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X-Prizes and Winner-Take-All

Updated: Mar 23, 2023

Notions regarding specialization in a trade or product are long established principles of societal efficiency, promoting access to goods and services to the masses that would not otherwise be possible. In other words, when you do one thing you do it better, and you make more of it. This, of course, is better for everyone. Just imagine trying to build a couch or TV for yourself (or any litany of even basic items in your house). Conversely, imagine the people who do this trying to do your job…they would also be as clueless as a llama at a horse farm.

One of the premises of law and economics is to use legal principles to promote the efficient allocation of resources to help people most, aka what is socially optimal. In an example that I’m pilfering straight from a class (credit to Neil Sukhatme), imagine that you and 7 strangers are competing for a hidden treasure worth $5 million dollars (for argument’s sake, we assume the treasure is pre-surgery pictures of Kim Kardashian valued at $5 million). We also assume that each of you believe you can actually recover the photos buried deep underground in a hidden Los Angeles Vault. How much would you be willing to spend? While this obviously depends on the belief in your ability to navigate the Los Angeles underworld, let’s assume that none of you are willing to spend more than $1 million in pursuit of such a prize. In this case, the total societal cost is $8 million (8 x $1 million) while the societal benefit is $5 million (creation of wealth to one person).

Why, then, are we experiencing an explosion of prize-related research and innovation when these numbers don’t seem to add up? From the likes of Peter Diamondis (the writer of Abundance and CEO/founder of the Xprize Group) to the US government, many are beginning to offer monetary prizes for innovations (in the former example, the tag line reads “Revolution Through Competition”). Does the increased popularity of these programs stem from our inner desire to indulge in enterprises that resemble gambling rings? From an inate psychological desire to win at all costs? From the altruistic need to do good and help others? While I can’t speak to the answers of any of these (and it’s probably a little bit of all of the above), the easy answer is that it is NOT efficient for each actor, independently, to invest money and resources when only one positive outcome can be recognized (a $5 million prize, for example).

Why, then, are these programs increasingly obtaining ubiquitous status? On its face, an instance where 5 companies spend $5 million each when only one can recoup the $20 million prize would seem to be societally inefficient. There are two reasons why I would argue these prizes contain societal value. In the Kim K example, it is licensing and selling. The premise is that a company like US Weekly (or some other semi-morally bankrupt magazine of whose pages I have never seen) would purchase the pictures for $20 million, and sell them and make millions more (intangible value derived by the readers would be that of pleasure and squealing excitement upon the discovery of such pictures). Outside of this, however, the societal cost would seem to exceed the benefit.

The second and more likely scenario is that the prizes are actually societally efficient based on the innovations that occur. In the instance above of five firms competing to earn $20 million, the $5 million loss is far offset by the societal benefit derived from the innovated item. Who is in the best interest of benefiting from such a thing? Why the government (and some well-intentioned 501(c)3’s) of course. This is why such prizes make sense on such a large scale. An example follows. The government, in its infinite wisdom, decides to offer a prize for $50 million to any person or company that can create sidewalks that charge streetlights through the pressure of the people walking on them (piezo-electricity fans take note!). 10 firms undertake the venture, each spending $8 million for a total cost of $80 million. Thus, the cost to society is $30 million. Imagine, then, that every city in America retrofits its sidewalks, and public consumption of energy for streetlights goes from $250 per efficient LED streetlight[1] to 0 (note this is the cost of running a streetlight for a year). In the city of Chicago alone, which contains a minimum of 250,000 streetlights[2], this amounts to a cost savings of $62,500,000.00. The savings (shifted between whatever government entities you would like) are already $32.5 million directly into the government coffers! However, what about prizes that do not directly benefit the government? And how do these things help the private sector?

But, you say, how does that help the private sector? The licensing of these new technologies, an area with which I am admittedly unfamiliar, would allow for private sector innovation on top of the technology created (one can only imagine the possibilities if walking on a floor could charge electrical components). On top of that, government expenditures are intended, on the most basic level, to provide for its citizens. Instead of allocating government resources to creating these sidewalks, allowing the private sector to compete would certainly lower the costs[3]!

The other side of the coin, however, is that this is how patents work FOR the private sector. A patent is granted in order to encourage competition, so that the winner can recoup the costs it spent researching the technology that led to the patent. As an example, 5 firms spend $20 researching technology for a brain controlled smartphone controller (because hey, we aren’t lazy enough yet). The technology is expected to result in $80 million in profits to the winning firm. A patent is awarded to the winner, who then recoups their costs and then some (and this folks, is the intersection of how law financially encourages innovation). A patent is substantively the same thing as granting a temporary monopoly to recoup their costs. Companies affirmatively base how much money they spend on R&D based on estimates for how much money they could recoup by licensing and selling that technology.

While the majority of innovations clearly should be allocated to the private sector, X prizes and government awards are simply an extension of this doctrine that allows for the efficient creation of new innovations, and because they’re government run, the creation of foundations upon which future private and public sector innovations can occur. Besides, the next time you need an excel Macro created at work to make your boss think you’re a genius, hire a group of 11-year-olds to write one and promise the winner $20. Ahhhh the beauty of capitalism and competition!

[1] Via Cree Inc., [2] [3] Fiscal Hawks take note…As should tea partier’s who believe the same as anarchists when it comes to government expenditures.

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