Under what conditions would contests for innovation work?

I came across a blog post here where somebody suggests a simplistic idea for accelerating algorithm development for a particular application. I welcome suggestions abd discussions about the conditions under which such algorithm development contests would work. Consider the following questions.

1. Who would fund the prize money, and why would they fund it?
2. Researchers at what level would be motivated towards the contest [at the level of a research lab]?
3. What would be the resources required to implement a contest like this, and what would be the value addition, if any?