What is direct procurement? Definition and guide

Effective procurement can be the difference between growth and stagnation for many small businesses. Among the four main types of procurement, direct procurement stands out for its potential to streamline supply chains, control costs, and enhance efficiency.

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In this guide, we’ll take a closer look at direct procurement, breaking down what it is, why it’s so important for profitability, and the benefits you gain from a sound direct procurement strategy.

What is direct procurement?

Direct procurement, also called direct spend, refers to the purchase of goods or materials that are necessary to create the products you sell. These include raw materials, components, services, and other inputs that are essential for the production of your goods. Direct procurement is an integral component of supply chain management (SCM).

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The primary objectives of direct procurement are to ensure a steady supply of high-quality materials, negotiate favorable terms with suppliers, and ultimately reduce production costs. By focusing on these goals, you can improve your business’s operational efficiency and maintain a competitive advantage in the market.

Direct procurement examples

The three main categories of direct procurement typically include raw materials, components, and finished goods. Here are some examples of each:

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• Raw materials: The basic substances used in the production process, such as metals, plastics, and chemicals. For an automotive company, some examples would be steel, aluminum, and plastics to manufacture the frame and body of a vehicle.
• Components: Partially finished products that are assembled to create your final product. Electrical wiring, microchips, and LCD screens are all examples of components an automotive manufacturer would need to assemble a vehicle.
• Finished goods: Complete products ready for distribution and sale. Tires are a good example of a finished product because they can be sold directly to consumers as well as auto manufacturers.

The 5 stages of direct procurement

The direct procurement process typically involves five stages:

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1. Needs identification: Recognizing the materials and components required for production
2. Supplier selection: Evaluating and choosing suppliers based on criteria like quality, cost, and reliability
3. Negotiation: Discussing terms and conditions to secure the best possible deal
4. Order placement: Issuing purchase orders to your selected suppliers
5. Delivery and quality inspection: Receiving and inspecting goods to ensure they meet specifications

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Why is direct procurement so important?

Direct procurement is crucial because it directly impacts your company’s cost of goods sold (COGS) and, by extension, your profitability. Some of the other business processes that direct procurement influences include:

Spend management

One of the most significant benefits of direct procurement is cost savings. By sourcing directly from manufacturers or primary suppliers, you can eliminate middlemen, negotiate bulk discounts, and achieve better pricing. This can lead to substantial reductions in production costs, improving your profit margins.

Quality control

Direct procurement helps you maintain stricter quality control over your materials and components. By working closely with suppliers, you can ensure they meet your specifications, resulting in consistent quality and customer satisfaction. This is especially important for industries where quality is a critical factor, such as automotive and electronics manufacturing.

Supplier relationships

Building strong relationships with suppliers is another key advantage of direct procurement. Long-term partnerships can lead to better collaboration, more favorable terms, and a more reliable supply chain. When suppliers understand your company's needs and expectations, they’re more likely to provide excellent service and support.

Challenges in direct procurement

Because direct procurement is crucial to day-to-day production, it’s essential that you understand some of the challenges you’ll likely run into as you navigate the process.

Supply chain disruptions

One of the main challenges in direct procurement is managing supply chain disruptions. Factors such as natural disasters, political instability, and economic fluctuations can impact the availability of materials and components. As such, your business should develop contingency plans to mitigate these risks and ensure you have a consistent supply of materials.

Cost control

Cost control is a major focus of direct procurement. Depending on the nature of your supplier contracts, you may have to deal with unpredictable materials costs, which can impact your budget and your bottom line. To minimize some of the risk associated with fluctuating costs, you could try to negotiate a fixed-price procurement contract. 

Inventory management

Effective inventory management and demand forecasting are crucial for successful direct procurement. Overstocking can lead to increased storage costs and runs the risk of your product becoming unsalable, whether due to spoilage or obsolescence. Meanwhile, understocking can result in production delays and lost sales. You need to strike the right balance by employing effective inventory management techniques.

Regulatory compliance

Compliance with regulatory requirements is another significant challenge. You need to adhere to various local, national, and international regulations, which can be complex and time-consuming. Non-compliance can result in fines, legal issues, and damage to your company's reputation.

Strategies to improve direct procurement

There are a few management strategies your procurement team can employ to improve your company’s direct procurement process:

Just-in-time (JIT) inventory management

Just-in-time (JIT) inventory management is a strategy that aims to align material orders with production schedules. By receiving goods and materials only when you need them, you can reduce inventory holding costs and minimize waste. However, JIT requires accurate demand forecasting and a reliable supply chain to be effective.

Supplier relationship management (SRM)

Supplier relationship management (SRM) involves developing and maintaining positive relationships with suppliers. This can include regular communication, performance evaluations, and joint improvement initiatives. SRM can lead to better collaboration, innovation, and supply chain resilience.

Technology and software

Leveraging technology is essential for modern direct procurement. Digital tools such as procurement software, automation, and data analytics can streamline processes, improve accuracy, and provide valuable insights in real time. For example, AI-powered platforms can help with strategic sourcing, supplier selection, contract management, and inventory optimization.

Streamline your procurement process with Ramp

Whether you're a small business owner, a supply chain professional, or a procurement manager, mastering direct procurement can lead to cost reduction, improved quality, and stronger supplier relationships.

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If you’re ready to take your procurement strategy to the next level, Ramp can help improve efficiency and visibility across all your company’s procurement activities. Our suite of modern finance tools can automate the procure-to-pay process, eliminate approval bottlenecks, and prevent out-of-policy spending before it happens.

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Control spend from the beginning with Ramp’s expense management platform. Try an interactive demo and see why Ramp users save an average of 5% a year.