"Anytime you do research and development, there's a cost associated with it," says Ian Murphy, director of media relations for the X Prize Foundation, which rewarded the first private manned suborbital flight. "What a prize does is to create a sense of competition that allows you to leverage your money. The Ansari X Prize was a $10-million prize, but a little over $60 million of research was spent by everybody. And when you're done, you only have to pay the winner."
But there's no such thing as a free lunch, according to Douglas Holtz-Eakin, director of the Congressional Budget Office. "Prize competitions do not change the underlying factors that determine risks and rewards," he warned in a 2004 appearance before the House Subcommittee on Space and Aeronautics. "Innovators and researchers must be paid for what they do. Inducement prizes have to be very large if the objectives sought are risky and expensive."
From an entrepreneur's point of view, how the prize is paid out matters as much as the size. One drawback to many technology prizes, such as the Defense Advanced Research Projects Agency's Grand Challenge to develop a robotic ground vehicle, is that they often lack a tiered award structure, opting instead for a single large pot for the winner. In an early example, the $25,000 New York-to-Paris Orteig Prize, won by Charles Lindbergh in 1927, had nine entrants, seven of whom spent more than the amount of the prize money in their attempt. When those teams lost, they lost big.
Even the people at the X Prize Foundation realize the drawbacks of a winner-take-all approach. "Toward the end we were thinking, 'Boy, we wish we had a second- and third-place prize,'" Murphy concedes. In a subsequent study for NASA's Centennial Challenges, the foundation determined that a multitiered prize structure--with purses of $150 million, $75 million and $50 million--would provide the right incentive to develop a human orbital vehicle. "This allows the companies that are really, really close to continue to work, to continue to find investors," Murphy explains. "You're also encouraging multiple firms to stay in the market, hence driving down that competitive price. That's what it's all about."