I don't think you should consider "Tools - Outline Numbering" and "format Numbering/Bullets"/numbering styles as just two different ways of numbering paragraphs. I feel both serve a very different purpose

* "format Numbering/Bullets" serves at creating numbered lists, i.e. itemized lists within your document. When referring to 'outlining', we shouldn't even be mentioning this function. Indeed, numbered lists can have a hierarchy and I thing there is the cause of the confusion: that particular numbering style is called "Outline" in the "Numbering style" or the "Numbering/Bullets" dialogues, while it shouldperhaps be called "hierarchical". Use that for lists only, not for outlining.

* "Tools - Outline Numbering" is the one single tool you should be using to number outline headings. It is in Tools - Outline Numbering that you assing a paragraph style its special meaning as an outline level. It is also there that you eventually assign it a number.