Abstract

This study investigates the relationship between regulatory policies governing public procurement and participation by small and medium enterprises (SMEs), using a large dataset on European procurement. We find that better quality procurement regulation is associated with greater SME participation and higher probability that SMEs win contracts. Dividing contracts into smaller lots, a key feature of 2014 EU procurement regulation reform, bolsters participation by SMEs but only increases the probability of SMEs winning contracts for small value lots (€25,000 or less). Our results suggest governments seeking to enhance participation by SMEs in public procurement without explicitly favoring SMEs can do so by improving the overall quality of procurement processes.

Introduction

Public procurement (PP) generally represents a significant share of aggregate GDP. In the European Union (EU), PP represents 13.3% percent of total EU GDP, with public authorities spending some €2 trillion per year during the 2015–2017 period on the purchase of services, works, and supplies (European Commission 2019). Most countries have put in place legislation that regulates the process through which public contracts for goods, services, and works are allocated. These generally seek to assure “value for money” and accountability for the outcome of contract award decisions. In the EU, specific directives define in some detail how procuring government entities—both EU institutions and at the member state level—must behave when undertaking public procurement that exceeds certain threshold values. The basic principles include competition, non-discrimination, and transparency.

Procurement regulation that reflects primarily “value for money” considerations may skew the allocation of contracts to large firms that are better able to incur the costs associated with procurement processes and satisfy criteria that are used to ensure bidders have the capacity and track record to implement a contract. Because small- and medium-sized enterprises (SMEs)^Footnote1 constitute most firms in any economy (Ayyagari et al. 2007), many governments have sought to address this potential bias and ensure that SMEs are able to participate in public calls for tender. SMEs generally confront various constraints, ranging from access to finance to limited human resources (Beck and Demirgüç-Kunt 2006), that may impede their ability to satisfy both the administrative and substantive requirements associated with PP processes, dissuading them from competing for public contracts. Reflecting this, many countries have introduced measures into public procurement regimes that aim to support SME participation. These may explicitly favor SMEs through provisions such as price preferences, earmarking a minimum share of total procurement or specific contracts to SMEs, or requiring winning bidders to sub-contract to SMEs.^Footnote2 Alternatively, they may focus on facilitating SME participation in PP through generally applicable measures that aply to all tenders, such as simplification of procedures, bid eligibility requirements that are feasible for SMEs to satisfy, and limiting the size of contracts.

In this article, we analyze the second type of policy. We ask whether generally applicable PP regulation aimed at fostering SME participation in PP has this effect. This research question is answered using detailed data on public contracts awarded in 32 European countries in 2016 and 2017. Specifically, we examine the relationship between SME participation and the “quality” of PP regulation, measured by how closely national regimes align with internationally accepted good practice. We also assess the role of contract size and subdivision of contracts into smaller lots, a key feature of the 2014 EU PP policy reform aimed at enhancing SME participation in PP.^Footnote3 Our interest is to investigate whether the quality of PP regimes affects participation in public tenders by SMEs and the likelihood of their success in winning contracts and to estimate the relationship between average contract size and the probability of SMEs winning tenders. We can do so because the EU reported whether SMEs participated and won tenders in 2016 and 2017.^Footnote4

We find that the quality of PP regulation, as measured by indicators compiled by the World Bank and by DigiWhist—a European public sector accountability research initiative^Footnote5—has a statistically significant positive relationship with SME participation in PP tenders. We also find an associated positive probability that an SME wins a PP contract. SMEs are more likely to submit bids when government entities employ open procedures (first price auctions) and when contracts are of small size. Threshold regression analysis reveals that conditional on contract size, dividing projects into smaller lots increases the probability that a SME wins the contract. To the best of our knowledge, these findings contribute to the literature on PP by being the first to document that measures aimed at facilitating SME participation in PP—as distinct from requiring preferential treatment of SMEs—can be effective.

The plan of the article is as follows. Section 1 discusses our research question and places it in the context of related literature. Section 2 characterizes the quality of PP regimes across countries, one of our explanatory variables. Section 3 describes the procurement data used. Section 4 reports the results of empirical analysis of the relationship between PP regulation and SME participation in procurement contests and the probability of success. Section 5 concludes.

Public procurement regulation and SMEs

Much of the extant empirical analysis of the effects of PP regulation tends to take a public sector governance perspective. Studies have shown that adoption of internationally accepted good practices in public procurement, such as transparency and use of design and award processes that reduce discretion and the scope for corruption, lowers project costs and/or increases quality by increasing competition for contracts. For example, Knack et al. (2019), using enterprise data for 88 countries, find that firms are more likely to participate in public procurement markets in countries with more transparent procurement systems that rely more on open competition. Taş (2020), focusing on public procurement in the European Economic Area, finds that PP regulation that is more aligned with internationally accepted good practice standards significantly increases competition and lowers average contract prices for procuring agencies.^Footnote6

Recent thinking in the economics literature frames the impact of policy on SMEs through the entrepreneurial ecosystem. In this framing, policies can have a leveraged or multiplicative impact on SMEs and ultimately economic performance (Stam and van de Ven 2019). PP regulation arguably is a salient dimension of the entrepreneurial ecosystem, an element of both the “quality of government” that helps to define the investment climate in which firms operate and a specific source of demand for SMEs.^Footnote7 There is substantial literature assessing the (potential) role of PP as a mechanism to support innovation (Edler and Georghiou 2007; Aschoff and Sofka 2009; Edler and Yeow 2016) and SME entrepreneurship (Dennis Jr 2011; Harland et al. 2019). One reason is that PP can represent a meaningful source of demand for firms, so that a government contract may encourage firms to invest more, expand employment, and increase productivity (Ferraz et al. 2015; Hoekman and Sanfilippo 2019). Success in promoting greater participation by SMEs in PP may help attain broader industrial development objectives (Geroski 1990; Acemoglu et al. 2018), including through spillovers within geographical clusters of economic activity (Porter 1990).

SMEs may confront greater difficulty in contesting public procurement markets than large companies (OECD 2018). Specific characteristics of SMEs may inhibit them from bidding for public contracts. SMEs may have limited capacity to incur the cost of lengthy payment delays, satisfy bid security, minimum turnover or experience requirements, or difficulties in obtaining loans for the working capital needed to execute a contract on a timely basis (Loader 2011, 2015; OECD 2018). Both financial and human resource capacity constraints are likely to be more severe for SMEs than for large firms, with implications for the capability to incur the (opportunity) costs of dealing with the administrative requirements associated with bidding for public contracts.

Evenett and Hoekman (2005) argue there are two important dimensions of procurement regulation. One relates to “leveling the playing field” by removing discrimination that impedes participation by some firms (often foreign). The other centers on transparency and related mechanisms that reduce discretion and the potential for corruption or collusion in the allocation of contracts. Competition and transparency are core elements of what is internationally recognized as good procurement practice, where the goal is value for money. Nondiscrimination may reduce the prospects that SMEs can successfully contest procurement opportunities as it will boost potential competition. Greater transparency and due process may be a positive or a negative for small firms.^Footnote8 On the one hand, it reduces fixed costs and there is a presumption that small firms will be less able to provide bribes or side-payments than larger firms. On the other hand, less discretionary procurement practices may encourage greater participation by firms that otherwise would refrain from bidding for contracts—or were simply excluded because they were not “connected.” How public procurement regimes where contracts are allocated based on transparent and competitive processes will affect participation by domestic SMEs—our research question—is therefore an empirical question.

Governments tend to take two types of approaches to enhance the participation of SMEs in PP. The first comprises measures that aim at “leveling the playing field” for SMEs, through, e.g., calling for contracts to split into parts that may be easier for an SME to bid on and for contracts to be awarded based on the “most economically advantageous tender” rather than the lowest price. Both are elements of EU procurement practice. The second goes further and involves proactive measures in PP legislation that favor SMEs, through, e.g., set-aside requirements and price preferences.^Footnote9 The extant literature assessing the effect of policies targeting SMEs is relatively limited and has tended to focus on the latter types of proactive policies. Nielsen (2017) surveys the existing research on the impact of SME-specific PP policies. He concludes there is some evidence that these result in greater SME engagement in procurement but also notes the evidence is mostly of a case study nature, with little attention given to the potential costs of SME preferences in terms of value for money forgone. Nakabayashi (2013) develops a theoretical framework to assess the effects of SME set-asides and procurement preferences and applies this to public procurement of construction services in Japan. He concludes that set-aside programs increased SME participation in public procurement auctions by approximately 40%.^Footnote10

In the present article, we cannot assess the effects of explicit PP preferences for SMEs because the EU—the source of our data on PP calls for tender and awards—does not apply such measures. In contrast to other jurisdictions, the EU does not use proactive discriminatory measures in its procurement legislation to favor SMEs in contract awards. Instead, the EU seeks to encourage participation by SMEs in public contracts by reducing barriers to entry and costs associated with PP processes (European Commission 2008). Specifically, reforms to EU PP legislation introduced in 2014 encouraged procuring entities to complement the use of a “most economically advantageous tender” criterion as opposed to the allocation of contracts to the lowest price bidder with the following elements: (i) reduce the average size of contracts where possible; (ii) consider subdivision of contracts into smaller lots where this is not detrimental to the realization of project objectives; (iii) implement e-procurement systems; and (iv) ensure timely payments (European Union 2014).^Footnote11

Our focus is on the role of national procurement regimes in general and on the four types of measures implemented in the 2014 EU procurement regulation, including dividing contracts into smaller lots to make them more accessible to SMEs. Research on the effectiveness of the “EU approach” has cast doubt on the efficacy of some its elements. Stake (2017), using Swedish PP contract award data, concludes that the use of “most economically advantageous” criteria in tender awards rather than lowest price did not increase SME participation and success rates. A reason for this may be the finding by Ancarani et al. (2019) based on a survey of SMEs in Canada, Hungary, and Italy that administrative requirements or price competitiveness is not regarded as a major barrier to participation in procurement auctions. Instead, limited human resource capacity and financial strength were reported as more important impediments. These factors commonly are found to be participation constraints in the literature. Direct targeting of these factors, including ensuring timely payment for services, should therefore facilitate greater participation in PP tenders by SMEs.

The same applies to splitting contracts into smaller lots. Evidence of the effects of this is both limited and mixed. Timmermans and Zabala-Iturriagagoitia (2013) argue that “coordinated unbundling” of contracts can be effective in promoting participation of SMEs in public procurement, but Glas and Eßig (2018), using data on 380 contract awards in Germany to assess the effectiveness of splitting tenders into lots, find that this does not significantly increase the success rate of SMEs. Instead, they argue that other factors, including the type of public procurement procedure, the degree of competition (number of participating companies), and the overall tender volume, influence SME success. Blind et al. (2020) suggest that one such factor may be the extent to which firms are successful in offering innovative solutions and engage in standardization activities at standards development organizations.

Characterizing public procurement regulation

The basic features of good administrative practice in public procurement from a value for money perspective are well known.^Footnote12 They include requiring procuring authorities to conduct procurement in a transparent and impartial manner and utilizing open (competitive) tendering methods to award contracts above a minimum value threshold.^Footnote13 Notices of intended or planned procurement should be published (including information on timeframe, treatment of tenders and contract awards, technical requirements, and evaluation criteria used to determine the winning bid and payment terms). Implementing regulations should specify whether procuring entities may (or must) treat domestic bids more favorably than those from foreign companies or consortia, what such treatment comprises and the criteria that apply.^Footnote14 Transparency is important for firms to be aware of opportunities. Publication of notices, ensuring sufficient time to prepare bids, and clearly specifying performance requirements are particularly important to SMEs as small firms have less capacity to be informed about procurement opportunities.

Djankov et al. (2017) characterize the quality of PP regulation for 142 countries in 2016. They assess three dimensions of the procurement process: (i) bid preparation; (ii) the content and management of the procedures used to award contracts; and (iii) payment of suppliers. The bid preparation score gauges the quality of the needs assessment associated with procurement projects and the call for tenders. The bid and contract management score considers the processes used for submission and evaluation of bids. The payment of suppliers’ score measures payment timeframes and the procedures for request of payment. The arithmetic mean of these scores is used to calculate an overall public procurement score. The data used to construct these scores come from surveys of more than 1900 PP experts. Djankov et al. (2017) describe the questionnaire and the coding of the scores in detail.

An alternative exercise with a similar goal but less comprehensive country coverage is the DigiWhist initiative, a EU Horizon 2020 research project involving a consortium of six European research institutes. It covers the (then) 28 EU member states, the European Commission, Armenia, Georgia, Iceland, Norway, Serbia, and Switzerland. One element of the project is to produce data measuring the transparency of public administration and the accountability of public officials based on both de jure and de facto practices pertaining to the scope, information availability, evaluation, open competition, and institutional aspects of public procurement in European countries. The DigiWhist effort builds on indicators used in the World Bank Public Accountability Mechanisms (PAM) initiative. The resulting EuroPAM indicators score the quality of PP processes and regulation in the European countries considered. DigiWhist public procurement quality scores are available from 2012 to 2017. Accordingly, we consider the annual changes in procurement quality when we employ DigiWhist quality scores in the empirical analysis.

Table 1 reports summary statistics for PP quality indicators generated by the two sources for European countries for which we have data on participation by SMEs and outcomes (awards) from the EU Tenders Electronic Daily (TED) database. These data are discussed further in Section 4 below. The summary statistics for the two sources of policy information are comparable.Table 1 World Bank and DigiWhist public procurement indicators, in selected European statesFull size table

Figure 1 displays the overall PP quality scores for European countries. It reveals there is some variation across the two sources in scores and associated rankings of the European countries included in the sample.^Footnote15 The overall PP indices vary significantly across countries, making it possible to assess how PP regulation quality affects levels of competition and cost-effectiveness using data on the outcomes of procurement processes from the TED database. In the empirical analysis, we consider the association between the basic features of PP regulation and participation by SMEs, complemented with a focus on a specific measure that has been adopted by the EU to encourage SME engagement: dividing contracts into smaller lots. Our interest is to analyze empirically the “EU approach” which centers on implementation of what are agreed—both at EU level and internationally—to be good general procurement practices, including measures introduced in the 2014 EU PP reforms that sought to “level the playing field” for SMEs, without explicitly favoring them.^Footnote16

Methodology

Data and sample

We use the World Bank and DigiWhist information on the quality of PP regulation and PP contract award data for 32 European countries sourced from the TED database, which contains information on all tender opportunities as well as information on contract awards made by procuring entities in the European Economic Area (EU28, Iceland, Lichtenstein, and Norway), Switzerland, and the former Yugoslav Republic of Macedonia.^Footnote17 In addition to acting as a platform for calls for tenders, TED is also a depository of information on PP outcomes, i.e., which firms win contracts.

Data in TED pertain to the three main categories of PP distinguished in EU law—services, supplies (goods), and works (construction- and infrastructure-related projects). Data are reported on the number and value of contracts issued by procuring entities for each of these three categories, as well as the procurement procedure that applies. These include open (competitive) bidding, restricted procedures, and the so-called competitive dialog. The first two account for most procurement. Under open procedures, contracting authorities are required to publish procurement opportunities in the Official Journal of the EU, specify the technical criteria that bidders must satisfy, and evaluate bids and allocate contracts on the basis only of the bids received. Restricted procedures, used for higher-value contracts, involve a process where contracts are awarded based on competition between prequalified suppliers that express interest in participating. Some 85% of PP contracts are allocated through open procedures in the European Economic Area, accounting for about three-fifths of total PP by value (Kutlina-Dimitrova and Lakatos 2016).^Footnote18

Public authorities are obliged to publish their tender invitations on TED for all contracts exceeding EU public procurement thresholds. For the period under analysis, the thresholds were €135,000 for public sector supply and service contracts issued by central government entities (€209,000 for other authorities); €387,000 for utility supply and service contracts; €80,000 for small lots within a project above the services threshold; and €5,225,000 for construction/utility works and services concession contracts. Many contracts that fall below these thresholds are also reported in TED, as authorities often use TED to publicize tenders independent of contract values.

The TED data are available online in CSV format starting in 2006.^Footnote19 The European Commission extracts the data from standard forms pertaining to the initial contract notice and final contract award notice that must be provided by each procuring authority.^Footnote20 For each contract, the TED database includes fields for the estimated contract value (determined by the procuring entity), the actual contract (award) price, the sectoral Common Procurement Vocabulary (CPV) code that applies to the subject of procurement,^Footnote21 the procurement method used, type(s) of contracting authority, and the names and locations of both the procuring agencies and the winning firms. TED includes information on SME participation for 2016 and 2017. A total of 1,018,794^Footnote22 tenders were awarded in these 2 years. For 205,578 of these tenders, or 20% of the total, information is reported on the number of SMEs that participated in the tender process. We focus on this subsample of contracts in the empirical analysis.^Footnote23

Dependent variable

We start with the economic factors that affect participation of SMEs in PP, using the ratio of SME bidders to total bidders for a contract c as the dependent variable,^Footnote24 and then examine the probability that an SME wins a contract. Information on whether an SME wins a tender is available for a larger set of contracts (531,164 in total), but data often are not reported on the number of SMEs participating in the PP tender process. Of the 531,164 contracts where information is reported whether an SME is awarded the contract, the SME win ratio is 53%. This ratio is higher in the subsample of 205,578 tenders for which we have information on the number of SME bidders per tender, i.e., participation rates are reported. In this subsample, which we use for the empirical analysis, 67% of tenders are won by an SME. Most of these contracts (185,682) were awarded using open procedures (first price auctions).^Footnote25

Independent variables

We employ public procurement regulation quality scores described in Section 3 as the main independent variables. Additionally, we examine whether dividing contracts into smaller lots promotes SME participation. The TED data contains information about the number of lots for each contract. We construct an independent variable, dividedlots, if the contract has more than one lot. Almost 80% (163,265) of the contracts in our subsample involved division of a part of the project into smaller lots.^Footnote26 Some 60% (123,842) of these tenders had estimated contract values exceeding the legal thresholds that determine if EU procurement regulations apply. Thus, 40% of the contracts in our sample are below the thresholds established in the EU regulation determining if PP rules must be implemented, i.e., publication of tenders and reporting information on winning bidders. This feature of the database is important for the empirical analysis as we are interested in low-value contracts that are more likely to be won by SMEs. The ratio of below threshold to total contracts is somewhat higher to that observed in the complete TED database, where 716,571 (70.3%) of all contracts are above the value thresholds specified in EU PP regulation.

Control variables

We use several control variables, including dummy variables for the type of procurement method used, the type of public procurement authority that issued the call for tenders, whether estimated costs exceed the legal thresholds above which EU procurement law applies, and whether the contract is divided into smaller lots. Sector fixed effects are used to control for possible sector-specific dimensions of PP participation and outcomes.^Footnote27 Contracts in the subsample are weighted towards goods: 79.3% of contracts comprise procurement in goods sectors (including works); services account for 20.7 of awarded contracts. Participation and win rates for SMEs competing for goods and services contracts are very similar. Table 2 reports summary statistics for the dependent and control variables.

Table 2 Summary statistics of the variables

	Mean	Standard dev.	Min	Max
Ratio of SME bidders	0.69	0.42	0	1
SME winner dummy	0.53	0.5	0	1
Above threshold dummy	0.60	0.49	0	1
Divided lot dummy	0.79	0.40	0	1