( This article is excerpted from the complimentary report — P2P Networks for Digital Transformation: Direct Materials Procure-to-Pay, Its Role in Strategic Competitiveness — available fordownload here. )
Direct Materials’ Strategic Role
Direct vs. Indirect Procure-to-Pay (P2P)
Direct materials1 are the lifeblood of manufacturing and retail supply chains. Manufacturers have historically put most of their sourcing and procurement efforts into direct materials, because those often constitute the firm’s biggest expense, and they are core to keeping the company’s production lines and revenue streams going. Starting in the late ‘90s, attention shifted to indirect2 spend as e-procurement software started addressing rampant maverick spend.3 Now, indirect spend has come to dominate the P2P (procure-to-pay) conversation in many cases. However, direct materials P2P is typically more mission critical, complex, multi-party, and challenging to manage than indirect goods procurement.
Direct Materials P2P | Indirect Goods P2P | |
| Types of Goods & Services | Includes all materials and components in the products sold by the company. Often listed in a top-level BOM4 or recipe/formula, these include parts and subassemblies, raw materials and ingredients, packaging, and subcontracted manufacturing services. For a retailer, it includes all products they sell. | Includes all other goods needed to run the company, other than what goes into the products being sold. This includes office equipment and supplies, facilities-related equipment, IT expenses, travel, and so forth. Note: in this table we are only including indirect goods, not indirect services.5 |
| Impact of Disruption | Medium to Very High—Disruption may impact production and revenue. Risk mitigation strategies should be executed, such as predictive early visibility into disruptions and prequalifying alternate sources. | Low to Medium—Disruption of supply for most goods, such as office supplies, is just an inconvenience; it’s easy to find alternate sources. (Note: disruption to indirect services may have a higher impact.) |
| Supplier Relationship | Often Strategic—For critical parts or materials, there is often a long-term strategic relationship with the supplier. | Often Transactional—Except for some service providers (IT, pro services, etc.), most indirect supplier relationships are not strategic. |
| Cost Reduction Potential | Larger—Direct materials spend is typically 40%-70% of revenue for a manufacturer, representing major cost-saving opportunities. | Smaller—Indirect goods for manufacturing, wholesale, and retail companies are usually less than 20% of revenue, sometimes less than 10%.6 |
| Change Orders | Common—Long lead time components and complex subsystems will often be subject to change orders to quantities or specifications. | Uncommon—Indirect goods typically have shorter lead times. Changes to an order, particularly spec. changes, are not common. |
| Fulfillment/Logistical Complexity | Usually High—Especially for custom long-lead-time parts, ship-from-factory, multi-stage, multi-party, international shipments. | Usually Low—Typically order from catalog, fulfill from DC domestically by truck or parcel. |
| Transaction Size, Duration | Larger, Longer Lifecycle Transactions—Orders tend to be larger and the lifecycle of an order longer and more complex. | Smaller, Shorter Lifecycle Transactions—orders for indirect goods7 tend to be smaller and fulfilled more quickly. |
| Industry-specific Processes | Yes—P2P processes are usually different between different industries. | No—P2P processes are similar across industries, varying somewhat between categories. |
| Internal Functions Involved | Many—Planning, manufacturing, sourcing (or merchandising), procurement, logistics (global trade, transportation, and warehouse), insurance, quality, compliance, treasury, AP. | Fewer—Requisitioner, approver(s), sourcing, procurement, AP. |
| External Parties Involved | Many—Suppliers, brokers/freight forwarders, ground and ocean carriers, consolidators, local offices, banks and 3rd-party financiers, insurance companies, inspectors, customs. | Fewer—Supplier, ground carrier. |
| Cost Accounting | Variable costs. The costs increase or decrease in direct proportion to unit production volumes. | Fixed costs. Indirect costs do not change for each unit of production volume change.8 |
Figure 1 below illustrates a typical direct materials P2P lifecycle. By our definition, the P2P cycle starts with the issuing of a blanket PO (a.k.a. a blanket purchase agreement or call-off order). Once the specifics of the timing, quantity, and exact materials needed are known and ready to be firmly committed, the buyer will issue a call off or material release or scheduled release against the blanket PO. In many industries, the material release is embedded in a rolling forecast. Alternatively, if this is a one-time order, the buyer may issue a standard PO. Note that some solutions call themselves P2P, but they are actually ‘P2I’ (Procure-to-Invoice), as they lack support for payment processing and settlement. Further, a P2I solution may have light or no coverage of forecasting and other activities that happen before the issuing of the material release or standard PO.
In Part Two of this series, we discuss the attributes of a digital supply chain and direct material P2P’s role in digital transformation.
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1 Direct materials are all the components and materials that go into the products a company sells. — Return to article text above
2 Indirect spend consists of the goods and services needed to run the business that are not part of the products the business sells. — Return to article text above
3 Maverick spend refers to employees buying off contract, not taking advantage of the savings negotiated by the procurement team. — Return to article text above
4 BOM = bill-of-materials — Return to article text above
5 Indirect services have different characteristics than indirect goods. The impact of disruption in these services can be high (e.g. if telecoms or IT/SaaS goes out), sourcing is more complex, supplier relations more strategic, and transactions larger. — Return to article text above
6 Service-only firms typically have little to no direct materials costs and may have a higher percent of indirect goods cost. — Return to article text above
7 In contrast to indirect goods, orders for some indirect services, especially enterprise-wide services such as telecommunications, IT infrastructure, and facilities management, can be large, complex, and long lifecycle. — Return to article text above
8 Of course, indirect costs will increase or decrease as the corporation grows and shrinks in size, but they do not change
in a 1:1 proportion to units of production. Hence, for accounting purposes, they are fixed costs to be allocated across the number of units of production made in an accounting period (e.g. quarter or year). — Return to article text above
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