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Risk management in the procurement of innovation Concepts and empirical evidence in the European Union Expert Group Report
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This report studies the way risk can be managed to enhance the procurement of
innovation. The latter is a concept that goes further than technology procurement,
occurring when a public agency places an order for a product or system, which does not
exist at the time but which could (probably) be developed within a reasonable period
(Edquist et al. 2000). The procurement of innovation includes technology but goes
beyond it and addresses non‐technological innovation and complex systems, where the
technology may be known and proven but not at that scale or level of complexity.
Public procurement can potentially boost demand for innovation and promote lead
markets. With public procurement equalling 16% of EU GDP, authorities can stimulate
private investment in research and innovation, when they procure either
products/services incorporating new technology or the R&D to develop the technology to
a point where such products reach the market. However, this type of procurement of
innovation is at the moment much less widespread than one would expect from such a
promising activity; one of the reasons for this is the large amount of risk inherent in
research and innovation activities.
The purpose of this report is to understand the various risks that public procurers are
currently facing, identify existing risk management practices and derive
recommendations that could help overcome this key barrier. This is done by
• a conceptualisation of risk in public procurement,
• the conduct of 12 case studies and
• insights gained from key incumbents (see below) invited to present at the expert
group meetings.
The research carried out was exploratory and the cases were chosen because of their
perceived information richness. Research conclusions are thus analytic or contextual
rather than rendering universal statistical generalisations. They do, however, lead to
concrete recommendations to improve the field.
The conceptualisation refers to the various types of risks that are relevant to the
procurement process, and indicates some governance and managerial challenges these
pose for a successful process of procuring innovations. The whole exercise builds up on
the assumption that the cost of risk management cannot be exactly measured but
procurers need to acknowledge in their budgets that it has a cost. It is therefore essential to get a better grasp for it, to make sure it is not excessive in terms of information and
delays and to keep in mind that the cost of no risk management may be a lot higher. The
message from this exercise is that for the procurement of innovation someone takes
responsibility for an additional cost, which leads to private and/or social returns on
investment when the cost is in a reasonable relation to the benefit of the innovation.
Risks can be characterised by (a) their nature and origin, (b) the likelihood of them
occurring and (c) the potential consequences. Risk management is a process that has to
deal with all these properties. It needs to be understood as a risk‐reward management,
as any risk is to be assessed not only against the likelihood of its occurrence and the
negative effects once they occur, but also weighed against the benefits out of the
procurement for the various actors involved. The benefit is not absolute, but determined
in relation to the overall targets and context conditions of the actors involved (see
below). Risks in public procurement can only be assessed if they are contextualised and
balanced against the benefits associated with the particular procurement.
The conceptualisation relates to the procurement cycle and the innovation cycle and
leads to a typology of risks, which were suggested and proved appropriate through the
case studies.
Five types of risks were defined:
1. Technological risks are all those risks that lead to non‐completion, underperformance
or false performance of the procured good and service. Due to its
more innovative nature, the risk lies in the technical characteristics of the service
or product or in its production, and thus originates in the suppliers’ side. This risk
appears of particular relevance in procurement of products in the fluid phase.
2. Organisational and societal risks: Organisational risks are all those risks of the
procurement failing or under‐delivering for reasons situated within the
organisation that procures. Societal risks are those related to a lack of acceptance
and uptake by the users of the new or changed service delivered within society.
3. Market risks are to be found on the demand and supply side. The former occur
when innovations in public procurement are also intended to spill over to private
markets and those private markets are not large or responsive enough or do not
built up quickly enough to justify capacity investment. The latter are those that
potentially disrupt or delay operations such as political instability and volatile
labour market; potential threats that a competitor will take over a supplier and
potentially lock out supplies, risks related to delays and insufficient quality.
4. The financial risks in public procurement are related to uncertainty in meeting
target costs and the ability to secure the funds needed.
5. Finally turbulence risks – in fact turbulence uncertainties as they are hard to
predict and measure – are associated with large scale‐projects and emerge from a range of unforeseen events that lead various actors in the whole process to reassess
their priorities or change their expectations.
The empirical evidence draws on 12 case studies, which were identified by the group as
offering interesting lessons for policy makers. They were not chosen following systematic
selection criteria and thus do not reflect a representative sample. While not claiming
general validity on the conclusions drawn out, they proved sufficiently diverse in many
dimensions and as such led to the identification of explicit and implicit risk management
practices.
The cases discussed took place in the Nordic countries, the UK and the Netherlands in the
last two decades; some of them took almost a decade to mature and take off. Risk
management under all its guises is a time consuming process as was seen in the case
studies. It seems that one can observe a trade off between the innovative (often
complex) character of a product/service to be procured and the speed of the
procurement implementation. The various techniques used (breaking down the
procurement into more stages, engaging in dialogue, engaging experts and consultants)
all need time and the time elapsing for a typical procurement of innovation is ipso facto
longer than in any corresponding standard procurement process. Shortening the time is
possible, if all information‐gathering processes are foreseen and well designed from the
beginning. The procurement budgets ranged from 87000 Euros to 270 million Euros
indicating that procurement of innovation is possible in all ranges of budgets and is not
reserved for larger (or smaller) projects only. There were no systematic differences in risk
management between large and small projects. The procurers involved in the case
studies were national and regional authorities, municipalities as well as specialised
agencies. In the material there is no preferred pattern identified. This again implies that
procurement of innovation should not be considered as a case to be followed by one
type of procuring agency / department but can be designed and implemented by any
type of public actor interested in procuring products and services that do not yet exist in
the market. Similarly the suppliers in the case studies varied including consortia, wellknown
multinational companies and SMEs. Both indigenous and foreign companies have
been successful bidders, the former more frequent than the latter. The type of
procurement was more often a classic type of direct public procurement, whereby
administrations buy for their own use. However, in many cases it proved to be a catalyst
for further technological developments beyond the original request. The procedure used
was sometimes part of the standard processes, in others the procurement was broken
down into different stages and in others competitive dialogue was used. Procurers and
suppliers tried not only to reduce risks by improving their access to information, using
the tools tolerated by the EU Directives, but occasionally found additional ways to reduce
risks by combining the procurement with additional elements of public or private
support. In their majority the case studies involved incremental or architectural innovation, sometimes resulting from design only. In some cases the innovative element
emerged from the larger scale or higher complexity of already existing technologies:
public procurement avoided applications that have not been tested on a commercial
scale, even if the technology existed (in principle). Lack of prior demonstration and design
functionality, as well as the coordination of increased complexity, were often the really
innovative elements.
In addition to the case studies, lessons were drawn from invited speakers presenting risk
management/perceptions in other areas. As with the case studies these presentations
reflected specific cases and are not generally valid but should be interpreted as
suggestions of good practices. Banks reduce risk through internal and external valuations.
When banks are asked to finance risky projects they expect the valuation cost is borne by
the bidder; in certain cases national policies are to offer second and third bidders
compensation from the State for that cost. Furthermore, banks rely heavily on expert
advice; selecting – as needed – best global experts. One way to manage financial risks is
offered by banks in the form of “stand‐by loans” for potential cost overruns (same or
marginally higher interest rate). Insurance coverage is mandatory against all events. In
order to decide on the interest of a bank to finance a project in the first place, “Go‐stop
scorecard” approaches are used, through which risks are perceived and questions get
binary responses (yes/no). Evidence from specialised national organisations in the
Netherlands and the UK highlight new approaches to encourage innovation. One example
is the shift from the traditional concept of procurement to an integrated concept,
whereby the procurer sets performance requirements and allows for more freedom of
choice on design and specifications to the contractor. Another one includes the
Innovation Platforms used in the UK, which enrich intelligence and awareness, reducing
technological and market risks. The business approach to manage risks focuses on the
careful selection of suppliers, building on certifications (ISO or otherwise, depending on
the contract), the utilisation of steering committees and project teams to closely monitor
progress and negotiations for insurance costs. Finally, risk sharing facilities are
increasingly offered by public and private organisations. These constitute a new type of
instrument providing strong additional support to research, development and innovation,
used also by the EU's 7th Framework Programme for Research to prioritise sectors
identified as key drivers of excellence in European research and innovation and present
significant lead market potential for Europe.
The deliberations in the expert group have further shown that the current institutional
framework in the EU (revision of the Directives) now offers a better set of tools, which
procurers are making an increased use of. There is however still a long way to go and
significant problems to overcome before the procurement of innovation becomes
widespread at the national level; possibly even longer until cross‐border procurement is
frequent.
European Commission - Personal Name
978-92-79-14660-2
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Management
English
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