The Battle For Procurement Supremacy: Direct Vs. Indirect

Derrick Steiner

Direct procurement is often considered to run like a well-oiled machine. Direct purchases are the most critical to an organization; they represent the materials used as direct inputs of products sold, not back-office expenses like pens and paper (indirect spend). Direct spend involves immense complexities compared to indirect spend, such as more detailed specifications, sole-source suppliers, quality, lead times, barriers to entry, and supply chain risks, to name a few. So how is it not managed to perfection? And how is it lagging behind indirect procurement, digitally or otherwise?

Digital evolution of procurement

Yes, there have been tremendous technology advances for the suite of integrated supply chain applications an organization can use to collect, store, manage, and interpret data to execute the many business activities related to direct spend. These include tools supporting materials management, product planning, manufacturing execution, Kanban, just-in-time, logistics, and inventory management.

However, the digital advancements for tactical and practical execution of procurement activities and collaboration between buyers and suppliers have primarily been focused on indirect spend. This is mainly because of the notions that direct spend is already closely monitored, managed, and under control; indirect spend is where all the fragmentation and mismanagement occurs; and direct spend is too complex for digital innovation.

Technology solutions such as e-auctions, spend analysis, sourcing suites, e-procurement, catalogs, purchasing cards, invoice automation, procure-to-pay integration, and dynamic discounting were all developed with indirect spend in mind. The last major digital, crypto-collaboration improvement between buyers and sellers applicable to direct procurement was EDI (Electronic Data Exchange). EDI was invented in the 1960s and became common by the early 1990s.

Financial statement analysis, COGS vs. SG&A

In addition to the general lack of digital innovation in the space, analyzing financial statement performance yields some interesting insights that suggest that indirect procurement performance is improving while direct is doing nothing.

  • Since 2000, selling general & administrative (SG&A) expense as a percentage of revenue performance has improved 4.0%, or ~US$1.2 trillion in cost avoidance. (SG&A is the traditional financial statement metric for indirect spend.)
  • Over the same time period, cost of goods sold (COGS) as a percentage of revenue performance has remained flat. (COGS is the traditional financial statement metric for direct spend.)

New options

Fortunately, there are now options. Companies and software providers are making significant investments to expand the use cases of these leading indirect procurement technology solutions into managing the more advanced requirements of direct spend. The result can be a fully integrated and unified procurement platform with digital collaboration across the entire supply chain ecosystem. By digitizing, modernizing, and unifying procurement operations, these solutions can enable organizations to operate with world-class execution, achieve strategic objectives, and increase shareholder value by reducing COGS and risk while improving margins, working capital, and service levels.

Note: Source of financial analysis: public financial statements from S&P Capital IQ: Global, 2,800 companies and US$30 trillion in revenue in 2017, calculation for cost avoidance: average % change in SGA 2000 vs. 2017 x 2017 revenue of the sample size ($30 trillion). Financial statement analysis is not a perfect science; it’s not a direct one-to-one relationship. For example, SG&A contains several line items not impacted by procurement. However, SG&A is generally considered the overhead of a company and includes indirect spend categories procurement does impact. The same is true for direct spend and COGS.

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Derrick Steiner

About Derrick Steiner

Derrick Steiner has significant experience leading companies around the globe through strategic and operational transformations to improve cost, cash flow and service as a former management consultant, trusted c-suite advisor, analytical engineer, and change agent. Derrick’s focus at SAP is developing thought leadership to help organizations realize the value and business outcomes of digital transformation.