Carlos Lozada -- Want to Innovate but Avoid Risk? Offer a Prize.

Sunday, August 2, 2009

Risk: Bad.

That is one of the lessons of the Great Recession, in which excessive risk-taking -- or the ever popular "reckless risk-taking" -- is invariably invoked as a prime cause of our financial woes.

But capitalism needs innovation, and innovation requires risk. So how can you innovate while getting someone else to shoulder the risk? Simple: Offer a prize.

An article in the latest issue of the McKinsey Quarterly charts the recent boom in philanthropic and corporate prizes. Consultants Jonathan Bays, Tony Goland and Joe Newsum identify 219 prizes with awards exceeding $100,000 each, totaling more than $375 billion. Whereas the arts and humanities made up a third of total prizes a decade ago, today they represent less than 10 percent, as awards in science, engineering, aviation, space and the environment have multiplied.

Drawing from a larger McKinsey study, the authors find that, increasingly, prizes are designed less to reward general excellence (think Nobels or Pulitzers) and more to offer incentives for particular innovations -- from improving Netflix's movie recommendations to creating a higher-performance car battery. Since 1991, nearly four-fifths of new large prizes have been such "inducement" awards, focused on specific goals.

The award sponsors (including philanthropists who made their cash in the 1990s tech boom) often develop the prizes to identify excellence in a given field or to influence public opinion, but the prizes are also designed to help them avoid or spread the risks of innovation. For instance, the Ansari X Prize offered $10 million for the development of a manned, reusable spaceship capable of flying 100 kilometers from the Earth's surface -- a hefty sum, for sure, but one dwarfed by the more than $100 million that competitors collectively spent pursuing the award.

"Prize competitors are typically confident and risk-loving individuals," the larger study found, "hence they tend to systematically overestimate their chances of winning." Competitors are also often more motivated by glory than by gold, the report finds, making them more susceptible to high-profile awards regardless of the sums involved -- and more likely to take on the risks of innovation.

-- Carlos Lozada

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