How to ensure in practice the procurement of R&D services 'at market conditions'?
One important condition for a pre-commercial procurement not to contain a State aid element is that the procurer should not pay more than market price.
(1) How can one define the market price for a product that still needs to be developed, for which the market does not exist yet?
To answer this question one needs to remember that pre-commercial procurement is not a supply contract (a procurement of goods/products) but a service contract (a procurement of R&D services). In PCP the procurer pays a team of researchers and/or developers to perform specific R&D activities for a time duration specified in the tender documents. As the market value of the salaries of researchers/developers in a certain sector and the costs of R&D material required to perform the work are known, one can check whether the price proposed by a certain company in a bid is in line with normal market conditions.
(2) How can one calculate the financial compensation that the procurer should get for not claiming IPR ownership rights which gives companies the opportunity to exploit solutions developed during the PCP to wider markets?
In pre-commercial procurement the procurer assigns IPR ownership rights to participating companies, leaving companies the opportunity to resell developed solutions to other markets afterwards, in return for a financial compensation that brings the overall cost of the PCP development for the procurer below the higher prices for exclusive development contracts. An exclusive development contract concerns the case where development is carried out exclusively for the procurer and the procurer thus obtains all results (including all IPRs) of the project.
What elements to take into account to calculate this financial compensation?
The Staff Working Document on PCP highlights the following based on the State aid rules for R&D&I: "For exclusive development projects, where all resulting IPRs are owned by the public purchaser, participating companies should not receive any advantage if the price paid (by the procurer for the exclusive development contract) does not exceed the costs of the company (related to carrying out the development work) plus a reasonable profit margin. In the pre-commercial procurement approach presented, where IPRs are not fully allocated to the public purchaser, the price paid by the public purchaser for the pre-commercial development must be lower than in the case of exclusive development in order to exclude a State aid element. The price reduction compared to exclusive development cost should reflect the market value of the benefits received and the risks assumed by the participating company. In case of IPR sharing in PCP, the market price of the benefits should reflect the commercialisation opportunities opened up by the IPRs to the company, the associated risks assumed 13 by the company comprise for instance the cost carried by the company for maintaining the IPRs and commercialising the products.
How to implement concretely the financial compensation?
There are a number of possible approaches used by public procurers around Europe to implement the financial compensation for leaving IPR ownership rights to companies in a development contract. Two examples are given below:
(1) Price reduction on the PCP development cost: This approach has been verified not to contain State Aid by Commission DG competition services in the case of the UK Energy Technology Institute's proposed implementation approach for pre-commercial procurement. This approach is also used by the EU co-financed PCP projects SILVER, CHARM and V-CON. This is a so-called "ex-ante" approach of implementing the financial compensation, meaning that the procurer feels the budgetary impact of the financial compensation on the price paid for the R&D work immediately at the start of the PCP. In this scenario, the public procurer's PCP tender documents require companies to offer - in their bid for undertaking the PCP development work - a price reduction that is proportional to the expected market value of the commercialisation opportunities opened up to the company by obtaining IPR ownership rights. Practically, this can be implemented for example by asking companies to state in their PCP bid the difference between "IP-in" compared to "IP-out" prices. "IP-in" is the company's price for undertaking the requested R&D work under PCP contract conditions, i.e. when keeping IPR ownership rights "in" the company. "IP-out" would be the company's price for undertaking the same R&D work under exclusive development conditions, i.e. when all IPR rights are claimed by the procurer. Before starting the evaluation of the received PCP bids, the procurer - based on his own knowledge about the market or with the help of a financial expert in the PCP tender evaluation committee - evaluates for each individual incoming bid whether the financial compensation (difference between IP-in and IP-out prices) offered in each bid is conform with market prices.
(2) Royalties on sales: An example of this form of financial compensation can be found for example in the default IPR agreement in the French CCAG guidelines for public procurement (CCAG = cahiers de clauses administratives générales). The UK Ministry of Defence's standard IPR agreement also leaves IPR ownership rights with companies in return for royalties on future sales. The royalty rate, as a percentage of sales is predefined by the procurer depending on the market characteristics, and is published in the PCP call for tender documents. This is a so-called "ex-post" approach of implementing the financial compensation, meaning that the procurer only starts feeling the budgetary impact of the financial compensation after the PCP is finished, namely at the moment that companies start selling solutions based on developments undertaken during the PCP to other customers beyond the procurer.
Regardless of whether approach (1) or (2) is chosen by the procurer, the value of the financial compensation for relinquishing IPR ownership rights to a company in a PCP procurement determines the total price finally paid by the procurer for the PCP development to that company. Therefore the format and value of the financial compensation have to be clearly specified in the PCP contract signed with that company. In order for the procurer to be able to compare PCP offers from different companies on an equal basis and verify whether the prices of the different offers are according to market conditions, the format for the financial compensation that the procurer finds acceptable has to be clearly communicated up front when publishing the PCP tender documents.
Some procurers in Europe fear to undertake a PCP because of this need for valuing IPRs. This fear is not justified, because whenever R&D is involved in a public procurement, valuing IPRs will always be needed whatever the procurement procedure chosen (PCP or other procedure), unless the procurer plans to produce products out of the IPRs himself. Because PCP leaves IPR ownership rights with suppliers from the start, valuing of the IPRs is something that needs to be looked into from the start of the tendering of the R&D. In procurement procedures that keep IPRs with the procurer during the R&D phase, when the procurer wants to transfer IPRs after the R&D phase to companies on the market to produce products for the procurer based on these IPRs, the procurer will need to get the IPRs valued at market price before being able to launch a tender for procuring commercial solutions based on IPRs developed during the R&D phase. The EU State aid rules require any transfer of IPRs from public procurers to market players to be done at 'market price'. Getting comparable market offers for the transfer of IPRs from various market players, which is needed to establish that the transfer is happening at market price to the highest bidder, can be done by the procurer by organising an auction. It is clear that the highest bidder that is able to offer the market price for IPRs held by the procurer may not always be the contractor that performed the R&D and generated the IPRs for the procurer during the R&D phase. In most cases this situation is not interesting for companies nor for procurers, because most companies don't aspire only to do R&D but also to commercialise solutions themselves based on their R&D.
Conclusion: Leaving IPR ownership rights with companies from the start of the R&D as in PCP, avoids having to do auctioning of IPRs after the R&D phase is finished, where the highest bidder may not be the contractor that generated the IPR in the first place. The fact that there is little evidence of public sector IPR auctions taking place in Europe, shows that public procurers in Europe often keep IPRs 14 resulting from procurements but then don't immediately make these IPRs available for commercialisation. This blocks innovation, as companies can not commercialise solutions based on IPRs that are locked up by public procurers. This is also one of the main reasons why in most regions of the world (US, Canada, China etc) it is mandatory for public procurers to always use the IPR regime as in PCP and leave IPR ownership rights from the beginning with suppliers in public procurements (see e.g. Bayh-Dole act in US) unless in limited cases where public procurers can justify the need for exclusive development.