I hope that you have enjoyed the article “Direct Procurement: Different Types Defined.”
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In the article, I contrasted “market-driven direct procurement” with “cost-driven direct procurement.” Allow me to give examples of each.
Let’s take the example of a bottle of ketchup. A bottle of ketchup lists eight ingredients.
Each of those ingredients is likely subject to its own market forces. And each major ketchup manufacturer is part of a huge food industry conglomerate that purchases many ingredients for many different product lines. So it is likely that each has different agreements in place with suppliers of those ingredients and pays different prices.
But the ketchup market is a mature one. The consumer expects to pay a certain price for a certain size bottle of ketchup. If one manufacturer charged $4.99 for a 16 ounce bottle of ketchup and another charged $1.99, which one would get most of the business?
High fructose corn syrup is an ingredient in ketchup. If one manufacturer paid $0.50 more for its high fructose corn syrup than the other manufacturer, that doesn’t mean that the consumer would be willing to pay $0.50 more per bottle for that ketchup. The manufacturer with the higher cost of ingredients would have smaller profits.
The ketchup manufacturer’s purchase of high fructose corn syrup would be an example of market-driven direct procurement.
In contrast, let’s consider painting services. Generally, when a consumer wants their home painted, they will get quotes from one or more painting contractors. Painting contractors are often small businesses. When their labor is booked, their supply is finite. They may turn down jobs, quote a start date weeks into the future, or even charge high rates so that their limited resources are reserved for only the most profitable jobs.
When a painting contractor quotes a job, they’ll estimate the amount of material and number of labor hours and add a healthy profit on top of those costs. There isn’t much of a standard size paint job. Pricing is generally private and different for each job. The price depends on what their costs are. The purchase of the materials for a paint job would be an example of cost-driven direct procurement.
If the paint for a job costs $18.99 and it would require three hours of labor at $45 an hour, the cost to the consumer would be $153.99. If the price for paint doubled and the painting contractor had to quote a near-identical job, the contractor would quote $172.98. The inflated cost for paint is passed onto the consumer and profits are pretty much unaffected.
Though both examples are examples of direct procurement, hopefully it is now clear that not all direct procurement activities are equally critical.