What is Direct Spend Management?

Whether it is a local flower shop or the latest biotech startup, small or large, every company spends money, and the principle remains the same. You have to spend money to make money, right? Yes, but as a business owner or the leader of a procurement team, you want to allocate resources smartly and profitably. 

To do that, there are some fundamental concepts to consider. 

Today, we’ll be talking about one of them: Direct spending.

What’s Direct Spend?

Let’s say that you run a business that designs and builds drones, among the many things your company is going to need to create those products, metals like aluminum or steel are at the top of the list, so you definitely must source suppliers for that and spend money to manufacture your business products.

That’s what direct spending is about. 

We call direct spending the money invested in procuring the raw materials a company needs to create the final product. Direct spending is part of the cost of goods sold or COGS, and as you can already guess, it’s closely linked to the revenue and sales performance of the business.

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Direct Spend vs Indirect Spend

Something that’s also commonly related to direct spend is indirect spend. 

In this case, the money goes to all the factors that keep the company’s operations running. Think of office rental, systems, payrolls, shipping costs… everything that goes into work behind the scenes, is considered indirect spend. 

You can better understand the difference between direct and indirect spending by comparing how both actions are managed. 

Direct procurement management:

It focuses on

• Sourcing and maintaining good relationships with suppliers 
• Keeping stability across the supply chain 
• Finding the highest quality for the materials 

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Indirect procurement management:

It works on

• Analyzing spending 
• Searching opportunities for costs saving 
• Optimizing spend categories 

Challenges of direct spend management

Alright, now that we have a clearer picture of what direct spend entails, let’s move on to the problems that direct spend management often deals with.

Lack of attention 

Yes, compared to indirect spend, direct spend has less attention from part of procurement teams. Traditionally, indirect spend is seen as something that can be actively optimized, direct spend, on the other hand not so much. 

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It’s a fixed cost 

Or so they say, following what we just stated above, direct spend has a reputation of being a fixed cost. An aspect that undermines saving opportunities. 

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A complex process 

This is a pain point for many direct procurement teams, there's just too much information to handle. Layers and layers of documentation and data to review make direct spend a route to bottlenecks.

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No one size fits all

With direct spend, every business and every industry will have its own preferences and special obstacles, so while there can be some general advice, it's almost impossible to find a solution for all. 

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Inventory Management 

Of course, inventory is something else to consider because how can you know what resources the business needs to buy? By checking what your inventory is showing. Problems however might occur if the inventory is not properly managed and situations of overstock or lack of products happen. 

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Best Practices for Optimizing Direct Spend

Now, that we have covered the bad, let’s move on to the pretty side and discover some ways of optimizing direct spend. 

Supplier relationship management 

This is the first step, and we’ll explain to you why. 

Companies are going to need to buy those materials and supply no matter what, they are the fundamental piece in the production process, that doesn’t mean however that you are forced to buy without thinking about where to get the best deals along with the highest quality. You'll also want reliability, formality, and trustworthiness from your suppliers. So when you find that, the best thing to do is to maintain a good and lasting relationship. 

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Analyze data

Many companies have convinced themselves that direct spend is a fixed cost and there's nothing that can be done to optimize expenses. This is not entirely true, there is always room for improvement, but to discover those opportunities you'll first need an accurate understanding of your current levels of direct spend. This kind of analysis can be simply done by using a digital platform that integrates with your systems and data. 

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Adopt Technology and Automation

Invest in Spend Management Systems. How? Implementing ERP systems or spend management software to streamline procurement processes, track spend, and enhance visibility. Automate Processes is also an advisable option you can use automation for tasks like purchase order creation, invoice processing, and spend tracking to reduce manual errors and improve efficiency.

Keep on track with market shifts 

That the world is constantly changing is not a secret, but for business, it is especially important to develop a sense of market awareness in terms of what the latest trends are, and what possible issues could hamper your supply chain so precautions can be taken. 

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Focus on categories 

Category management (link to our blog about this topic inserted here) is one of the most effective ways to streamline procurement processes. Category management allows businesses to divide their products and spendings on specific categories based on market insights.  

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Cross-Functional Collaboration

Coordinate with Other Departments, and make a habit of working closely with finance, production, and other relevant teams to ensure alignment on spend management objectives and strategies. Facilitate communication and information sharing across departments to improve decision-making and process efficiency.

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Review and Improve 

One of the most effective ways to know if something needs a check-up or improvement is to seek feedback. Regularly gather feedback from stakeholders and suppliers to identify areas for improvement in your spend management processes.

Learning from others is also a good practice. Compare your spend management practices against industry best practices and benchmarks to identify opportunities for enhancement.

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Impact of Direct Spend Management 

A good management of direct spend positively impacts the overall bottom-line costs of businesses. 

Here's why: 

• Greater balance across costs: Taking a proactive approach to how expenses are managed when manufacturing your products creates opportunities to analyze and improve the ratio quality/ cost of raw materials.
• Payment terms negotiations: One of the best advice to maintain liquidity flowing is to set the payment terms for suppliers according to what benefits both parties. Extended payment periods or early payment discounts are some of the benefits that can be achieved through strong relationships and negotiation. 
• Reduce maverick buying: This is another benefit of automating PO, as it helps businesses to track expenses and minimize out-of-budget costs 

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Final Thoughts 

Direct spending is an important piece for companies, as it involves purchasing and paying for the basic materials required to manufacture their ultimate products. While it’s often mentioned in tandem with indirect spending, it’s not the same. Indirect spend focuses on the expenses that keep operations running. Both play crucial roles in procurement management. However, direct spend faces challenges, like the lack of attention, the complexity of the process, and that it might be difficult to apply a single strategy as the requirements across industries can vary. 

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