Direct spend encompasses all the materials, components, and chemicals that a company acquires for the purpose of creating the end product. The expenditure associated with these purchases is referred to as direct spend. For instance, in the case of a paper manufacturing company, chemicals, pulp, and water would fall under the category of direct purchases since they are necessary for producing the final product. On the other hand, indirect spend includes everything that does not directly contribute to the final product but supports the overall business operations. This typically includes services procured by the company for facility management, marketing, and human resources. Indirect spend also includes items like office supplies, phones, laptops, and maintenance-related goods.
A bearing could be a direct purchase as well as an indirect purchase, depending on the use of the product. If the bearings are purchased for building an engine, like in the case of an automotive manufacturer, they are a direct spend. However, if bearings are purchased for the machinery that actually produces the engines, it is an indirect spend and typically classified as a maintenance, repair and Operations (MRO) item.
Purchasing Category
Categories in purchasing are created by combining items, components, raw materials, or services that share common characteristics, serve similar purposes, or are obtained from the same suppliers. These categories can be established at the local, regional, or global level, depending on the company's structure and operational approach.
Category Taxonomy
Taxonomy refers to the classification of purchasing categories into a hierarchical structure that consists of parent and child categories or main and sub-categories. The hierarchy can be made as granular as it makes sense from a management perspective. By creating a uniform category taxonomy, the company gains visibility of its purchases and related spend. The company can start identifying cost-optimization and value creation opportunities.
Below is an example of what a category taxonomy could look like. The raw materials, metals and chemicals have been grouped according to the type of the metal or the chemical in question. Services have been classified according to the end use. IT has been split into software, hardware and infrastructure categories as typically these are purchased separately from different supply markets. The taxonomy should be revised if the company sees benefits in creating larger, or more granular categories.
Category Management
Category management refers to a strategic approach to managing and optimizing the procurement and purchasing of goods and services within specific categories or groups. It involves analyzing and understanding the spending patterns and requirements of an organization across various categories, such as IT, marketing, facilities, or raw materials. The goal of category management is to drive cost savings, improve supplier relationships, and enhance overall value for the organization. It involves a systematic process that includes:
- Category Analysis: This involves analyzing historical spend data, identifying trends, and understanding the organization's current and future needs within each category.
- Supplier Evaluation and Selection: Assessing existing suppliers and identifying potential new suppliers based on factors such as cost, quality, reliability, and innovation.
- Negotiation and Contracting: Engaging in negotiations with suppliers to secure favorable pricing, terms, and conditions. This may involve leveraging the organization's purchasing power and establishing long-term contracts.
- Supplier Relationship Management: Building and maintaining strong relationships with suppliers to ensure ongoing performance, collaboration, and continuous improvement.
- Performance Monitoring and Optimization: Regularly monitoring supplier performance, tracking key metrics, and identifying opportunities for further cost savings, process improvement, and value creation.
By adopting category management practices, organizations can gain better visibility and control over their spending, optimize procurement processes, and achieve cost savings while maintaining or improving the quality of goods and services acquired.