The news last month that two groups of computational researchers have qualified for the $1 million Netflix Prize got me thinking about how other prizes have had a very influential role in technology development. For those of you that missed this nugget, several dozen different computer scientists and mathematicians have tried over the past year to improve upon the algorithms that Netflix uses to recommend new videos to its subscribers. The teams that could get better than a 10% improvement (defined very precisely by Netflix) would qualify to win the prize purse.

This is only the latest in a series of prize-motivated developments. For the past three years, a group of southern California investors have been working on a venture called Prize Capital. The effort grew out of the work of the Ansari X PRIZE Foundation that awarded a $10 million prize in 2004 for the first private spaceflight.

Prize Capital combines old-fashioned greed with socially conscious investing on a grand scale. Their concept is thrilling, with a simple idea at its core. An investment firm creates a fund that will be used to invest in the total field of competitors in a single niche market. The complexity comes about in its execution, which may be why no one has ever tried to do it on the scale that they envision before now. The first prize effort is underway to develop better biofuels.

Unlike traditional venture funds that invest in multiple companies or sector funds that serve particular markets, the prize capital model starts with this “matrix fund”. The genius behind the idea is that this fund drives an entire ecosystem for directing high-return innovations. The largest and most noticeable element is a very public science contest that all of the funded companies take part in, going after a ten million dollar prize purse and racing to be the first to establish a particular invention, task, or medical cure.

The Prize Capital notion is revolutionary and differs from existing venture or sector funds on several different dimensions. First, the combination of the matrix funding model with the prize competition is a brilliant deal-discovery mechanism. The allure of the challenge and the chance to be in the spotlight, not to mention the actual cash prize itself, can help to locate and identify potential technology solutions in a particular market niche. Because the prize is a public one, the bright light of worldwide publicity associated with the contest can help bring about all sorts of benefits to the competing companies, including attracting additional investors and management talent.

Second, “the matrix model permits investors to bet on every horse in the race,” says Lee Stein, one of the founders of Prize Capital and an early leader in the Internet payments industry in the mid-1990s. “A lot of times VCs don’t make investments because they have a short list of companies in a particular niche but can only invest in one. The matrix model enables them to play the full field and spread their risk.”

Traditional venture capital funding is not structured to take positions in direct competitors, while the matrix concept relishes this situation. Prize Capital leverages its relationship with the prize management industry to take positions with everyone in a given field. As long as the competition is attractive enough to cause everyone in a given field to enter a particular competition, the result is a new opportunity for investors to become involved with cutting edge technology. Spreading the investments across the matrix can create additional leverage and reduce the risk of the investors.

A third difference is that Prize Capital will own a royalty stream on the intellectual property generated by the teams in the competition. Even if a given company fails to win the prize, the fund has the ability to succeed.

Fourth, the prize mechanics are important part of the deal, and here is where the groundbreaking work on the Ansari X PRIZE has paid off. These mechanics have to be carefully scripted and innovation targets clearly defined. The competition also requires that the ultimate science must be repeatable and independently verifiable. This was done on the Ansari X PRIZE and is an essential element of any planned future competitions.

The prize is only awarded when a positive report comes back saying everything works. This process is more stringent than that is typically required by peer-reviewed academic journals, the current prestige venue for scientific results. Prize Capital thus could be in an interesting position of being able to set a very high bar here for how basic research is conducted in the future.

While the traditional VC trades capital for equity positions in their portfolio companies, Prize Capital can use other kinds of benefits, including the additional influence from the publicity and activities of the competitors as they work hard to meet the particular goals to win the prize, to secure stakes in the innovation on favorable terms.

Most science competitions have been funded through philanthropic means. Prize Capitalism leverages the large jumps in technology innovation and uses it to fuel an entire ecosystem of investments to take advantage of these innovations.

Look at what happened with the original X PRIZE. That initial $10 million prize purse was leveraged into over $100 million into work being done to develop two spaceports in the New Mexico and Arabian deserts. This isn’t just a lot of dot-com sock puppets or social networking startups depending on ad click-throughs. This is hard-core real estate development, new job creation and engineers building real assets on the ground.

The Prize Capital model has something for everybody. It could bring a ray of hope for many people that are looking at ways to dramatically increase basic research and kick start medical cures. It can co-opt the heavy publicity surrounding the whole prize itself and the take advantage of the spirit of invention and innovation that so often goes hand-in-hand with the best American capitalists. It has universal appeal across nations and cultures too, and can play as well with the new generation of Asian proto-capitalists and with the old crew along Sand Hill Road too. And it has some Hollywood glitz on the order of “American Idol” and yet still appeals to button-down Wall Street bottom-line sensibilities. It is an intriguing mix of investors, capitalists, non-profit charities and philanthropists working hand-in-hand, all in the name of advancing science and fostering innovation. I wish them well and hope to see the fruits of their labors soon. In the meantime, keep your eyes on other prizes.