What is Indirect Material Optimization, and How Can It Turbocharge Your Supply Chain?

Many companies know that indirect expenditure puts a drag on their bottom lines. Seemingly insignificant indirect materials such as glue and fuel can quickly pile up the costs when consumed in high amounts. Some analysts estimate that about 40% of a typical company’s annual expenditure is spent on indirect materials.

These findings suggest that indirect material optimization can be a highly effective way of increasing your working capital. With the help of AI-enabled supply chain technologies, you can review and streamline your direct and indirect material management processes to create savings across your entire supply chain.

In this article, we explore what indirect material optimization is and how you can use it to make your supply chain more efficient.

Direct and indirect material optimization

Businesses, especially those in the manufacturing industry, use a mix of indirect and direct materials to produce their goods. 

In many cases, only direct materials–which normally have part numbers and are physically built into the product–are tracked and added to the cost of the finished product. Indirect materials such as manufacturing equipment are seldom managed as meticulously as direct materials.  

As a result, many companies lose tens of thousands of dollars each year due to ineffective management of indirect materials. To minimize these losses, business leaders have turned to direct and indirect material optimization technologies–which use artificial intelligence (AI) and machine learning capabilities–to create better spending effectiveness. 

The effect of indirect material optimization on your supply chain 

According to McKinsey analysts, AI-enabled cost reduction technologies can help industrial companies cut indirect costs by up to 20% in as little as 12 to 18 months. These technologies allow supply chain managers to gain visibility into their indirect expenditure and connect disparate indirect materials data across facilities.

With the insights provided by these technologies, managers can establish formal strategies for indirect procurement and expenditure management. Indirect material optimization can help improve performance and profits not just in procurement and manufacturing but across your entire organization.

Challenges to indirect material optimization

Although businesses may realize the benefits of indirect material optimization technologies, some may not have the working capital to transition from Excel spreadsheets and in-house knowledge to innovative data management systems. Others may not realize the full extent of their indirect expenditure, which can include office supplies, maintenance costs, and emergency expenses.

For many business managers, the long-time focus on direct materials has made indirect expenditure somewhat of an afterthought.

Indirect materials can be more difficult to quantify and measure 

The problem of poor indirect material management stems partly from the inability of legacy and manual data management systems to quantify and measure indirect materials. These systems focus on the movement of trackable, direct materials but often ignore the indirect materials that are not utilized in the finished product. 

This problem is further compounded by the fact that some organizations may not have internal controls in place to categorize and attach value to indirect spending. There might also be a lack of employee education about how and why indirect materials must be managed.

Industry analysts estimate that US manufacturers could save over $5 trillion annually just by optimizing their indirect material management processes.

Indirect materials have traditionally been deprioritized in relation to direct materials

Supply chain managers have historically focused on the cost of direct materials and labor consumed by their finished products. 

They consider these items to be more visible and impactful to their bottom lines than indirect materials, which are usually ordered in high volumes and lumped into bulk commodities contracts.

As indirect materials have become increasingly deprioritized, managers have had more difficulty quantifying indirect materials and measuring their costs. Overlooking the cost of indirect materials has often gradually reduced their manufacturing efficiency and bottom lines. 

Fortunately, manufacturers and other supply chain firms are now seeing the value of applying new, data-focused approaches to indirect materials management. With better insights into their materials data, several firms have been able to reduce production costs and offer products at competitive rates to their customers. 

How to optimize your indirect material optimization

Firms can improve their indirect material optimization by using a variety of strategic processes that make their materials data more transparent.

Though these processes may take some time and effort to implement at the beginning, once established they can help you minimize indirect expenditure and strengthen relationships with your suppliers.

Track your indirect–as well as direct–inventory 

The popular adage, “that which cannot be measured, cannot be improved” applies well to the world of materials management. 

When you track your indirect and direct inventory, you build up a database of supply chain data that can be analyzed to shed insight on your operational and production costs.

The best tool for carrying out this data analysis is often AI-driven data analytics software, which can monitor all of your supply chain data in real-time. These applications can track hundreds of stock-keeping units (SKUs) and thousands of suppliers from multiple contracts. Managers can use them to compare different indirect materials categories, record quote prices, and determine optimal inventory levels.   

Increase data visibility by investing in supply chain management software

Firms with holistic procurement processes can often further increase visibility into their agile supply chain by using big data, AI, data visualization, and process-mining tools.  

The use of analytics can help managers consolidate indirect expenditure data, which is often fragmented and collected in multiple systems every hour. It can also help managers extract essential insights quickly and act on them.

One area in which increased data visibility can have a big impact is demand planning. Self-learning AI-enabled technologies can identify gaps in inventory levels and highlight material use trends that can help managers make more accurate forecasts. 

Unlike Excel and legacy systems which cannot be scaled to handle data from multiple sources efficiently, AI-enabled technologies can combine external data such as weather forecasts and sales data with your internal materials data to create detailed reports.

Strengthen strategic supplier relationships with improved communication

Companies don’t often treat indirect supplier relationships with the same level of care as direct supplier relationships. 

Procurement teams see direct materials as crucial to the quality of the end product and therefore invest time, effort, and energy into building long-term relationships with direct material suppliers.

Relationships with indirect material suppliers, on the other hand, tend to be more transactional. The focus here is more on competitive costs because buyers want to buy indirect materials in bulk and at lower prices than their competitors. However, the problem with this approach is that firms are left with little leverage to create better savings opportunities for indirect expenditure.

A better strategy may be to take a more collaborative approach with all suppliers. Deepening your strategic supplier relationships can help you negotiate shorter lead times, better payment terms, and fairer prices.

Review indirect spend contracts or spend leverage 

Procuring indirect materials can involve many suppliers and contracts. Without a proper indirect expenditure contract system in place, your firm could end up missing important pricing and terms agreements and overpaying for items and quantities you did not order. 

Your employees might also unknowingly sign large indirect expenditure contracts outside the scope of the procurement department, creating financial and operational risk for your company.

If these contracts are left unmanaged for too long, they could reduce profits and decrease the efficiency of your manufacturing process. 

That’s why you should aim to review indirect spend contracts regularly to cross-check the quantities you’ve ordered against contract budgets. Contracts for materials that no longer meet your specifications may need to be terminated and replaced with new ones. 

Standardize the indirect materials you use  

Indirect materials procurement is notorious for being decentralized and scattered. 

It seldom has the same centralized procurement processes as direct materials management because indirect materials tend to be procured whenever there’s demand. In addition, different teams with independent budgets and procurement plans often like to put in their own orders from suppliers and brands of their choice.

This lack of control can sometimes lead to needlessly complex procurement processes that waste time and working capital. A better use of your employees’ time might be to ask them to standardize the indirect materials they need. By choosing only a few trusted brands and suppliers, you can reduce costs and improve efficiency in your supply chain.

Over time, standardization can help your teams receive materials on time and at competitive rates. You may even end up strengthening your relationships with your suppliers. 

Utilize the power of AI-enabled technologies and automation 

Automating materials management tasks–such as inventory replenishment and order analysis–with the help of AI-enabled technologies can lower your overall costs of indirect expenditure. 

These technologies can provide you with real-time insight into your inventory and offer data-driven suggestions about the indirect expenditure categories that could be further optimized.

Most AI-enabled supply chain optimization software today is user-friendly and can be installed without support from specialized technicians. If your firm is looking to improve its materials management processes, utilizing data analytics technologies can be the most effective way of doing so.

Gain insight into your direct and indirect materials with an AI-enabled cloud platform

Verusen’s innovative supply chain software can give you unparalleled insight into your materials data, inventory, and procurement. With our purpose-built technology, you can better understand your disparate and incomplete data and connect it to your business outcomes. 

Our system harmonizes data across your entire supply chain, self-cleanses it, and provides automated insights into your stock and inventory levels. 

We’ve helped customers identify savings opportunities of up to $10 million within 90 days of using our platform. To unlock the value in your data for massive optimization gains, try our inventory optimization software today.

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