Improving Government-SME Partnerships
for the Development of New Technologies

The U.S. Small Business Innovation Research Program
The U.S. Advanced Technology Program
6 Countries Programme Conference
Vancouver, Canada
June 6, 2003
Charles Wessner, Ph.D.
Director, Innovation and Technology
National Research Council
1
Charles W. Wessner, Ph.D.
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
2
Charles W. Wessner, Ph.D.
The U.S. National Academies
NAS
NAE
IOM
NRC
• 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.
3
Charles W. Wessner, Ph.D.
The National Academies’
Board on Science, Technology, and Economic Policy
STEP Recognizes New Challenges to the
U.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
4
Charles W. Wessner, Ph.D.
Trends & Anomalies in U.S.
R&D Funding
5
Charles W. Wessner, Ph.D.
Trends in U.S. R&D Funding
The Good News
6
Charles W. Wessner, Ph.D.
Trends in U.S. R&D Funding
The 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
7
Charles W. Wessner, Ph.D.
20%
0%
Mechanical engineering
Electr ical engineering
Geologic al sciences
Chemical engineering
Physics
Chemistry
Astronomy
Psychology
Agricultural sciences
- 40%
Charles W. Wessner, Ph.D.
8
Metallurgy/materials engineering
Universities & Colleges
All performers
Mathematics
- 60%
Atmospheric sciences
Astronautical engineering
Social sciences
Environmental biology
Civil engineering
Aeronautical engineering
Biologic al sciences
Other engineering
Oceanography
Medic al sciences
- 20%
Computer sciences
Percent change
Trends in U.S. R&D Funding
The Bad News: An Uneven Record
Changes in Federal Research Obligations for All Performers and
University/College Performers FY 1993–1999
100%
80%
60%
40%
- 80%
Trends in U.S. R&D Funding
The Really Bad News
Real Declines in Federal Obligations for Research
FY 1993–1999*
Chem istry
Physics
Chem ical
engineering
Geological
sciences
Electrical
Mechanical
engineering engineering
10%
0%
-10%
-20%
-30%
-40%
-50%
All performers
Universities & Colleges
*constant, 1999 dollars
-60%
9
Charles W. Wessner, Ph.D.
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
10
Charles W. Wessner, Ph.D.
September 11, 2001
New Challenges
Real Anger
Dynamic Government Response
11
Charles W. Wessner, Ph.D.
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
12
Charles W. Wessner, Ph.D.
New Challenges: Countering Bio-Terror
Large Increases for Bio-terrorism R&D and Facilities at NIAID
Source: Science 21 February 2003
13
Charles W. Wessner, Ph.D.
Government Support for R&D in
Industry
A Key Element in an Innovation
System, but often Controversial in
the United States
14
Charles W. Wessner, Ph.D.
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.
15
Charles W. Wessner, Ph.D.
Role of Government in Early-Stage
Technology Development
• Markets for Allocating Risk Capital to EarlyStage 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
16
Charles W. Wessner, Ph.D.
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
17
Charles W. Wessner, Ph.D.
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
18
Charles W. Wessner, Ph.D.
Improving Our Understanding
of the Innovation Process
Linear & Non-Linear Models of Innovation
Challenges Small Firms Face in Bringing
Innovation to Market
19
Charles W. Wessner, Ph.D.
The Myth of the Linear Model of Innovation
Basic Research
Applied
Research
Development
Commercialization
• 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.
20
Charles W. Wessner, Ph.D.
Non-Linear Model of Innovation
Basic
Research
Feedback:
• Basic Research
needed for discovery
•Search for new
ideas and solutions to
solve longer term
issues
Quest for Basic Understanding
•New Knowledge
•Fundamental Ideas
Potential Use
•Application of Knowledge to
a Specific Subject
•“Prototypicalization”
Applied
Research
Feedback:
Applied Research
needed to design
new product
characteristics
Development
Feedback: Market Signals/
Technical Challenge
• Desired Product Alterations
or New Characteristics
•Cost/design trade-off
21
New
Unanticipated
Applications
Development of Products
•Goods and Services
Commercialization
Charles W. Wessner, Ph.D.
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
22
Charles W. Wessner, Ph.D.
Early-Stage Funding
• Firms Face Multiple Hurdles in
Bringing Innovation to Market
• What are the Main Hurdles?
23
Charles W. Wessner, Ph.D.
The Valley of Death
Early-Stage Funding Gap
Capital to Develop Ideas
To Innovation
Federally
Funded Basic
Research
Creates New
Ideas
Applied
Research
No Capital
&
Innovation
24
Charles W. Wessner, Ph.D.
Branscomb’s Darwinian Sea
Business Risks
25
Charles W. Wessner, Ph.D.
Small Firms Actually Face Many Hurdles
Crossing the Valley of Death and the Darwinian Sea only
to Arrive in the Jungle of Prosperity
“Valley of Death”
The Darwinian Sea
Basic
Research
Invention
Innovation &
New Businesses Must Swim
Past:
•Management Failure
•Technology Obsolescence
in the Jungle
of Prosperity
•Alternative Business Models
•Debilitating26Legal Proceedings
Charles W. Wessner, Ph.D.
•Hostile Acquisitions
Imperfections
in the
U.S. Innovation System
Early-Stage Finance
27
Charles W. Wessner, Ph.D.
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
28
Charles W. Wessner, Ph.D.
Breakdown of U.S. Venture Capital by
Stage of Development-2001
Startup/Seed
$799 million
18%
1.93%
23%
57%
Total= $41,284 million
Early Stage
Expansion
Later Stage
Startup/Seed
Source: PricewaterCoopers, Venture Economics, National Venture Capital Association, 2003
29
Charles W. Wessner, Ph.D.
Breakdown of U.S. Venture Capital by
Stage of Development-2002
$302.8 million
17%
Startup/Seed
1.43%
63%
19%
Total = $21,179 million
Early Stage
Expansion
Later Stage
Startup/Seed
Source: PricewaterCoopers, Venture Economics, National Venture Capital Association, 2003
30
Charles W. Wessner, Ph.D.
Average Deal Size
Important in Early-Stage Funding
$13.2
12
$8.7
$10.1
8
$7.2
$5.4
$4.4
$5.4
4
$4.8
Source: PricewaterhouseCoopers/Thomson Venture Economics/National
Venture Capital Association MoneyTree™ Survey
31
2002
2001
2000
1999
1998
1997
1996
0
1995
Millions of Real Dollars (2001)
16
Charles W. Wessner, Ph.D.
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 services
Source: 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
32
Charles W. Wessner, Ph.D.
“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 8year low
• Total investments,
nationwide, in Q12003 is $3.6 billion,
down from $4.3 billion
in Q4, 2002
33
Charles W. Wessner, Ph.D.
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
34
Charles W. Wessner, Ph.D.
U.S. Policies for
Innovation-Led Growth
An Entrepreneur-Friendly Environment
35
Charles W. Wessner, Ph.D.
U.S. Entrepreneurial Environment
A 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
36
Charles W. Wessner, Ph.D.
Positive Policy Framework
1. 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
37
Charles W. Wessner, Ph.D.
U.S. Policies for
Innovation-Led Growth
Government Awards to Spur
Innovation-Led Growth:
SBIR & ATP
38
Charles W. Wessner, Ph.D.
Programs to Bridge the Valley of Death
Uncertainty and
Distance to
Market
Strategic research
Curiosity research
Applied research
Startup: Friends, Families & Fools
Seed: Angel Backers
SBIR Procurement
ATP
Prototype
Product
development
1st Round VC
2nd Round VC
Commercialisation
Business
development
The Financial
“Valley of
Death”
The Focus of
SBIR and ATP
Capital Allocation
Curve
Expansion
Total Allocated
Resources
Investment
39
Charles W. Wessner, Ph.D.
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
40
Charles W. Wessner, Ph.D.
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
41
Charles W. Wessner, Ph.D.
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
42
Charles W. Wessner, Ph.D.
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
43
Charles W. Wessner, Ph.D.
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.
44
Charles W. Wessner, Ph.D.
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
45
Charles W. Wessner, Ph.D.
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
46
Charles W. Wessner, Ph.D.
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
47
Charles W. Wessner, Ph.D.
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
48
Charles W. Wessner, Ph.D.
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
49
Charles W. Wessner, Ph.D.
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
50
Charles W. Wessner, Ph.D.
Real-Time Project Monitoring
• Compliance with Regulations?
• Progress: Technical Milestones Achieved?
• Goals consistent with Award?
ATP STOPS projects that are failing
Willingness & Ability to
Stop, Drop, & Recommit
is rare in public programs
51
Charles W. Wessner, Ph.D.
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
52
Charles W. Wessner, Ph.D.
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%
53
Charles W. Wessner, Ph.D.
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!
54
Charles W. Wessner, Ph.D.
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
55
Charles W. Wessner, Ph.D.
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
56
Charles W. Wessner, Ph.D.
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
57
Charles W. Wessner, Ph.D.
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)
58
Charles W. Wessner, Ph.D.
Conclusions
59
Charles W. Wessner, Ph.D.
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
60
Charles W. Wessner, Ph.D.
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
61
Charles W. Wessner, Ph.D.
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
62
Charles W. Wessner, Ph.D.
END
Charles W. Wessner, Ph.D.
Board on Science, Technology, & Economic Policy
National Research Council
500 Fifth Street NW
Washington, D.C. 20001
cwessner@nas.edu
Tel: 202 334 3801
http://www.nationalacademies.org/step
63
Charles W. Wessner, Ph.D.