July 4, 2020
The world of corporate procurement can be quite vague and misunderstood by some people — maybe even most people.
In my own experience, I've worked with many people who thought that any position at a company with the words "purchasing", "procurement", or "supply-chain" in the title was just a glorified admin who clicked some buttons in an ERP system and emailed a Purchase Order to a supplier.
Sure. Exactly. That's all there is to it.
(eh-hem... lots of sarcasm here)
There's even far fewer people who understand the difference between direct materials and indirect materials — or even that there is a difference in the first place — and the different processes, knowledge, techniques and tools that go into the procurement and supplier management for each.
In this post we're going to break down the differences and highlight how direct material procurement has its own unique set of challenges.
We'll start with some quick generalized definitions of the two major 'buckets' of procurement. If you care to go deeper, we have a separate, more in depth post comparing direct to indirect procurement and how they present different challenges.
Generally speaking, the split between direct vs. indirect materials depends on whether the material is part of the Bill of Materials (BOM) for a product a company sells, or general overhead for a company's operations.
Direct materials are part of the BOM, integrated in the final product both physically and from a cost standpoint.
As their name suggests, they directly contribute to the Cost of Goods Sold (COGS) for a product. These are things like components, sub-assemblies, and contract manufacturing services.
Indirect materials, on the other hand, are the overhead needed to keep a business running, the cost and use of which is not directly tied to a unit of product the company sells.
These could be things a company needs to either produce a product, design or create a product, or generally support the business. Office equipment, outsourced business services, travel-related services, and other things of that nature.
Certainly both direct and indirect procurement are key functions in a company. Both have their own unique sets of challenges, and both have an extremely large impact on a company's bottom line.
But our focus here today will be to outline some key ways in which direct material procurement is different from it's indirect cousin.
OK, here's the list of ways in which direct-material procurement is different from standard procurement for indirect materials:
Being in the game of managing direct material procurement means that you often have to go 'hunting' for suppliers of some part or component that may not exist yet.
Perhaps your Engineering team has invented something new that requires a very special part that the world has never seen.
Or perhaps you need to find some supplier who will agree to hold extremely tight mechanical tolerances or cosmetic finish requirements.
This typically involves lots of emails, phone calls, and even visits with suppliers, many of which can turn into dead ends.
This is real sourcing work, very unique to the direct material procurement world, and it can be very tiresome. It's a situation I've found myself in many, many times in my career.
Improving this type of 'supplier hunting' was one of the driving factors behind developing Supplios — cloud-based sourcing automation and supply-chain engagement software, custom built for direct material procurement.
The components and materials that go into a company's products are often quite specialized, and are often not available from local suppliers.
In the electronics industry, for example, most direct material supply-chains run through places like China, Southeast Asia, and Korea, simply becuase that's where the electronics component manufacturers are located these days.
This typically requires direct material procurement people to 'get out of the office' more, doing lots of supplier visits, audits, and onsite technical meetings with their engineering and manufacturing colleagues.
Indirect procurement teams may also work on a global scale, particularly for large corporations, but not typically more than the direct material teams.
In order to be effective at finding and qualifying suppliers and understanding the technical details of the parts being supplied, direct material procurement specialists are often required to focus on a certain commodity or industry segment full-time.
In many large organizations, there may be one or more "Global Supply Managers" (GSMs) or "Commodity Managers" assigned to cover a certain segment.
Their job is to know that segment inside-and-out so they are well prepared to find reliable partners, evaluate high-level technical capabilities, and negotiate agreeable terms.
Direct material procurement often requires extensive technical knowledge of the material being purchased, as many of the components are technical parts and/or custom engineered by the buying company.
Buying decisions therefore have many stakeholders, likely including representatives from internal Engineering, Product Development, Manufacturing and Quality organizations, in addition to the Supply Chain and Procurement teams.
Certainly indirect procurement must focus on environmental and CSR issues as well, but with direct material procurement these such compliance requirements have multiple added dimensions.
In buying components or manufacturing services from a supplier and using them in their own products, a company is directly connecting their own brand to the supplier. The supplier's business practices, quality, environmental and social responsibility practices directly reflect on the buying company.
Issues at a supplier can cause major negative publicity for a buyer, as has been the case for companies like Apple, Nike, and other major manufacturers in recent decades.
Proper due dilligence on suppliers for these things has become a major undertaking in the direct material procurement world, and must be taken seriously — far more than just a simple check-box on a contract or RFQ form.
Just as with the compliance requirements mentioned above, a direct material supplier's quality is directly inherited by the buyer in their own products.
Quality requirements must be well established in advance of the sourcing process, and must be well documented in specific detail as part of any contractual agreements.
Quality in the context of direct materials is typically measured with specific metrics both at the part-level (AQL, Cp/Cpk, etc.) and with specific quality system certifications at the supplier level (ISO900x, Six Sigma, etc.).
In making purchasing decisions for direct materials, it is critical to get a thorough understanding of a supplier's quality processes, any past quality issues, and the quality guarantees they will contractually commit to.
As inputs into a company's production process, direct materials are on the critical path for a company booking revenue. Therefore schedule, lead-time, and on-time delivery are critical factors to consider when sourcing direct materials.
A supplier's track record and contractual obligations with these things is often a key decision point when making purchasing decisions.
Certainly schedule is important with indirect materials, but with direct materials, it is near the top of the list of importance, and it is something that must be managed closely with a supplier on an ongoing basis.
As the result of being very schedule-driven (see above), purchasing decisions and source-to-purchase cycles can be very short with direct materials, and sometimes very unexpected.
Unexpected spikes in demand, natural disasters, global health pandemics, geopolitical issues, or simply quality issues at an existing supplier can lead to emergency sourcing situations that require rapid action.
It is certainly possible for shortage of a single component to cause an entire production line to stop, stopping a major revenue stream for a company.
These types of emergency situations are quite rare with indirect materials.
It is very common in direct material procurement to select multiple "winners" in a purchasing decision.
In these cases, the production volume may be split between these multiple suppliers either as a risk mitigation strategy, price negotiation strategy, or with the idea that one supplier may not reach final technical qualification.
This strategy, typically uncommon in the indirect procurement world, adds to the overall burden on a supply-chain or procurement team: more suppliers to manage, more terms to negotiate, and more schedules to coordinate.
The terms RFP, RFQ, RFI, or RFx are thrown around quite often in the procurement world, and their meanings can vary greatly.
Generally speaking, however, an RFP is a more open-ended in nature, allowing some flexibility in the exact solution proposed by suppliers — hence the 'P' in RFP — 'proposals'.
RFQs on the other hand, are usually much more specific in nature, with a company specifying exactly what they need to purchase, using the RFQ to solicit specific price quotes from suppliers.
In the world of direct material procurement, RFQs are very commonly used, often with entire Bills of Materials (BOMs) being sent to suppliers and component distributors in the form of multi-line RFQs.
Managing and sorting through the responses to such complex RFQs is often a very tedious task without the use of purpose-built RFQ software.
Due to the face that direct material suppliers are part of a company's production process & final output, company/supplier relationships typically span across many departments within the company, well beyond a procurement or supply-chain team.
There are often direct connections between engineering teams on both the company and supplier side, as well as quality teams, production teams, planning teams, and others.
This changes the game for the procurement and supply chain team, as there are multiple layers of relationships and communications to manage and stay informed of.
These deep relationships can be beneficial long term as they evolve into strong partnerships, but they can also cause complications during contract negotiations, and can sometimes be difficult to unwind if the relationship ever sours.
It certainly adds another dimension of complexity that is less often seen in the indirect material procurement world.
As companies look for the edge in developing, launching, and manufacturing market leading products, they often turn to technology-based solutions to move faster, run leaner, and streamline operations.
ERP systems, PLM (Product Lifecycle Management) sytems, QMS (Quality Management Systems), MES (Manufacturing Execution Systems), are all quite commonplace these days, and all have their own place in product development and manufacturing.
Gone are the days of a paper invoice being sent to a supplier for a full year's worth of part inventory.
The lucky ones working in Suppy Chain and Procurement often have the wonderful opportunity of working with all of these systems. 😂
ECOs from Engineering, NCMR on a supplier's parts from manufacturing, cutting POs in the ERP together with a finance team... its all part of a days work being on the critical path of a company's production and revenue.
Such integration with so many internal systems is less common on the indirect side of procurement, and therefore the tools they use to manage the procurement process can be slightly less complex.
On the direct material side, there are finally some tools coming to market, such as Supplios, which helps with supplier relationship management, as well as providing integrations with ERP, PLM, QMS, and other internal systems.
This list is certainly not complete. There are so many different unique challenges involved in direct material procurement and supply-chain management — we could talk about it for days. (Some of my friends think I do!)
So despite other "sourcing automation" or "digital procurement" solutions hitting the market in recent years, we found that none of them really fit all the unique challenges involved in managing a fast-moving, modern, global supply chain.
Most of those other solutions are really just intended for the still-very-important but different "other side" of procurement — managing indirect spend.
And this is exactly what led to the creation of Supplios — a purpose-built integrated platform to enable Supply Chain teams to do more, faster.
OK, time to get back to work on some new features...
If you, too, are on the direct-material side of the procurement world, we'd love to show you what we've built — we think you'll like it.
Drop us a line at firstname.lastname@example.org or contact us and we'll setup a custom demo to show you how Supplios can save you and your team valuable time and scale out a world-class supply-chain.