May 28, 2014
Innovation prizes and innovation organization
Posted by Michael Burstein

Innovation prizes – rewards for the development of a new technology – have enjoyed a surge of popularity lately in both the popular and academic presses, and among policy makers.  Private foundations like the X Prize Foundation offer large scale, high profile prizes for things like the development of private spaceflight or fuel efficient cars.  Companies like Netflix offer prizes to attract alternative talent and solve specific technological problems.  Small inventors and coders routinely compete with one another to solve discrete problems on platforms like Innocentive and TopCoder.  And the government has caught on too; in 2010, Congress authorized all federal agencies to use general appropriations for prize contests.  A recent McKinsey study estimated the size of the “prize sector” to be $1-2 billion.

In the legal academy, we often analyze prizes as alternatives to intellectual property that may be, at least in some circumstances, less socially costly.  (See here for a good overview of and contribution to the economic debate).  Prize sponsors, though, see them very differently.  Both the private sector and government proponents of innovation prizes see them as an effort to jump start entrepreneurial activity.

Fiona Murray (MIT Sloan) and I see prizes still differently – as mechanisms for organizing innovation.  We are writing a paper in which we use a detailed case study of the Progressive Insurance Automotive X Prize (PIAXP) – a $10 million prize for the development of production ready high fuel-efficiency cars – to draw lessons about how to govern innovation prizes.  The PIAXP was launched in 2006 and awarded in September 2010.  111 teams registered for the competition, and after a series of stages to winnow the field, 28 vehicles competed in the final on-track race events.  The $10 million prize split between three divisions – a “mainstream” and two “alternative” divisions.  You can see the winning cars here.

The PIAXP experienced several challenges that we have reason to believe are typical of what other prize sponsors face.  The first challenge is how to establish the rules of the competition.  The problem here is that the technical knowledge needed to formulate aggressive yet achievable goals, and the rules of the competition to get there, are likely to be highly dispersed among a large number of individuals.  The PIAXP, for example, knew that it wanted to set a high standard for the ultimate fuel efficiency goal.  But it had to engage in an iterative process of rule development with a wide variety of experts – automotive engineers, environmental scientists, safety experts, and others – in order to arrive at a concrete number and in order to specify the other rules and guidelines that entrants would have to follow.  Of course, in small innovative communities, some of these experts may well have been potential competitors.  The second challenge arose when the technology outstripped the rules.  That is, the organizers found that they needed to change the rules when it turned out that the course of technological development left some rules obsolete or rendered some entrants non-comparable.  This led to predictable discontent among competitors who felt at times like the goal was a moving target.  Finally, the organizers needed to implement the rules fairly.  Like any legal problem, some guidelines were more rule-like while others were more standard-like.  Competitors often worried that necessary flexibility was implemented unevenly.

Fiona and I argue that these challenges should not come as a surprise.  They arise because innovation is characterized by uncertainty and information asymmetries.  Progress toward any technological goal requires adaptation in the face of technological change that cannot be predicted ex ante, and often requires collaboration and information sharing among dispersed individuals.  These characteristics make it difficult for prize sponsors to credibly commit to awarding the prize.  It is difficult to do so when those who make the rules also abide by them, when the rules must change midstream, and when necessarily ambiguous criteria need to be applied to highly variable technologies.

Prizes can be seen as a particular institutional response to the problems of uncertainty and information asymmetry.  They offer an arrangement for organizing innovation that is different from patents or government grants.  They provide institutional forums for collective action toward a particular technological goal even though uncertainty and information asymmetries may not be fully resolved over the course of development.  We suggest that the choice of innovation incentive mechanism should take into account how each organizes innovation and which system of organization is best suited to a particular technological problem.

But I want to suggest that a focus on institutions can help us to understand innovation within and between firms as well.  Fiona and I draw upon Elinor Ostrom’s “institutional analysis and development” framework, which she originally applied to study natural resource commons, and that Brett Frischmann, Katherine Strandburg, and Michael Madison have adapted to the study of information commons.  This framework, which asks what resources need to be shared by whom under what rules and arrangements, might just as well address the problems of firm-based innovation; and Ron Gilson, Charles Sabel, and Robert Scott’s work on contracting for innovation raises similar issues in the inter-firm context.  So prizes, while interesting in their own right, also raise broader issues about the organization of innovation that have gone mostly unexplored.

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