Innovation for Growth – i4g
Policy Brief N°2
Public Procurement of Innovation
Lena Tsipouri

A powerful tool to foster innovation is targeted and specifically designed public
procurement (PPI). Therefore, public procurement shall be utilised to stimulate
innovation and to create new markets.
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Awareness rising and changing the minds of procurers is essential to overcome the
slow and timid application of PPIs in Europe and to fight barriers and risks associated
with the change of procurement culture.
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Actions required are:

o
Building up the necessary human resources and skills for operating PPI;
o
Structural Funds envisaging enabling measures in their guidelines;
o
A Minister responsible for both procurement and innovation and/or the
establishment of special agencies.
Moderate innovator countries and catching up countries would benefit most of PPI
as intervention needs are moderate and Structural Funds would be most
instrumental.
This report does not necessarily reflect the views of the European Commission. These comments are
based on a number of previous presentations including expert group reports for the EC.
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Public Procurement of Innovation
Some definitions (What is meant by PPI?)
Public Procurement of Innovation (PPI) is a demand-side policy instrument influencing
innovation. It has been defined as the process by which public organisations place an order
for the fulfilment of certain functions by a new product (good, service, system) that does not
yet exist, and whose development and diffusion will influence the direction and rate of
technological change and other innovation processes. Scholars consider it as a promising
(though very challenging) and important demand-side innovation policy instrument (Dalpé,
1994; Edler and Georghiou, 2007; Geroski, 1990; Rothwell and Zegveld, 1981). This policy
sees the government as an intelligent customer able to combine the coverage of its needs with
its development policy.
PPI is a kind of public-private partnership, which, if properly implemented, can offer the best
of both worlds:

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the government specifies a desired output, taking its immediate needs and/or future
need and social challenges into consideration
the private businesses creativity and efficiency are mobilised to meet the
requirements with the best available technologies or with technologies developed
specifically to provide the desired output.
It is suggested since decades that PPI is one of the most effective demand side measures
(Geroski, 1990; p. 183). More recently in a survey of more than 1000 firms and 125 industry
federations, over 50% of respondents indicated that new requirements and demand are the
main source of innovations, while new technological developments within companies are the
major driver for innovations in only 12% of firms (BDL, 2003 in Edquist 2012). The most
recent evidence is from the UK, where in a survey of 800 responding suppliers 2/3 of firms
said public procurement has had positive influence on innovation and 25% of firms attribute
all R&D to demand by public buyers (Underpinn project)1.
PPI can be classified according to (at least) two dimensions2:
1. The character of the procurer: Direct PPI is the simplest form, when the procuring
organisation is also the end-user of the product resulting from the procurement but there
is (or may be) another (public or private) market for the resulting product, which then is
diffused. Catalytic PPI occurs when the procuring agency serves as a catalyst, coordinator
and technical resource for the benefit of other end-users, not itself.
2. The novelty of the product and its position in the innovation cycle: The most promising
but also more risky PPI is developmental PPI, which is the case when the procurer buys
completely new-to-the-world products and/or systems are created as a result of the
procurement process. It can be regarded as ‘creation oriented’ PPI and involves radical
innovation. Conversely adaptive or diffusion-oriented PPI is when the product or system
procured is incremental and new only to the country (or region) of procurement. Hence,
innovation is required in order to adapt the product to specific national or local
1
2
http://underpin.portals.mbs.ac.uk
These dimensions rely on definitions used in the papers of Edquist (2012), FhG (2005), EC (2009)
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conditions. It may also be labelled ‘diffusion oriented’ or ‘absorption oriented’ PPI
(Edquist 2012, EC 2005). Adaptive PPI may occur either intentionally (as a result of the
procurer’s intention to support suppliers to adapt technologies) or unintentionally (in case
the procurer is unaware of the adaptations needed and the benefits occurring because of
that).
Pre-commercial procurement (PCP), which has been extensively addressed in the EU3 refers
to the procurement of (expected) research results and is a matter of direct public R&D
investments, but with no actual product development. While it may eventually help producers
to create innovative products and launch them into the market, at the PCP stage it is rather
“contract” research and may include development of a product prototype; hence it is a supply
side measure that neither creates nor stimulates a new market (Edquist 2012).
Direct, developmental PPI has been practiced more extensively in the US defence sector and
in the past in the Scandinavian countries. Adaptive PPI is increasingly used in the case of
environmental protection and energy saving (alternative energies and waste management).
Catalytic PPI is mostly encountered in countries with centralised public procurement
authorities. Innovation leading countries and companies are more likely to generate
developmental PPI, whereas diffusion can be encountered in all types of countries and
companies.
The economic rationale (Why does it matter?)
The underlying rationale for all demand-side policies is that the most effective way to
stimulate innovation is by creating markets for innovative products, which improve business
expectations. Public procurement is one way of market creation.
In economic terms the rationale for intervention is based on fundamental arguments:
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Market failures lead to sub-optimal investment in R&D and innovation because of
risks and appropriability: Hence the basic Arrow (1962) rationale applying to all
R&D incentives apply to PPI as well.
Economies of scale: New products need significant scale to amortise not only the
investment necessary for R&D, but also investments and commercialisation costs, in
particular for specialised and co-specialised assets (Teece, 1986). Innovation
expenditure is usually much higher than R&D itself; hence an initial client, who can
be relied upon for large quantities and be used for demonstration to trigger large scale
global demand, may constitute a major milestone in the go/stop decision.
Increasing competitiveness in new technologies in general and lead markets in
particular. Conditions of domestic demand are one of the main dimensions that build
up competitive advantages (Porter, 1990). Edler and Georghiou (2007) see the
rationale of PPI in its role in supporting local demand (subsequently creating a lead
market), which constitutes a major factor in the location decisions of companies and
in the inclination to generate innovations in a given location. To some extent this
reminds of industrial policy infant industry arguments and has thus been rejected by
policy makers as a tool of protectionism in the past. However, PPI is not limited to
Communication
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national boundaries and is hence not incompatible with EU competition rules. If
anything, it is leverage to speed up creative destruction.
An additional market failure refers to PPI as policy tool to satisfy social needs that
are not met by markets. In the case of social challenges, the rationale of intervention
takes public goods (like climate change) into consideration. The overall logic of
intervention then is that, although PPI is not sufficient to turn innovative production
into a profitable activity, it can have a major leverage effect, by intervening so that
risks are reduced and anticipated private returns on investment become more
attractive for the suppliers. At the same time the intervention envisages important
social returns on investment, either by directly meeting social needs or by stimulating
economic growth. Long-term social benefits justify support to make up for short-term
reduced profitability.
Conversely, the risk of PPI is the creation of lock ins and the longer-term dependence of the
public sector on specific technologies, which may prove outdated or too expensive.
In addition PPI, in its form described here, may be seen as a classic demand-oriented tool that
displace new ways of innovation produced directly by public services or by the codevelopment of innovations through public-private partnerships. The cases of urban public
transportation and health services are reported as prominent such sources of innovation.
Experiences of PPI (Who does what)
Both the OECD (OECD 2010) and the EU (Aho Report, Innovation Union, OMC PCP)
promote PPI as an effective policy instrument. In their last amendment4 the EC Directives
specify five different procedures that can be used for public procurement: the open procedure,
the restricted procedure, the competitive dialogue, the negotiated procedure and the design
contest. The competitive dialogue is especially relevant for complex public procurement
projects, particularly those requiring significant technological innovation. With these
amendments the Directives are no longer a legal barrier for PPI, although it is still a difficult
procedure that public procurers prefer avoiding for convenience.
Despite convergence of academic and policy recommendations PPI remains a rarely used
instrument. At the level of rhetoric most EU member states recognise the relevance of such
demand-side instruments for achieving the Lisbon objectives in their recent policy
documents. In several cases discussions are launched and implementations are expected to
start in the near future. But only few countries are adopting specific measures. (Germany,
Sweden, UK, Flanders, the Netherlands and the UK are the best-known examples). However,
even there, critical observers see progress as slow and timid (House of Lords 2010). In fact it
is suggested that even in the Scandinavian countries, who were the champions of PPI
(Edquist 2012) the number of PPIs is reducing rather than increasing.
The US SBIR programme is one model that some EU member states have adopted (UK, the
Netherlands) and others are discussing as a special adaptation of PPI. SBIR is, however, often
(depending on its specific features) more a case of PCP than PPI. In other cases a special
share of the public procurement budget is earmarked for PPI, such as in the case of the
4
This refers to the formal adoption, there are new amendments planned but not yet adopted
4
Spanish Government passing a law fixing at 3% the objective of public procurement of
innovation in 2013 for the budget of the General State Administration 5. Cyprus reports a
similar internal discussion with no specific initiatives yet. In a similar but more refined
approach in France the law of modernisation of the economy 2008 allows public purchasers
to reserve a part of their public procurement for high tech, R&D and technological studies for
innovative SMEs or by giving them preferential treatment for this procurement. Another
option is a more systematic information tool towards the private sector by the creation of an
Action Plan for the implementation of a demand- and user-driven innovation policy, as in the
case of Finland. In addition in Finland public procurement actors can apply to TEKES for PPI
funding in the dialogue phase/development of criteria etc. Similarly, the Flanders Action Plan
on PPI, has adopted a horizontally integrated approach in order to help government to identify
public demand and define purchasing needs and increase the public commitment to
procurement of innovative solutions from the private sector (use of innovation platforms).
(OECD, 2009). In Italy pilot cases are reported where two regional administrations launched
pilot schemes investing research funds instead of procurement money to help regional supply
(Bonnacorsi et al.)
Selection of case studies in different papers and studies (TC 2012, OECD 2009, FhG 2006,
EV 2009) indicate that the sectors of ICT and energy-environment (energy-saving
construction and waste management) are probably the most often encountered cases of PPI,
almost exclusively taking the form of adaptive PPI.
Problems and barriers (Why does it not work fast enough?)
The slow and timid adoption of PPIs in Europe is attributed to a large number of barriers and
risks associated with the change of culture necessary to massively change the state of mind of
procurers.
The barriers are of different kinds:
1. The dominant patterns of procurement and the resistance to change (inertia):
Procurement processes developed over decades show that only competition, as
understood by auction theory (Edquist et al., 1999) and price matter. The lack of
interaction safeguards competition and the lowest possible price reduces public
spending. The careers of procurers are traditionally built on these two criteria. Hence,
their reluctance or hesitation to intervene in markets with insufficient information
availability should not come as a surprise. With significant efforts the life-cycle cost
idea could be adopted but further risky assumptions meet resistance. These dominant
patterns prevent interaction, articulation of innovation needs and early
communication of future needs.
2. The significant skills needed for operating PPI: Off-the-shelf public procurement is a
relatively simple and straight forward process, requesting procurement –specific
5
http://www.micinn.es/portal/site/MICINN/menuitem.edc7f2029a2be27d7010721001432ea0/?vgnextoid=94af08541a901310V
gnVCM1000001d04140aRCRD&vgnextchannel=4346846085f90210VgnVCM1000001034e20aRCRDc
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3.
4.
5.
6.
technical skills and basic management skills. Turning from simple procurement to
PPIs means that more demanding and complex conceptual, operational and
managerial skills will be needed to tackle information asymmetries and complex,
multilateral negotiations. Technical skills and insight are more demanding the more
PPI refers to radical innovations. These capabilities may be difficult to find and
possibly even more difficult to reward appropriately in the public sector.
The risks of the PPI process, which are by definition high constitute an additional
barrier. Policy risks are even higher because, in addition to the technological risk,
policy makers need to anticipate the response of actors. A risk analysis (EC 2009)
decomposed the PPI risks into technological risks related to non-completion, underperformance or false performance of the procured good and service; organisational
and societal risks of the procurement failing or under-delivering for reasons situated
within the organisation that procures or to a lack of acceptance and uptake by the
users; market risks are to be found on the demand and supply side and financial risks
related to potential cost overruns and/or the inability to secure the funds needed. In
addition to that uncertainties associated with large scale-projects, longer time-horizon
projects can hamper the completion of a PPI.
An additional risk, occasionally mentioned refers to market distortions. One is the
danger of lock-ins mentioned above. Another one refers to the risk of large players’
dominating the global market. Finally there is a risk of de facto (hidden)
protectionism, since it is argued that, even if competitive dialogue is open at the
European level, procurers cannot avoid an inherent preference to negotiate with
suppliers in close distance and similar culture.
In certain cases the lack of an enabling environment can also be a factor that inhibits
even the generation of ideas for PPI. The lack of sophisticated demand (in Porter’s
sense) or incumbent ‘national’ industries dominating the domestic market means that
there are no potential suppliers interested to boost PPI.
Finally the institutional framework, namely the EU directives, although not
forbidding anymore, may discourage procurers, because of the caution they request.
Suggested interventions (What to do next?)
It seems that there is no special need for more rhetoric or policy documents but
actions/incentives to eliminate the barriers identified above, which have prevented the rise of
PPI. To scale up this type of procurement interventions can take three different forms,
analysed in order of increasing difficulty below. All three of them can be addressed with
different degrees of ambition and intensity:
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The PPI culture and climate
Policies
Governance.
The PPI culture and climate: EU and national policy papers have paved the way towards
raising awareness. The next step is to engage into changing career prospects and helping build
up the necessary skills to successfully implement PPIs.
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The former is a matter of national public policy sanctions and rewards: internal
procedures need to be formalised on how procurers who attempt PPIs are rewarded
and reassured that potential failures will not be held against them (provided they have
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
adopted sound processes). This calls for innovative human resources policies in the
public administration.
The latter can only be addressed by extensive training for understanding the EU
Directive, the options they offer and the way to address them. More importantly
training is needed on how to deal with the different stages of the procurement
process, when adopting PPIs: Identifying the requirements and user readiness; market
intelligence; tendering process; assessing tenders and awarding contracts and
managing contract delivery (FhG, 2005). Such training may be more effective if
undertaken in networks of procurers rather than individual organisations.
It seems that the neither specific percentages earmarked for PPI, nor the action plans have as
yet been able to trigger a change. What might be a next step would be a request to procurers
to submit a short annual report indicating the list of procurements they undertook and for
which, among them, they considered the option of PPI (when dealing with societal
challenges) and why they adopted or rejected it. This can help build up a new way of thinking
and combat inertia.
Policy intervention: The most important barriers are associated with the risks that procurers
face and their ability to overcome them. In addition to the training mentioned above, what is
necessary are additional resources mobilised from outside the procurement budgets. These
can take different forms, each one associated with its own challenges and benefits:
1. The adoption of SBIR-types of intervention is the most often discussed and adopted
one. However, as with PCP, SBIR may or may not end up in successful PPIs. If,
unlike the US, R&D support is offered under the condition that the outcome will be
procured by a public organisation, this will be a clear PPI form.
2. Supporting procurers with innovation grants in the initial, preparatory stages of a PPI
(based on the TEKES model mentioned above) is one way of facilitating the process
and helping reduce information asymmetries. The problem with this type of policy
intervention is that it offers limited resources that may not be sufficient to prevail
over inertia.
3. Another form, if ambitions are to be increased is the mobilisation of innovation grants
for the procurement process itself to complement the standard procurement budget.
Procurers adopting PPI solutions could, under such facilities, request additional
resources in order to decide on a PPI instead of of-the-shelf procurement for the same
need. The synergies of the combined budgets would reduce financial risks but would
trigger coordination problems that need to be addressed in new governance modes.
4. Finally, probably the most ambitious and challenging intervention would be a special
insurance mechanisms for PPIs, in particular as an effective way to stimulate
innovative procurement from SMEs. Korea has tried a programme of this kind
established in 1996, which was not binding. The ultimate problem was the weak legal
grounds for enforcing public procurement. A change of provisions led to a significant
upscale and from 2000 to 2005 new SME technology products passed from 3% to
9.3%. The organisation and cost of such an intervention is a significant challenge.
The first type of intervention described above only makes sense at the national level, the
second and the third can be implemented at the national or at the EU (Commission) level,
whereas the third might be best suited for EIB-EC cooperation. Structural funds can adopt
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such interventions in their guidelines and pilot joint standard procurement and innovation
policy support.
In addition to such interventions that support procurers/suppliers directly, indirect
interventions for the creation of platforms or lead market initiatives can be helpful, if
adequately organised. This, however, only makes sense in innovation leaders and followers 6,
where sophisticated demand and interested suppliers co-exist or at the EU level.
Governance changes: The missions or needs of procuring agencies do not include an
innovation rationale. PPI is in that sense a policy serving two masters. It may well be argued
then that the current governance of public procurement is not well suited for PPI and there is a
need for new governance models to address this double-aim by combined/coordinated
instruments. In particular PPI raises important issues of governance and coherence between
its primary goals and its goal as an innovation policy instrument.
A simple change of governance is to adopt the idea of the Forward Commitment
Procurement, which involves providing the market with advance information on future needs
in outcome terms, early engagement with potential suppliers and the incentive of a forward
commitment (House of Lords). This, combined with the idea of an annual report, mentioned
above, can pave the way to a broader, more frequent procedure for subsequent PPIs.
Another change of governance is the idea to create special agencies to manage PPI
(Netherlands and UK), which will have the necessary human resources and expertise to deal
with the procurement of functional requirements rather than products or services. They can
act as support mechanisms to standard procurement agencies.
Still another, more radical option, is the proposal of the House of Lord in the UK, which calls
for “a single Minister being made responsible for both procurement and innovation across
government and that, further, a Minister should be appointed in each government department
with specific responsibility for procurement and innovation within their departments. In
addition departmental Chief Scientific Advisers should have a greater role in ensuring the
procurement of innovative ideas by their departments, encouraging engagement with industry
and academic communities and assisting departments in the formulation of their long-term
planning through horizon-scanning activities”.
Finally, an option combined with the policy measure suggested for shared budgets above,
would be for an ad hoc coordination committee or innovation policy makers and procurers to
follow up throughout the individual PPIs.
Conclusions
It is suggested that PPI needs to be adopted to stimulate innovation and competitiveness in
Europe and mobilise additional resources to meet the Lisbon objectives. Despite recent policy
documents this has not sufficiently taken off the ground. Hence, a number of possible
interventions are suggested to scale it up. These need reorganisation, cost and persistence.
They are more likely to be adopted by innovation leaders but direct, diffusion PPI is likely to
6
In the jargon of the IU Scoreboard
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come up in moderate innovators and catching up countries are well. The following matrix
suggests how the risks and interventions needs can be illustrated:
Direct
Catalytic
Development PPI
High risks, high rewards
(potential lead market
development), need for
coordinated, ambitious
interventions
High risks, high rewards
(potential lead market
development), need for
ambitious interventions and
multi-level coordination
Diffusion PPI
Easiest and most often
encountered type;
intervention needs are
moderate; use of Structural
funds can play a major role
Relatively easy process with
coordination problems; use
of Structural funds can play a
major role
It is, however, important to note that PPI should not be interpreted as panacea. On the
contrary it is loaded with justified barriers and reluctance that need to be carefully addressed
at the level of implementation. In addition, at the level of policy design it needs to be
carefully addressed to avoid the creation of lock-ins and/or the displacement of innovations
produced directly in the public service.
REFERENCES
Edquist, C., Zabala-Iturriagagoitia, J. M. (2012), Public Procurement for Innovation (PPI) as
Mission-oriented Innovation Policy, Version of April 7, 2012. Accepted for publication in
Research Policy. Forthcoming during 2012.
Edquist C., Hommen L., Tsipouri L. (eds.) (2000), Public Technology Procurement and
InnovatioN, Kluwer Academic Publishers Group.
Edler, J. and Georghiou, L. (2007), Public procurement and innovation -Resurrecting the
demand side. Research Policy, 36(9), 949-963.
Fraunhofer Institute Systems and Innovation Research (2005) Innovation and Public
Procurement. Review of Issues at Stake, Study for the European Commission (No
ENTR/03/24)
Georghiou, L, (2007), Demanding Innovation – Lead Markets, Public Procurement and
Innovation, NESTA Provocation 02: February 2007, London: NESTA.
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