Direct Procurement Explained

Imagine a chocolatier, known for producing premium chocolate bars with a rich, sophisticated flavor and velvety texture that melts in the mouth. The success of this business hinges on the careful selection and acquisition of the high-quality cacao beans, sugar, and milk needed to make its fine chocolate. Direct procurement involves the sourcing and purchasing of those ingredients, all of which are considered essential to crafting the signature chocolate bars customers crave.

A strong direct procurement program is vital not only for that chocolatier, but for all businesses. For instance, a furniture maker needs wood, upholstery, and hardware to build tables and chairs; an electronics manufacturer requires circuit boards and screens to assemble smartphones; and a clothing company must secure fabric and zippers to create skirts and slacks. By expertly negotiating fair prices and favorable terms with suppliers, a well-executed direct procurement strategy allows a company to acquire all the necessary supplies to create products within budget and on time to meet production deadlines.

When direct procurement is mismanaged, however, a company can find itself exposed to significant risks, potentially leading to increased costs, inadequate supplies, or poor product quality, which may affect its ability to produce enough goods to meet consumer demand or customer satisfaction. This article delves into how businesses can address common challenges in direct procurement, as well as best practices for optimizing the direct procurement process. With proper foresight, businesses can make sound procurement decisions, ensuring that production continues to run smoothly and customers remain satisfied even if market conditions abruptly change or a supply chain disruption strikes.

What Is Direct Procurement?

Direct procurement, also known as direct spend, is the process of acquiring the essential goods, materials, and components necessary for producing a company’s core products or services. The primary objective of direct procurement is to make sure the business receives a steady supply of high-quality materials at affordable prices, enough to keep production running at optimal levels and reliably meet customer demand. Effective direct procurement involves strategically selecting and managing key suppliers, negotiating favorable terms, monitoring supply chain performance, and keeping an eye out for potential disruptions that could prevent the arrival of materials, upset production schedules, or compromise the quality of a company’s products or services.

Advanced technology, such as supply chain management and procurement software, can ease the direct procurement process by providing real-time insights into inventory levels, automating supply ordering tasks, and allowing businesses to quickly pivot, if necessary, in response to changing market conditions.

Direct vs. Indirect Procurement

While direct procurement entails buying supplies that are integral to production, indirect procurement refers to acquiring goods and services that support business operations but aren’t directly used to build a company’s core products. Examples of indirect procurement include a company’s office supplies, cleaning services, computer software licenses, and utilities.

Although indirect procurement is less visible in the production process and typically accounts for less of a company’s budget than direct procurement, spending on products and services that support business functions is important for creating a happier, more efficient workforce. Investments in state-of-the art software, for instance, can make employees’ jobs easier by automating routine tasks and boosting worker productivity and morale.

Key Takeaways

• Companies with more mature procurement processes tend to be more profitable, consistently seeing higher earnings than businesses with less sophisticated procurement practices.
• Procurement leaders must continually mitigate a variety of potential risks, including sudden cost increases and supply shortages.
• It’s important for companies to nurture their relationships with key suppliers, including offering incentives, favorable contract terms, and increased orders to suppliers that consistently provide excellent service or provide a critical product or service.
• Advanced technology, such as procurement and supply chain management software, can assist with the direct procurement process by monitoring spending, managing supplier relationships, automating purchasing tasks, and providing real-time data to help track procurement performance.

Direct Procurement Explained

Direct procurement, which involves sourcing and purchasing products and services that are essential to a company’s core production processes, requires significant resources. Companies not only need to buy all the required materials to build their products; they also must invest time and money in forecasting demand, monitoring inventory levels, nurturing supplier relationships, and managing potential risks, such as supply chain disruptions, to make sure the right materials are ordered at the right price and arrive at the right time.

The link between a well-oiled procurement process and business success is clear. Companies with more mature procurement processes tend to be more profitable, consistently seeing earnings at least five percentage points higher than their peers with less refined procurement operations, according to a 2024 McKinsey analysis.

Why Is Direct Procurement Important?

Direct procurement plays a crucial role for businesses. In a nutshell, it drums up the indispensable supplies needed for producing the goods and services that will ultimately generate a company’s revenue. Procurement teams focused on sourcing raw materials have the important responsibilities of managing multiple suppliers, controlling material costs, maintaining the quality of products, and influencing the final product’s pricing and profit margins. In addition, a sophisticated direct procurement process can help safeguard against supply chain disruptions by making sure materials are consistently delivered on time to avoid costly production delays that could reduce a company’s sales and damage its reputation.

In recent years, automobile dealerships have seen firsthand the critical importance of direct procurement. During the pandemic, a sudden drastic shortage of semiconductor chips, a key material needed to build cars, prevented the production of an estimated 13 million vehicles worldwide in 2021 and 2022. Although the supply of these chips has rebounded considerably, many automotive companies are still struggling with the ripple effects; in fact, vehicle production and sales aren’t expected to fully recover to prepandemic levels for years. While the entire auto industry was impacted, companies with more sophisticated direct procurement practices were better able to mitigate damages from the crisis.

Building strong relationships with reliable suppliers allows companies to gain preferential access to scarce materials, cutting-edge technologies, and other exclusive resources, leading to potential innovations, improved product features, and cost advantages that can set a company apart from its competitors.

Addressing Common Challenges in Direct Procurement

In light of recent economic uncertainties, product price increases, and supply chain interruptions, procurement teams are facing more pressure than ever to control costs while strengthening the flow of essential production materials. Indeed, a recent Hackett Group study showed that, in 2024, the top three priorities for procurement leaders were reducing costs, ensuring supply continuity, and combating inflationary price increases. Here’s a closer look at some of the major challenges procurement teams are grappling with:

• Cost control and budget adherence. Although inflation rates have stabilized and even declined in some sectors, businesses are still reeling from the impact of rising supply prices. This makes procurement teams that are already budget-conscious extra focused on reining in costs. In fact, 65% of procurement departments named cost control as their top priority in 2024, according to a global survey of procurement leaders by PwC. Yet tamping down costs can be difficult due to the volatile and complex nature of global supply chains. For instance, electronics manufacturers regularly struggle with the unpredictable pricing of semiconductors and rare earth metals, which can alter the cost of producing smartphones, laptops, and other devices. Quality and regulatory requirements also play a role. For example, a pharmaceutical company can’t take shortcuts that might compromise the purity of its active ingredients simply to reduce costs.
• Supplier relationship management. Managing suppliers requires carefully balancing cost-reduction goals with the need to maintain strong, mutually beneficial relationships with vendors. If an appliance manufacturer feels the need to seek lower prices on critical components to remain competitive, for instance, the company also needs to be careful that it doesn’t use cutthroat negotiation tactics that turn off its main supplier and damage the relationship over the long term. Companies also need to make sure they’re working with a diverse group of suppliers so that if one company abruptly stops providing materials due to a natural disaster, geopolitical tensions, or other unexpected crisis, additional suppliers are available to beef up their shipments to fill the gap.
• Risk management and mitigation. The pandemic exposed vulnerabilities in many companies’ supply chains, leading to large-scale production disruptions in multiple industries. Trade disputes between countries have also led to sudden export restrictions, forcing procurement teams to quickly change course. Adding to that, rising costs caused by inflation have impacted the direct procurement process. Indeed, chief procurement officers (CPOs) say risk is here to stay. In fact, more than 70% of CPOs said that procurement-related risks and supply chain disruptions had increased in the previous 12 months in a 2023 Deloitte survey—and that was on top of an already elevated baseline. The top two issues with the greatest impact were cost risks at 89% and supply shortages at 79%.

But these aren’t the only risks procurement teams face. Companies today also need to thoroughly vet their suppliers’ environmental practices and labor conditions—or run the risk of reputational damage. For instance, a clothing manufacturer might receive bad press if one of its fabric suppliers uses unsustainable practices or exploits workers by paying meager wages. Cybersecurity risks are another constant concern. A major cyberattack on a key supplier could compromise sensitive data and interrupt shipments of goods and services. Increasingly, procurement teams are managing risks by developing more sophisticated risk assessment and mitigation strategies, including investing in advanced analytics, supply monitoring, and contingency planning.

6 Best Practices for Optimizing Direct Procurement

While today’s business leaders understand that they can’t avoid every unknown threat that might disrupt their operations at any given time, they can take steps to strengthen their direct procurement processes so they can navigate the next eventual setback and avoid production slowdowns—or worse, complete shutdowns. Here are six best practices for optimizing direct procurement.

1. Select and Evaluate Suppliers Strategically

   It’s too risky to rely on a select few suppliers. Instead, businesses need to diversify their supply chains, selecting multiple suppliers with solid reputations for coming through, even during turbulent times. A 2024 Gartner survey of supply chain leaders revealed that 73% have made supply chain network changes in the past two years, and 48% have pursued new supply locations with new supply partners. The goal for most is to fortify resilience.

   When strategically selecting suppliers, companies can start by systematically identifying and evaluating businesses that best meet their needs in terms of providing a steady stream of quality supplies at the right price. Prior to partnering with vendors, it’s important to thoroughly assess the stability of these prospective partners. To do so, companies can use a scoring system to rate companies on various criteria, including technical capabilities, financial health, product quality, and years of experience in the business.

2. Foster Strong Supplier Partnerships

   Once a company settles on a group of suppliers, it’s important to nurture those partnerships to maintain strong relationships. Companies should keep the lines of communication open with their suppliers and regularly discuss both short- and long-term business needs and goals. For instance, a clothing manufacturer might hold quarterly meetings with its key suppliers to discuss current fashion trends and production forecasts, allowing suppliers to align their output with the manufacturer’s requirements. Or a consumer electronics company might work closely with a display panel provider to develop more energy-efficient screens, improving sustainability for both businesses.

   Businesses can also offer their suppliers incentives for exceptional performance, including bonuses, favorable contract terms, and increased order volumes to vendors that consistently prove their value. A juice company, for instance, might offer a guaranteed minimum purchase of apples at a set rate over a specified period in exchange for priority access to high-quality crops, creating a more reliable supply chain that improves product quality, controls costs, and ensures a steady supply of fruit.

3. Use Technology and Automation

   Technology can take much of the stress out of procurement, and a growing number of business leaders know it. In the Deloitte survey, digital transformation was the second-most-cited procurement strategy by CPOs after supplier collaboration, and analytics and robotic process automation were the top technologies companies were investing in and gaining value from. Yet many businesses still have plenty of work to do to get up to speed. While a 2023 Hackett Group study showed 45% of executives are accelerating digital transformation, 42% of enterprises reported they still have legacy systems they need to replace.

   Businesses with more mature procurement programs are benefiting from software that offers comprehensive supplier management capabilities and incorporates artificial intelligence, allowing them to manage supplier contracts and track performance more effectively. Advanced procurement software often incorporates features that automate purchase order creation, routing, and approvals based on predefined settings, reducing manual data entry and accelerating the procurement cycle. And many systems offer real-time spend analytics and forecasting tools, so procurement teams can identify cost-saving opportunities, stay on top of inventory levels, and make more strategic sourcing decisions.

4. Conduct Regular Audits and Performance Reviews

   Conducting periodic audits to evaluate the performance of both a company’s internal procurement process and the performance of its suppliers is crucial for driving continual improvement in direct procurement. Businesses should establish a structured monthly or quarterly audit schedule to assess the effectiveness of direct procurement functions, such as supplier performance, contract compliance, and cost-saving initiatives.

   For instance, a cosmetics company might enlist both internal and external auditors to conduct a monthly review of its direct procurement of the natural oils, fragrances, and chemical compounds needed to formulate its skincare and makeup products, with the goal of identifying inefficiencies or noncompliance with its quality standards. Companies should also evaluate supplier performance on cost competitiveness, technological readiness, and on-time delivery, while also auditing internal procurement processes to spot any slow practices that are regularly causing delays.

5. Implement Sustainable Procurement Practices

   In recent years, consumers have increasingly stated their preference for purchasing products from companies with sustainable procurement processes, pushing businesses to adopt a growing array of environmental, social and governance (ESG) practices. And businesses are responding: A global KPMG survey of procurement leaders in 2023 found that 66% are making environmental responsibility and sustainability a top priority.

   To improve sustainable procurement practices, businesses can start by establishing clear goals for evaluating suppliers, looking not only at cost and quality but also at their environmental performance and labor practices. A company that produces guacamole, for example, might prioritize suppliers that conserve water and avoid pesticides in their agricultural farming methods. In addition, companies should work closely with their suppliers to set sustainability targets, share best practices, and jointly develop innovative production methods that conserve resources. Businesses might even consider providing incentives, such as bonuses, to suppliers that reach sustainability goals. In the end, companies benefit from an improved reputation among consumers, as well as gaining cost savings through reduced energy consumption, waste reduction, and improvements in resource use.

6. Align Procurement Strategies With Business Objectives

   Businesses must ensure that their procurement strategies are in sync with their business objectives. For example, if a company is aiming to expand into new markets, the procurement team should focus on identifying and partnering with suppliers in the regions being considered, making sure they can source materials in compliance with local regulations. Or, if cost reduction is a company’s primary goal, procurement teams could seek to negotiate long-term supplier contracts at fixed prices or explore partnerships with new suppliers offering better terms.

   Aligning a procurement strategy with a company’s broader business objectives requires constant communication between procurement and other departments, including finance, product development, and the C-suite, to make sure everyone is on the same page regarding the best ways to advance the company’s goals.

Measuring Success in Direct Procurement

Companies can measure the success of their direct procurement strategies by employing a variety of key performance indicators and metrics that align with their business objectives, often emphasizing two key areas: cost management and supplier performance.

To manage costs, companies can track metrics such as cost savings, which quantifies the reduction in spending due to procurement activities, and cost avoidance, which outlines the potential costs that were averted. When measuring supplier performance, companies should assess suppliers based on the volume of materials provided, lead times from order placement to delivery, the quality of their products, and other factors, such as a supplier’s commitment to sustainability as well as its ability to weather natural disasters, economic downturns, and other potential supply chain disruptions.

Discover NetSuite’s Comprehensive Solution for Procurement

Direct procurement teams are tasked with a complex, high-stakes job. If an essential material doesn’t arrive when it’s needed, production could come to a standstill, impacting a company’s revenue and overall performance. NetSuite Procurement provides the support companies need to efficiently buy essential goods and services at optimal prices. The system closely tracks orders and monitors delivery timelines, automates the receipt of ordered items and the payment process, and improves visibility into a company’s spending patterns. Plus, it’s easy to find up-to-date information about all the materials vendors are supplying, so purchasing managers can track vendor performance, quickly identify procurement processes that need improvement, negotiate more favorable contracts and, ultimately, avoid unexpected price increases and disruptions to production cycles.

In addition, NetSuite supply chain management solutions allow companies to leverage AI to optimize the flow of materials and update inventory levels, outstanding orders, and production data in real time. The software assists with a variety of key tasks, including planning for future demand, allocating resources, and overseeing production to get products to customers in a timely and cost-effective manner.

Direct procurement teams face a variety of significant challenges, from keeping costs under control and managing a maze of supplier relationships to mitigating a multitude of risks that could threaten to disrupt the supply pipeline and impact production. Yet companies can take steps to improve their procurement process, including strategically selecting suppliers, conducting regular performance audits, aligning procurement strategies with business objectives, and leaning on technology to ease procurement-related tasks.

Direct Procurement FAQs

What are direct materials?

Direct materials are the raw materials, components, or supplies that are essential to the manufacturing of a product, such as the wood required to make a kitchen table or the glass used to produce a lightbulb.

What are the three main types of procurement?

Here are the three main types of procurement:

1. Direct procurement involves the acquisition of raw materials that are used in manufacturing a product, such as the cowhide, rubber, stitching, dyes, and adhesives to make footballs.
2. Indirect procurement entails sourcing the supplies and services needed for a company’s day-to-day business operations that aren’t used to create end products. Examples include office supplies, facility maintenance services, and computer software.
3. Services procurement refers to acquiring services from external suppliers, such as consultants, technology providers, and marketing agencies, to support the business.

What is an example of direct procurement?

An example of direct procurement is a bakery purchasing essential ingredients, such as flour, eggs, and baking powder, to make the cookies, cakes, and bread it sells.

What is the difference between direct and indirect procurement?

Direct procurement involves securing the goods and services that are directly incorporated into a company’s end product or service, such as the raw materials used in manufacturing automobiles. Indirect procurement, on the other hand, focuses on purchasing goods and services that support a company’s daily operations but aren’t used to create products. Examples of indirect procurement include cleaning services, office furniture, and software subscriptions.

What is another word for direct procurement?

Direct procurement is also known as direct spend, which emphasizes the focus on managing expenditures related to the acquisition of raw materials and components that are directly linked to a company’s core production of goods or services.