reduction. These circumstances mean that indirect spend is managed quite differently when compared to direct spend.
When it comes to supplier relationships for indirect spending, companies actually benefit from creating competition between vendors. With the extra wiggle room, businesses can afford to shop around for the best pricing rather than focusing on mutual benefits. Because of this, third-party consulting with companies like P3 Cost Analysts can help businesses leverage competition and secure better rates.
Procurement of indirect spend categories often falls across different departments within a business. Indirect spend is considered a lower priority, and items are typically purchased only when the need arises. Decision makers of indirect spend choices are often not procurement experts and, therefore, can benefit significantly from outsourcing to companies like P3 Cost Analysts, who have cost-saving experts across many industries.
With indirect spending, products are not typically stored and are only ordered when there is a demand for supplies. Because running out of these items won’t have a major effect on the business’s bottom line, there is no need for a large inventory on hand. Materials are instead purchased in small quantities when the need arises.
Most organizations don’t have a specific department to handle indirect spend procurement, making it the perfect area to consider outsourcing. For example, P3 Cost Analysts is made up of a team of experts that can save your business money across the board on various areas of indirect spend.
P3 has saved our clients millions of dollars in areas such as telecom, utilities, uniforms, small parcel shipping, managed print, linen services, and more. By outsourcing indirect spend procurement to us, you’re equipping yourself with a team of market experts that know exactly where to look to find savings. As a result, you can save between 20 and 40 percent with a full cost reduction audit.
The P3 cost reduction process includes examining your current vendor contracts and invoices to find potential savings and overcharges. Once your current contracts are up, we can help you minimize indirect spend by finding the most cost-effective vendors. Outsourcing with P3 is one of the easiest ways to save your business money in multiple areas.
Understanding the difference between direct and indirect spend can help businesses make smarter decisions about their finances by allowing them to track where their money is going and take steps toward reducing unnecessary expenses.
Monitoring both types of spending also helps create better budgeting strategies going forward so that businesses can stay competitive in an ever-changing market landscape. With proper tracking tools in place, businesses can maximize their ROI by getting the most out of every dollar spent.
Businesses often have much more wiggle room when it comes to indirect spend, as these costs don’t have as much of a direct effect on your final product. Indirect spend procurement is the perfect place to look for savings, and P3 Cost Analysts are the experts to help you do just that.
If you’re ready to take control over your business’s spending, schedule a free call with one of the cost reduction experts at P3 Costs Analysts today.
