The New York Times published a great article on prizes recently.
“Another big impulse toward prizes comes from the rise of new forms of collaboration and new marketplaces on the Internet. What eBay does for buyers and sellers, companies like InnoCentive do for problem solvers. InnoCentive got its start as e.Lilly, an innovation unit inside the drug company Eli Lilly. Now it’s a marketplace where hundreds of companies post problems and a reward amount, and 250,000 solvers around the world get to work. Can you invent a no-contact way to weigh pigs from a distance? You can win $50,000. Have a method for reducing fat absorption in battered fried foods? Can you find a more ecologically sustainable material that mimics wood? There are prizes for that, too.
Prizes have other advantages. They can correct some of the market failures in our current strategy for encouraging innovation, the patent system. Patents reward innovators with a period of monopoly control over their invention. This means that there is very little incentive to pursue innovations that don’t promise to be lucrative. To see the distortions this can cause, look at medicine. Some very serious diseases attract very little research, because the market they offer doesn’t make expensive research and development worthwhile. Rare disorders — defined as those that affect fewer than 200,000 people in the United States — get very little research, and there are more than 7,000 of them. Other diseases may be widespread, but mainly among people who can’t pay. Nor do companies have an incentive to pursue one-off treatments, as therapies that must be taken every day are far more lucrative.
The reward for innovation — a 20-year monopoly — can also create perverse incentives. Last year, the Office of Health Economics, a think tank with connections to the Association of the British Pharmaceutical Industry, wrote a report funded by GlaxoSmithKline recommending that Britain, together with the United States, offer prizes instead of patents to spur the invention of new antibiotics. The problem is that patent holders try to sell as much as possible before their monopoly expires and generic competition sets in. The report warned that the patent system was encouraging potentially dangerous overuse of antibiotics, creating drug resistance.
Another market failure in the patent system is that monopoly control can limit access to a new product. Especially when an innovation is in the public interest, it’s counterproductive to encourage the patent holder to price it out of range of most users.”