Direct procurement refers to the spend on materials and services that are used in core business operations and production. What are the curiosities of direct sourcing and material forecasting? This blog has got you covered!
Procurement can be divided into direct and indirect material categories.
Direct procurement, or direct spend management, is the company's process of purchasing or obtaining materials, resources, goods, and services that are used in the core operations of its business and eventually make up its product.
Direct items are sourced and used in the production of goods and services for the end customer or client.
Indirect and direct procurement vary from each other by their category characteristics and nature. In this article, we will cover what direct material procurement is all about.
What are direct materials?
In cost accounting, direct materials are any physical items built into a product. Simple examples of direct materials in manufacturing are ingredients for a cake, parts for a car, and fabric for clothing.
In manufacturing organizations, direct material spend represents the largest percentage of total spend, even up to 80%.
This would equal to 80% of your pricing structure, competitive advantage, quality, customer satisfaction, and innovation potential. Direct materials are easy to identify, and measure, and are directly linked to the cost of production.
To bake a cake, you need flour, eggs, dried fruit, sugar, etc. These are the direct materials needed to make the cake.
What is a BOM?
BOM stands for a bill of materials. It is a commonly used term in the production landscape. A Bill of materials is a list of all items needed to make a product. The cake ingredients list is a BOM.
In manufacturing, a BOM includes a comprehensive list of raw materials, components, assemblies, and instructions required to construct or manufacture a product or service.
BOM is usually expressed in a hierarchical table format; the finished product is at the top and items are listed in descending order of importance or complexity.
Each line item in BOM is likely to include the product code, item name, item number, item revision, description, quantity, unit of measure, size, length, weight, and specification or description of the item.
Direct materials vs Indirect materials
Indirect materials are those materials that are used in production but do not form a part of the finished goods.
Indirect purchases, both goods, and services are needed to support day-to-day operations. In the cake example, we use protective items such as gloves and other utensils as well as kitchen electricity and work clothes.
While indirect materials enable the production process, it is not possible to accurately allocate their costs to a specific product. The cost of direct materials on the other hand includes any expense directly associated with those raw materials. This may include transportation, insurance, and import-related costs.
The categorization of direct materials is industry and organization specific. Direct category groups vary between companies and industry fields based on the nature of their end products.
Automotive direct materials could look very different from those in the pharmaceutical or food industries. Indirect procurement categories on the other hand tend to be relatively similar across industries. Indirect categories include marketing, business travel, IT, facilities, and professional services.
Direct procurement is the spend on raw materials, goods, and services in order to produce goods or services. Direct procurement includes direct material categories of spend but can also include the indirect materials and services directly linked to the manufacturing process.
Direct materials and direct procurement are often used interchangeably but there are important differences.
In the cake example, the bakery could have outsourced some of its bakers (direct services procurement). On the other hand, indirect procurement should include all the categories of spend that enable a company to maintain and develop its operations.
Direct materials have a direct impact on the end product and profitability of a company. Direct material procurement may be a complex and labor-intensive process. It is a business-critical task to master that will have a direct impact on end products and customers.
Direct material sourcing
Direct procurement is dependent on the continuity of supply while market volatility and price fluctuations bring their own challenges to the equation. It can entail global suppliers, lengthy lead times, and heavy reliance on forecasting and logistics performance.
Sourcing direct materials involves expertise, time, consideration, and attention. Direct material procurement also requires extensive collaboration—there are numerous parties involved, internal and external, and multiple activities to plan, track, coordinate, and control.
Direct materials quality defines the quality of your product and therefore impacts your competitive advantage and customer satisfaction. Therefore, quality management is an important part of direct procurement. Quality management practices vary based on material type and category.
For instance, food quality management could include food safety audits and automotive component quality management could include durability tests.
Spend and material forecasting
Direct procurement relies heavily on its supplier network and material availability and quality. Direct procurement connects multiple items purchased from various suppliers with varying delivery and production schedules.
Complications on both sides of an order require sharing forecasts and visibility into large volumes of data in an accurate format and timely manner.
Direct procurement needs to understand its spend, bill of materials, and aspects that may have an impact on its future demand for those materials. Analyzing the spend patterns of direct materials will help identify the following improvements:
effective production scheduling and demand planning
efficient transportation and warehousing
increased customer satisfaction.
Best performing companies recognize the need to analyze levers impacting bottom line performance – while also looking ahead to drive profitability.
There are multiple tools for spend and material forecasting from spreadsheets to sophisticated solutions fit for large companies. Best-of-breed solutions can provide insights not accessible using ERP systems or Excel spreadsheets that may be clumsy and prone to error.