From Targets To Structures: Rethinking Strategies For Public Procurement From MSMEs

In 2017, the Union government issued an order that set a target for Union ministries, departments, and undertakings to procure from MSMEs. This target was increased in 2018 and was imposed in addition to the 300-plus items exclusively reserved for procurement from MSEs.

The MSME Act of 2006 enables procuring entities to undertake preferential procurement from MSMEs, and some existing rules on procurement contained in the manuals for procurement were amended to incentivise MSMEs to bid for procurement contracts. These included permitted relaxations in the eligibility criteria for bidders, including turnover and prior experience requirements.

Government-reported data, however, suggests that while many departments and undertakings have achieved these targets, between 40 and 47% have been unable to do so, despite the reservations and the changes to rules. What could be the reason for continued missed targets in some cases but success in others? 

First, procurement laws set uniform targets without a deeper consideration of the underlying market conditions. Some markets are more naturally suited for entry by MSMEs, whereas others are not. This requires market engagement—where procuring entities are well-informed of the market and can amend tender strategies to suit the market. For instance, studies point to unbundled tenders as a strategy that might incentivise more participants in a thin market. 

Second, the current structure of procurement rules that permit relaxations is principle-based rather than prescriptive, setting a broad outline of relaxations that may be applied appropriately at the discretion of procuring entities. For instance, the rules allow (but do not mandate) a relaxation in prior turnover and prior experience criteria during the tender process but do not specify what the relaxed turnover or experience criteria must be. Procuring entities must therefore have the capacity to determine these based on sector-specific market conditions, which may vary even across the type of goods, services or works within a single industry. 

A third consideration is that eligibility criteria are often deemed as a risk mitigation strategy to ensure that a vendor will deliver on the contract. In addition to the risk of non-delivery, the procuring entity is also answerable to bodies such as the Comptroller and Auditor General for contracts, where work has not been completed or has been stalled, enhancing the scrutiny attached to procurement processes. How can procuring entities successfully meet targets while managing their risk?

An example of successful procurement from MSMEs from a relatively young but technologically sophisticated sector is the procurement of drones by the Survey of India department, under the Survey of Villages and Mapping with Improvised Technology in Village Areas Scheme.

The SVAMITVA scheme provides rural households in Abadi areas with a record of rights to their land, for which it undertakes the mapping of village areas using drones procured by the SOI. The scheme was the first of its kind, raising new challenges for procurement. A responsive bidder engagement strategy was adopted to optimise their drone procurement processes.

Balancing targets and risk: The initial design outlined that drones alone would be procured with SOI personnel piloting those drones to adhere to security requirements. However, considering the scheme deadlines, a decision was made to also procure services. How did they manage and mitigate the risks of procuring drones from small firms? SOI adopted a two-pronged strategy for drone procurement: (i) they procured some quantity of drones from large firms to minimise the risk of procuring from smaller firms with less experience, and (ii) they augmented their procurement strategies to include MSMEs and start-ups, considering the scheme’s targets towards this.

Structuring relaxations based on market conditions: Recognising that startups and MSMEs may have the technical ability but may not fulfil eligibility requirements, some criteria were waived off entirely under the scheme’s procurement. An exemption was given for the turnover requirement and previous experience requirement, considering the size and newness of the firms in the drone sector. There was, however, no compromise on the technical specifications. 

Unbundled tendering: The procurement package was unbundled into smaller lots of ~5 drones, which helped manage the size and value of a contract, making it amenable to participation from smaller firms and improving competition. Notably, on account of their high contract value, bundled tenders are also demanding on their technical and financial eligibility criteria, further narrowing the pool of eligible competitors. Therefore, where vendors have limited capacity to service large tenders, unbundling strategically may be one strategy to widen the supplier base and encourage diverse vendor participation. 

Ongoing market engagement and support: A recent survey recording challenges faced by MSMEs reported market access, marketing support, knowledge sharing and participation as key concerns for Indian MSMEs. SOI’s ongoing market engagements created awareness of the licensing, registration, and other compliance requirements for participating in the procurement under SVAMITVA. This reduced information asymmetries on procurement expectations and provided vendors with predictability and information.

While target-setting induces a norm for achievement, deeper thought needs to be poured into deciding how these targets can be met and what the target must be. It is critical to get the structure of incentives right.

For instance, the present order of eligibility criteria creates both implicit and explicit barriers to entry and reduces competition in the market. High compliance requirements on the part of bidding firms, tender modifications, the longevity of most works contracts, the frequent incidence of prolonged payment delays, contract management difficulties and the high likeliness of disputes and litigation bulk up the overall costs of doing business with government entities. If targets must be set and met, they must be accompanied by structural and strategic changes by procurement entities.  

Procurement reforms that address challenges such as entry barriers and existing infirmities in the contract life cycle are inevitable if smaller firms are to successfully bid for and win public contracts—improving competition and cost-effectiveness.

The case of procurement of drone services under the SVAMITVA scheme holds some insights for improving contracting practices with MSMEs and perhaps meeting targets through strategising; it is also evidence of the government’s responsiveness to the market and application of principles and enabling provisions provided for by the legal framework. Simplistically applying reservation targets will seldom succeed in eliminating entrenched structural and capacity barriers to reforms, making it imperative to undertake a root cause analysis for missed targets.

Diya Uday and Charmi Mehta are researchers at XKDR Forum, Mumbai.

The views expressed here are those of the author, and do not necessarily represent the views of BQ Prime or its editorial team.