Prizes, pieces, and property rights

David Leonhardt’s Economix column today suggests that prizes may be a useful way of stimulating innovation. His primary example is’s million dolar prize for any one that can improve its movie suggestion algorithm by 10%. The current best team is at 6.75 percent. Netflix may be better positioned than most companies to be able to offer prizes that will provide the winners reputational benefits that may exceed the value of the prize itself, but Leonhardt may still be right that prizes are an often overlooked means of accomplishing corporate goals.

The prize is an example of “crowdsourcing.” The web site Innocentive contains many such crowdsourced offers. If, for example, you can develop a pressure sensitive adhesive for re-sealing flexible bags for salty snacks (the adhesive must not adhere to potato chips or hands reaching in to take out chips), you can make $50,000 (plus the eternal gratitude of me, a Doritos connoisseur). An advantage of this approach over conventional sourcing is that the project sponsor does not need to assess the quality of those who may work on the project.

Why do we not see more crowdsourcing via prizes? See my comments after the jump.

A significant drawback of prizes is the possibility of redundant work. There is no incentive for participants to share information about failed efforts or partial progress. Even if I am sure that I can achieve a solution in a race for a $50,000 prize, if I estimate that about four other equally competent solvers will also be racing, then the prize will only be worth about $10,000 to me in expected value terms. At least in this case, it would be cheaper for the entity needing the solution to enter into a contract with a sole solver — perhaps providing $20,000 conditional on a solution being produced.

Could crowdsourcing via prizes be improved to the point where it is generally cheaper than alternative approaches, so that even a company like Microsoft might start relying on subsidized peer production rather than on its own employees to create software? I think that is possible. We have already seen that peer production without subsidies can produce large well-integrated products, and subsidies should allow for even more impressive ones.

But there are two key obstacles, if redundant work is to be minimized. First, the sponsor of the prize must promise to divide the prize in proportion to achievement by participants, and must be able to convince potential participants that this will be done in a relatively efficient way. As long as showing that one seemingly attractive approach won’t work counts as an achievement worthy of some prize money, some redundancy can be eliminated. Moreover, dividing prizes into pieces allows for greater specialization by the sourced crowd. My own view is that it should be possible to create sufficiently independent judges of contributions that this is a surmountable obstacle.

Second, there needs to be some type of at least tentative property rights. Competitors might work on essentially parallel solutions simultaneously (for example, crafting modules of computer code that perform essentially the same function), unless there is some means of allowing one competitor exclusive rights. If the sponsor of the research can delineate property rights, some type of auction might work; alternatively, the sponsor might grant rights to the first party that proposes to work in a particular area upon submission of a property claim. I have not seen much attempt at solving this problem, but real innovation is possible here.

In the end, crowdsourcing via prizes could rival existing industrial organization structures, but it may require a fair bit of careful supervision. The ultimate question, as Ronald Coase’s Theory of the Firm suggests, is whether the costs of that supervision are less than the costs associated with the organization of hierarchical firms. Perhaps the small role of crowdsourcing in today’s economy suggests that they are not. But if information technology continues to reduce the costs of controlling crowdsourcing, that could well change.

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7 Responses

  1. Eric Goldman says:

    Greg Linden has suggested that the good response to Netflix’s contest is due less to the prize than to the public availability of a much richer dataset than was previously available. See Eric.

  2. Michael, You suggest splitting-up prize money based on pro-rata contribution. Does it help to split the challenges up before-hand into micro-challenges.

    One way to avoid redundant activity is to create a market for partial solutions. The eventual winner might have purched one or more partial solutions in the process. (The purchase price could be a percentage of any eventual winnings). This would also allow Prize-seekers to hedge their bets by selling partial solutions.

  3. KipEsquire says:

    A system of prizes will, by defintition, reflect the subjective preferences of the prize offeror and not the objective needs of the market the way that traditional intellectual property does.

    Rich Philantropist may offer a huge prize for the discovery of a cure for Obscure Disease, but intellectual property will make sure that Rich Pharmacuetical Company will devote it profit-seeking resources to a cure for Widespread Disease.

    The two systems can certainly exist side-by-side (ignoring crowding out effects). But if we abandon IP entirely and move to a government-financed prize-based incentive system, as some propose, then we are no longer dealing with Rich Philanthropist but instead with Powerful Politician and Busybody Bureaucrat.

    No thanks.

  4. I think some advertising firms offer prizes. My cousin worked for awhile at a famous ad firm in Dallas, and she routinely sent emails to her family and friends asking them to name new products. These emails were sent to all employees of the firm and then sent outward. The “winner” received a small cash prize, like $25 or $50. I’m not sure if “winning,” was determined by the ad exec’s decision or the client’s, though.

  5. Kate Litvak says:

    How is this different from prosaic “buy” ads in the Classified section of your local newspaper?

  6. Haninah says:

    Another consideration is that the prize offered must be small enough to make crowdsourcing cheaper than hiring, but large enough to be bigger than the profit that the winner could expect to make on his own (in the Netflix case, for Netflix to get what it wants the prize that it offers must be more than the inventor of the better algorithm believes s/he can make by either selling his/her algorithm to Netflix or a competitor in a marketplace or by starting his/her own competitor with the improved algorithm as its chief competitive asset.

  7. Amaresh says:

    You mention some interesting points about redundant work and IP issues.

    I recently blogged about the Netflix prize and tried to examine the applicabilty of the model overall to analytics.