Towards a management framework for public procurement of innovation

Transcription

1 Towards a management framework for public procurement of innovation Ville Valovirta VTT Technical Research Centre of Finland Correspondence: ville.valovirta@vtt.fi Conference: Demand, Innovation and Policy: Underpinning Policy Trends with Academic Analysis Manchester Institute of Innovation Research, Manchester, March 2012 Abstract: As governments are adopting public procurement of innovation as a focal instrument in their toolboxes for demand-driven innovation policies, public organisations are faced with a need to develop capability to manage new organisational processes. Public procurement of innovation represents a function which requires a new combination of skills and management practices. The capability required needs to accommodate an innovation perspective with the procurement practice. This paper suggests a framework for managing public procurement of innovation. First we will review issues related to the topic and identify the essential characteristics involved with procurement of innovation. Second, we will report empirical data from a case study focussing on three public organisations in Finland. Drawing on the review of issues and empirical data, we will formulate a tentative framework for managing public procurement of innovation. This effort is intended to emphasize the interactive and reciprocal nature of innovation procurement at the interface between public demand and private supply. Keywords: Public procurement of innovation, innovation management, market interaction, risk management 1

2 1. Introduction As governments are adopting public procurement of innovation as a focal instrument in their toolboxes for demand-driven innovation policies, public organisations are faced with a need to develop capability to manage new organisational processes. Public procurement of innovation is an approach which requires novel skills and management practices. An innovation perspective sets new challenges for the organisation and the procurement practice some of which are not part of traditional procurement skills. Also general management needs to adjust their practices to reap full benefits of the novel approach. This paper investigates public procurement of innovation from a management perspective. First we will review relevant issues related to the topic and identify the essential characteristics involved with procurement of innovation. The focus is on management aspects specific to innovation procurement as contrasted with mainstream procurement. The second part of the paper reports empirical observations from three case studies with public procurement organisations in Finland. We analyse the organisational expectations towards a new management practice, as well as boundary conditions set by various intersecting organisational processes. In the final part we summarise the findings and suggest a tentative framework for managing public procurement of innovation. 2. Review of management issues related to procurement of innovation Public procurement of innovation has been subject to only a few studies focusing explicitly on management issues. The majority of available research investigates economic impacts and policy implications of innovation procurement. The managerial aspects have been most notably discussed in few recent studies focusing on risk management in innovation procurement (Tsipouri et al 2010, Kalvet & Lember 2010). The management perspective together with a focus on innovation is also studied in recent work on procurement of complex performance (Caldwell & Howard 2011). While these studies on risk management and complex performance are highly relevant for the topic at hand, they represent specific aspects to managing public procurement of innovation. There is a gap in the literature covering the broader aspects related to managing public procurement of innovation which this paper seeks to address. In order to capture essential characteristics of management issues more broadly, it is necessary also to consult the body of literature on public procurement which does not directly address innovation issues, but provides useful insights regarding procurement objectives, market interaction, risk management, and performance measurement. To structure the discussion, we adopt a simple policy cycle approach including the elementary phases of identification of needs and objectives, implementation, and evaluation. Procurement needs and objectives When innovation is set as an expressed goal for procurement it is added in the list of other objectives for public procurement. As compared to supply side support measures, such as R&D grants, which are highly targeted measures to support 2

3 innovation, public procurement for innovation needs to serve multiple goals. According to Schapper et al (2006) public procurement aims to achieve three principal objectives: first, public confidence to the fairness of the procurement process; secondly, efficiency and effectiveness of the money being spent; and thirdly consistency with various other policies. These goals are not always in full harmony when practicing procurement. The parallel goals have been given varying emphasis in different times and stakeholders tend to balance them differently in their expectations. Introducing promotion of innovation as an expressed goal for public procurement shifts this balance in ways which have also managerial implications. Most obviously, procurement of innovation has potential contribute to improved efficiency and effectiveness of public services through encouraging better solutions to be developed by firms and acquired by public bodies to improve service delivery. Innovation procurement has potential both to incremental improvements and radical improvements of value for money in public spending. However, efficiency and effectiveness gains can not be guaranteed due to the inherent risks involved with any innovation. Technological risks may lead to a non-completion, under-performance or false performance of the procured service or product (Edler & Georghiou 2007, Tsipouri et al 2010). Introducing explicit objectives to promote innovation through procurement essentially increases the risks as outcomes of procurement of innovation cannot be controlled to same extent as when procuring offthe-shelf products services. A higher degree of risk might, particularly in the short run, undermine the potential improvement of value for money. The realisation of efficiency and effectiveness gains may also extend over longer period of time than in traditional procurement. Managing technological risks related to lower than expected performance of the procured service or product is a key element in management of public procurement of innovation. There are a range of established techniques to manage technology risks (see Tsipouri et al 2010). However, it needs to be acknowledged that the risks can never be fully eliminated since part of innovation efforts fail due to uncertainty of outcomes. This risk can be dealt with in two principal ways. First, the risks and expected rewards can be balanced in a portfolio of innovation procurement projects at a strategic level. Innovation procurement becomes thus a subject to a larger issue of innovation management in public organisations. Second, the risk can be shared by cofinancing schemes with those organisations responsible for public innovation funding. These agencies are responsible for encouraging investments in innovation by sharing some of the risks through public funding. This leverage can be used also in conjunction with public procurement. In addition to technological risks, organisational and societal risks may also undermine the potential benefits from innovation procurement (Tsipouri et al 2010). Lack of acceptance from the users or the society of the new or transformed service is another major risk in procurement of innovation. Various approaches to engage users in the development process and testing of new services and products are available to manage these risks. Promoting and managing acceptability of innovative services and products procured should be a part of the management framework for innovation procurement. 3

4 Innovation as an objective for public procurement is, in effect, an additional goal for public procurement. Public procurement has been already subjected to many other socio-economic expectations similar to innovation targets. These horizontal policies include goals such as environmental objectives, economic development of disadvantaged groups, employment, and small businesses (Arrowsmith 2010, Piga & Thai 2007). Public procurement is thus widely used as a policy tool to advance various socio-economic goals. Innovation adds to that list of objectives another layer of complexity in the goal setting. It has been noticed that public procurement has to manage multiple stakeholder objectives, which often are in contradiction with each other (Caldwell et al 2005, Arrowsmith 2010). It has also been argued, that while setting social and economic goals to procurement is legitimate, these goals should primarily be pursued with other policy instruments than procurement (Eliasson 2010, Uyarra & Flanagan 2010). This would mean innovation needs to remain a secondary objective behind the traditional goals of procurement. Balancing innovation objectives with other procurement goals emerges as another dimension in management of procurement of innovation. Market interaction Traditional procurement is based on a transactional approach which keeps the suppliers at an arms length from the public buyers. Procurement of innovation calls for more relational and interactive approach to engaging with market players. There is a need to understand the market power of the government buyers, structure of the supply side, and knowledge of supplier capabilities in order to reap full benefits from innovation procurement. The shift towards more complex supply chains requires deeper understanding of value chain structures and industry capabilities (Schapper et al 2006). More extensive management skills are needed at the buyer s side to understand suppliers potential to respond to demand signals for new innovations. A topical discussion in the general procurement literature emphasises relationship management as opposed to transactional contracting. The complexity of services procured, consisting of bundles of service and product characteristics and shifting towards contracting performance over an extended lifecycle is considered to call for partnership based approaches (Schapper et al 2006, Caldwell & Howard 2011). In many cases of complex procurements, they involve public buyers and private suppliers, entering into a relationship based on more than contractual arrangements, in order to facilitate innovation over the contract period. While from an innovation promotion perspective relationship based management approach would be called for, it is clear that it there is a risk to encourage favouritism, oligopoly and artificial creation of barriers to new entrants (Caldwell et al 2005). Utilizing a more relationship based management approach is a challenging task to build as public procurement rules are based on strict procedural rules with regard to communication with suppliers. However, the rules are particularly constraining when a bidding process is ongoing. In a phase preceding the publication of a call for tenders are not that restricting. In practice, government s market power is often fragmented into distinct departments and agencies with little coordination (Caldwell et al 2005). While in aggregate terms the government in many policy domains commands a substantial share of demand, its 4

5 fragmented implementation leaves public procurers with less upper hand with relation to the markets. Bundling this demand across organisations and departments creates larger incentives for firms to invest in product development targeting a larger and more varied market. Cross-organisational coordination is thus an essential management requirement. Good practices are in many policy domains already available such as common procurement units and procurement networks which can be used also for procurement of innovation purposes. In the same vein, bundling demand across the European countries within the single market creates larger markets for innovative products. This is particularly important for sectoral government agencies which are typically the lead buyers for their respective industries with highly specific needs. Bundling the demand at the European level opens larger markets for specialised products and services. An international collaboration dimension is thus added into the management framework for innovation procurement. Technology and innovation studies emphasize the pivotal role of user-producer interaction and learning as a basis for innovation. Brought into the context of innovation procurement, the learning process between government buyers and private suppliers is constrained by tighter procedural rules for interaction than in the private procurement. A very specific organisational capacity needs to be developed within the public buyer organisations for effective market engagement approaches which are applicable within the boundaries of public procurement regulations and state-aid rules. Essential for user-producer interaction is exchange of information regarding future needs of the government and suppliers technological and organisational capability to respond to these needs (Edvist et al 2000). Various legitimate market engagement techniques to be used at the pre-procurement phase are available, such as use of reference groups, joint foresight, and market sounding methods (OGC 2009). The increased use of outsourcing and contracting out has changed public agencies from production organisations into procurement organisations. The emphasis has shifted from procurement of goods to service contracting and purchase of complex service-product combinations (Schapper et al 2006, Caldwell & Howard 2011). Engagement of suppliers in order to tap into their innovation potential emerges as a key issue for the strategic management of procurement. The ultimate goal for public procurement of innovation is that new products and services diffuse to private markets and overseas users. Understanding the preconditions for diffusion process is a key requirement (Rolfstam et al 2011). A particular risk for procurement of innovation is that new products and solutions do not spill over to private markets (Tsipouri et al 2010). Poor diffusion of innovations can undermine higher investments in procurement. Analysing the preconditions for diffusion and selecting the appropriate procurement approach with regard to degree of diffusion possibilities is a particular requirement for innovation procurement. Looking at the issue of diffusion from firm perspective, it translates to the question whether firms have sufficient incentives to commercialize and sell products and services to broader markets. This requires sufficient level of intellectual property to remain with the supplier (Nyiri et al 2005). Complex contractual arrangements are often needed, particularly in pre-commercial R&D procurement, to ensure that necessary incentives for the companies to invest in innovation are available through 5

6 IPR, while allowing sufficient user rights at the buyers side to exploit the new product or service. Assigning intellectual property is a very specific topic with many highly technical aspects having high relevance for managing public procurement of innovation. Linking with research and development Managing public procurement of innovation also creates a need to create better links between the procurement function and research and development (R&D) function. It has been addressed particularly within the discussions concerning public technology procurement (Edqvist et al 2000), R&D procurement and the pre-commercial procurement approach promoted by the European Commission. However, the topic has been discussed relatively little in the available academic studies from a management perspective. The key issue is to create appropriate integration of R&D and procurement as a sequenced process taking into account the maturity of the technology or solution. Advanced technology procurement organisations have developed sophisticated approaches to creating this integration. It has been noted that creating functioning links between procurement and R&D might be easier to establish for procuring organisations strong in mission-oriented R&D. This is common specifically in the sectors of defence, space, and energy, but also to a lesser extent in other domains. Variation between countries appears to be large. 3. Case study In this section we will report first observations from a case study on three public organisations in Finland. A case study method has been applied with a focus on organisational expectations and needs appearing when ramping up the capability to procure innovation. The data consists of qualitative data collected by interviews and focus groups between September 2011 and March The three case organisations include a large city, a mid-sized city, and a government agency. Both cities are responsible for provision of a large variety of public services including health care, social services, primary education, water, waste, energy, and public transportation. They purchase a large variety of goods, services, and construction contracts. The government agency accounts for provision of infrastructure and related services, spending a substantial budget for investment and service procurement. The annual procurement budgets of the three organisations vary between 260 million and 1.7 billion Euros. Case 1: Large city The first case organisation, the large city, is the most recent of the three organisations starting to build capability to procure innovative products and services. Their most immediate management need concerns identification of appropriate opportunities for innovation procurement. How the need for unsatisfactory performance and opportunities for acquiring better solutions from the market can be identified and 6

7 determined is a practical management concern. The city procurement office would benefit from having a template process for deriving the most attractive opportunities for using procurement of innovation. Another key management issue which has appeared concerns the division of work between the central procurement function and the departments providing services. While in mainstream procurement the division of labour is clear and follows an established process, innovation procurement blurs this established distinction. It requires higher level of involvement of domain experts in the procurement process than in mainstream procurement, extending over the longer period of time in various phases of the procurement process. How to manage this collaboration process and determine the appropriate balance of involvement with regard to organisational boundary conditions appears as a specific management issue. The third key management issue for the large city is creation of capacity to support procurement of innovation. Management of both procedural support as well as advisory capacity is needed. Whether it should primarily rely on in-house expertise or external service providers is under consideration. Case 2: Mid-sized city The second case organisation is a mid-sized city. It has been experimenting with few procurement processes aiming to stimulate innovation and use novel procurement methods. With the first experiences at hand, their needs for improving management practices concern various topics. First, the city staff has identified a capability gap in anticipating future needs which later will become subject to procurement. Foresight and planning tools are looked for to bridge the gap between future needs and procurement at the level of strategic management. The second management issue discussed relates procurement with other available means to promote provision of high quality and efficient services. Procurement of goods and services is but one means to promote renewal of the city services. How does one know whether a particular improvement need is best served through procurement of innovation or other means? There is a need for skills and management tools to analyse the appropriate scope for procurement of innovation as part of a larger framework of managing renewal and innovation. Another related issue concerns applicability of innovation procurement to various types of procurement and supplier segments. Is it equally applicable to high and low volume activities? Knowledge of the market and interaction with suppliers is another key issue emerging. A small city suffers from a narrow supplier base which leaves them with fewer options to choose from than in the large cities. Through their first experimentation the mid-sized city has also experienced management challenges with communicating the innovation procurement initiatives with the local decision-makers. Opposition to novel approaches and risk taking has occasionally been high, particularly in the beginning of the process when the understanding of a new approach is low. Gradually more support has been gained leading eventually to approval of innovation procurement project. A very specific management challenge appears which has to do with communication to elected 7

8 decision-makers representing varying levels of education and occupational backgrounds. Case 3: Government agency The third case organisation is the most advanced and established buyer of innovative solutions serving their needs. The agency has a well-articulated procurement strategy with explicit goals set for innovation and promotion of functioning markets. Having experimented and adopted several measures to promote innovation, such as market interaction, performance-based specifications, alternative procurement methods (framework contracts, competitive dialogue, design contest), and inclusion of incentives and sanctions in the contracts, the agency is now seeking to move towards promotion of more radical supplier driven innovations. While the agency has a clearly structured strategic management framework through which implementation of organisational goals can be done effectively, it is not very clear how innovation in general is managed. An established research and development function is in place, but adding innovation with a strong supplier focus has not yet found its position. The agency aims to define an innovation process where procurement of innovation has a specific role, leading eventually to an overarching approach to innovation management suiting their needs. A new kind of relationship between procurement and R&D is needed. The uniting link is currently looked for in the area of pre-commercial procurement which links R&D and public procurement into an integrated process. The agency operates in an environment which is characterized by strong collaboration between public and private actors. Innovation requires close interplay between the players. New types of combinations between public services and privately provided commercial services particularly enabled by opportunities from application of information and communication technologies call for new forms of management. Innovation is inextricably linked to the dynamics taking place in the marketplace whose viability and healthiness is a concern for the government agency. 4. Management framework Drawing on the review of issues and the case study data we now formulate a tentative framework for managing public procurement of innovation. The framework puts together a set of requirements for managing innovation procurement. These requirements are presented as general aspects deserving attention. The space here does not allow reviewing the various management approaches or tools which could be applied to these purposes. Use of particular tools is probably also very much contingent on the specific conditions of the procurement context. Making uniform, one-size-fits-all type of recommendations about appropriate tools would be not justified. Rather, it should be more useful to provide a menu of tools from which approaches can be selected to fit the purpose. Summarizing the preceding findings and discussion we suggest a loose framework which lists key requirements for management of innovation procurement: 8

9 1. Strategic management of procurement of innovation Anticipate future needs which later will become subject to procurement Early identification of performance improvement needs as opportunities for procurement of innovation Analyse the appropriate scope for procurement of innovation as part of a larger framework of managing renewal and innovation in public services; an approach to innovation management which suits a public procurement organisation Balance innovation objectives with other procurement objectives 2. Market interaction Understand the market power of the government buyers Understand the structure of the supply side Knowledge of suppliers capability to respond to demand signals for innovative services and products Effective market engagement approaches Relationship management capabilities which are applicable within the boundaries of public procurement regulations and state-aid rules 3. Risk management Understand and manage technological risks related to lower than expected performance of the procured service or product Promote user acceptability of innovative services and products procured Promote compatibility of new innovative services and products with existing services, systems, and organisational practices 4. Coordination and communication Communicate goals and approaches innovation procurement initiatives with the politically elected decision-makers Manage collaboration between domain experts and the procurement professionals in the process Cross-organisational coordination in order to bundle demand International collaboration between sectoral authorities to bundle demand at the European level in order to open larger markets for specialised products and services. 5. Capacity building Creation of capacity to support procurement of innovation This list is far from exhaustive, as it only highlights the management issues that are specific to procurement of innovation. The mainstream procurement skills, such as preparing specifications, managing the bidding process, bid evaluation, contract awarding, and contract management add to the list of required skills. Many of the traditional skills also need to be adjusted and expanded to match innovation procurement. 9

10 5. Concluding remarks Incorporating an innovation perspective in the procurement practice requires improving and expanding organisational capabilities. In effect, the issue covers a larger set of issues beyond procurement extending to strategic management of renewal in public services, managing market interactions with the suppliers, and coordination with research and development. Public procurement of innovation requires a strategically sophisticated understanding of the use of it as a policy tool. A management practice is needed which allows a certain degree of risk taking involved with innovation while maintaining transparent, non-discriminatory and legally sound procurement practices. Finding effective organisational routines for managing this process will take time to find their shape. This article aims to pave the way for structuring the necessary elements into a management framework. One of the main conclusions of the study is that public procurement of innovation needs to be embedded as an instrument in the broader framework of public service renewal. The reviewed literature together with the empirical findings from the case study indicates that this broader framework is largely missing at the moment. We suggest developing an innovation management approach to the public sector which encompasses public procurement as a central tool in acquiring innovative solutions to improve public services. This framing needs to acknowledge also that procurement might not be the best available instrument in many cases. Furthermore, using procurement in conjunction with other approaches is another issue requiring further investigation. Finding the appropriate application space for procurement of innovation remains a challenge calling for more conceptual and experimental work. As a final remark, we would like to emphasize that the research reported in this paper is a work in progress, and results should be considered as tentative at this stage. In the succeeding phases of the project we will continue conceptual framing of the managerial aspects of innovation procurement, and follow up the piloting process of the management framework in the case organisations. References Arrowsmith, S Horizontal policies in public procurement: a taxonomy. Journal of Public Procurement 10 (2), Caldwell, N., Howard, M Procuring complex performance: studies of innovation in product-service management. Routledge, New York. Caldwell, N., Walker, H., Harland, C., Knight, L., Zheng, J., Wakeley, T Promoting competitive markets: the role of public procurement. Journal of Purchasing & Supply Management 11, Edler, J., Georghiou, L Public procurement and innovation resurrecting the demand side. Research Policy 36, Edqvist, C., Hommen, L., Tsipouri, L Public technology procurement and innovation. Springer. 10

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