Editor’s Note: Over the next few weeks on CPO Rising, we’re publishing some “best of” 2024 articles as we reflect on the year and prepare for the new year ahead.
In one of my articles about suites vs. specialists, I briefly mentioned dedicating a future piece to direct materials. Today’s article will do just that. I’ll look at direct materials sourcing and what makes it unique and complex. In an upcoming piece, I’ll explore other areas of procurement tech where direct materials need special attention. But let’s start with defining direct materials.
What Is Direct Materials?
I take a fairly fundamental view of direct materials. I subscribe to the original accounting view of the term that Merriam-Webster sums up well: “material used in manufacturing processes which becomes an integral part of the product and the cost of which is identifiable and chargeable directly to it.” This means that only manufacturing companies source and procure direct materials. But even with this definition, there is significant variation in the different categories that fall under direct materials, ranging from raw materials to complex sub-assemblies. What the categories have in common, however, is a direct relationship to the demand of the end product and the criticality of supply for the organization. The latter is not unique to direct materials because many different categories of spend can be critical for your business, even if it’s not direct materials. Direct materials are sometimes very complex, requiring specific capabilities from both a sourcing and procurement perspective.
Direct Materials Sourcing Has Specific Requirements
Direct materials sourcing tends to be quite complex. Its importance is obvious as the impact on the profit margin of the end product, and by extension the entire organization, is direct. As often stated, one dollar saved in procurement equals 10 dollars more in sales (assuming a 10% profit margin).
The complexity of direct materials sourcing comes in different forms, depending on the type of product that’s being bought. Raw materials are often fairly simple from a pure sourcing execution perspective, but very complex from the perspectives of timing, quantity, and hedging. In other words, when do you buy, how much do you buy, and do you need to hedge?
Other types of direct materials might be more stable (or at least predictable) but complex from a sourcing perspective. In the past, I was responsible for sourcing electronics for a large manufacturing company and purchased significant amounts of multi-layered printed circuit boards (PCBs). The problem was that there were thousands of SKUs, some with smaller volumes and some with larger ones, but all required a significant amount of work for the suppliers to quote. Each of the PCBs came with a bill of materials (BoM) and several drawings.
What sourcing capabilities and support an organization needs depends on what’s being sourced, but in almost all cases it requires some combination of:
- Ability to support BoM (Bill of Materials) structures. Most items purchased by a manufacturing company beyond raw materials consist of multiple components or parts that are defined by a bill of materials. To get detailed pricing breakdowns and enable comparisons between suppliers and your should-cost models (see next bullet) your sourcing solution should support the BoM structures without complex workarounds.
- Should-cost modeling. The ability to estimate the product cost by starting from a clean sheet and then identifying/defining each process step and component provides both negotiation leverage and the opportunity to identify savings potential in existing products.
- Market analytics and modeling. Understanding and keeping track of the various raw materials and component markets is a critical and often overwhelming task for many direct materials buyers. Having access to analytics solutions to identify trends and create forecasts and sensitivity analysis is critical for certain spend categories.
- Sourcing optimization. As said many times, in Ardent Partners’ view, sourcing optimization is one of the most underutilized capabilities/technologies today. This is perhaps even more the case in direct materials sourcing. Given the need to balance different factors, such as cost, risk management, delivery ability, quality, environmental impact, and so on, it’s virtually impossible to find the best award allocation without advanced sourcing optimization support.
- Sourcing automation. In some categories of direct materials, such as smaller series/volumes or those with frequent changes, it’s important to easily create quick RFQs to ensure competitiveness. Having automation capabilities that allow operational or tactical buyers to send these requests to a set of pre-approved suppliers can greatly reduce the workload for category managers and strategic buyers. These solutions can also be leveraged by R&D/product development that may need to order test batches or proof of concepts.
- Integration capabilities. While this is (or at least should be) table stakes today, having the ability to integrate into relevant systems is a major efficiency factor. Significant time is spent by direct materials buyers pulling product data from ERP/MRP and product lifecycle management (PLM) systems, etc., only to push pricing and delivery times back.
While Ivalua has a leadership position, no solution supports all of the above, but several S2P providers like Coupa and GEP are investing in these areas. Thus, features and support are improving rapidly.
Know Your Spend and Prioritize Your Needs
So, when it comes to evaluating solutions for direct materials sourcing, it is very important to understand the needs defined by your specific spend profile and prioritize them. As always, Ardent Partners is available to help identify the solution providers that best fit your needs, so don’t hesitate to contact us.
Check in next week for more on direct materials procurement and supplier management.
RELATED RESEARCH
Magnus Mondays: It’s Time to Improve eSourcing Adoption
The Intersection of Data and Sourcing
Creating a Business Case for Sourcing Automation – Project Overview
The Visibility Factor – Another Best-in-Class Advantage (for Sourcing)
