Innovation Contest Design with Product and Supplier Diversity

Abstract

We study the optimal design of an innovation contest wherein a buyer wants to induce product variety and faces a moral hazard problem. The suppliers have different areas of expertise and may differ in their flexibility to adopt approaches outside their specialties. When the suppliers are equally flexible, the buyer-optimal fixed-prize contest implements the first best. When the suppliers differ in their flexibility, the optimal fixed-prize contest induces product variety, but there is a distortion from the first best due to the buyer's limited commitment power. In either case, an auction with entry fees is an optimal contest and implements the first best.

Keywords: innovation contests, product diversity, procurement

JEL Classification: D82, L22, O31