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Bounties Spur Innovation January 25, 2007

Posted by federalist in Finance.
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Interesting column by David Wessel today discusses prizes offering a unique incentive for innovation.

The U.S. and other modern capitalist economies rely on a handful of approaches to stimulate innovation.

Big corporate research-and-development shops invest shareholders’ money in the search for future profit. Small entrepreneurial start-ups do the same with venture capital.

Academics toil in big universities, sometimes for profit, sometimes for glory. Open-source software wizards mend and tend shared software that no one owns, the high-tech equivalent of a barn-raising. Government steps in where private money fears to tread.

Now, a proliferation of prizes is attracting bright minds to stubborn problems.

InnoCentive, a company spun off six years ago by drug maker Eli Lilly, charges clients (“seekers”) to broadcast scientific problems on a Web site where scientists (“solvers”) are offered cash — usually less than $100,000 — for solutions; more than 50 challenges are now pending. Netflix, the mail-order movie company, is offering $1 million for an algorithm that does 10% better than its current system for predicting whether a customer will enjoy a movie, based on how much he or she liked or disliked other movies.

The outfit that gave $10 million in 2004 to the first team to build and fly a spacecraft capable of carrying three people into space twice within two weeks has morphed into the X-Prize Foundation. With the backing of a Canadian diamond-mining magnate, it’s now offering $10 million to the first team that can build and demonstrate a device to sequence 100 human genomes within 10 days or less. The Rockefeller Foundation also is getting into the act to help solve science and technology problems faced by the poor.

“‘Prize philanthropy’ is useful for breaking a bottleneck where government bureaucracy and markets are stuck,” says Thomas Vander Ark, who recently left conventional philanthropy at the Bill & Melinda Gates Foundation to run the X-Prize Foundation. While Gates and similar foundations “push” money on people to solve problems or meet social needs, he says, prizes “pull” people to problems.

Such prizes, newly popular and possible in an age of instant, cheap global communication, have a venerable history. In 1714, Britain offered £20,000 (roughly equivalent to £2.5 million, or $5 million, today) for a way for mariners to determine their longitude. Sir Isaac Newton was convinced the solution lay in astronomy. He was wrong: John Harrison, a working-class joiner with little formal education, built a clock that did the job. In 1919, hotel owner Raymond Orteig offered $25,000 for the first nonstop flight between New York and Paris. Eight years later, Charles Lindbergh won.

Prizes prompt a lot of effort, far more than any sponsor could devote itself, but they generally pay only for success. That’s “an important piece of shifting risk from inside the walls of the company and moving it out to the solver community,” says Jill Panetta, InnoCentive’s chief scientific officer. Competitors for the $10 million prize for the space vehicle spent 10 times that amount trying to win it.

Contests also are a mechanism to tap scientific knowledge that’s widely dispersed geographically, and not always in obvious places. Since posting its algorithm bounty in October, Netflix has drawn 15,000 entrants from 126 countries. The leading team is from Budapest University of Technology and Economics.

After examining 166 problems posted by 26 research labs on the InnoCentive site over four years, Karim Lakhani, a Harvard Business School professor, found 240 people, on average, examined each problem, 10 offered answers and 29.5% of the problems were solved.

One surprise: The further the problem was from a solver’s expertise, the more likely he or she was to solve it. It turns out that outsiders look through a completely different lens. Toxicologists were stumped by the significance of pathology observed in a study; within weeks after broadcasting it, a Ph.D. in crystallography offered a solution that hadn’t occurred to them.

InnoCentive seekers and solvers are anonymous. “An undergrad from the University of Dallas solved a problem for a Fortune 500 company,” Ms. Panetta says. She sees that as an advantage: “They are really judging it on the sciences, not on who is standing behind it.”

Prizes aren’t a panacea. They won’t replace corporate R&D labs or universities. Some problems — a cure for cancer — are just too big. Some require too much upfront investment. Some scientists are reluctant to admit defeat and surrender a problem.

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