What drives the difference in direct spend management?

This content was made possible through a collaboration with SAP Procurement

“Direct and indirect spend management are not the same thing, nor should they be treated as such. Anyone who tries to convince you otherwise is focused on simple document transactions.”

- Jennifer Ruscelle Petersen

If procurement loves anything, it is categorizing spend. We categorize through multi-level taxonomies, nuanced processes, and expertise-based team assignments. Different types of spend represent different forms of value to the enterprise and are associated with different types of market leverage and efficiency.

The top-level of addressable spend categorization is a binary one: is the spend direct or indirect? The answer will always be based on industry, company, and context. Procurement will need to study the number and nature of third-party relationships, the level of process and data integration that is required, and the plans that have to be in place to address complexity and risk.

Third-Party Relationships with Direct Suppliers

All key or strategic supplier relationships are ‘important,’ but there is a different importance implication when a third party’s product or handiwork will come into direct contact with your customers. In many cases, these third parties are manufacturers themselves, and this has to impact how companies in different industries manage their direct supply chains.

For example:

• The high-tech industry has engaged contract manufacturers and electronics manufacturing companies for decades. Their ability to collaborate more effectively with these suppliers over time directly affects their production plans, determining just how much flexibility and responsiveness they have with channel and retail customers.
• Life sciences is driven by planning and quality-related processes, striving to work ever more closely with contract manufacturing organizations to ensure alignment throughout the entire production cycle.
• Fast-moving consumer goods providers work side by side with co-mans (co-manufacturers) and co-packers so they can speed up time to market. This enhances their ability to effectively test the target market and launch new products without having to make massive capital investments to build or retrofit their own factories.

The examples shared above are as different as the industries they involve, but this type of supplier engagement in direct spend – close, almost integrated, working relationships – is becoming the norm across industries. If a supplier’s ability to perform is critical to a company’s ability to generate revenue, the partnership has to seamlessly transcend the traditional transactional relationship that continues to be pervasive in indirect spend management.

Integrated Direct Spend Management Processes

Just as relationships between a company and its direct spend suppliers have to be transparent and seamless, so do the processes that take products and services from design to point of sale. Documents such as purchase orders (POs) are far too 2-dimensional to capture all of the associated importance and nuance.

Long before a direct spend PO is created, manufacturers and their supply-side trading partners have to be in sync, and retailers have to be perfectly aligned with their merchandise vendors and private label manufacturers. When a new recipe or product design or specification is in the works, the sourcing and contracting of components, ingredients, and raw materials ensures that trading partners can support your production plans. The selected suppliers then become a critical part of supply chain planning and execution, from design to invoice and payment.

This tight interaction deliberately brings procurement and suppliers into the product development process early, providing critical visibility into and control over final product costs. That control plays an important role in determining how the offering will be priced, both for the sake of competitive advantage and target market share.

Integration is absolutely critical at multiple points in the production process:

• If trading partners can’t commit to forecasts or orders at the planning stage, or when suppliers’ inventory replenishment plans are outside of the desired tolerance range, procurement will need to get involved. It is important to identify and solve such bottlenecks if supplier partners are to be able to drive the levels of on-time delivery and performance your company requires.
• New orders and supplier replenishment plans must flow directly into the company’s ERP system. Otherwise, it is too easy for customer orders and inventory replenishment plans to fall out of sync, especially in a fragile, extended supply chain, or one that is susceptible to disruptions from weather, labor strikes, regulatory changes, or geopolitical issues.
• Contract manufacturers and critical suppliers also have a key role to play in managing quality, and the same can be said for capacity collaboration. Otherwise, deliveries will fall short of customer’s quality expectations, or deals could be closed with no inventory available to fill them.

Although these integration requirements sound overwhelming, technology exists to handle the back and forth and real-time updating that are required. There is no need to bear the risk and time burdens of emails and phone calls when systems can bring companies operationally close, no matter how geographically distributed they may be.

Direct Spend Risk Aversion

Of course, even as we are making the point that direct spend suppliers are indispensable components of a healthy organization, we must remember that the more dependent we are on them, the more risk they represent.

Never in business history has this been more apparent than during the COVID-19 pandemic. We have had an unrequested – yet valuable – real life stress test, and many gaps have been identified. Examples include managing raw materials supply, rapidly changing forecasts, finding and qualifying alternative sources of supply, and meeting excessive demand. Resolving these weaknesses is a top priority for organizations.

Complexity is inherent in modern supply chains, as is risk. In fact, a supply chain with insufficient complexity is probably too under-optimized to be competitive. In a crisis, managing this complexity requires business critical integration points and end-to-end processes and analytics.

All of the points made above make it undeniable that direct spend requires high levels of collaboration, integration, and transparency in order to be sustainable. Achieving any or all of these is not possible without a true business network. A true business network is an agile and multi-faceted platform that solves strategic business challenges as well as it resolves standard connectivity and information needs.

A true business network provides:

• Many to many connections that allow suppliers to reach multiple customers with one information effort, and that customers can use to quickly onboard new suppliers
• Business rules to ensure that processes and documentation adhere to stated governance. Examples include making sure forecasts are committed to within a specified tolerance, and that a three-way match (PO, ASN, invoice) is made to ensure that no incomplete or incorrect invoices hit the ERP
• Analytics that support the desire of customers and suppliers to track and improve performance
• Connectivity to other networks to ensure that multiple business processes can be supported, even as new needs are identified

Direct spend is not the same as indirect spend, and it cannot be treated as if it is. Whether it means changes to third-party relationships, processes and data integration, or complexity and risk mindsets, procurement – and their technology and information sources – have to be prepared to meet the challenge.

Click to hear real-life examples of enterprises across industries who are collaborating with their direct spend trading partners.