Procurement Contracts — Atlas of Innovation

Definition

A procurement contract for innovation commits a buyer to purchase goods or services from a specific firm, provided they meet technical or functional requirements. These contracts are made directly with selected suppliers, including for-profit and non-profit organizations, and set clear conditions for payment in exchange for delivering of defined outputs.

While commonly used for routine purchases, they can also be used for innovative goods and services.

Why might procurement contracts be the right funding approach?

Procurement contracts work best when policymakers can clearly define the needed product or service and can identify the characteristics of a qualified team. The flexibility of procurement options makes procurement contracts applicable across a wide array of innovation challenges, from early-stage development to large-scale product delivery.

Procurement contracts work best for innovations with the following characteristics:

Government as a major end user or purchaser: Procurement contracts are appropriate when the government itself is a natural buyer of the product or service — either because it will be used directly by government agencies, or because the innovation has broader societal benefits that justify public provision.
Clear technical requirements: Contracting requires the funder to clearly define the functional or performance criteria for the desired product or service, but the technical approach to meeting those requirements can remain flexible.
Identifiable teams: To award contracts effectively, the funder needs to confidently identify or competitively select the team best placed to deliver the innovation. This works best in fields where prior work, expertise, or submitted proposals provide strong signals of a team’s competence.

When used well, procurement contracts offer key advantages, including:

Shaping participation: Procurement contracting allows funders to directly negotiate with teams and decide who participates in developing a solution, rather than relying on companies to decide independently. This flexibility helps avoid duplicative efforts when research outcomes are highly correlated (that is, if one company fails, it is likely others will too, so funding multiple parallel efforts is duplicative and inefficient). Alternatively, when broad participation is desirable, awarding multiple contracts can bring in researchers that might not compete due to the inherent risk of losing as in approaches like prizes or advance market commitments.
Paying on delivery: Like other outcome-based tools, procurement contracts link payment to successful delivery. This ensures funds are spent only on innovations that meet the required specifications and helps keep companies accountable and motivated to follow through. In practice, governments are more familiar with procurement contracts, relative to other outcome-based approaches like advance market commitments. This familiarity can make them more straightforward to deploy.
Addressing market buyer power: Procurement contracting is especially useful for stimulating innovations in markets with a dominant buyer. Large buyers can exploit their market power after suppliers have incurred investment costs, knowing companies would prefer selling at a loss rather than earning nothing. The primary buyer, such as a government, might later try to reduce prices to a level that is so low that it discourages companies from investing in initial development — often called the hold-up problem. By committing to a price in advance, a procurement contract gives companies the confidence to invest in critical innovations.

Choosing the right contract structure

Procurement contracts can be structured in different ways that enable funders to more effectively achieve their specific goals. When choosing how to structure contracts, funders must weigh the tradeoffs between risk tolerance, speed, flexibility, and cost. Key types of contracting used to purchase innovative goods or services include:

Fixed-price contracts

Fixed-price contracts set a predetermined payment for delivering a product or service that meets agreed-upon specifications. These contracts offer budget certainty to the funder and shift the risk of cost overruns onto companies. Fixed-price contracts put companies on the hook and push toward efficiency: companies gain from cutting costs and lose if costs rise. The funder and innovating company must be able to agree on target specifications and price in advance, but the technology does not need to be mature.

Cost-plus contracts

Cost-plus contracts reimburse suppliers for their expenditures plus a negotiated profit margin. The funder absorbs the risk of cost overruns, making participation in high-uncertainty innovation projects more attractive to contractors. They are best suited for projects where funders are willing to pay for faster development or flexibility to address unforeseen technical problems, and where complexity makes costs hard to estimate upfront. They require effective oversight, including accurate cost audits, to prevent inefficiency. Safeguards like spending caps and shared cost-savings measures can curb excessive costs. Cost-plus contracts are better when speed matters, while fixed-price contracts win out when controlling total costs matters more.

Indefinite delivery/indefinite quantity (IDIQ) contracts

IDIQ contracts establish baseline terms for future purchases, such as price and the minimum or maximum quantity that will be purchased, but leave the exact quantity and timing of orders flexible. A guaranteed minimum functions as a type of volume guarantee and gives suppliers revenue certainty to invest in innovation and capacity. These contracts are especially useful when demand is unpredictable but readiness is essential, such as for public health emergency supplies or cybersecurity systems. IDIQs can also be structured as multiple-award contracts, where several companies receive base agreements that prequalify them under common terms. Companies later compete for specific orders, combining flexibility with ongoing competitive pressure.

Other Federal Acquisition Regulation (FAR) mechanisms, such as time-and-materials contracts, labor-hour contracts, and blanket purchase agreements (BPAs), are less commonly used for innovation procurement, but can offer flexibility in specific contexts such as services or emergency needs.

Contracting experts use many labels to describe procurement processes, often highlighting specific goals of the contract. While not a comprehensive list, several terms are especially relevant for using procurement contracts for innovation. Advance purchasing agreements (APAs) are contracts made before a product exists in order to stimulate its development. Volume guarantees commit a funder to compensate a supplier if sales fall below a specified baseline. In return, suppliers commit to a specified price and production level. This reduces supplier risk and encourages investment into scaling up production. Stockpiling involves acquiring and holding a surplus supply to ensure future availability for the purchaser. These tools often intersect with the contracting types described above. For example, stockpiling could be structured through cost-plus contracts.

What can go wrong?

Funders should be aware of the following challenges:

Fixed-price constraints: Restrictive budgets may discourage participation by companies or sacrifice innovation quality. To avoid this, funders should assess market readiness and consider offering bonus payments for early delivery or exceptional performance. Over repeated interactions, these concerns are somewhat mitigated by the negative effect low quality has on reputation. Fixed-price contracts are difficult to use when costs of development are poorly understood.
Cost-plus overruns: Cost-plus contracts provide weak incentives to avoid cost overruns. This problem is exacerbated by “gold plating” — excessive spending or unnecessary features added to inflate project budgets. Regular audits and incentives for efficiency (e.g., fixed-plus-incentive structures) mitigate these risks.
IDIQ supply gaps: Maintaining strategic readiness is difficult if suppliers downscale during dormant contract years. To address this, funders should design regular performance checks and/or attach payments to capacity maintenance milestones.

Competitive selection processes

Funders must decide how to choose the supplier for a procurement contract. How funders select suppliers shapes whether contracts reward capability, cost discipline, or novel ideas. Some common selection processes include:

Requests for Proposals (RFPs): A formal solicitation where the funder issues a detailed scope of work and bidders respond with written technical and cost proposals. RFPs provide a structured way to compare bidders across multiple criteria, such as technical merit, past performance, and cost.

Auctions: A rule-based competition where eligible bidders that meet minimum requirements submit price offers under rules set in advance (e.g., reverse auctions, multi-round bidding), and the lowest qualifying bid wins. Auctions can ensure cost transparency and sharp price competition when the contract involves standardized outputs with easily verifiable outcomes.

Open calls: A low-barrier call for ideas, such as Broad Agency Announcements (BAAs), pitch rounds, or staged down-select tournaments, where companies propose approaches without a rigid scope of work. By making it easier for suppliers to engage with funders, open calls can broaden the supplier base and surface non-traditional suppliers and novel approaches that a funder might overlook while crafting an RFP or auction requirements.

Examples

Governments can choose between available procurement contracting structures like fixed-price, cost-plus, and IDIQ contracts to match the right incentive structure with the innovation goal:

NASA Commercial Orbital Transportation Services (COTS) Program: NASA leveraged a fixed-price structure under its COTS program to stimulate private-sector spaceflight and to deliver cost-effective rocket systems. Companies such as SpaceX competed for milestones and fixed-price contracts, cutting development costs roughly tenfold and variable costs two- to threefold compared to traditional cost-plus contracts. This program shows how milestone-based payments can also overlap with other approaches.
Nuclear submarine development: Early U.S. Navy nuclear submarine development relied on cost-plus contracting to share risk with suppliers. The unprecedented technology and unpredictable costs made guaranteeing reimbursements essential for supplier participation. While effective in fostering innovation, the program’s high costs and delays underline the importance of monitoring mechanisms and other efforts to align incentives for suppliers.
Subscription-based antibiotics procurement: The United Kingdom pays pharmaceutical companies a fixed annual fee for access to effective antibiotics through a subscription-based procurement model. The proposed PASTEUR Act in the US would create similar multi-year contracts with substantial guaranteed payments. This model gives companies predictable, long-term returns, which encourage sustained investment in novel solutions to antibiotic resistance.

Procurement contracts complement other funding mechanisms by targeting a specific stage of the innovation pipeline. For example:

Milestone payments: Allocating milestone-based procurement contracts combines periodic funding with direct accountability at each stage of development, which can be especially effective in long-term R&D projects.
Prizes: While prizes encourage broad experimentation and exploration of diverse technical pathways, procurement contracts secure downstream delivery once a solution is proven viable.
R&D contracts: R&D contracts use contracting to pay for early exploration and prototype development, while procurement contracts step in once a concept is closer to delivery and scaling.