There are many reasons to start paying more attention to the indirect procurement process. A modernized, efficient indirect procurement process is a source of cost reductions, community economic growth, improved sustainability and increased profit. It also drives measurable value, using many of the same tools and metrics as direct procurement.
Indirect procurement has long been the ignored child of the procurement function, with direct procurement getting most of the attention. Yet, optimized indirect procurement can bring measurable value to the business. Realizing that value begins with a change of perception, and a willingness to invest in the resources to efficiently manage and track indirect suppliers, and spend, rather than relegate them to a fragmented buyer process. In fact, the indirect procurement process needs a complete overhaul in most businesses, so it can be folded into strategic procurement planning and execution. This category of purchasing needs the same type of attention as direct procurement in terms of planning, technologies, category management, and metrics.
CHOOSING INDIRECT PROCUREMENT TRANSFORMATION
One reason that indirect procurement is often given little attention is because the main focus is naturally and understandably placed on the delivery of materials, goods and services linked to driving performance and profit as inputs into the production of whatever the company sells. Indirect procurement is the sourcing, buying and management of the goods and services needed to operate the business. This includes categories such as office supplies, waste management services, repairs, and maintenance. Traditionally, businesses develop long-term relationships with major suppliers in direct spend categories, while the focus on indirect suppliers is on spend rather than relationship.
A company usually does not apply Supplier Relationship Management (SRM) best practices in the indirect procurement categories. It is mostly about getting the lowest cost, which leads to continual shifting between suppliers. Many of these suppliers are, however, local small and diverse-owned businesses, and the shifting of business back and forth means they do not get the same chance to expand their businesses with the corporate customer like direct suppliers do, i.e. by expanding delivery locations, or growing with the customer’s business growth. This hurts small businesses and suppresses local economic growth.
So while value creation works on both sides of the supplier equation – for the corporate customer and the indirect suppliers, indirect procurement is usually not perceived as value-creating and thus receives minimal attention. McKinsey & Company research found that optimizing indirect-procurement can reduce costs by 15-17%. Transforming the indirect procurement function can lead to up-front value capture, sustained annual improvement, and long-term value. There is a crossroads, at which businesses must decide if they are going to simply change a few practices or undergo a total transformation which is the real path to long-term value creation.
BUILDING SUPPLIER RELATIONSHIPS BEGINS WITH ANALYTICS
The transformation of indirect procurement first requires the business to change how it perceives the process. With a new perspective, procurement can develop a strategic sourcing plan, based on an in-depth analysis of indirect spend in each category. In many organizations indirect spend is fragmented, with departments and functions given control. This places indirect spend outside of procurement and inevitably leads to untapped value and waste. A strategic approach would categorize the spend and suppliers for procurement management, while centralizing organizational monitoring and management, if decentralized category management is retained.
Based on the analysis, procurement begins building strong supplier relationships as part of its category management process. The same practices (such as regular communication and supplier performance monitoring) applied to direct spend suppliers should be applied to indirect suppliers. This is also an opportunity to mentor women- and minority-owned businesses, in order to drive community economic growth and help them grow their businesses.
Tracking the indirect spend categories on an analytical level means there must be an investment in technologies and developing employee skill sets. Some of the technologies include automated procure-to-pay (P2P). This improves cash flow management, while ensuring suppliers are paid in a timely manner, important to the typical smaller suppliers of indirect goods and services. Procurement needs digital technologies that enable classifying and categorizing indirect spend, meaning a data collection system is required. Pooling data gives the ability to develop analytics with more meaning for the organization. For example, duplication and waste are easier to identify, and areas where negotiations with suppliers can increase value become visible. Real-time analytics provide category managers with a better view of supplier performance and spend.
MEANINGFUL KPIs FOR INDIRECT PROCUREMENT
Other digital resources include machine learning, Artificial Intelligence and cloud computing, to name a few. The challenge is developing KPIs for indirect spend categories that are as meaningful as those for direct spend. The analytics should assist procurement and internal buyers with identifying more than costs and quantity. They include identifying spend concentration with suppliers, spend on contracts, top suppliers (accounting for 75% of indirect spend) and trend analysis. Other important metrics include lead times, internal costs of purchasing, and capacity to respond to demand. Metrics and KPIs should help optimize quality, compliance with sustainability and social goals, compliance with diverse supplier spending targets, and timing. Notice that many of these are the same metrics used with larger suppliers on direct spend.
There are many software systems and Software-as-a-Service vendors that can streamline cost management, supplier relationship management, and inventory management for indirect purchasing. Unlike direct spend items procured and maintained in inventory, indirect procured items are bought based on demand. Analytics can help buyers optimize demand and supply, a major source of cost savings.
MOVING BEYOND COST REDUCTION
There are many ways to drive value through indirect procurement, but the first step is getting away from only a cost reduction focus and determining what it will take to move into value generation. Assessing a number of factors can identify areas where value is untapped. These include quality metrics, transactional costs, delivery frequency, size of orders, and product specifications. Doing this analysis across the indirect procurement value chain leads to the identification of opportunities to benchmark performance process, reduce costs, improve sustainable sourcing, develop supplier relations that increase value, and negotiate sourcing contracts.
Of course, not every category of indirect spend needs this level of attention. The audit of each category will produce informative analytics that enable prioritizing based on financial information. An important part of the process is educating procurement staff and internal stakeholders, so getting their early involvement in the transformation process is wise. A final reminder is to ensure that employees with roles in the transformation process and transformed indirect procurement system are well-trained on the new tools and resources.