Seven steps to reducing indirect procurement costs

28 June 2024    By Heidi Humphries


These purchases support the infrastructure and operations of the business, ensuring that everything runs smoothly. Examples of indirect procurement include office supplies, IT services, utilities, travel expenses and professional services such as consulting and legal advice.

Indirect procurement plays a crucial role in maintaining operational efficiency and supporting the production process as well, particularly within the manufacturing sector. While direct procurement focuses on acquiring raw materials and components that are directly used in manufacturing products, indirect procurement ensures that the necessary support systems and services are in place. This includes everything from maintenance, repair, and operations (MRO) supplies to IT infrastructure and employee training programs.

Effective management of indirect procurement can lead to significant cost savings and operational efficiencies. For instance, ensuring that maintenance supplies are readily available can prevent costly downtime in production. Similarly, investing in employee training can enhance productivity and reduce errors, leading to better overall performance.

Direct vs. indirect spend

Understanding the differences between direct procurement and indirect procurement (aka spend) is essential for effective management and cost reduction strategies.

Direct spend

  • Definition: Direct procurement involves purchasing materials, parts, or products that are directly incorporated into the final product. These are tangible components that become an integral part of the finished product.
  • Examples: Raw materials like steel for car manufacturing, cotton for clothing production, or ingredients for food processing.
  • Nature and focus: Closely aligned with the company’s core production activities. Any interruptions can significantly disrupt production.
  • Budgeting and planning: Often involves large budgets, long-term contracts and scheduled orders, given the critical importance of these purchases for production.
  • Strategic importance: Impacts the cost of goods sold (COGS) and, therefore, the company’s profit margins. The quality of direct purchases also affects the quality of the final product.

Indirect spend

  • Definition: Indirect spend refers to the purchasing of goods and services that support a company's activities but are not directly included in the finished product.
  • Examples: MRO, Office supplies, software licenses, consulting services, cleaning services and employee training programs.
  • Nature and focus: Supports business continuity but isn’t critical to the production process itself. Places emphasis on operational functions, administrative duties and overall business operations. 
  • Budgeting and planning: The budgeting and planning process may include spontaneous purchases and may not always be guided by extended agreements. Budgeting could be decentralized amongst a variety of sites and departments. 
  • Strategic importance: The strategic value of indirect procurement can influence operational costs significantly. Inefficiencies or excessive spending in indirect procurement can diminish profit margins, though not always in a straightforward manner. 

The challenges of managing indirect procurement

Indirect procurement can be a struggle to get control of, and with global indirect spend rising on average 7% a year for over the last decade, it’s more vital than ever. Indirect procurement is often fragmented across multiple departments and locations, leading to a lack of centralized control and visibility. Different departments may have their own procurement processes and suppliers, making it difficult to standardize and optimize procurement activities.

Moreover, indirect procurement covers a wide range of categories, each with its own set of suppliers and market dynamics. Managing a diverse supplier base and ensuring compliance with procurement policies across various categories can be challenging. Often, there’s also a lack of dedicated resources and expertise in this area, which can further compound suboptimal supplier negotiations and missed opportunities for cost saving.

Indirect procurement strategies for reducing costs

Procurement leaders can implement several strategies to reduce costs in indirect procurement:

  1. Gain visibility and analyze indirect spend data: The first step in reducing costs is to gain visibility into indirect spend. This involves consolidating all spend data into a single source of truth, such as a spend analytic platform, and standardizing procurement policies and procedures across the organization. By analyzing this data, procurement leaders can identify potential cost savings, such as duplicate spend, supplier consolidation opportunities and unnecessary purchases.
  2. Establish policies and spend thresholds: Implementing clear procurement policies and spend thresholds can help control indirect spend. For example, requiring stakeholders to source multiple quotes before making a purchase can ensure that the best-value option is chosen. Spend thresholds can also be established to determine the limit up to which someone can spend without procurement team intervention.
  3. Reduce maverick spend: Maverick spend refers to purchases made outside of the approved procurement process. Reducing maverick spend involves educating employees about procurement policies and implementing systems that make it easy for them to comply. This can include using e-procurement platforms that guide users through the approved purchasing process.
  4. Leverage technology and automation: Automating procurement processes can lead to significant cost savings. E-procurement systems can streamline tasks such as supplier onboarding, purchase order creation, and invoice processing. Automation reduces the administrative burden on procurement teams and minimizes errors, leading to more efficient operations.
  5. Rationalize the supplier portfolio: Reducing the number of suppliers can lead to better pricing and terms. By consolidating purchases with a smaller number of preferred suppliers, companies can fully leverage their spend and negotiate more favorable contract terms. This also simplifies supplier management and reduces administrative costs.
  6. Implement category management strategies: Category management involves grouping similar products and services together to maximize purchasing efficiency. By managing categories strategically, procurement leaders can identify opportunities for cost savings and improve supplier relationships. This approach also allows for better demand forecasting and inventory management.
  7. Partner with procurement experts: Working with procurement consultants can provide access to expertise and resources that may not be available in-house. These partners can offer insights into best practices, market trends and cost-saving opportunities. They can also assist with strategic sourcing and supplier negotiations. 

Conclusion

Indirect procurement is a critical component of a company’s overall procurement strategy, particularly in the manufacturing sector. While it may not directly impact the production process, effective management of indirect procurement can lead to significant cost savings and operational efficiencies. By following these guidelines, procurement leaders can ensure that their indirect procurement activities contribute positively to the organization’s bottom line, supporting both operational efficiency and financial performance.

Check out how we helped one global automotive manufacturer save over 16% on their indirect spend.