Milestone Payments

Definition

Milestone payments are staged funding disbursements that reward incremental progress toward an innovation target. Innovators receive pre-specified payment tranches upon successfully achieving key technical or development milestones.

Why might milestone payments be the right funding approach?

Milestone payments are most useful when innovation requires a clear sequence of technical achievements that can be specified in advance. They combine the accountability and incentive alignment of pull funding (conditioning payouts on outcomes, e.g., prizes and advance market commitments) with the regular capital support of push funding (providing resources upfront, e.g., research grants and R&D contracts), making them particularly suited for long-term, multi-stage innovation projects where funders can define the pathway to success.

Milestone payments can help resolve the frictions of pull funding programs by:

• Easing capital constraints: Innovators, especially smaller start-up teams, may struggle to privately finance the research and development of a technologically distant product. Periodic milestone payments provide innovators with crucial working capital as they progress toward a final goal. This is particularly significant because companies typically have a higher cost of capital than public-sector agencies.
• Addressing learning spillovers: Milestone payments ensure fair rewards when intermediate insights benefit others. In situations where breakthroughs are difficult to patent or maintain as proprietary, compensating for intermediate results may be necessary. Milestone payments also provide flexibility to move between innovators, enabling different companies to handle different stages of innovation. Additionally, milestone payments can incentivize the sharing of valuable interim discoveries that benefit the broader field.
• Increasing funding certainty: Funders often face fixed obligation windows, but paying based on outcomes makes it hard to predict the timing. Teams also have a preference for greater funding certainty, especially if they’re worried the funder may renege on their commitments. Milestone payments break the conditional reward into smaller, defined checkpoints, giving funders clearer visibility into when obligations are likely to occur.

Milestones can also protect against the pitfalls of large upfront push funding programs by:

• Incentivizing efficient resource use: Tying payments to progress creates a more substantial incentive to use funds effectively, compared to large upfront grants that lack direct penalties for failing to meet goals.
• Screening out ill-suited teams: Milestone requirements help screen out weaker teams early, as innovators who are unlikely to meet targets often opt not to apply or continue.
• Providing checkpoints for budget management: Funders may prefer to minimize uncertainty about budget overruns by linking payments to progress. Milestone payments create a natural monitoring system in which, at a failed milestone, the funder can consider whether the project is worth continuing.

What can go wrong?

Funders should beware of several failure modes:

• Overly rigid milestones: Rigid milestone specifications may constrain innovation by locking projects into predetermined technical approaches and, potentially, tempting teams to game the metrics, where the team clears the checkpoint without advancing toward the spirit of the program’s goal. Detailed milestone plans may assume more foresight than funders often have.
• High administrative costs: Complex milestone structures can create a high administrative burden and monitoring costs to verify when milestones have been met. However, this added effort can also help filter out weaker projects early, allowing funders to focus resources on the most promising teams.
• Front-loaded participation: Milestone programs may attract participants who are skilled at achieving early technical targets but lack the capacity, expertise, or commitment to deliver the final outcome. This can result in stalled progress and wasted resources in later stages.
• Payment miscalibration: Setting appropriate payment levels requires a deep understanding of both technical and financial aspects of each stage. Programs can mitigate this by asking the proposer to suggest specific milestones and a corresponding cost breakdown, which shifts the program’s challenge to adjudicating the suggestions. Overpaying earlier risks wasting resources on unsuccessful ideas and can attract teams focused on short-term wins. Overpaying later risks not successfully easing capital constraints and spillovers.

To help mitigate these challenges, programs can incorporate regular review cycles, allowing funders to assess progress, adapt requirements, and, if necessary, terminate underperforming projects early.

Examples

Two programs show the range of milestone designs from contractor-specific upfront tranches to open-field staged payments upon completion:

• NASA’s Commercial Orbital Transportation Services (COTS) program: NASA’s COTS program used milestone-based contracts to spur the development of private spacecraft and new launch systems. The milestone contracts for the COTS program provided upfront capital support in company-specific contracts that helped enable less-capitalized companies to participate, like SpaceX in 2006.
• AgResults Brucellosis Vaccine Prize: The Brucellosis Vaccine Prize offers staged payments ($100,000 for the application phase, $1 million for safety and efficacy studies, $20 million for the final prize) to incentivize the development of a vaccine against Brucella melitensis in small ruminants. This program shows how milestones can structure a multi-phase competition with an open field.

Related funding approaches

Rather than always being a standalone policy, milestone payments are often a design element that can strengthen other funding approaches when development pathways are clear but final outcomes are years away. They should usually be considered as a tool to complement other funding approaches:

• Advance market commitments (AMCs): When added to AMCs, milestone payments help bridge long development periods while maintaining the final market incentive. This combination works well for projects like vaccine development, where both technical progress and eventual manufacturing matter.
• Prizes: For grand challenges requiring substantial upfront investment, milestone payments can help capable but capital-constrained participants compete while preserving the incentive effects of the final prize.
• Research grants: To help bridge capital constraints, the payment structure for grants can be built around the completion of milestone payments, as opposed to cost-reimbursement or advance payment.
• R&D contracts: In complex technical R&D contracts, milestone payments create natural checkpoints to maintain accountability and assess developments in the research project while providing regular funding for sustained R&D efforts.

Further reading

1. Enabling US Government Participation in Pull Mechanisms for Social Impact Innovation by Steven Kosiak and Rachel Bonnifield
2. An Assessment of Cost Improvements in the NASA COTS/CRS Program and Implications for Future NASA Missions by Edgar Zapata