Innovation Contest Design with Product and Supplier Diversity

We study the optimal design of an innovation contest where the designer wants to induce product variety and faces a moral hazard problem. The innovators have different areas of expertise and may differ in their flexibility to adopt approaches outside their specialties. When the suppliers are equally flexible, we show that a fixed-prize contest with entry-fees is an optimal contest and implements the first-best. When the innovators differ in their flexibility, a fixed-prize contest results in 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