Attracting investment with challenge prizes

Attracting investment with challenge prizes Vidal Kumar December 2021

Introduction The growing interest in the use of challenge prizes as an inducement to innovation provides a mechanism for more transformative change in the way innovation is funded. The social and economic challenges that continue to emerge from the COVID-19 pandemic also emphasise a need to innovate innovation, and to learn how best to rapidly stimulate investment in a problem area.

Theoretically, a well-designed and properly structured challenge prize can accelerate movement in a field in a given direction by leveraging investment beyond the value of the prize purse and attracting human and financial capital in pursuit of a solution. Leverage in challenge prizes, therefore, can occur through either the investment in R&D of capital, resource and time made by participating teams during the competition, or the external investment innovators attract during and after the prize. This mobilising of capital reflects some key positive effects of prizes – people’s views fundamentally change about what is possible in the problem space and stakeholders react quickly to signals that suggest innovation is socially and commercially valuable.

Whilst theory on the role of challenge prizes to induce innovation, particularly in the field of economics, is relatively advanced, empirical evidence from actual prizes about how challenges work is less developed.1 At Nesta Challenges, we are addressing this gap by working to gather robust insights from the prizes we develop, deliver and support. In doing so, our overarching aim is to also develop a more systematic approach to how we think about our impact, and to improve our processes for measuring and reporting on challenge prizes.

Central to this process is our theory of change, which describes the different ways in which challenge prizes achieve impact. Our theory of change contains a number of hypotheses that set out research questions for us to prioritise, and to enable us to assess the strengths and weaknesses of the evidence-base in support of the claims we make.

1. Murray, F., Stern, S., Campbell G. and MacCormack. A. (2012) ‘Grand Innovation Prizes: A Theoretical, Normative, and Empirical Evalua­tion’, Research Policy, 41 (10): 1779–92; Williams, H. (2012) ‘Innovation Inducement Prizes: Connecting Research to Policy’, Journal of Policy Analysis and Management, 31 (3): 752–76.

Attracting investment with challenge prizes

Testing our hunches Two of our core hypotheses are that challenge prizes incentivise participating teams to invest their own funding and resources and that prizes leverage greater additional funding.

On the former, there is growing evidence of this effect in challenge prizes. For example, the development of a suborbital spacecraft for the Ansari X Prize induced a total R&D investment by all prize participants of about $100 million, which was the equivalent of ten times the cash purse.2 Similarly, the DARPA Challenges were estimated to have induced investments from entrants up to 50 times the size of prize purse.3 Evidence from four of our own challenge prizes (Dynamic Demand Challenge Prize, Data Driven Farming Prize, Open Up Challenge and the Longitude Prize) found that participants were willing and able to invest personal funds in order to compete, and were motivated to do so by a variety of perceived monetary and non-monetary benefits.

A range of funding sources were identified by participating teams across the four challenge prizes in support of R&D and innovation efforts, typically including a combination of grant money, venture capital, philanthropic funding, and personal financial contributions. Whilst winning the challenge prize was a primary motivator for participants, multiple other benefits were identified by teams, with the top motivation related to the opportunity to better understand a global problem and have real-life impact with their solution. This diversity of motivations helps explain why teams leverage investment – often at a personal level – to compete.

Attracting further investment to a prize field On the idea that challenge prizes leverage greater additional funding – as participants are able to attract more external funding than otherwise would have happened due to the raised profile, wider platform and visibility to key stakeholders that a prize provides, we are beginning to gather insights to support this claim. Figures taken from Crunchbase – an open-source database of entrepreneurial activity – was used to look at how much investment individual teams raised in the Open Up Challenge before they participated and after they’d been registered onto the prize. The Open Up Challenge was a £5m prize fund backed by the CMA to inspire solutions that use new open banking technology to transform the way small businesses discover, access and use financial services. Available data for fourteen out

2. Newell, R. G., & Wilson, N. E. (2005) Technology Prizes for Climate Change Mitigation, Discussion Paper, Washington, D.C.: Resources For The Future.

3. Schroeder, A. (2004) The Application and Administration of Inducement Prizes in Technology. Golden, Colorado: Independence Institute.

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Attracting investment with challenge prizes

of the twenty participants that took part in stage 1 of the challenge showed that they had received a combined total of £102.7m investment prior to the prize commencing, whilst they collectively went on to secure £638.1m subsequent to taking part in Open Up.4 Data on stage 2 of the Open Up Challenge shows the investment received for ten participants – out of a total number of twelve – in the pre-prize phase totalled £320.7m, and the total post-prize amounted to £288.6m.5 Finally, data taken from the Open Up 2020 Challenge, which finished recently in October 2020, also saw an increase in the external funding received by the fifteen participating teams.

The chart below shows the aggregate investment in teams on the Open Up and Open Up 2020 Challenges, and highlights the positive link with challenge prize participation. Teams that received investment across the three challenges include Funding Circle, Funding Options, Fluidly, Mojo Mortgages and Moneybox.

Stimulating innovation investment 800

600

£m

400

200

0 External investment pre-challenge

Seed-funding and prize money won during the challenge

Open Up Challenge 2017 (Stage 1)

Open Up Challenge 2018 (Stage 2)

Equity and debt funding generated post-challenge Open Up Challenge 2020

To illustrate how this leveraging works in practice, Upside Energy – now KrakenFlex – was one of the entrants to Nesta Challenges’ Dynamic Demand Challenge with the idea of harnessing the energy in back-up power supplies, such as batteries in data centres, traffic lights and electric car charging points, to create a virtual energy store that could be drawn on when needed. It received £10,000 to develop a business plan and prototype and started formally trading 18 months later, in April 2015. By the end of 2018, Upside had raised more than £3 million in grant funding and £6.7 million in equity finance.

4. Crunchbase only converts funding rounds and acquisitions to US dollars, so data presented here does not use exchange rates applicable to a transaction when it was first recorded in the financials.

5. There was some overlap between participants that competed in stage 1 and stage 2 of the Open Up Challenge.

Investment that occurred between the period of stage 1 launch and end totalled £6.03m, of which £3.42m was received by stage 2 participants that also participated in stage 1. Interpretation of the stage 2 investment figures, therefore, need to allow for the benefits some participating teams may have already accrued in stage 1.

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Attracting investment with challenge prizes

Mojo Mortgages, who combine credit scoring and open banking data to help determine a client’s mortgage readiness and offer personalised mortgage recommendations, were one of the winners of the Open Up 2020 Challenge. Mojo Mortgages felt that the prestige of being a finalist, and then winner, led to a wave of positive and high-profile press coverage that helped their brand grow exponentially. They were able to make numerous industry connections that they thought would have been difficult to establish as a start-up, had they not taken part.

Subsequently, RVU, the owners of Uswitch, Money.co.uk and Confused.com, agreed to buy Mojo Mortgages (subject to regulatory approval) with the aim of scaling the business to handle the mortgage enquiries from some of the 15 million users that visit its sites each month.

Increasing our confidence on the leverage effect Qualitative insights from the Dynamic Demand Challenge Prize, Data Driven Farming Prize, Open Up Challenge and the Longitude Prize further indicate that a significant number of innovators were able to secure additional external funding while participating in the prize and subsequent investment thereafter, which was largely attributed to the value added to the business from going through the prize process and the legitimacy conferred to the problem area by the challenge. These findings suggest that innovators were highly committed to working on their solutions post-prize, and were successful in continuing to raise funding to further develop their ideas and to progress their businesses. Participants felt that ‘winner’ status added greater credibility when seeking further funding, whilst greater use of stagegates to signal more interim winners was cited as an approach to help more teams to directly benefit from external funding.

Although these findings are largely supportive of our hypotheses, we recognise limitations of the evidence. Comparing investment before and after the Open Up challenges on boarding is complicated by other factors that were also changing at the same time the prize was taking place. Answering this question more definitively requires the construction of a counterfactual analysis, in order to estimate how innovation in open banking technology for small businesses and related investment would have evolved in the absence of the Open Up Challenge. Nesta Challenges are currently pursuing opportunities to run experiments that test some of our core thinking about prizes – and would welcome connecting with other organisations interested in this area.

Though the evidence is still developing, there is data to suggest that challenge prizes do leverage resources in the pursuit and development of solutions. Challenge prizes can be a mechanism to help teams scale and maximise their impact, and the investment that competing teams receive post-prize can be seen as a demonstration of the real-world success and diffusion of prize solutions.

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Author Vidal Kumar, Evaluation Manager, Nesta Challenges

About Nesta and Nesta Challenges Nesta Challenges exists to design and run challenge prizes that help solve pressing problems that lack solutions.

We shine a spotlight where it matters and incentivise people to solve these issues. We are independent supporters of change to help communities thrive and inspire the best-placed, most diverse groups of people around the world to take action. We support the boldest and bravest ideas to become real, and seed long-term change to advance society and build a better future for everyone. We are part of the innovation foundation, Nesta.

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