Spend vs. spend: The difference between direct and indirect
While the concepts of direct spend and indirect spend can seem elementary to those in the industry, the granular details can get a little fuzzy. Whether you’re a ‘spend’ expert or a novice trying to figure out the difference between meetings — we have you covered. Keep reading to discover the technical differences between the two types of spend and how to really drive home their meanings.
Direct spend is all the purchases of goods and services directly involved in the manufacturing of a product. Often, direct spend is incorporated into a business’ expenses and accounted for ahead of time. These are expected costs and can often work hand in hand with purchasing supplies in bulk.
Here are some examples of direct spend:
- Raw materials
- Subcontracted manufacturing
- Ultimately, any purchased material goods used to create a product fall under the umbrella of direct spend
Of course, to create and push out a product, there are extenuating costs that don’t involve the raw materials required to make it. And that’s what indirect spend is: it relates to every purchase, not directly related to the manufacturing of the product.
Here are some examples of indirect spend:
- IT support
- Safety goggles
- Printed forms
- Office supplies and equipment
How does this affect spend activities?
Knowing the difference between direct and indirect spending informs more than just your financial strategy — it impacts all of your spend activities across the board. With a tighter grasp on these concepts, spend activities can be streamlined and optimized accordingly.
With direct spend, procurement has traditionally spent its energy building and maintaining relationships with the company’s suppliers. While with indirect spend, their focus is on spend management more than on managing supplier relationships: it’s much more about controlling costs than building relationships.
As you’d imagine, direct procurement deals with physical products, and physical products need to be kept in stock. So the direct procurement team has to account for a healthy inventory management strategy, whereas indirect procurement is entirely structured by demand. With indirect procurement, purchases are only made when they’re needed, limiting the need for inventory management.
Differences in calculating KPIs
The way you measure the effectiveness of direct or indirect procurement will differ because of their separate objectives. For example, for vendors who provide goods needed for products (direct spend), you’ll want to take note of their ability to be on time, quality of product, and accurate invoicing. For indirect spend vendors, you will need to pay attention to other elements like customer service, ROI, and how easy it is to get users to adopt it.
In the past, many companies relied on a centralized direct procurement team and a decentralized indirect procurement strategy. However, the decentralized strategy can lead to murky approvals and confusing reports, while a centralized procurement team can lead to too specialized processing that leads to confusion in the company as a whole.
To solve both problems, companies can upgrade to new systems that take advantage of modern technology to create a more intuitive user experience for the whole company and make all purchasing and approvals transparent and easy to analyze.
Properly identifying direct and indirect spend has consequences expanding across all spend activities. From keeping inventory up to date to encouraging a centralized procurement strategy, it’s hard to find an element of your spend activities left untouched by direct or indirect spend.
Why it’s important to have your spend under control
You need to be aware of your business’s direct and indirect spending. This way, you can properly account for your expenses and anticipate what will be coming down the pike.
It may seem like common sense, but having a handle on your spending allows your organization to flourish and expand at scale.
As an organization, you want to have as much visibility into your spend as possible. It’s not a matter of control — it’s a matter of staying informed and being able to predict what comes next.
How Tradeshift can help
In addition to all of the differences listed above, there are still more notable variants between indirect and direct spend. More specifically, the way they’re tracked.
We’ve covered the difference between the two kinds of spend, how it impacts all spend activities, and why it’s all-important. But, how do you track these separate spends? For many organizations, this is a proven pain point and calls for a solution. Luckily, we have solutions here waiting for you to utilize.
For direct spend, elevate your accounts payable with our Tradeshift Pay solution for automating AP processes. Tradeshift Pay is the #1 network solution for automating AP, e-invoicing, and invoice tax compliance and upgrading your processes to be paperless and touchless. Use Tradeshift Pay to let AI do your coding and approvals by learning from you to become smarter and smarter.
For indirect spend, we have Tradeshift Go ready to join your tech stack. Tradeshift Go allows you to see all of the spend you’ve approved in one place, keep an eye on employee spend, and pre-approve where funds go. Combining Tradeshift Go with your existing card program lets you issue pre-approved, encrypted virtual cards through one simple web app.
A large obstacle preventing organizations from properly estimating their costs is the all-too-common confusion between direct and indirect spend.
After analyzing exactly what those two concepts mean, how they affect spend activities, and the importance of keeping your spend under control, we have a clearer understanding of the function of these spend types and their impacts. Plus, you know where to go for cutting-edge assistance in tracking indirect and direct spend.
Want to learn more about the features and capabilities the Tradeshift Platform provides? Our team of experts is ready to take you on a demo of our network to show you how we can help you make shift happen in your own organization. To get started, reach out to our team today.