Talking about sourcing is one of our favourite topics on this blog. However, sometimes we focus so much on it, on trying to help our customers and readers with concepts that are clearly related to sourcing, that we forget about others that, although in a secondary way, also have a direct impact on the supply chain.
This is the case with indirect purchasing, which is often relegated to the background compared to direct purchasing. As is the case with tail purchases, this type of procurement represents a significant opportunity to improve efficiency and reduce costs, because it can have a significant impact on profitability. Although in many cases indirect purchases are not directly related to a company’s core production activity, their proper management is essential to maintain operability and strengthen the financial base of the business.
What exactly are indirect purchases?
Indirect purchases cover a company’s overhead and structural costs that are not directly related to its core business. These purchases, while not part of the production process, are essential to the day-to-day running of the organisation. They include a wide variety of items ranging from promotional material to energy, work clothes, insurance and communications, among others. Efficient management of indirect purchases is essential to ensure the operational continuity and financial strength of the company.
Bearing in mind that indirect purchases are those that do not directly affect the production of goods or services, their correct identification and management become a key factor in optimising resources and reducing operating costs. The differentiation between direct and indirect purchases allows companies to concentrate their efforts on the areas that have the most direct impact on their economic performance, thus facilitating strategic decisions aimed at improving their competitiveness in the market.
Differences between direct and indirect purchases
Direct and indirect purchasing represent two fundamental aspects of a company’s procurement process, each with specific characteristics that impact on its operation and cost management in different ways.
Impact on cost management
Direct purchasing is closely linked to the company’s core business, directly influencing the production of goods and services, which makes it a determining factor in cost management. On the other hand, indirect purchases, although not directly related to production, also have an impact on the organisation’s total costs and require efficient management to optimise their impact on the profitability of the business (or even to reinvest the money saved on direct purchases).
Examples
In order to provide a more detailed understanding of the fundamental differences between direct and indirect purchasing, it is useful to delve deeper with specific examples that illustrate how each type affects a company’s purchasing management differently.
Examples of direct purchasing
Direct purchases are intrinsically linked to the final products or services that a company offers. They are essential to the creation of the final product and therefore have a direct impact on production. Examples include:
- Raw materials: In a furniture factory, the purchase of wood and hardware are considered direct expenses, as they are major components of the final products.
- Specific components: In the automotive sector, the purchase of parts such as engines or braking systems that will be directly installed in vehicles.
- Production outsourcing: Companies that outsource part of their production process, such as hiring an external workshop for the sewing of garments in a fashion company.
These costs are often variable, as they fluctuate according to the company’s production levels.
Examples of indirect purchases
- On the other hand, indirect purchases support the company’s operations but are not directly incorporated into the production of goods or services sold. These purchases are crucial to operational support and the well-being of the working environment, including: Energy and supplies: Electricity to light facilities and operate equipment that is not directly involved in production, such as heating or air-conditioning systems.
- Communication services: Expenditure on internet and telephone services to facilitate communication internally and with customers.
- Insurance: Policies that protect company property, as well as liability insurance to safeguard against legal claims.
- Promotional materials: Items such as brochures, company logo uniforms, corporate gifts and other marketing materials that are essential for promotional activities but are not part of the direct offering of products or services.
Unlike direct purchases, these expenses tend to be more fixed, as they are necessary to maintain operations regardless of current production levels.
Both types of purchasing are vital to business success, but their management requires different strategies and approaches due to their different nature and impact on business operations. Effective management of indirect procurement can not only reduce costs, but also increase operational efficiency and contribute to a more robust and sustainable business structure.
Optimisation of indirect purchases
Optimising indirect procurement is crucial to a company’s operational efficiency. Implementing effective strategies to reduce costs and manage risk in these procurements can have a significant impact on the financial results and competitiveness of the business.
Strategies to reduce costs
- Analyse and compare suppliers to obtain better prices.
- Negotiate long-term contracts to ensure price stability.
- Automate procurement processes to reduce administrative time and costs.
Risk management in indirect purchasing
Risk management in indirect purchasing involves identifying possible contingencies that could affect the company’s operations. Establishing preventive measures and having a contingency plan in place can help minimise the impact of unforeseen situations on resource procurement and business continuity.
Implications for the calculation of the retail price
The efficient management of indirect purchases has a significant impact on the calculation of the retail price of the company’s final products. The indirect costs associated with these purchases must be taken into account to accurately determine the retail price. The key implications in this process are detailed below:
Indirect costs in the manufacture of the final product.
- Indirect costs, such as those related to office materials, insurance or utilities, influence the final price of products.
- These costs must be properly distributed among the different products in order not to affect their profitability.
- Inefficient management of indirect purchases can lead to cost overruns that have a negative impact on the RRP.
Importance of indirect purchasing management in the business
- The correct management of indirect purchases not only affects the calculation of the RRP, but also influences the overall profitability of the business.
- Optimising these processes reduces unnecessary costs and increases the operational efficiency of the company.
- Transparency in the management of indirect purchasing contributes to better financial planning and more informed decision-making.
Improve your indirect purchases, improve your results!
As we have seen throughout this article, indirect purchasing is vital to the smooth running and economic stability of any company. No matter that they are less visible, the implementation of effective strategies for their management, such as the negotiation of long-term contracts, the automation of procurement processes and a proper evaluation of suppliers, can make the difference in the profitability and competitiveness of a company.
Moreover, efficient procurement management not only optimises costs but also contributes to more transparent financial planning and more informed decision-making.
This proactive approach to indirect purchasing management is not only an economic measure, but a comprehensive strategy that strengthens the company’s operational and financial structure, ensuring its long-term growth and success in an increasingly competitive market.