Charles W. Wessner, Ph.D. 1 Improving Government-SME Partnerships for the Development of New...

Charles W. Wessner, Ph.D.1

Improving Government-SME Partnershipsfor the Development of New Technologies

The U.S. Small Business Innovation Research Program

The U.S. Advanced Technology Program

6 Countries Programme ConferenceVancouver, Canada

June 6, 2003

Charles Wessner, Ph.D.Director, Innovation and Technology

National Research Council


Presentation • Trends and Anomalies in the U.S. Innovation

System– Trends in U.S. R&D Funding– Responding to September 11– Ambivalence over Support for Industry R&D – Linear and Non-Linear Models of Innovation– Capital Market Imperfections

• U.S. Policies for Innovation-Led Growth– An Enabling Business Environment– Government Awards to Spur Growth– SBIR– ATP

• Conclusions


The U.S. National Academies

• The NRC is the Operating Arm of the National Academies, which includes the Board on Science, Technology, and Economic Policy (STEP)

• The NRC Mission is to Advise the Government and the Nation on Science, Engineering, and Medicine.

NASNAS

NAE IOM

NRC


The National Academies’ Board on Science, Technology, and Economic Policy

STEP Recognizes New Challenges to theU.S. Innovation System

• Post Cold War imbalances in U.S. public and private R&D

• Changing relationships among industry, government, and universities

• Growing recognition of value of partnerships to bring new technologies to market and capture the benefits of heavy U.S. R&D investments


Trends & Anomalies in U.S. R&D Funding


Trends in U.S. R&D FundingThe Good News


Trends in U.S. R&D FundingThe Less-good News

• Private Research is Up• But it is Closer to Market

– Many of the large industrial labs are smaller or gone

• Public Research has Surged in Some Areas yet Dropped in Others

• Important: Support for Public R&D Contributions Has Dropped Relative to the Increased Size of the U.S. Economy


Trends in U.S. R&D FundingThe Bad News: An Uneven Record

-80%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

Com

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Med

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Oc

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phy

Oth

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Biolo

gical scie

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Aero

nautic

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Civil e

ngine

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Environ

menta

l bio

logy

Social scie

nces

Astro

nautic

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Atm

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Math

ematics

Agric

ultu

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Psy

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Metallu

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aterials e

ngine

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Astron

omy

Chem

istry

Physics

Chem

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ngine

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Geolo

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nces

Ele

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Mech

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All performers Universities & Colleges

Changes in Federal Research Obligations for All Performers and University/College Performers FY 1993–1999


Trends in U.S. R&D FundingThe Really Bad News

-60%

-50%

-40%

-30%

-20%

-10%

0%

10% Chemistry Physics

Chemicalengineering

Geologicalsciences

Electricalengineering

Mechanicalengineering

All performers Universities & Colleges

Real Declines in Federal Obligations for Research

FY 1993–1999*

*constant, 1999 dollars


Basic Research Underpins Science-Based Growth

• Basic Research is key in supplying a steady stream of “fresh and new” ideas

• Ideas if effectively transferred to the private sector, can become innovations

• With the right policy support, innovations can become commercial products driving growth

• Basic research is essential, but it is not enough!

• Developing incentives to spur innovative ideas for new products is a central policy challenge


September 11, 2001

New ChallengesReal Anger

Dynamic Government Response


Securing the U.S. Homeland

• $37.7 billion (FY 2003) for Homeland Security– up from $19.5 billion in 2002.

• Department of Homeland Security R&D Budget– $800 million in FY’03– $1 billion in FY’04

• Homeland Security Advanced Research Projects (HSARPA) will be created on DARPA model

• Bio-terrorism R&D portfolio stays in NIH


New Challenges: Countering Bio-TerrorLarge Increases for Bio-terrorism R&D and Facilities at NIAID

Source: Science 21 February 2003


Government Support for R&D in Industry

A Key Element in an Innovation System, but often Controversial in

the United States


Significance of Early-Stage Technology Development

• Early-Stage Technology Development is Important.

• It transforms Nation’s Portfolio of Science & Engineering Knowledge into Innovations.

• New Technologies Generate New Markets and Industries.

• Large Returns to National Economic Capability Can Result from Relatively Small National Investments.


Role of Government in Early-Stage Technology Development

• Markets for Allocating Risk Capital to Early-Stage Technology Ventures are not Efficient

• Most Early-Stage Funding comes from– Individual private-equity “Angel” investors– Corporations– Federal Government – Not Venture Capitalists!

• Federal Technology Development funds can Complement Private Funds– More important than we thought


Estimated Distribution of Funding Sources for Early-Stage Technology Development

Branscomb & Auerswald, Between Invention and Innovation An Analysis of Funding for Early-Stage Technology Development, NIST, 2002


U.S. Policymakers are Ambivalent about Government Support of Industry R&D

• Ideology overstates the efficiency of “the market”– “If it is a good idea, the market will fund it.”– Successful ATP program associated with the Clinton

Administration, therefore opposed by Republicans– This view ignores past achievements as well as current

practices in the U.S. and abroad• Policymakers are most comfortable with “linear model”

of innovation– Many believe that increasing government support for basic

R&D in critical areas will transfer seamlessly to meet national needs

• European Call for 3% R&D Target Adopts a Linear Model


Improving Our Understanding of the Innovation Process

Linear & Non-Linear Models of Innovation

Challenges Small Firms Face in Bringing Innovation to Market


• Major overlap between Basic and Applied Research, as well as between Development and Commercialization

• Principal Investigators and/or Patents and Processes are Mobile, i.e., not firm dependent

• Many Unexpected Outcomes• Linear model omits “feedback loops”, which suggest

that technological breakthroughs may precede, as well as, stem from basic research.

The Myth of the Linear Model of Innovation

Basic ResearchApplied Research

Development Commercialization


Basic Research

AppliedResearch

Development

Commercial-ization

Quest for Basic Understanding•New Knowledge•Fundamental Ideas Potential Use

•Application of Knowledge to a Specific Subject•“Prototypicalization”

Development of Products•Goods and Services

Feedback: Market Signals/Technical Challenge• Desired Product Alterations or New Characteristics•Cost/design trade-off

Feedback:Applied Researchneeded to designnew product characteristics

Feedback:• Basic Research needed for discovery •Search for new ideas and solutions to solve longer term issues

NewUnanticipatedApplications

Non-Linear Model of Innovation


Models of Innovation are Models

• The Real Innovation Process Needs Help– Information is imperfect– So Markets are imperfect– Management Challenges are high

• Yet Potential Social Gains are Great• Government Action can Help


Early-Stage Funding

• Firms Face Multiple Hurdles in Bringing Innovation to Market

• What are the Main Hurdles?


Federally Funded Basic

Research Creates New

Ideas

Applied Research

&

Innovation

Capital to Develop Ideas

No Capital

The Valley of Death Early-Stage Funding Gap

To Innovation


Branscomb’s Darwinian Sea Business Risks

Research & Invention

Innovation: new business

The Struggle of Inventions to

Become Innovations

Research & Invention

Innovation & new business

“Struggle for Life”in a Sea of Technical and Entrepreneurship Risks


Small Firms Actually Face Many HurdlesCrossing the Valley of Death and the Darwinian Sea only

to Arrive in the Jungle of Prosperity

“Valley of Death”

Research &Invention

Innovation: newbusinessViableViable

Business Business

The Darwinian SeaBasic Basic

ResearchResearch

InventionInvention Innovation &New Businesses Must Swim Past:•Management Failure•Technology Obsolescence•Alternative Business Models•Debilitating Legal Proceedings•Hostile Acquisitions

in the Jungle of Prosperity


Imperfections in the

U.S. Innovation System

Early-Stage Finance


Capital Markets are Imperfect

• VC Firms:– Limited information on new firms– Prone to herding tendencies– Focus on later stages of technology

development– Most VC investors seek early exit– Large U.S. venture capital market is not

focused on early-stage firms


Breakdown of U.S. Venture Capital by Stage of Development-2001

Source: PricewaterCoopers, Venture Economics, National Venture Capital Association, 2003

1.93%23%18%

57%

Early Stage Expansion

Later Stage Startup/ Seed

Startup/ Seed$799 million

Total= $41,284 million


Breakdown of U.S. Venture Capital by Stage of Development-2002

Source: PricewaterCoopers, Venture Economics, National Venture Capital Association, 2003

1.43%19%17%

63%

Early Stage Expansion

Later Stage Startup/ Seed

Startup/ Seed$302.8 million

Total = $21,179 million


Average Deal SizeImportant in Early-Stage Funding

$7.2

$8.7

$4.8

$5.4

$5.4

$10.1

$13.2

$4.4

0

4

8

12

16

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

Mil

lio

ns

of

Rea

l D

oll

ars

(20

01

)

Source: PricewaterhouseCoopers/Thomson Venture Economics/National Venture Capital Association MoneyTree™ Survey


Shock and Response of VC Investors Front-End Shock: No New Funding

Young companies have difficulty gaining customers and generating revenues due to the decline in technology spending

Back-End Shock: No Exit- Current financial markets present sobering

valuations and illiquidity- Result: Venture investment dropped 44% in 2002

• 14% drop in healthcare investing• 48% drop in IT products• 60% drop in IT servicesSource: Ernst & Young/VentureOne Venture Capital Survey, January 27, 2003

Venture Capitalists are now more risk-averse – Fewer seed and first round investments

Source: Ernst & Young/VentureOne Venture Capital Survey, January 27, 2003


“Venture Capital Outlook Remains Bleak”The Washington Post, May 5, 2003

• Since peaking in early 2000, VC investment has plummeted for 12 consecutive quarters

• The number of new companies being financed is at an 8-year low

• Total investments, nationwide, in Q1-2003 is $3.6 billion, down from $4.3 billion in Q4, 2002


Capital Market Challenges

• Institutional Role of Venture Capital in Early-Stage Finance is Limited

• Growth in Average Deal Size Works Against Small Firms

• Increased Risk Aversion by Institutional Investors Works Against New Innovations, especially those in small firms

• Government Support for R&D partnerships is effective—but no policy consensus


U.S. Policies for

Innovation-Led Growth

An Entrepreneur-Friendly Environment


U.S. Entrepreneurial EnvironmentA Key to Knowledge-Based Growth

Sources and Limitations

Drive for Ownership: High Rates of Business Formation High Social Value placed on business success

Low Regulatory barriers for entry• Ease of company formation• Pace of activity increases the effective value of

capital• Access to early-stage financing—very important

Deep and Diverse capital Markets = Access to Capital• Substantial Growth in VC Funding, very rapid in late

1990s• Substantial Contraction since 2000—trend now

negative


Positive Policy Framework1. Microeconomic Incentives for an Entrepreneurial

Environment• Intellectual Property Regime: Incentive for Invention

• Tax Policy: Incentive for High Risks

• Regulatory Policy: Low Regulation for New Entrants

• Labor Flexibility: Hire and Fire as Needed

2. Public-Private Partnerships• Innovation Awards

• Industry Consortia

3. Growing Role of Universities as Innovators & Investors• Enabling Policy Framework with Incentives for Professors and

Universities

• Universities are (or have to become) more agile, more flexible, more diverse to encourage commercialization

• S&T Parks growing in importance


U.S. Policies for Innovation-Led Growth

Government Awards to Spur Innovation-Led Growth:

SBIR & ATP


Programs to Bridge the Valley of Death

Total AllocatedResources

Uncertainty and Distance to

Market

Prototype

Product development

Commercialisation

Strategic research

Curiosity research

Applied research

Capital Allocation Curve

The Financial “Valley of

Death”The Focus of

SBIR and ATP

Seed: Angel Backers

Expansion

1st Round VC

2nd Round VC

Business development

Investment

Startup: Friends, Families & Fools

Need fo

r Supp

orti v

e

Poli cy

Fram

ew

ork

SBIR Procurement

ATP


The SBIR Program

Small Business Innovation Research Program

• Created in 1982, Renewed in 1992 & 2001• Participation by all federal agencies with an annual

extramural R&D budget of greater than $100 million is mandatory– Agencies must set aside 2.5% of their R&D budgets for

small business awards– No budget line, No budget debate

• Currently a $1.6 billion per year program– Largest U.S. Partnership Program

• Common 3-Phase Structure Across Agencies – Variation within Agencies based on Mission


SBIR: 3 Phase funding approach:Phase I or Feasibility Phase

• Competitive award of limited federal research funds for short term investigation of scientific merit and feasibility

• Up to $100,000 in funding• Normally up to 6 months to complete the first

phase• Highly Competitive—only 12 to 14% of submitted

proposals receive Phase I awards


SBIR: 3 Phase funding approach:Phase II or Prototype Phase

• Selection emphasizes research projects with strong scientific merit as well as strong commercial merit

• Maximum award level of $750,000– Sometimes more, e.g., for drug development– Typically restricted to two years for completion– Still Competitive

• Only 40% of Phase I of firms receive Phase II awards


SBIR: 3 Phase funding approach:

Phase III or Commercialization Phase

• No Additional SBIR Program Funding– Federal agencies can provide procurement

funds, but the agency must finance Phase III using non-SBIR funds

• Intent: Product development and Commercialization arising from Phase II projects

• Fact: Sometimes Multiple Awards But Usually Not


SBIR differs among agencies• Multiple Program Goals

– Commercialization and Research

• Multiple Agency Goals– NIH is often directed more towards long-term product

development: makes larger awards– DoD is directed more towards product acquisition

and often encourages outside commercial application– Agency Sub-Units have different goals

• From Special Forces equipment to Vaccines to Supply Management

• Multiple, Flexible Management Systems– Each agency typically has its own manner of

choosing awardees and screening applications.


Contributions of SBIR

Catalyzes the Development of New Ideas and New Technologies

Capitalizes on Substantial U.S. R&D Investments

Addresses Gaps in Early-Stage Funding for Promising Technologies

Certification Effect—Government Endorsement of Technical Quality


Contributions of SBIR

Provides a Bridge between Small Companies and the Agencies, especially for Procurement

Contributes New Methods and New Technologies to Agency Missions

Provides a Bridge between Universities and the Marketplace

Encourages Local and Regional Growth, increasingly through the University connection

An Interesting Program; Not Well Understood


The Advanced Technology Program:A Unique Role

• ATP funds high-risk, high payoff technologies beyond capabilities/hurdle rates of individual firms.

• ATP can, thus, act as a countervailing force to “herding” tendencies of venture finance.

• ATP is uniquely positioned to contribute to cross-disciplinary challenges—such as those in genome research

• ATP encourages the formation of partnerships and consortia to encourage technology development and diffusion


ATP Characteristics• Industry-initiated Proposals: Bottom-up Approach• Highly Competitive:

– Rigorous selection process• Independent evaluation of the project's technical merit,

commercial worthiness and potential for broad-based benefits• De-briefing for all non-winners

• Cost Share: All Awards are cost shared with industry—Acts as a Reality Check

• Partnering Encouraged: Dissemination of enabling technologies is key to public benefits and rationale for public support

• Assessment Program is Well-developed– Prove Program Effectiveness


ATP Characteristic: Constant Assessment

• Ex ante: Selection Process• Real Time: Project Monitoring• Post Hoc: Evaluation of Project Impact• Portfolio of Evaluation Techniques• External Objective Assessment

Requests– National Academies


Ex Ante Evaluation• Rigorous Selection Process• Companies Must Prove Need for

Government Support• Social Benefits and Goals

– Spillovers

• Technical Merit– Quality– Feasibility

• Commercial Merit– Business Plan required– Joint Ventures receive more funds


Real-Time Project Monitoring

• Compliance with Regulations?• Progress: Technical Milestones Achieved?• Goals consistent with Award?

ATP STOPS projects that are failingWillingness & Ability to Stop, Drop, & Recommit is rare in public programs


Post Hoc—Follow-up Evaluation

• Impact of award– Technical Goals Achieved?– Additional Funding Obtained?– Sales?– Market Penetration Achieved?

• Social benefits– Savings to Health Care Systems?– Better Outcomes for Patients?– Jobs Retained?

• Indirect Paths to Commercialization


Who Wins ATP Awards?• Small Companies 63% of Awards• Large Companies Valuable Partners• Role of Universities Growing

For What?• Electronics & Computers 38%• Manufacturing 22%• Biotech and Advanced Materials 14%• Information Tech 12%


Results of NRC Assessment

• NRC Found that “the ATP Program works”• NRC Analysis Also Found that the ATP

Needs:– More stable funding– More cooperation with universities

• Result of NRC Analysis:– $200 million restored by Congress– Policy analysis works!


Innovation Awards vs. Tax Credits

• R&D Tax Credits are often too Broad in Application– Cost is too high compared to awards

• Tax Credits Imply Revenue—Small Firms do not Have (Credits Can Help Established Businesses)

• Tax Credit Impact and Additionality Hard to Calculate


Innovation Awards vs. Tax Credits

• Innovation Awards are Targeted on Specific Outcomes: Higher Impact at Lower Cost

• Innovation Awards are:– Powerful through leveraged resources– Conditional: work can be stopped– Industry-driven:

• Less bureaucratic• Closer to market• More “take up” of technologies


Characteristics of U.S. Innovation Awards

• Both SBIR & ATP are Highly Competitive: Many Apply; Few Win Rely on Industry Initiation and Leadership Keep Public Funding Limited in Time and

Amount Have Clear Objectives—ATP more rigorous Employ Regular Assessments & Learning—ATP

only

• Both Play Valuable, if Limited, Roles in the U.S. Innovation System


Awards Help Move Ideas up the Innovation Ladder

• Address very-early-stage financing (SBIR)

• Fund promising new technologies with broad applications (ATP)

• Advance new university-based ideas towards the market (SBIR)

• Draw synergies among universities, small business, and large companies (ATP)

• Attract private funding (SBIR & ATP)


Conclusions


Sustaining Science-Based Growth

• Generating Science-Based Growth is a Major Policy Interest around the World

• Not Enough is Known about Early-Stage Finance

• The Linear Innovation Model Needs Help! – Inputs for more research are not enough (e.g., the

3% R&D target)

– The process of ideas to innovations to products can be improved with awards to small business innovation

• Small business is instrumental in bringing the benefits of university research to the marketplace


Government plays a unique role in partnerships:

• Imperfect Markets Give Imperfect Outcomes• Government-SME Partnerships

– stimulate technology diffusion;– provide conduit to the marketplace for national R&D

investments and stimulate universities; and– help justify further R&D support.

• Regular, Institutionalized Evaluation is Essential– Internal and external evaluation works best


Common Challenges

• National Innovation Systems are Different in Scale and Flexibility

• All Systems Have Common Challenges– Need to justify R&D expenditures– Need to create new jobs– Need for institutional reform– Need to recognize that project failure does

not equal program failure

• Learning from Each Other is a Pathway to Progress


END

Charles W. Wessner, Ph.D.Board on Science, Technology, & Economic Policy

National Research Council500 Fifth Street NW

Washington, D.C. [email protected]: 202 334 3801

http://www.nationalacademies.org/step

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