Innovation Procurement Auctions and Administration Costs

Abstract: We analyze the innovation problem currently facing a particular sector of the pharmaceutical industry and propose the use of procurement auctions to encourage innovation. We investigate the impact of operating costs on procurement auctions for innovation that potentially use both prizes, in the form of direct monetary transfers, and contracts as incentives. We find that, when faced with per-agent costs to conduct the procurement auction, extending the mechanism to two periods by performing an initial entry auction can result in higher welfare if agents have prior knowledge of their capabilities. Furthermore, we find that only the principal and innovator are likely to benefit from the entry auction, whereas the manufacturers will be worse off.