The process of purchasing raw materials like metal, glass, plastic, and rubber or inputs like electrical components may not seem all that important in the long run.
However, these direct procurement practices have a strong influence on your product quality and costs.
In this guide, we’ll take a deeper look at direct procurement, how it impacts your business’s success, and provide some helpful suggestions to help you optimize this key business process.
What is direct procurement?
Direct procurement is the process of purchasing raw materials or components that are necessary inputs for the goods you sell.
Sometimes, this process will be referred to as direct spend or direct cost.
Direct procurement is a prevalent practice in several industries, such as manufacturing, and construction.
For example, a company that manufactures vehicles relies on direct procurement to source the rubber, mechanical parts, metal, and electrical components required to assemble the cars they sell.
Direct procurement is distinct from indirect procurement, which is the purchase of goods and services that support the business’s daily operations but aren’t incorporated into their final product or service delivery.
The importance of direct procurement
The ability of your procurement department to source quality raw materials and input parts at favorable terms can dictate the price you charge consumers, the cost of goods sold (COGS), how profitable production is, the speed of manufacturing, and the condition of the final product.
If direct procurement processes become lax, you could end up lacking the proper raw materials or inputs to meet target production quantities and fail to meet customer demand.
Plus, the procurement team must select suppliers and negotiate contract terms that will keep COGS low, supporting the bottom line. Otherwise, you could face a difficult decision between shrinking profits or raising consumer prices to make up for it.
The 3 steps of direct procurement
Each company will have its direct procurement guidelines and procedures to best fit its unique manufacturing needs.
However, the following steps provide a general idea of how the process might look:
- Identifying needs
The direct procurement process begins with assessing the specific goods, materials, or services you need to produce the end product, and in what quantities.
To ensure product quality, you should also consider the specifications and standards you require from a supplier.
For a furniture maker, this might include the specific grades, finishes, and dimensions of wood they need, certain tools and equipment, and hardware.
Making a list of needs before evaluating suppliers will help you prepare for negotiations, ensuring you get the exact level of quality and quantities they require to support production.
- Supplier selection and negotiation
Next, the procurement team should research potential suppliers and inquire about their capabilities.
Some important questions to ask suppliers during this stage include:
- What are the quality standards for your materials or products?
- Do you offer customization to meet our specific requirements?
- What is the pricing structure?
- Are there volume discounts available on large orders?
- What are your lead times for fulfilling orders?
- How do you handle order deliveries?
- What measures do you have in place to address supply chain disruptions?
- Do you offer samples of your materials or products?
- Can you provide references from other customers you’ve worked with?
For smaller organizations, this might be an informal process with open dialogue between the procurement team and potential suppliers.
However, larger organizations may choose to issue a request for proposal (RFP) to potential suppliers to engage in a formal bidding process.
Once the team has found the right supplier, you will need to negotiate the procurement contract.
The stakes can feel high at this point, as you want to secure the best value (lowest price for the highest quality), without compromising the new supplier relationship.
However, the contract must protect the company’s best interests with favorable pricing, payment terms, and delivery schedules that support the timely, profitable, and high-quality production of your products.
- Making and receiving orders
It’s finally time to start making orders for raw materials from the new supplier.
You will submit purchase orders based on the procedures and guidelines laid out by the supplier during negotiations, likely through an online system.
Pricing, quantities, payment, and delivery times should adhere to the contract terms.
Upon delivery, the goods should be inspected for quality to verify that they meet the proper standards and specifications.
From there, the materials can be used in production, and your team can monitor inventory and make subsequent orders as needed.
Common direct procurement challenges
Since direct procurement is such an integral part of a company’s manufacturing process, certain challenges can arise that threaten production, with possible ripple effects throughout the entire organization.
Here are some of the unique roadblocks you might encounter in the direct procurement process:
Supplier risk
It’s essential that suppliers are reliable and consistently deliver quality materials on time.
Thus, one of the primary risks in direct procurement is that a supplier you rely on for critical inputs or raw materials is unable to meet its contractual obligations, disrupting production.
Maybe one of their suppliers went out of business, a natural disaster impacted their operations, or they faced economic challenges that impacted their ability to deliver materials.
Regardless of what caused the disruption, you may want to consider diversifying your supplier base to mitigate this type of risk.
Cost control
A principal focus in direct procurement is to keep costs low by securing contracts with suppliers who offer favorable pricing terms.
Depending on the type of procurement contract in place, you may be subject to fluctuating raw materials prices, which could impact profitability in certain economic conditions.
If possible, negotiate a fixed-price procurement contract to hedge against rising materials costs.
The key here is to find the right balance between quality and cost.
It’s possible to find a cheaper source for raw materials than what your current supplier offers. However, you may have to compromise on quality to secure lower prices, which might not be a sustainable business choice over the long run.
Maintaining relationships
It can be tricky to manage relationships with suppliers, especially as your business grows and you start to work with a growing supplier base.
However, your relationship with suppliers can be an important asset, helping you foster better trust and loyalty throughout your engagement.
Then, when it’s time to negotiate your contract, you may be able to secure more favorable terms like more flexible payment, lower per-unit costs, and priority delivery.
In other words, don’t let supplier relationships take a back seat, no matter how busy you might get.
Strategies for optimizing direct procurement
To improve the efficiency and effectiveness of direct procurement, consider implementing these strategies:
Adopt sustainable procurement practices
A strategic and sustainable direct procurement strategy can provide your business stability and efficiency, helping you support mutually beneficial, long-term relationships with suppliers rather than burning through them frequently and constantly expending resources to secure new partners.
This starts with negotiating a fair contract.
Negotiate terms that support your overall business strategy and objectives. But, be willing to accommodate the supplier and create a win-win scenario you can both benefit from.
These suppliers will be more willing to work with you over the long term, creating a certain level of consistency in your production process as you receive materials from the same reliable source.
Leverage technology
It can get quite tedious and time-consuming for businesses to manage contracts, submit orders, time payments, and monitor supplier performance by hand.
Luckily, in the digital age, there are plenty of programs and software systems that streamline the direct procurement process.
For example, many businesses today use an enterprise resource planning (ERP) tool to help manage the supply chain and provide transparency in procurement activities.
These programs not only help you submit orders more efficiently and communicate with suppliers, but many will also track important metrics and key performance indicators (KPIs) to help you identify possible areas of improvement in the supply chain.
Supplier relationship management
Your relationships with suppliers should be more than transactional.
As we mentioned above, how you manage your supplier relationships can result in tangible benefits for your business down the line.
While there’s no exact formula for managing supplier relationships, start with the basics by meeting your contractual obligations through on-time and accurate payments.
This way, you can show the supplier that you respect how they operate and are a reliable partner.
Beyond adhering to payment terms, you can support the relationship through open communication.
Be transparent about your business objectives, explaining how they support your success and how you will measure their performance.
If there is an issue with the quality or timeliness of deliveries, promptly inform them of the problem and give them the chance to improve. They will most likely appreciate your flexibility and understanding, and extend the same to you.
Simple direct procurement payments with BILL
Optimizing direct procurement means you’re able to foster long-term relationships with reliable suppliers, who provide you with cost-effective and high-quality raw materials and components for manufacturing your products.
A good procurement strategy is two-sided. You need a supplier who consistently delivers on time and to your quality standards, but you also need to hold up your end of the deal with accurate and timely payments.
BILL’s automated accounts payable solution makes it simple to pay suppliers on time, eliminating much of the hands-on work spent on requesting approvals, reconciling accounts, and sending payments ahead of the due dates to make sure you meet your contractual obligations.
Streamline your direct procurement process today with BILL’s automated supplier payments tool.
