Incentives

Business Economics

Here’s a couple of examples from my notes that I go back to when I am thinking about incentives and value chains.

DARPA Challenge 2009 – in this competition, teams from different US Universities had to locate 10 red balloons placed around the United States and report their coordinates.

Finding 10 balloons in a 9,629,091 sq km area sounds either extremely tedious or expensive. However, an MIT team managed to complete the challenge in less then 9 hours. They used a technique similar to multi-level marketing to recruit nearly 100k participants using social media. They set up a 2k USD prize per balloon to be distributed up the chain of participants leading to the successful balloon spotting. No matter where you were in that chain of discovery, you would get paid.

This example is a great reminder that if you get financing right, incentivise each node in your value chain to attain a well defined goal, even extremely hard and low-success challenges are feasible.

Large-scale innovation is not possible without a financial infrastructure behind it. In most cases you’ll need well-functioning financial markets, a certain degree of system stability, and then well-defined risks and rewards.

Let’s take another low-success-rate investment area: a drug discovery with the following characteristics
• 10-year testing phase
• large initial investment
• 5% success rate of the testing phase
Is this an investment you would put your money in?

Let’s suppose that we could raise enough capital to finance 40 independent studies addressing the same disease. As each of them has a 5% rate, under the hypothesis that they are independent, the probability of having at least 1 success is 1 minus the probability where all researches fail at the same time: 1-0.95^40= 87%.

Incentivised value chains with well-defined/structured (via diversification) risks and rewards, with the proper scale, are a fundamental principle that can transform low success probability projects into way more attractive ventures.

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