1. HOW DOES THE PATENT SYSTEM AFFECT PRIZE CONTESTS? Lee Davis Dept. of Innovation and Organizational Economics Copenhagen Business School KEI & UNI-MERIT Maastrict Workshop on Medical Innovation Prizes January 28-29, 2008

2. Lee Davis, "Can Prizes Work?" KEI & UNI-MERIT Workshop, January 20082 Central question Economic studies on inducement prizes focus either on a comparison between patents and prizes (and contracts), or on contest design But we also need to ask: How effective can an ex ante inducement prize system be, given the existence of the patent system? Do patents crowd out prizes?

3. Lee Davis, "Can Prizes Work?" KEI & UNI-MERIT Workshop, January 20083 Comparison between patents, development contracts and ex ante inducement prizes

4. Lee Davis, "Can Prizes Work?" KEI & UNI-MERIT Workshop, January 20084 Why inducement prizes? Increased criticism of incentive effects of IPRs Open source approaches to innovation Benefits of prizes Attract broad range of solutions to problems Shift risk from prize-giver to contestants Capacity for inspiring the public Can fill a hole where no other incentives exist Can be more efficient incentives than patents (De Latt, 1996, Shavelle and Van Ypersele, 2001, Gallini and Scotchmer, 2002, Maurer and Scotchmer, 2003)

5. Lee Davis, "Can Prizes Work?" KEI & UNI-MERIT Workshop, January 20085 But given the existence of the patent system, can prizes work, in practice? Effect of prior patents on prizes without patents (where the result cannot be patented) The individual contestants entry decision Prizes in the context of the firms R&D choices Effect of prior patents on prizes that permit patenting Conclusions and implications

6. Lee Davis, "Can Prizes Work?" KEI & UNI-MERIT Workshop, January 20086 Prizes without patenting (1) Effects of prior patents on the individual contestants entry decision Contestant must either invent around existing patents or pay license fees Cannot use own patent holdings strategically in the area of the prize Complex industry: cant use patents as bargaining chips Discrete industry: cant use patents to build fences Result: Given these problems plus the uncertainties of winning the prize, the contestant will not enter

7. Lee Davis, "Can Prizes Work?" KEI & UNI-MERIT Workshop, January 20087 Prizes without patenting (2) Effects of prior patents in the context of the firms R&D priorities Firm has a choice: Project A (with a patentable outcome) or Project B (possible prize contest entrant) Both cases: must invent around existing patents or pay license fees Further problems with backing Project B Cannot use own patent holdings strategically Contest specificity Result: Given these problems plus the uncertainties of winning the prize, the firm will choose Project A

8. Lee Davis, "Can Prizes Work?" KEI & UNI-MERIT Workshop, January 20088 Prizes that permit patenting Why should a firm spend the extra effort to go for the prize? Incurs the same costs and uncertainties as with patenting alone Must weigh possible reputational benefits against extra costs related to contest specificity and possible sponsor bias Does not eliminate social costs of patenting But may aid in contest design Patents can signal competencies to sponsors

9. Lee Davis, "Can Prizes Work?" KEI & UNI-MERIT Workshop, January 20089 Conclusion The impact of patents on prize contests may circumscribe any future wider role for inducement prizes Prize contests liable to fail because firms will be uninterested in entering Both for prize contests that do not allow patents, and for those that do, patents will tend to crowd out prizes

10. Lee Davis, "Can Prizes Work?" KEI & UNI-MERIT Workshop, January 200810 Some implications Entrants to prize contests tend to be university academics and/or professional engineers working in their spare time Commercial firms willing to sponsor these teams, but reluctant to enter contests themselves Transfer risk to academic teams Reap reputational benefits If project wins, may develop invention Problems with this Academic teams not well informed about prior patents Socially valuable ideas may languish…

11. Lee Davis, "Can Prizes Work?" KEI & UNI-MERIT Workshop, January 200811 Recent successful prize contests Winner licensed out its patents along the way to supplement income (Scaled Composites – X-prize) Awarded by government agencies (Stanley – DARPA prize) Can we interest commercial firms in entering other types of prize contests? Kremers patent buy-out scheme Would bigger prize sums work? Prizes can succeed if firms do not enforce their patents Or in fields where patents are not important Problems faced by contest entrants may provide another argument for reforming the patent system