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Innovation: The European Journal of

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Risk management in public

procurement for innovation: the case
of Nordic–Baltic Sea cities
a a
Tarmo Kalvet & Veiko Lember
a
Department of Public Administration , Tallinn University of
Technology , Estonia
Published online: 28 Mar 2011.

To cite this article: Tarmo Kalvet & Veiko Lember (2010) Risk management in public procurement
for innovation: the case of Nordic–Baltic Sea cities, Innovation: The European Journal of Social
Science Research, 23:3, 241-262, DOI: 10.1080/13511610.2011.553509

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 Innovation
The European Journal of Social Science Research
Vol. 23, No. 3, September 2010, 241
262

RESEARCH ARTICLE
Risk management in public procurement for innovation: the case of


Nordic Baltic Sea cities
Tarmo Kalvet* and Veiko Lember

Department of Public Administration, Tallinn University of Technology, Estonia

(Received 20 September 2010; final version received 7 January 2011)

State support for innovation in enterprises has been long-standing. One of the
specific support measures is public procurement for innovation, which has only
recently re-emerged in academic discussion as well as in the European policy
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discourse. While the spillovers from this type of innovation policy measure may
be substantial, the complex processes underlying the support for innovation
through public procurement are associated with high risks. We take an
exploratory approach to determine the state of practice of risk management in
public procurement for innovation at the local level. Five case studies, which were
selected as representative cases of the Nordic
Baltic Sea region in Europe, were
analyzed. We found that the cities were, for the most part, actively involved in risk
identification; the risks are primarily being met with mixed contracting strategies
rather than comprehensive risk management tools.
Keywords: risk management; public procurement for innovation; cities; Stock-
holm; Helsinki; Tallinn

Introduction
State support for innovation, i.e. for ‘‘the implementation of a new or significantly
improved product (good or service), or process, a new marketing method, or a new
organisational method in business practices, workplace organisation or external
relations’’ (Organization for Economic Co-operation and Development and Eurostat
2005, p. 46; see also Schumpeter 1934, p. 66) in enterprises has been long-standing
(e.g. Reinert 2007). One of the specific support measures is public procurement for
innovation, sometimes referred to as ‘‘public technology procurement’’ (Edquist
et al. 2000) or ‘‘innovation oriented procurement’’ (Rothwell 1984), which in the
present article denotes a situation in which a public agency purchases or places an
order for a product
a service, good or system
which does not yet exist, but could
be developed within a reasonable period of time based on additional or new
innovative work by the organization(s) undertaking to produce, supply and sell the
product being purchased (Edquist and Hommen 2000, p. 5).
The United States, along with Japan, China and other Asian countries, has been
using public procurement to promote innovation since the nineteenth century
(European Commission Working Group 2006, Ruttan 2006). The Internet, GPS
technology, the semi-conductor industry and passenger jets are perhaps the most
prominent examples which have resulted from government innovation-oriented

*Corresponding author. Email: tarmo.kalvet@ttu.ee

ISSN 1351-1610 print/ISSN 1469-8412 online

# 2010 Interdisciplinary Centre for Comparative Research in the Social Sciences and ICCR Foundation
DOI: 10.1080/13511610.2011.553509
http://www.informaworld.com
 242 T. Kalvet and V. Lember

procurement (Cabral et al. 2006, Ruttan 2006). The potentially more important role
of public procurement for innovation within the innovation policy mix has recently
re-emerged in academic discussion (e.g. Edquist and Hommen 1999, Edquist et al.
2000, Cabral et al. 2006, Edler and Georghiou 2007, Rolfstam 2009, Uyarra and
Flanagan 2009), as well as in the policy discourse (e.g. Kok 2004, Currie 2005, Edler
et al. 2005, Aho et al. 2006, European Commission Expert Group 2005, 2010,
European Commission Working Group 2006, Nyiri et al. 2007).
In Lember et al. (2011), we provide a detailed research framework for including
innovation policy in public procurement at the urban level, and use this as a general
framework for the present study as well. In short, as innovation in the private sector
is increasingly being recognized as an engine of economic development and
competitiveness, we suggest using public procurement to support this process (see
also Rothwell 1984, Geroski 1990, Edler and Georghiou 2007). While being an
important tool for resolving existing as well as emerging social challenges, public
procurement can be used to influence the technology life cycle and to promote
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clusters and innovation systems. Public procurement for innovation can create
demand for new products or technologies, enhance providers’ innovativeness, create
and protect infant industry, and thus increase the diversification of economic
activities and average wages. As urban competitiveness can be considered a function
of diverse economic activities, higher average wages, increasing returns, positive
externalities and a high degree of cooperation, it can be presumed that public
procurement for innovation positively affects these factors. However, in contrast to
regular procurement in which governments place orders for ready-made or ‘‘off-the-
shelf’’ products, procurement for innovation involves procuring products that might
require additional R&D efforts and, consequently, carry additional risks
generally
defined as the measureable uncertainty (likelihood) for something to happen that
decreases the utility of an activity’s outcome or reduces the achievement of certain
goals (of an organization, a project, etc.; European Commission Expert Group 2010)

for all stakeholders.
It therefore becomes crucial for the public sector to deal with these additional
risks. Yet there seems to be a dilemma. If the government aims to manage risks in
traditional procurement (or even in public
private infrastructure partnerships) by
transferring technology, financial and delivery risks to private providers, then the
emergence of radically or incrementally innovative solutions assumes a somewhat
different logic. Simply transferring all technology- and finance-related risks to
private providers does not suffice to achieve the maximum innovation effect, as in
this case the government may end up buying ‘‘off-the-shelf’’ rather than innovative
solutions. The usual risk management tools in procurement, such as screening for
abnormally low offers, screening suppliers through insurance schemes and different
scoring rules (e.g. closest to the arithmetic average of all submitted offers), may
outplay the most innovative offers (Cabral et al. 2006). Moreover, tight competition
as such may not even be desirable, as it reduces the innovators’ prospective rents and
may therefore reduce the incentives to invest in innovation (ibid.). Sound public
procurement of innovation should consequently involve risk management, ‘‘having in
place a corporate and systematic process for evaluating and addressing the impact of
risks in a cost effective way and having staff with the appropriate skills to identify
and assess the potential for risks to arise’’ (National Audit Office 2000, p. 2),
although this may not necessarily mean that a formal (or more ‘‘traditional’’) risk
management structure is set up (Chapman and Ward 2004).
 Innovation
The European Journal of Social Science Research 243

There is evidence that cities are becoming increasingly involved in procuring

innovative solutions to solve existing as well as emerging social challenges (e.g. Pohl
and Sandberg 2005, Edler et al. 2005, Binks 2006), and increasing their competi-
tiveness (Lember et al. 2011), yet there is a lack of empirical evidence on how the
risks are addressed and managed at the local level. The current study was carried out
to fill these gaps and analyzes the risk management aspects of public procurement for
innovation by mapping the existing practices of risk management at the local level.
The central question of this study is whether cities apply traditional risk management
measures that entail risk minimization via risk transfer only or whether there is any
evidence of sharing technology, financial and other risks between the government
and providers to boost the innovation effect, and whether impacts on innovation are
more likely to emerge if the latter prevails.
We take an exploratory approach to determine the state of practice of risk
management in public procurement for innovation at the local level. To answer our
research question, we analyze five case studies which were selected as representative
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cases of the Nordic
Baltic Sea region in Europe.

The article is organized as follows: in the second section, risks and risk
management are analyzed from a theoretical perspective and the case study method
is introduced. The third section describes and analyzes five cases of public
procurement for innovation from the risk management perspective. The paper
concludes with a discussion, policy implications and future research challenges.

Methods
Risk and risk management
Risk results ‘‘from the direct and indirect adverse consequences of outcomes and
events that were not accounted for or that were ill prepared for, and concerns their
effects on individuals, firms or society at large. It can result from many reasons both
internally induced and occurring externally with their effects felt internally’’ (Kogan
and Tapiero 2007, p. 378). We base our study on European Commission Expert
Group (2010), the most recent and extensive study that aims to understand the
various risks public procurers currently face and to identify existing risk manage-
ment practices when procuring innovative solutions. While extensive literature is
available on risk management in the financial sector and by businesses
bigger
companies in particular
research from the public sector perspective is quite limited,
the European Commission Expert Group (2010) study being a noteworthy exception.
Moreover, the literature dealing specifically with risks in public procurement for
innovation is rather scarce. The strength of the referred study is that the
conceptualization of risk in public procurement is based on the synthesis of a wide
range of academic literature already available, as well as on additional insights from
key stakeholders and the analysis of a set of case studies.
The European Commission Expert Group (2010) has identified five major types
of risk in public procurement for innovation. Technological risks include all risks
that result in non-completion, underperformance or faulty performance of the
procured service or product for reasons attributable to technical operation.
Technological risks may arise because suppliers were not able to achieve the solution
agreed on, chose a wrong or sub-optimal technology (i.e. the product does not work
as expected, does not suit the purpose intended, does not match the required
 244 T. Kalvet and V. Lember

standards, etc.), chose a technology prematurely, failed to take account of

technological compatibilities, failed to develop the solution in-house or to buy
components and knowledge as claimed in the tender process.
Market risks occur when private demand does not respond adequately or as
expected, when public markets remain fragmented or when there is a lack of
companies that deliver innovations. One of the reasons for this may be that the
specification requirements are too stringent.
Organizational risks refer to risks that relate to the procurement’s failure or
under-delivery for reasons based within the procuring organization. Indeed, there are
usually too many goals a public administrator must achieve in modern public
procurement
cost savings, transparency, sectoral policies (e.g. environmental,
energy, industrial, etc.)
which often contradict each other (Cave and Frinking 2007,
Nyiri et al. 2007). This may lead to a misallocation of resources, where agency goals
conflict with wider policy aims. A dilemma exists between the micro cost
effectiveness of a contract and the higher costs of R&D-based product/services
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which boost innovation (Cabral et al. 2006). The process itself
procurement for
innovation
is costly and time-consuming. Procurement for innovation demands a
strong coordination between stakeholders and continuous evaluation and learning.
However, coordination and evaluation always involves transaction costs which have
to be taken into account when implementing the process. Cave and Frinking (2007)
point out that a potential for expensive coordination failure exists. When the payoff
is unclear, the innovative solution may be perceived as the more expensive solution
(Brammer and Walker 2007). Under the current culture of public procurement, cost
savings may ultimately still be perceived as the most important goal. In this regard,
societal risks refer to a lack of acceptance and uptake by the users of the new or
modified service delivered within society.
The financial risks in public procurement are twofold: one is associated with the
uncertainty of meeting target costs, and the other with the ability to secure the funds
needed to begin with.
Finally, turbulence risks are primarily linked to large-scale projects. Risks emerge
from a range of unforeseen events which may cause various actors involved in the
process to reassess their priorities and change their expectations, which, in turn, may
lead to further dysfunctional responses by other actors involved in the process, and
so on and so forth. Such risks may occur within organizations, but are often a result
of the interplay between various actions and actors involved in the entire process
(Figure 1).
According to European Commission Expert Group (2010), risk management
faces three major tasks: first, to define and assess risks and rewards for all partners
involved at the various stages of the procurement process, including the nature of
risks, which may change during the various procurement stages, the causes for and
sources of risk, the likelihood of risks to occur and the potential consequences of risk
occurrence (additional costs, reduced rewards); second, to take action to prevent or
reduce the likelihood of the occurrence of the given risks, and to allocate
responsibility to take action to reduce this possibility; third, to define actions for
the mitigation of the given risks’ potential consequences and to determine who bears
the costs of mitigation and the reduced benefits (see also Ward and Chapman 1991,
Hood and Rothstein 2000, Zhao and Duan 2008).
Various risk management methods exist for managing risks, including awareness
measures, contract design, early supplier involvement, training schemes, etc.
 Innovation
The European Journal of Social Science Research 245
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Figure 1. Risk map in public procurement for innovation. Source: European Commission
Expert Group (2010), p. 39.

(European Commission Expert Group 2010). However, little literature is available on

risk management at the local level. Nyiri et al. (2007) assert that lack of innovation
orientation, budget and skills are the major barriers for local governments to
implement procurement for innovation. The shortage of proper know-how among
procurement professionals about suitable procurement methods to meet wider social
goals seems to be a global phenomenon (e.g. Brammer and Walker 2007). A lack of
awareness and readiness by public authorities to understand markets and technol-
ogies can be considered an additional barrier (Lember et al. 2011).

Method for case studies

To arrive at an answer to our research questions on risk management practices in
procurement for innovation, we tested our hypotheses in the Nordic
Baltic Sea
region, using a selection of cities as our test cases. The region includes both highly
developed cities (Helsinki) and emerging cities (Tallinn); it also comprises relatively
large cities (Stockholm) as well as many smaller cities (Tallinn). At the same time, all
cities belong to a common European legal framework, which makes the comparison
particularly interesting (albeit not all cities had yet implemented the new EU
procurement guidelines).
Building on a thorough literature review, the study uses a three-step approach to
gather empirical data. First, a web-based questionnaire, which was designed to gain
overall knowledge about procurement for innovation in the participating cities, was
forwarded to the selected cities. An equally important objective was to identify key
cases and individuals who were involved in the public procurement for innovation
 246 T. Kalvet and V. Lember

processes. Our aim was to identify two or three representative cases for each city. A
list of procurement- and innovation-related characteristics was submitted to the
contact persons of the participating cities and they were asked to select cases that
matched the characteristics on the list. They made an initial selection of
corresponding cases and provided the names of the persons responsible. Owing to
the focus of our study, namely, the implementation of new or significantly improved
technology, not all initially selected cases were suitable for further analysis, because
the innovation aspect was missing or because regular procurement was being
conducted. In a second step, in-depth structured interviews were carried out with
representatives of the cities, the provider organizations and field experts. The purpose
of the interviews was to acquire specific information about procurement for
innovation cases in the participating cities.1
In a third step, a follow-up questionnaire was sent to the representatives of the
cities, which specifically addressed risk management issues, and additional interviews
were carried out. In total, five suitable cases were identified for our risk management
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study and 21 persons from three cities were interviewed. Empirical information was
also derived from secondary sources, including published and unpublished reports
and documents. With regard to the issues related to risk management, we partly
relied on the questionnaire and interview structure developed by European
Commission Expert Group (2010).

Case studies
Earlier research has shown that public procurement for innovation is not at the top
of the agenda in the Nordic
Baltic Sea region and continues to be implemented
rather modestly by the cities in the region. With reference to the strategic level of
public procurement and innovation, Helsinki and Stockholm have developed a policy
strategy linking procurement and innovation in their region, but they are still far
from using the tool to its fullest extent (Lember et al. 2011). Therefore, to find out
what the current situation in public procurement for innovation and the related risk
management aspects is, a representative case study approach was implemented. The
following sections provide an overview of the current situation of the risk manage-
ment aspects in public procurement for innovation. We begin with the procurement
for more radical innovations.

Ethanol-fueled pickup trucks, Stockholm

Overview of the case study
The first case study covers a recent phase of an ongoing procurement project of
environmentally friendly cars, which began in 1992 (see also Pohl and Sandberg
2005, Birath 2007). Environmental issues are considered a priority in Stockholm, and
the E85 ethanol-based Ford Focus is (largely due to previous public procurement
projects) very popular in Sweden (nine out of 10 are fueled by E85 ethanol). An
infrastructure for such cars exists as well in the form of 1000 filling stations. As no
ethanol-based light-duty vehicles are available, although companies have a consider-
able interest in this technology, the City of Stockholm undertook cooperative
procurement to draw car manufacturers’ attention to this market. This is also to
some extent an example of catalytic procurement, as buying such trucks for the City
 Innovation
The European Journal of Social Science Research 247

of Stockholm was a secondary goal. The primary goal was to create a market for
such vehicles.
Requests to express interest in acquiring ethanol-fueled pickup trucks (vans with
a load capacity of 2
5 and of 6
18 m3) were sent to 5000 legal entities that were using
light-duty vehicles. In total, 41 local governments/municipal companies/county
councils and 186 privately-owned companies (a total of 227 units) expressed interest
in purchasing vans with a load capacity of 2
5 m3. The procurement process was
initiated and specifications drafted in cooperation with the interested buyers. The
Stockholm Environment and Health Administration, City of Stockholm, closely
cooperated with the Procurement Bureau and also assigned an expert for technical
evaluation.
Information on procurement was forwarded to all automobile manufacturers
from the very beginning of the project. A separate letter to manufacturers was sent to
their Swedish head offices in late 2005. Manufacturers were invited to a meeting once
buyer interest had been determined and the specifications finalized.
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As it was impossible for the City of Stockholm to independently carry out the
procurement on behalf of so many other municipalities and companies, the
Stockholm Environmental and Health Administration contacted Kommentus
(currently SKL Kommentus AB), a company that organizes coordinated procure-
ments involving the participation of municipalities, county councils, municipal
companies and other local government agencies.
Two tenders were received. One of the tenders for a van from Volkswagen with a
load capacity of 2
5 m3 was accepted; the other for a van with a load capacity of 6

18 m3 and a 1 tonne flatbed/pickup from Ford was rejected due to the unacceptably
long delivery time. Delivery was not possible until 2010, and procurement for the
larger vehicles was therefore postponed. For the 2
5 m3 van, Volkswagen AG
submitted a bid based on the Volkswagen Caddy. At that time, Volkswagen AG did
not have any ethanol-based vehicles in production. The tender that was accepted was
for one of the three requested classes: a van with a load capacity of 2
5 m3.
Volkswagen was awarded the general contract and began supplying VW Caddy 1.6
BioFlex vans for SEK 132 920 (excluding VAT) in early 2008.
According to the signed framework agreement, the entities were entitled to place
orders for roughly 2500 vans, which would be paid on delivery.

Risk management aspects

This project did not involve any real risks for the City of Stockholm, because the
agreement did not specify that buyers would have to actually buy the vans
the
agreement only included a reference that at least 2000 potential customers existed.
The only direct cost the city had was pooling the demand and carrying out the
procurement process. However, the City of Stockholm had to bear the risk that the
attempt to create the market for ethanol-fueled trucks would fail, either because of
technology failure and non-delivery or because of the low interest of potential
buyers. To cope with these potential risks, the City of Stockholm hired SKL
Kommentus AB, which was made responsible for carrying out the procurement
process, including technology specifications and the development of risk scenarios. A
performance-based consultancy contract was signed, with the consulting company
not being guaranteed any pay. The consultants only received a special fee consisting
of a percentage of the purchase price of all vehicles sold during the contract period.
 248 T. Kalvet and V. Lember

If no bids came in, no vehicles would be sold and the consulting company would not
be paid. Similarly, if there was a delay and no car was actually delivered, the
consulting company would not receive any remuneration.
The representatives of the City claimed that this is common practice in Sweden
and did not consider this particular case to be any different from ‘‘regular’’ public
procurement procedures. A special, central governmental environmental investment
fund was used to initiate the project. In this particular case, the initiators heavily
relied on different technology standards in order to specify the expected results, yet
at the same time gave the providers the opportunity to come up with novel solutions.
As no direct contractual relationship existed between the end-users and the provider
prior to the delivery of the product, no insurance schemes were established.
In sum, the risks were managed well by a thorough feasibility study, the pooling
of demand, etc. However, trust risk was not considered ex ante: if delivery had failed,
it would have influenced the image of the city government.
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Journey Planner for public transportation, Helsinki

Overview of the case study
Journey Planner offers commuters information on the best door-to-door public
transport connection within the Helsinki Metropolitan Area. The fastest route can
be found by entering the departure and arrival addresses into a Web browser. Besides
timetables, commuters also have access to information on means of transportation,
travel instructions and a route map. The service covers buses, trams, metros,
commuter trains and ferry routes. Journey Planner’s search features can be tailored,
for example, by entering one’s own walking speed or favorite means of transporta-
tion. The Finnish version of Journey Planner also includes Helsinki City Transport’s
‘Own Departures’ service, which offers on-demand online timetables regularly used
by commuters. ‘Own Departures’ timetables are available for bus and tram stops,
commuter train and metro stations, as well as for ferry harbors. Commuters can sign
in to the service and edit their preferences using a browser or a mobile phone.
The procurement was initiated in 2000 after the first attempt had failed four years
earlier. No similar product was available on the national or global market at the time.
The specifications were based on to some extent similar services available in other
countries, combining those services’ best features. All bidders were able to provide a
functional journey planner software product which required considerable improve-
ments to meet the client’s needs.
The procurement was carried out by the Helsinki Metropolitan Area Council
(YTV), and the service was delivered by Diptec.com OY (currently part of Logica).
The development of the product began in the start-up company, and Journey Planner
was a critical project for the company’s success
a credible reference. The company
has now become part of larger companies (sold six times), and a new product line
based on the original product has also been developed.
A three-stage competition was organized. In total, 10 bids were initially received,
six of which were selected for the first qualification round, and three which were
chosen to demonstrate implementation of the software. The unique aspect in this
particular procurement process for innovation was that it involved three bidders who
were asked to demonstrate their product using real data prior to the final bid
selection. The price of the product was EUR 160,000.
 Innovation
The European Journal of Social Science Research 249

The main criterion for selection was the fulfilment of the functional requirements.
These included maintenance and data structure. Five main groups of criteria were
elaborated: user and usability; output of the plans; managing and configuration
(with regard to maintenance); actual trip planning and algorithm (i.e. quality of
results); ability to configure the trip planning; and data update process (the company
would be responsible for regularly updating the product database).
The duration of the procurement process was 10 months. It was initiated in
August 2000 and finalized in April 2001. The original contract was for five years. The
Metropolitan Council extended the service with a newly negotiated contract.
The service has become extremely popular: the average number of daily hits
Journey Planner receives is 90,000; on the busiest days, there are 100,000 hits (2008).
Calculations of time saved on account of more effective itineraries and personal trip
planning, as well as an increase in the use of public transportation, resulted in savings
of EUR 5 million in 2002 (Laine et al. 2003). The system has been used for several
other transport systems in Finland, including National Journey Planner, Tampere,
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Oulu. The product has been sold to several cities in the United States and other
countries around the world.

Risk management aspects

When the project was initiated, the City of Helsinki identified four risks which had to
be addressed during the procurement process. These were potential procurement cost
overrun, high costs for system maintenance, non-delivery and technology failure. The
risk management tools applied in this case involved simultaneous (pre-selection)
testing of three prototypes with real data; promoting competition by translating the
tender documents and pro-actively searching for possible contractors; and including
the calculation for future maintenance and operating costs as part of the tender
evaluation. This particular case can be described as having posed medium-level risks
for the public sector, considering that the City of Helsinki was involved in the
development of the pre-commercial product. By assuming responsibility for the
funding of the field testing of the three final prototypes, the city took on some of the
risks providers usually have to cope with and which are covered by financial penalties
in purchase contracts.
Another risk was the possible lack of public acceptance if the service were to
include personal travel data linked to a specific individual; however, the system was
introduced as an anonymous service and this problem was thus eliminated.
Public officials clearly considered this particular procurement case as having been
different from ‘‘regular’’ public procurement. This was not only because complex
multi-sourcing (having several active suppliers in parallel) and multi-stage sourcing
(having two or more qualification rounds) tendering procedures were used, but
mainly because prototype testing was implemented. The representative of the City of
Helsinki admitted that this procurement case was unique, because ‘‘multi-stage
selection and pre-selection test implementation, especially by several suppliers, were
used for the first time and have rarely been used since’’.
No technology standards were used which would have helped mitigate the
problems stemming from detailed technology specifications. According to the
officials, they searched for standards, but found none that were applicable. At
the same time, the City of Helsinki tried to diminish the perceived risks by
introducing insurance schemes. The companies competing for the contract had to
 250 T. Kalvet and V. Lember

pass the company viability qualification by means of financial documents and had to
offer financial guarantees for the delivery and warranty period. Further, the source
code for the technology was held in escrow in case of failure to meet the contractual
obligations.
Although the Metropolitan Area Council as a single authority carried the risks,
the services of a consulting company were used throughout the entire process (from
the market study to the acceptance of the service). The company was also responsible
for drafting the technical specifications.
In sum, the risk management tools applied here included a thorough feasibility
study, the promotion of competition, field testing of the three final prototypes,
detailed calculations on future maintenance and operating costs and linking
payments to performance quality. The case is a good example of proper risk
management and successful procurement of innovation.
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The Environmental City District Hammarby Sjöstad, Stockholm

Overview of the case study
The Environmental City District Hammarby Sjöstad was initiated by the City of
Stockholm in 1998. The objective is to rebuild an old industrial area of the city using
a unique method for integrated and sustainable planning of infrastructure, as well as
for the implementation of innovative technology for energy, water and waste
management. As of 2009, more than 30 catalytic public procurements for innovation
have been carried out, involving both incremental and radical innovations.
The plan includes the building of 15,000 apartments and 10,000 offices. The
planned completion date of the project is 2012. The budget for the national
government subsidy program in Stockholm (Stockholm local investment program,
LIP, managed by the City of Stockholm) amounts to SEK 634 million, with SEK 60
million allotted for public procurement for innovation.
Similar projects have been carried out before. During annual exhibitions for
building companies, city exhibition areas have similarly been rebuilt. A couple of
years before this project was launched, the City of Stockholm included environ-
mental goals in the rebuilding of a small district. However, the Hammarby Sjöstad
project is the largest and most diversified building program (buildings, infrastructure,
and technical support) that has ever been carried out in Sweden, in terms of both
scale and ambition
a holistic ideology.
One example of the procurement for innovation is the procurement for a
technology for individual metering. The aim was to develop a new technology for
cost allocation of energy and water consumption in family homes. The idea was to
create a system which monitors the energy consumed and indicates the distribution
of costs for each apartment accordingly. The project was carried out from 1999 to
2000, during a period when this type of technology was not available on the Swedish
market. The buyers’ group consisted of 10 different housing companies. With the
help of external experts, the group determined the technical requirements. The
company selected to provide the technology installed meters in 500 apartments.
Intellectual property rights were left to the supplier. However, the firms that created
the product were unable to increase the market and consequently did not receive
sufficient orders from other parts of the country or worldwide.
 Innovation
The European Journal of Social Science Research 251

Another example of cooperative procurement is the case of procurement for

energy-efficient windows. The requirements demanded that these windows have a
higher efficiency value or to be improved windows, e.g. in terms of weight or
esthetics. Bids were received from three or four window-producing companies.
Energy-efficient windows were already being produced in Sweden, but at 30
40%
over the desired price. The buyers’ group included all the large construction and
housing companies in Hammarby Sjöstad, creating a fairly substantial production
volume. The group acquired the new windows at the same price as conventional ones,
resulting in a substantial price reduction. No technical improvements, but improve-
ments in the production process (more efficient, rational) were made (process
innovation).
Hammarby Sjöstad is visited by more than 10,000 decision-makers and experts in
the field every year, making it one of Stockholm’s most important attractions. It has
become one of the world’s highest profile examples of sustainable city development,
mentioned in expert publications worldwide. It is the Winner of the World Clean
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Energy Award in the Construction Category of 2007. With regard to the

procurement success, the results are mixed: some of the most innovative procure-
ments (fuel cells, common Internet) failed; others (e.g. individual metering) were only
partly successful; technology procurements with incremental improvements (e.g.
energy-efficient windows) were the most successful, leading to a market increase and
lower environmental impact, both at the local and national levels.

Risk management aspects

As this project was launched to upgrade the technology used in the buildings, the
main risks identified by the city were those associated with technology failure and
non-delivery as well as the risk of disinterested stakeholders. Depending on the
particular procurement, non-delivery and technology failure had different emphases.
Sometimes the failure resulted from stringent requirements (e.g. a very high risk in
the procurement of fuel cells that ended with the delivery of a non-functional
product). In some cases, sub-optimal technologies were chosen (e.g. construction of a
local area network with some specific services was procured, but the Internet and
services already available turned out to be superior). Disinterested providers were not
considered a risk ex ante. However, there were cases when there were no bids. For
example, although proposals for a more environmentally friendly asphalt and
asphalt-laying process were called for (product and process innovation), no offers
from any companies were submitted. Half a year later, the existence of an asphalt
cartel in Sweden was uncovered.
Considerable institutional risks were revealed. The first was lack of integration:
the procurement of technologically innovative products was not integrated in the
overall planning process, making implementation of some of the solutions difficult or
in some cases impossible (e.g. solar panels). Legislative risks were also identified: the
Act on Public Procurement did not facilitate the process; instead, the opposite was
the case
particularly for cooperative procurement. As the law was not very clear on
this issue, a discussion ensued about whether or not this form of cooperation was
acceptable. Although not clear at the start of the project, one positive aspect of the
Act is the ability to include environmental impact as a selection criterion. Through
the project legislation, interpretation of the regulation of the field became clearer. In
addition, strong political backing was helpful in dealing with all uncertainties and
 252 T. Kalvet and V. Lember

question marks. Political risks were not really considered, although political changes
are a very real possibility in large-scale projects with a long duration, a risk that
materialized in the current project. During the initiation of the project, the Social
Democrats were in power and supported the project and guaranteed funding. During
the implementation of the project, the right-wing party came to power in the City of
Stockholm, and there were some discussions about canceling the project.
Several solutions were used by the city to address the aforementioned risks.
Feasibility studies were conducted
due to the unique nature of the project, the
procurement process differed from day-to-day procurement practices. Compared
with ‘‘regular’’ procurement, emphasis was put on a thorough study of the market
and technology prerequisites. Various technology standards were used where
applicable. An extensive mix of different public procurement procedures was
included (from extended negotiation procedures with successive stages of discussion
and multiple feedback loops to multi-sourcing tendering; i.e. using several active
suppliers simultaneously). In many cases, market dialogue to select the most suitable
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technology and procurement process was initiated. A special public investment fund
was established and covered 100% of the public procurement for innovation costs.
On several occasions, prototype testing was implemented before making the final
purchase. Consultants were hired who were responsible for risk analyses (develop-
ment of risk scenarios) and elaboration of technology specifications. Some
procurements required interdisciplinary teams. The complex projects were divided
into separate components, which enabled the buyers to diminish the risks. In many
cases, the procurement of radically new and risky technologies was avoided to reduce
the risks related to non-delivery and technology failure.
In sum, risk management in this case included explicit ex ante risk management
for numerous operational risks (mostly technology failure and non-delivery), but
also institutional and market risks. Spreading risk to include most of the relevant
parties was the main management principle. The methods applied included feasibility
studies, the use of technology standards, a mix of different public procurement
procedures (from extended negotiation procedures with successive stages of
discussion and multiple feedback loops to multi-source tendering that involved
several active suppliers simultaneously), prototype testing, hiring of consultants and
division of complex procurements into separate components.

Mobile ticketing for public transport, Helsinki

Overview of the case study
The mobile ticketing service works on all mobile phones that can send and receive SMS
(Short Message Service). All major mobile network operators in Finland have
provided access to the SMS ticket service. The service uses standard SMS text
messages and a unique validation method to provide mobile tickets. The ticket arrives
in real time displaying the valid time and area, identification number and consigner
number. The price of the ticket is automatically charged to the customer’s phone.
The service was procured by HKL Enterprise, a unit of Helsinki City Transport,
and the technology was developed by Plusdial Ltd in cooperation with Add2Phone
Ltd. A joint development project was launched in 2001, and the first mobile tickets
were sold and tested on Helsinki City Transport’s trams, metros and ferries on the
International Car Free Day in August 2001. It was the first mobile ticketing service
 Innovation
The European Journal of Social Science Research 253

worldwide for public transportation accessible to the general public. The actual
mobile ticketing pilot was implemented in trams and metros in 2002. The production
contract was signed with Plusdial Ltd and Helsinki City Transport in 2003.
Currently, mobile ticket sales are an isolated service given that it is only available
within the Helsinki city area. The share of mobile tickets for trams exceeds 55% of all
single tickets sold (2006). By October 2006, 9 million mobile tickets for Helsinki
City’s public transport had been delivered to passengers’ mobile phones. The annual
sales continue to grow steadily, and passengers have frequently expressed the wish for
the service to be expanded to the wider Helsinki Metropolitan area.
Plusdial Ltd has already introduced its mobile ticketing service in Germany, Italy, the
UK and Sweden. The mobile ticketing service has also raised much international interest,
and similar services by other companies are widely being applied in several countries not
only for transportation, but also for other commercial (mobile commerce) purposes.
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Risk management aspects

The main risks of this particular procurement case identified by the city were
technology failure and non-delivery of the product. The main risk management tools
implemented by the city included detailed specifications of technology requirements
and strict financial sanctions, which were introduced in the contract. The tender
process was considered different from regular procurements as extended negotiation
procedures were implemented with successive stages of discussion and multiple
feedback loops. In this case, no insurance schemes were used; however, technology
standards were determined and performance agreements introduced.

ID ticket for the public transportation system, Tallinn

Overview of the case study
The ID ticket is an electronic ticket for the public transport system (bus
tram

trolley), which is sold to users via the electronic payment collection system and which
the user verifies with his or her personal identification document (national ID card).
Thus, it suffices to carry an ID card when using public transportation to be presented
to the controller, who has a special machine to check the ticket’s validity. ID tickets
can be purchased via Internet banking, a mobile phone or from sales points.
Estonia began issuing national ID cards in January 2002. Without the existence
of this infrastructure, several innovative public services in Estonia (for example,
e-voting2) would not be possible. In addition to being a physical identification
document, the card has advanced electronic functions facilitating secure authentica-
tion and a legally binding digital signature for public and private online services. An
electronic processor chip (a ‘‘smart card reader’’ is needed for operation) contains a
personal data file as well as a certificate for authentication. Certification Center Ltd
is the key organization behind this project and was established as a 100% privately
owned company in 2001. As of 2007, it is the only certification authority providing
certificates for authentication and a digital signature on Estonian ID cards.
The Tallinn City Government established a working group in September 2002
which included representatives from the Tallinn Transport Department as well as
Registrikeskus (Citizen Registration Center) and was seeking ways to increase the
number of people officially registered as residents of Tallinn. Discounted public
 254 T. Kalvet and V. Lember

transport tickets were considered one possibility. Furthermore, alternatives to the ID

card were considered (e.g. a separate magnetic card to be used only in Tallinn). The
procurement process generated bids from six applicants; one was a joint tender by
AS Certification Center, AS EMT (mobile telephone operator) and AS Eesti
Ühispank (bank), which was ultimately selected. The service was successfully
introduced in 2004.
No fixed price was agreed. The price was to be based on the turnover of tickets
sold, with 4.49% of returns to the benefit of the procuring company. As a result, the
company was motivated to ensure that the application worked as efficiently as
possible.3 The ID ticket was not to replace the old channels of distribution, but to
create additional ones. It turned out to be a very efficient service, especially from the
perspective of controlling the usage of tickets: (1) the ticket is personalized, so it is
not possible to ‘‘share tickets’’ or use other methods to avoid purchase, as was the
case with paper-based tickets; and (2) enforcement mechanisms to control the
validity of tickets in public transport have been streamlined. The ID ticket was one of
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the services that generated interest in obtaining a national ID card. Today, a similar
service has also been introduced in Tartu, Estonia. The intellectual property remains
with the Certification Center.

Risk management aspects

Initially, the financial risks in terms of R&D and production costs were left entirely
to the provider. However, by guaranteeing the provider a minimum level of returns
annually, the city assumed some of the financial risks in terms of future returns. The
technological risk was considered low by the representatives of the city, as the
technologies to be developed relied on already existing and functioning electronic ID
card-based infrastructure. The provider had already run field tests of the prototype,
which implied that they already had an operational reference for the city. Hence, the
main concern was whether the provider would succeed in integrating the existing
prototype in the local context (technology failure) and how the new service would be
welcomed by the users (societal risk). The city organized this tender as it does any
other procurement process, and no specific measures were undertaken to address the
risks through a tendering process. The tender documents did not explicitly refer to
any specific technology standards, but because the entire system was to be based on
the electronic ID card infrastructure, existing standards were indirectly referred to.
The city also requested potential providers to submit financial guarantees against
non-delivery. However, no performance guarantees were specified. This was
addressed in the contract. The contract provided for little upfront investment by
the city with the assurance of participation in the profits of the project after
implementation. Although not strictly speaking a performance-based contract, it
certainly contained elements of such a contract.

Discussion
Table 1 summarizes the results of the case studies. Based on these results, we can
make the following observations.
First, cities can successfully implement the procurement-for-innovation instru-
ment. Risk management is an important tool to ensure the success of this type of
procurement. It seems that the cities were, for the most part, actively involved in risk
 Table 1. Risk management in Nordic-Baltic Sea cities.

Stockholm Helsinki Stockholm Helsinki Tallinn

Procured Ethanol-fuelled Journey planner The Environmental City Mobile ticketing for Electronic ID-tickets for
innovative lorries District Hammarby Sjöstad public transport public transportation
solution
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Innovation
The European Journal of Social Science Research 255

Goal of the Market creation (for New service (more Development of an Service innovation (easier Service innovation (to
procurement cleaner environment) efficient and effective environmentally friendly and more comfortable simplify collection of
public transport) city district (integrated and access to the service payments, attract people
sustainable planning of resulting in an increased to register as local
infrastructure as well as for usage of public transport residents)
the implementation of rather than individual
innovative technology for cars)
energy, water and waste
management)
Nature of Radical Radical Mixed Radical Adaptive
innovation
(in terms of
local market)
Level of risk for Low Medium Low/medium Low Low
procurer
Risks identified Market failure; non- Procurement costs Technology failure; good Non-delivery; technology Non-delivery; technology
by cities delivery; technology overrun; raised costs of will of stakeholders failure failure; non-adoption by
failure system maintenance, non- users; unknown running
delivery; technology costs
failure
 256 T. Kalvet and V. Lember
Table 1 (Continued )

Stockholm Helsinki Stockholm Helsinki Tallinn

Risk Performance contract Simultaneous (pre- Special public investment Detailed specifications; Financial sanctions;
management with consultants; selection) testing of three funds used for covering 30% financial sanctions in performance payments
tools applied special public funds prototypes with real data; product costs; prototype contract combined with guaranteed
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by the cities used for procurement promoting competition testing; consultants minimum payments for
preparations; risk- (translated documents, responsible for risk-analyses the provider; R&D and
scenarios pre-active contacts); (risk-scenarios) and maintenance costs carried
projected maintenance technological specifications; by the provider
and running costs division of a complex
included in tender project into separate
evaluation; multi- components
sourcing and multi-stage
sourcing
Deviation from No Yes
extensive use of mix
Yes
as prototype testing Yes
extended No
regular was included of procedures (extended negotiation procedures
tendering negotiation procedures with with successive stages of
procedures successive stages of discussion and multiple
discussion and multiple feedback loops
feedback loops; multi-
sourcing (having several
suppliers active in parallel).
Through study of market
and technology
prerequisites
Technology Yes No (although looked for) Yes (when possible) No Yes
standards
referred to
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Innovation
The European Journal of Social Science Research 257

Table 1 (Continued )

Stockholm Helsinki Stockholm Helsinki Tallinn

Insurance No Yes
company viability No No Yes
financial guarantees
schemes qualification by financial for delivery period
documents; financial
guarantees for delivery
and warranty period;
source code held in
escrow in case of failure
to fulfill contractual
obligations
Performance Yes (with consultants) No No No Yes
agreements
In-depth Yes Yes Yes Yes No
market study
 258 T. Kalvet and V. Lember

identification. Although one can argue whether the long-term risks in the form of
technology decay and maintenance of technological innovations were considered, the
cities were evidently prepared to meet the challenges underlying these more complex
procurements.
It follows from the case studies that, in spite of some negative experiences in the
past, the cities implemented public procurements for innovation and placed more
emphasis on explicit risk management. For instance, Stockholm’s procurement of
alternative fueled vehicles and Tallinn’s electronic ID-based ticket system did not
actually produce the expected results after initial attempts, but the experience gained
from these trials was used to achieve successful results in later attempts. The City of
Helsinki
in the Journey Planner procurement case
reduced some of the bidders’
financial risks by awarding the three finalists monetary prizes. Again, it is interesting
that the City of Helsinki implemented prototype testing because previous attempts to
buy this technology had failed. As the representative of the city of Helsinki
acknowledged: ‘‘The previous negative experience demonstrated the need to carry
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out a market study first and then an implementation of demo versions in the final
stage’’. Nonetheless, as stated by the representatives of the City of Helsinki and as
the other cases demonstrate, the cities rarely use public procurement for pre-
commercial solutions, which includes higher risks for public procurers, but is more
rewarding in terms of innovation impact.
Second, the cities identified significant risks for most of the projects presented
here. Technological risks were more dominant than other risks, including financial
risks. With regard to technological innovation, technology failure is a major concern.
One explanation is that these projects were considered so important for the effective
delivery of government services that the cities were willing to bear some of the cost-
related risk but less so the technological risk. To manage technological risks,
information gathering was carried out in the early stages of the procurement process
and the involvement of all possible stakeholders from the beginning turned out to be
fruitful. Studies emphasize that prototype testing ought to play an important part in
public procurement for innovation (European Commission Working Group, 2006, p.
92). There are already signs that cities are using this tool to effectively cope with
technology failure and non-delivery. The City of Helsinki implemented simultaneous
prototype testing using real data before making its final purchasing decision on a
Web-based journey planner.
Third, contract design was considered one of the major means to manage
technological risk, since different contractual modes offer different incentives for the
contractor to deliver quality and to not run up excessive costs. The cities’ approach
to contracting in this regard differs significantly from other types of contracting. To
reiterate, cities seem to understand the fundamentally different nature of this type of
contracting and thus apply different rules and procedures. With regard to the types
of contract mechanisms for risk management, performance contracts seem to be
preferred in about the same number of instances as insurance/bonding. Some very
unique solutions were introduced in this area, such as Helsinki’s escrowing of the
source code and Tallinn’s contract structure with small upfront payments and profit
participation.
It seems that the challenge of this type of innovation contracting, at least in the
cities studied here, is being met with new solutions for contracting (or implicit)
strategies rather than with comprehensive risk management strategies explicitly
aiming to reduce technology or innovation-related risks for providers.
 Innovation
The European Journal of Social Science Research 259

Fourth, local authorities do not act like risk-takers when promoting innovation
through public procurement. With the exception of Stockholm, the case cities do not
implement a policy to influence economic growth through public procurement
the
cities are not ready to take further steps to reduce the risks of providers associated
with investments in R&D, production or field testing. Risk management largely
consists of shifting risks to the suppliers (evident in most cases) or to other funding
bodies (e.g. the use of public investment funds in the case of the Environmental City
District Hammarby Sjöstad). As the cities do not engage in high-risk procurement, it
is too early to say whether the new contracting strategies applied thus far are
sufficient to meet the risks related to public procurement for innovation.
It is also still too early to determine whether all the risks described in the second
part of the paper have actually been effectively deal with or not. It can be argued
that, in the short-term, all cases have proven successful in terms of innovation
generation and have produced many positive spillovers (see also Lember et al. 2011).
However, as all cases are fairly recent, the long-term innovation impact in terms of
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adaptation and diffusion is to some extent still unclear. This, in turn, demonstrates
the significance of the political risks involved in public procurement for innovation.
It may not be politically rewarding to launch a (technologically) risky project, whose
benefits are not immediately clear (Stiglitz and Wallsten 1999). The presence of
political risk may explain why the Nordic
Baltic Sea cities only rarely engage in
public procurement that supports innovation. In general, there is a lack of awareness
among city officials about the links between procurement and innovation (see
Lember et al. 2011 for further discussion on this issue), including risk management.
In several cases, the capacities of the cities to administer such complex procurements
were limited and they did not have explicit risk management strategies in place to
deal with innovation-related issues. Thus, external consultants were used in several
cases, which proved highly practical.

Conclusion
Public procurement for innovation is potentially a powerful innovation policy tool
that can contribute to urban, regional and national competitiveness and economic
development. It is also a policy tool that the scientific communities as well as many
governments are currently rediscovering. Compared with traditional public procure-
ment of ready-made goods and services, public procurement of innovative products
entails more risks which need to be identified and effectively managed. To date, little
is known on whether and how cities
economic players with growing significance

address the question of risks in public procurement for innovation.
The current study focuses on the Nordic
Baltic Sea region and reveals that the
cities of the region are in general capable of procuring innovative products and that
they are for the most part actively engaged in risk management. The study
demonstrates that the public sector has to be able to deal with different kinds of
process risks (from technology to turbulence risks). At the same time, as the cities
rarely engage in high-risk procurement of radical innovation, there are no signs that
these risks are addressed through comprehensive risk management strategies
explicitly aiming at reducing providers’ technology or innovation-related risks.
Instead, we discerned that more implicit strategies were used, namely new
approaches in contracting strategies. However, if the cities’ aim is to fully exploit
the potential of public procurement for innovation
implying involvement in high-
 260 T. Kalvet and V. Lember

risk projects and assuming a greater share of the technology and innovation-related
risks
the use of more comprehensive risk management tools will become
unavoidable.
Nonetheless, the empirical evidence points to the fact that the cities are capable of
identifying and managing process risks when procuring innovative solutions. The
cases demonstrate that, in order to successfully implement public procurement for
innovation, the public sector has to be capable of dealing with all possible process
risks. This is illustrated by the identification and management of:

“ technology risks (e.g. prototype testing in the case of Helsinki’s Journey

Planner);
“ market risks (e.g. demand aggregation in the case of Stockholm’s ethanol-
fueled trucks);
“ financial risks (e.g. securing funds with the help of national grants in the case
of the regeneration of Stockholm’s environmental city district or the use of
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profit-sharing schemes in the case of Tallinn’s ID tickets);

“ organizational risks (e.g. employing consultants in various cases);
“ societal risks (e.g. pooling of potential users in the case of Stockholm’s
ethanol-fueled trucks);
“ turbulence risks (e.g. developing risk scenarios and spreading risks among
stakeholders in the Stockholm cases).

The case studies presented a variety of possible solutions available to cities when
seeking practical solutions in public procurement for innovation risk management.
These solutions can also be utilized by other cities; however, we must bear in mind
that all of the cases reviewed represent success stories to some extent, which means
that more information on the critical factors related to failures is required.
Further studies are needed to document how the public sector meets the risks
related to public procurement for promoting innovation. Also, further research is
needed to build coherent theoretical models that address this issue.

Acknowledgements
Information on the case studies was collected while the authors were working on a research
report on public procurement for innovation in Baltic Metropolises for BaltMet Inno; we are
grateful to all interviewees and Kenneth A. Kriz for his contribution to an earlier version of
this article. We are also indebted to the anonymous referees for their valuable comments. The
usual disclaimer applies.
Involvement in the work of the European Commission Expert Group on Risk Manage-
ment in Public Technology Procurement greatly enhanced our understanding of risk
management and enabled us to further work on the case studies. Research for this study
was partially supported by the Estonian Science Foundation (grants ETF8423, ETF7441 and
ETF8418).

Notes
1. For results on the first and second steps, see Lember et al. (2011), where the question of
innovation impact resulting from public procurement is also analyzed.
2. E-voting as remote Internet-based voting in nationwide elections
which involves
technological, institutional (legal and political) and societal risks
demands complicated
risk management and can, as such, be considered one of the most, if not the most,
 Innovation
The European Journal of Social Science Research 261

ambitious field of ICT application. For more information on Estonia’s e-voting success
story and the argument that it is linked to the country’s explicit and effective risk
management and that all expected risks were addressed by enhancing the capacities of the
procurer, by carrying out in-depth risk analyses, and endeavoring to generate trust through
consistent dialogue and openness, see Kalvet (2009).
3. In case of a turnover below EUR 3.5 million (in sum, EUR 9.6 million for the entire
period), the Tallinn City Government would have been obliged to compensate
to some
extent
returns not achieved and based on the previously agreed percentage. If returns, for
example, had been 0, the Tallinn City Government would have been obliged to pay
approximately EUR 0.4 million over three years, which equalled 4.49% of the planned
returns.

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