Market shaping

Give me a lever long enough and a fulcrum on which to place it, and I shall move the world.
— Archimedes

The Challenge

The Challenge

Market forces sometimes fail to incentivize innovation for some of our most pressing challenges

Some technologies with high social value have insufficient commercial value, discouraging private investment in research and development. These market failures hinder solutions to global threats such as climate change, pandemics, and neglected diseases.

The Play

The Play

Market-shaping instruments, such as advance market commitments, incentivize and de-risk R&D

In recent years, governments and the private sector have used market shaping to correct for market failures, spurring the development of life-saving COVID vaccines, climate solutions, and antibiotics and restoring America’s leadership in space.

This involves:

  1. Identifying a consequential problem that market forces will not immediately solve.
    For example, many climate solutions have a “green premium.” A public or private customer who is willing to pay the green premium can help drive down the cost through economies of scale and learning by doing, reducing or eliminating the green premium. Another example is innovations that benefit low-income communities, such as vaccines and therapies for Neglected Tropical Diseases.

  2. Crafting a performance-based description of the salient features of an effective solution.
    Defining eligibility criteria at the outset guarantees that winning proposals actually address consumer needs.

  3. Pledging a financial reward, such as a prize, subsidy, purchase order, or series of milestone payments, to one or more teams that solve the problem.
    The promise of future payment activates future markets for yet-to-be-developed solutions, motivating firms to pursue innovation in domains they might otherwise neglect.

The upfront commitment of a financial reward is also known as a “pull mechanism.” The University of Chicago’s Market Shaping Accelerator (MSA) explains:

Whereas “push” funding pays for inputs (e.g. research grants), “pull” funding pays for outputs and outcomes (i.e. prizes and milestone contracts). These mechanisms “pull” innovation by creating a demand for a specific product or service, which drives private sector investment and efforts towards developing and delivering that product or technological solution.

Types of market shaping or pull mechanisms

  • Incentive Prizes typically offer a cash payment to a team that accomplishes a particular goal. DARPA’s competition for autonomous vehicles, for example, has stimulated significant private sector investment in self-driving cars by both new entrants and incumbents.

  • Volume Guarantees, an explicit agreement by buyers to purchase a minimum quantity of an existing product (often matched with a multi-year supply contract that sets the price), can offset manufacturer risk and enable buyers to negotiate lower prices. Volume guarantees have been successfully used by the Bill & Melinda Gates Foundation and other donors to cut the prices for select commodities in half and help increase product uptake (with the Gates Foundation guaranteeing to pay for unmet demand).

  • Advance Market Commitments are commitments to purchase a certain quantity of a product at a given price that meets key performance specifications. This can be used to commit to purchase a product that doesn’t exist yet, which will de-risk private investment in R&D and manufacturing. An AMC for a pneumococcal vaccine has resulted in the immunization of 150 million children, and saved the lives of 700,00 people. Operation Warp Speed negotiated agreements with multiple companies to purchase millions of doses of COVID-19 vaccines, contingent on FDA approval.

  • Advance Purchase Commitments are similar to AMCs, but are agreements with a single supplier as opposed to multiple suppliers.

  • Milestone Payments reward innovators for intermediate progress towards a specific goal. For example, NASA’s partnership with SpaceX was structured as a series of milestone payments for the development of the Falcon 9 rocket, capable of delivering cargo and astronauts to the International Space Station.

  • Challenge-Based Acquisition is an approach that allows government agencies to select solutions on the basis of demonstrated capabilities as opposed to written proposals.

Advantages of market-shaping approaches

Well-designed market-shaping approaches allow the sponsor to:

  • Establish a goal or outcome, while being agnostic as to the team or approach that is most likely to be successful.

  • Increase the number of people and organizations that are working on a particular problem, including non-traditional performers.

  • Stimulate private sector investment, which may result in improved performance, higher volumes, lower prices, and faster rates of improvement.

  • Pay only if a team is successful in achieving a goal.

  • Solve an important “information asymmetry” problem identified by Nobel Laureate Michael Kremer. If the government is providing funding using government grants or contracts, the government doesn’t know whether a given performer is applying for funding because (a) they genuinely believe they have a good chance of being successful; or (b) the government is supporting the R&D. Because market-shaping approaches require that performers make upfront investments, they are more likely to elicit efforts from teams that genuinely believe they can be successful.

Market shaping benefits all parties: funders only pay for successful results, firms can recoup initial production costs, and consumers can more easily afford new technologies.

Case Studies

Case Studies

Market-shaping mechanisms are gaining traction and have already accelerated innovation across multiple sectors.

Pneumococcal vaccine

The pneumococcal AMC, launched in 2007, funded a second-generation vaccine targeting strains prevalent in developing countries, saving an estimated 700,000 lives. The Global Alliance for Vaccines and Immunizations (GAVI) capped prices for the vaccine at $3.50 per dose, guaranteeing affordability. GAVI pledged per-dose subsidies to all firms that presented viable solutions.

View this video about the pneumococcal AMC by Gavi, the Vaccine Alliance.

Chris Snyder, one of the architects of the AMC, spoke to Statecraft about the critical role philanthropic funding from the Gates Foundation played in the success of the AMC:

It was partly a matter of well-placed individuals in these organizations seeing the merits and getting the Gates Foundation and then GAVI interested. Together with the finance ministries of the countries — Italy, the UK, Canada, Russia, and Norway — they built a fund of $1.5 billion. That's orders of magnitude larger than the development programs we tend to see.

Snyder goes on to describe how to factor in social value and development costs for analogous products to price an AMC:

You can try to make some scientific estimates of how many people are dying and ill and how much of that would get mitigated by a vaccine campaign that's rolled out at a certain rate. Getting a monetary estimate there requires valuing a healthy year of life, but there are techniques for doing that. Even if we are conservative, you get some really high estimates of value.

Atmospheric carbon removal

A 2018 IPCC report on our climate future stressed the insufficiency of mere emissions reduction, calling for accelerated atmospheric carbon removal. In response, Frontier launched a $925 million AMC for low-cost solutions. The target product profile has resulted in a technology-agnostic portfolio, establishing offtake agreements for approaches ranging from direct air capture to enhanced weathering.

Nan Ransohoff, Head of Climate and Stripe and Frontier, describes the suitability of carbon capture technologies for market interventions:

The problem comes down to commercial incentives. A market for carbon removal doesn’t exist because the end buyer doesn’t get direct value out of it, unlike, say, paying for energy. Why would an entrepreneur start a company if they won’t have customers? Why would an investor invest in a company with no path to continued revenue?

She proposes three criteria for evaluating whether a challenge would be well served by an AMC:

  1. Those who could develop a solution are blocked by uncertainty around whether there will be a buyer and/or if that buyer can pay enough.

  2. We can (at least partly) describe the end product that would solve the problem, but we don’t know exactly who is best positioned to invent it or how.

  3. Even after a product gets invented, further incentive is needed to bridge the gap to a long-term market.

SpaceX's Falcon 9 rocket

In 2010, NASA applied firm, fixed-price milestone payments to support the development of SpaceX’s Falcon 9 rocket. For an initial investment of roughly $400 million as part of its Commercial Orbital Transportation Services, or COTS program, NASA gained access to a capability that would have cost them between $1.7 billion and $4 billion using a more traditional, “cost-plus” arrangement.

A “cost-plus” contract would have made NASA responsible for any overruns in cost. Through the milestone agreement, the risk was shared. In this case, SpaceX received funding only after reaching specified achievements, such as the delivery of certain amounts of cargo.

In a paper by the American Institute of Aeronautics and Astronautics, Edgar Zapata, formerly with NASA, breaks down the difference between this performance-based approach and traditional methods:

By way of analogy, in a firm fixed price contract NASA pays a person to mow the yard, whereas in a cost-plus contract NASA pays a person to try to mow the yard. Costs are difficult to control in the latter, while the former partnership approach assures everyone is pulling the mower in the same direction.

This partnership propelled the U.S. to a leadership position in commercial launch services. By increasing competition in the market for launch services, it also lowered prices paid by the U.S. Department of Defense.

Watch the Falcon 9 rocket take off.

Potential applications

Potential applications of market shaping

A growing community of technical experts and organizations are exploring how demand-side interventions can help:

There is still abundant untapped potential: MSA’s request for proposals generated ideas for de-carbonized aluminum production, synthetic fertilizers, energy-efficient water desalination, broad-spectrum antivirals, and much more.

Well-designed market-shaping mechanisms typically target challenges that industry would otherwise neglect.

Snyder describes why diseases like Alzheimer’s and cancer are less suitable candidates:

We're typically targeting areas where the social need is great, but the commercial incentives are less so. Those are two cases where the…net present value is almost incalculable, but the commercial incentives are pretty great too.

Identifying problems for market shaping

Aligning on market needs

An effective approach to designing a market-shaping mechanism is to first build consensus around a market need. The development of a Target Product Profile (TPP) is useful in identifying the ideal specifications of a product based on stakeholder needs, including both end users and industry.

How we can help

How we can help

Renaissance Philanthropy’s leadership has a long track record of working on market-shaping. For example, Renaissance Philanthropy CEO Tom Kalil worked to secure DARPA prize authority in the 1990s, and worked with the Senate to give every federal agency prize authority for up to $50M per prize. Agencies have supported over 2,000 prizes.

Renaissance Philanthropy works with a network of partners – including the Market Shaping Accelerator, Luminary Labs, Center for Global Development and Stripe Climate – to help philanthropists and foundations design and implement market-shaping mechanisms and maximize their chance at success. To do this, we:

  • Conduct market analyses, interviewing industry leaders and quantifying market demand to identify opportunities and determine how to incentivize companies to pursue R&D;

  • Collaborate with technical experts to develop a target product profile, outlining the desired performance characteristics of viable solutions;

  • Conduct detailed impact modeling to determine the expected social value of a new technology;

  • Design a market-shaping mechanism, deciding whether to use an advance market commitment, prize, set of milestone payments, reverse auction, or some other strategy; and

  • Manage the market-shaping mechanism by managing stakeholder communication, building funding coalitions, contacting expert teams, and helping evaluate proposals.

Resources

Resources