Understanding Indirect Spend
In any area dealing with procurement, you will likely hear the term “indirect spend,” along with “direct spend.” You might also hear references to “indirect materials,” “GNFR,” “indirect procurement,” “overhead,” and “variable and fixed indirect costs.”
It may come as a surprise, but these terms have roots dating back to 1760 during the Industrial Revolution, when cost accounting was first introduced to calculate the cost of a product in order to calculate the price based upon the desired profit. Due to the complexities of running a large-scale business, cost accounting was born.
The Difference Between Direct and Indirect Costs
In order to understand the difference between direct and indirect costs, we need to understand the basics.
Cost accounting breaks down costs into three basic elements: raw material, manual labor, and overhead. Material and labor costs belong to both direct (GFR [goods-for-resell]) and indirect (GNFR [goods-not-for-resell]) categories. Overhead is always an indirect cost and is further divided into variable and fixed costs. Direct costs are always a variable cost and are calculated as a multiple of the units produced to sell.
Direct costs are the dollars spent on raw material and the labor to produce the product and finished goods purchased for resell. Indirect costs are the administrative labor, selling overhead, facilities, depreciation, distribution, maintenance, technology, and the variable and fixed costs to operate the business.
Is GNFR the Same as Indirect Spend?
Whereas indirect spend is the total costs a company must put forth to operate the business, GNFR is a component of indirect spend. GNFR is defined as the purchase of goods and outside services to operate a business. Examples of GNFR include facilities, maintenance, consultants, utilities, contractors, supplies, fixtures, printing, advertising, and rent.
Does Indirect Spend Have a Supply Chain?
Yes, there is in fact such a thing as an indirect supply chain. When large enterprises have medium to large-scale consistent purchases that need to be delivered to multiple locations by specific times, it is by definition a supply chain. On the other hand, not all businesses have an indirect spend supply chain. For example, advertising and accounting firms don’t, but retail chain stores and large manufacturers certainly do.
In many cases, the indirect supply chain can rival or greatly exceed a GFR supply chain with regard to complexities.
The Complexity of Indirect Spend
While the concept of indirect spend seems quite simple, the complexity lies in the diversity of the spend categories. For example, purchasing for IT is very different from purchasing fixtures or maintenance. In retail, GFR makes up 80% of the purchase dollars and 20% of the suppliers, while GNFR constitutes 20% of the purchase dollars and 80% of the suppliers. Also, as opposed to GFR, it is not uncommon to see a high number of GNFR transactions at a low-dollar value.
Unlike GFR, the number of GNFR influencers and purchasers are large, and many purchases are made outside the purchasing department. Unfortunately, efforts to reduce indirect costs are difficult to trace to an ROI and subsequently to the bottom line.
For these reasons, indirect spend becomes a lot more complicated and difficult to manage.
Why Is Indirect Spend Important?
Indirect spend is critically important due to its positive or negative impact upon operational efficiencies, risks, and profitability—especially profitability. For example, if a company’s net profit is 5%, for each dollar misspent, it takes $20 in additional gross revenue to recoup the loss. Likewise, increasing operational control of indirect spend can raise net profit percentage by several basis points, as indirect spend savings affect profitability at a one-to-one ratio.
Amazingly, indirect spend can absorb approximately 6-11% of total revenue. This means that, in order to manage costs and operate efficiently, it is a part of the budget that should always be monitored, managed, and intelligently controlled. There is a lot of potential for savings within most of the indirect spend categories.
How Indirect Spend Is Successfully Managed – Best Practices
- Make visibility into indirect spend a corporate priority.
Gain executive alignment and sponsorship to empower the organization with tools to make better decisions.
- Optimize cross-functional processes.
Establish standards around sourcing, procurement, execution, compliance, and risk mitigation.
- Optimize value.
Gain better control over how the budget is spent, what it’s spent on, and when it is spent.
- Optimize the supply base.
Measure, measure, measure to engage the suppliers who can deliver the right price and the right goods on time.
- Add visibility to every step along the way.
Add visibility end to end from sourcing, procurement through to delivery, and performance monitoring.
Maximizing Indirect Spend Savings & Managing Risks
In order to implement the best practices, there are two next-generation enabling tactics that can assist companies in managing and controlling indirect spend: Source-to-Settle and On-Time Delivery Control.
Source-to-Settle consists of requisitioning and approvals, sourcing, procurement, spend analysis, receiving, and payment settlement. There are many tools on the market available to meet the various indirect spend needs within a company. P2P (Purchase-to-Pay) is a very popular indirect spend tool used by many companies to reduce the unit cost to process a PO from invoice to payment. Unmanaged P2P processes can cost a company as much as $14 per invoice to pay. Implementing P2P can significantly reduce the cost.
A second and growing tactic is On-Time Delivery Control due to its inherent ability to drive efficiencies, perform execution, mitigate risks, and improve supplier performance. Without a means to manage On-Time Delivery, poor supplier performance can substantially increase project costs and decrease revenue as a result of missed milestones and project due dates.
Since receiving indirect goods normally occurs outside the normal receiving function within a company, indirect spend delivery visibility can significantly help mitigate and manage risks associated with tracking these goods to their final destination.
Even though indirect spend is more difficult to track, manage, and thoroughly analyze, implementing best practices in conjunction with Source-to-Settle and On-Time Delivery Control systems can make a huge difference in your company’s bottom line. Understanding the logistics of indirect spend can help your company analyze its cash flow and maximize savings. It’s an important aspect of procurement that should never be overlooked.
Lumatrak provides a full range of real-time On-Time Delivery Control tools to help better manage supplier and delivery performance from order to the final mile of your indirect goods supply chain. Provided in the cloud through its Software-as-a-Service (SaaS) offering and already connected to vast numbers of manufacturers and contractors, Lumatrak’s solution can be quickly implemented to complement and enhance any ERP, Strategic Sourcing and Procure-to-Pay systems.
To learn more about how a better GNFR-delivery management solution could save your company both time and money, contact the team at Lumatrak today.