Sourcing Innovation: Integrated System or Individual Components?

Scholars have developed a sound theory of how to design procurement mechanisms for sourcing a simple innovative product. In practice, however, many (if not most) procurement efforts involve complex products consisting of multiple interacting components. Yet theory offers few guidelines regarding the design of procurement efforts for such complex innovations despite an abundance of pertinent questions. Of these, perhaps the most crucial is whether a firm procuring a complex innovation should purchase (a) an integral product from a single supplier or rather (b) the product's constituent components from (possibly) different suppliers. We use a game-theoretic model to identify the two most critical factors for answering this question: the extent of the required innovation and the size of the supplier base. We also characterize favorable designs of procurement contests that aim to source (respectively) a full product or individual components.