Written by Marijn Overvest | Reviewed by Sjoerd Goedhart
Fact Checked by Ruud Emonds | Our editorial policy
Direct Sourcing — Everything You Should Know
What is direct sourcing?
- Direct sourcing is the process of procuring goods and services that are essential to a company’s core operations, such as raw materials or components used in production.
- Direct sourcing directly affects the final product and the company’s revenue.
- Good inventory management is a big contributor to direct spend management.
Direct Sourcing is the spending on goods and services that gives your company profit, performance, and competitive advantage. In simple terms, this is the procurement that most procurement managers are very familiar with. You acquire and source out supplies so you can gain an advantage over your competitors.
I have created a free-to-download editable procurement process: 7 steps template. It’s a PowerPoint file, together with an Excel file, that can help you with your direct sourcing process. I even created a video where I’ll explain how you can use this template.
Direct Sourcing – Is It the Same As Direct Procurement?
At its core, direct sourcing refers to procuring goods and services that are critical to your company’s end products or services—these are the materials that directly impact production, performance, and profit. These goods often include raw materials, parts, and components that are essential for creating the final product your company sells to its customers. Because of this, direct sourcing becomes a vital element in ensuring the continuity and growth of a company.
So, is direct sourcing the same as direct procurement? In essence, yes. Both terms are often used interchangeably because they cover the same procurement processes that involve acquiring materials directly used in production. The critical factor here is that direct procurement focuses on items that affect the product’s quality, cost, and delivery timelines—areas where there’s little room for error. Without a strong direct procurement process, a company risks delays, higher production costs, or even a compromised final product.
Why are direct sourcing and direct procurement considered the same? Here are a few key reasons that highlight their intertwined roles in ensuring production efficiency and quality:
1. Core Business Impact
Direct procurement, like direct sourcing, is directly tied to the production of goods or services. If a company fails to procure these items, it cannot operate or fulfill customer demands. This process requires a strategic approach to selecting suppliers who can ensure a consistent and high-quality supply.
2. Long-term Supplier Relationships
Both direct sourcing and procurement emphasize building long-term partnerships with key suppliers. These relationships are crucial since any disruption in the supply chain can significantly affect the company’s operations.
3. Cost and Efficiency Management
Effective direct procurement, or sourcing, directly influences cost control and production efficiency. Companies rely on stable supply chains to keep manufacturing costs predictable and mitigate risks associated with price fluctuations.
4. Production-Critical
Whether you call it sourcing or procurement, the goal remains the same—securing the materials or services necessary to maintain uninterrupted production lines and meet market demands.
Direct Sourcing VS Indirect Sourcing – What is the Difference?
Since we’ve established that direct sourcing is the same as direct procurement, it’s time to set it apart from its other form, which is indirect sourcing
Now for the nitty-gritty of details. Indirect sourcing is the process of buying supplies or services so that a company can operate on a regular basis. If this particular company doesn’t procure supplies on a regular basis, the company will not function at all. Think of car companies and businesses that cater to very specific products that need to be ordered. If you’re about to build a car but you’ve run out of tires, there is no way that you’d be able to make one, right?
Direct sourcing works the other way around. Companies procure supplies in order to keep the company growing. Sometimes, companies also go for direct product sourcing if they need to buy equipment that will improve or upgrade a company’s ability to create new products or provide new services. As such, direct sole sourcing is more common with most companies nowadays.
Examples of Direct and Indirect Sourcing?
To help our dear procurement managers distinguish the difference between direct and indirect sourcing, we’ve come up with these examples:
Best Practices for Managing Direct and Indirect Sourcing
One of the best things about both direct and indirect sourcing is that anything positive that you do with one process will also remain with the other. In short, the best practices that you do for indirect sourcing should also be the same as direct sourcing!
Here are some tips for managing your direct and indirect sourcing!
1. Inventory management
Inventory management keeps track of the type and quantity of materials a company has in stock and what products need to be replenished throughout the year.
Having strong inventory management takes a proactive approach to managing direct spending by ensuring that the company has enough supply to run its operation.
On the other hand, indirect spending in inventory management is more reactive in execution.
Supplies are only ordered when necessary. Also, regular assessment of indirect spending can help companies determine when and what the minimum level of supplies is needed.
2. Centralized e-procurement solutions
Professionals in indirect spending frequently work with and receive requests from non-procurement teams. Thus, implementing an intuitive e-procurement solution will be beneficial for employees who usually need to outsource goods and services in their role.
For direct spending, using an e-procurement solution optimizes supply chain logistics and communications, while lowering the risks of human error.
3. Effective cost management
Direct sourcing professionals commonly use strategies like should-cost analysis to negotiate supplier pricing in cost management. This strategy estimates the final pricing of the supplier by estimating the total costs the supplier needs to spend to make or deliver the final products.
For indirect sourcing professionals, they prefer starting each new budgeting period from scratch. In this strategy, every dollar counts and each expense needs to be reevaluated and justified for the next fiscal period to be approved.
Thus, this strategy eliminates redundancy in spending and prevents companies from wasting their budget on expenses that do not contribute to the growth of the company.
4. Invest only in the Best Technology
What this means is investing in the right automated software for your procurement strategy. This is already a given since, with every procurement strategy, good software is a must. Make sure that the tool you are investing in is working, has a good interface, and is full of features that cross over to other procurement functions, such as sourcing and data analysis.
5. Developing a Strategic Sourcing Plan
Strategic sourcing works well with indirect sourcing . It allows the procurement team to find the best possible suppliers while following the company’s goals. You can have a look at our article for Strategic Sourcing here. Otherwise, we can give you more information about it through our Negotiation Gamechanger course.
6. Partnering with a Group Purchasing Organization
Since indirect sourcing deals with buying supplies that are meant to keep the company in working condition, then partnering up with a group purchasing organization is ideal. GPOs can help you balance your expenses and it reduces supplier risk. The move also saves you time and money.
7.. Proactive Change Management
Since this procurement strategy demands people who know exactly what they are doing, if you ever need to change some of the members of your team, then it is always a good idea to do so. Training new members can also help and there is certainly a rising boom for procurement analysts and procurement managers nowadays. Also, choosing your software vendor is a part of this process. If you found a good software vendor for all the automated software needed for the procurement process then you are certainly lucky.
Procurement Expert’s Advice on Direct Sourcing
For this article, we asked a seasoned procurement professional to share his insights regarding direct sourcing practices.
Sjoerd Goedhart
Owner, Goedhart Interim Management & Consultancy
LinkedIn Profile: https://www.linkedin.com/in/sjoerdgoedhart/
1. Can you share a personal example of direct sourcing? What can readers learn from this?
“It’s intriguing to engage in e-sourcing for indirectly sourced products. This practice not only saves time but also presents opportunities for additional cost savings. Ideally, these cost savings should be reinvested in resources to foster growth, profitability, and competitive advantage.”
Follow-up Question: In pursuing e-sourcing for indirect products,
how do you balance the efficiency gains
with ensuring the quality and reliability of the sourced products?
“To optimize e-sourcing for indirect products, it’s crucial to establish clear standards, including minimum quality benchmarks and Key Performance Indicators (KPIs). These conditions, along with Service Level Agreements (SLAs), can be automated for efficient measurement and data-driven decision-making.”
2. What should readers know about direct sourcing?
“Procurement professionals should have a clear view of which materials are related to direct spending and which to indirect spending. Investing in direct sourcing is an investment in growth, profit, and competitive advantage.“
3. What is the biggest misconception about direct sourcing? What do most people get wrong about it?
“Many people believe that this method is solely about cutting costs, but it’s actually about investing money into drivers that directly contribute to business growth or profit. It’s essential for companies to regularly evaluate all costs and their contribution to core products.“
Follow-up Question: You mentioned investing the savings in drivers contributing to new business.
How do companies measure the direct impact of these investments on acquiring new business opportunities?
“To measure the direct impact of investments on acquiring new business opportunities, companies should focus on clear savings from direct sourcing and establish ROI metrics for investments. Maintaining a balance is crucial. Implementing zero-based budgeting (ZBB) can help allocate budgets efficiently, ensuring investments consistently deliver more value than their cost. Each investment should be backed by a well-defined business case, demonstrating how it contributes to the company’s growth and exceeds the savings achieved. This approach ensures that every euro spent generates more than one euro in return, fostering a mindset of sustainable and impactful financial decisions.”
4. What advantages does direct sourcing offer over traditional procurement methods?
“Cost savings, increased efficiency, and greater control over suppliers are advantages of direct sourcing compared to traditional procurement methods.“
5. Can you share an example of a successful direct sourcing strategy and its impact on the supply chain?
“One of my former companies implemented a successful direct sourcing strategy by partnering with a supplier who purchased a component we needed on a larger scale. By combining our volume with theirs, we leveraged their purchasing power to secure the component at a lower cost. This collaboration resulted in mutual benefits: we obtained the component at a reduced price, while our supplier gained increased volume and negotiating power.“
6. How will you differ direct sourcing to indirect sourcing?
“Direct sourcing involves acquiring raw materials or components essential for the production of finished goods, directly contributing to a company’s core operations, growth, profitability, and competitive advantage.“
7. What should be the first step that a newcomer in the field of procurement should know in direct sourcing?
“This person should first focus on building knowledge about the market of the raw materials, the existing suppliers, and potential suppliers.“
Conclusion
Direct sourcing emerges as a pivotal element for procurement professionals, distinct from its counterpart, indirect sourcing. As we navigate the realm of direct sourcing, the strategic maneuvers and distinctions from indirect sourcing come to light.
It’s not merely an acquisition of goods and services; rather, it’s a strategic investment in materials that propels the company toward growth, profit, and a competitive edge.
By exploring examples, tips for managing spend, and best practices, procurement managers can fortify their expertise in both realms. Direct sourcingunveils itself as a dynamic force, demanding precise strategies, robust technology, and proactive change management.
Armed with this knowledge, you are primed to ascend as an adept practitioner in the intricate dance of direct sourcing, steering your procurement endeavors toward unparalleled success. Cheers to mastering the nuances of direct sourcing and steering your organization toward unparalleled success!
Frequentlyasked questions
What is direct sourcing?
Direct sourcing refers to the process of procuring goods and services that are essential to a company’s core operations, such as raw materials or components used in production. These materials directly affect the company’s output and profitability, making it crucial for maintaining competitive advantage and ensuring business growth.
What is indirect sourcing?
Indirect sourcing involves acquiring supplies or services that support the day-to-day operations of a company, such as office supplies or utilities. While these items don’t directly impact the final product, they are necessary for keeping the business functioning efficiently and ensuring smooth internal operations.
Is direct sourcing the same as direct procurement?
Yes, direct sourcing and direct procurement are often used interchangeably as both involve acquiring essential materials or services that are directly linked to production. Both focus on securing items that impact the quality, cost, and timely delivery of the company’s final product.
About the author
My name is Marijn Overvest, I’m the founder of Procurement Tactics. I have a deep passion for procurement, and I’ve upskilled over 200 procurement teams from all over the world. When I’m not working, I love running and cycling.
