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 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 Charles W. Wessner, Ph.D.

The U.S. National Academies NAS 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. NAE IOM NRC Charles W. Wessner, Ph.D.

STEP Recognizes New Challenges to the 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 Charles W. Wessner, Ph.D.

Trends & Anomalies in U.S. R&D Funding Charles W. Wessner, Ph.D.

Trends in U.S. R&D Funding The Good News 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 Charles W. Wessner, Ph.D.

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 Charles W. Wessner, Ph.D.

Trends in U.S. R&D Funding The Really Bad News Real Declines in Federal Obligations for Research FY 1993–1999* *constant, 1999 dollars 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 Charles W. Wessner, Ph.D.

Dynamic Government Response September 11, 2001 New Challenges Real Anger Dynamic Government Response 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 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 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 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. Charles W. Wessner, Ph.D.

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 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 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 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 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. Charles W. Wessner, Ph.D.

Non-Linear Model of Innovation Quest for Basic Understanding New Knowledge Fundamental Ideas Basic Research Potential Use Application of Knowledge to a Specific Subject “Prototypicalization” Feedback: Basic Research needed for discovery Search for new ideas and solutions to solve longer term issues New Unanticipated Applications Applied Research Feedback: Applied Research needed to design new product characteristics Development of Products Goods and Services Development Feedback: Market Signals/ Technical Challenge Desired Product Alterations or New Characteristics Cost/design trade-off Commercial- ization 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 Charles W. Wessner, Ph.D.

Early-Stage Funding Firms Face Multiple Hurdles in Bringing Innovation to Market What are the Main Hurdles? Charles W. Wessner, Ph.D.

Federally Funded Basic Research Creates New Ideas The Valley of Death Early-Stage Funding Gap Capital to Develop Ideas Federally Funded Basic Research Creates New Ideas To Innovation Applied Research & Innovation No Capital Charles W. Wessner, Ph.D.

Branscomb’s Darwinian Sea Business Risks 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 Alternative Business Models Debilitating Legal Proceedings Hostile Acquisitions in the Jungle of Prosperity Charles W. Wessner, Ph.D.

Imperfections in the U.S. Innovation System Early-Stage Finance 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 Charles W. Wessner, Ph.D.

Breakdown of U.S. Venture Capital by Stage of Development-2001 $799 million Total= $41,284 million Source: PricewaterCoopers, Venture Economics, National Venture Capital Association, 2003 Charles W. Wessner, Ph.D.

Breakdown of U.S. Venture Capital by Stage of Development-2002 $302.8 million Total = $21,179 million Source: PricewaterCoopers, Venture Economics, National Venture Capital Association, 2003 Charles W. Wessner, Ph.D.

Important in Early-Stage Funding Average Deal Size Important in Early-Stage Funding 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 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 8-year low Total investments, nationwide, in Q1-2003 is $3.6 billion, down from $4.3 billion in Q4, 2002 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 Charles W. Wessner, Ph.D.

U.S. Policies for Innovation-Led Growth An Entrepreneur-Friendly Environment 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 Charles W. Wessner, Ph.D.

Positive Policy Framework 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 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 Charles W. Wessner, Ph.D.

U.S. Policies for Innovation-Led Growth Government Awards to Spur Innovation-Led Growth: SBIR & ATP Charles W. Wessner, Ph.D.

Programs to Bridge the Valley of Death Uncertainty and Distance to Market Startup: Friends, Families & Fools Strategic research Curiosity research Applied research Seed: Angel Backers The Financial “Valley of Death” The Focus of SBIR and ATP SBIR Procurement ATP Need for Supportive Policy Framework Prototype Product development Commercialisation 1st Round VC 2nd Round VC Capital Allocation Curve Business development Investment Expansion Total Allocated Resources Charles W. Wessner, Ph.D.

Small Business Innovation Research Program 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 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 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 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 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. 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 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 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 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 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 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 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 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 Charles W. Wessner, Ph.D.

Who Wins ATP Awards? For What? 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% 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! 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 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 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 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) Charles W. Wessner, Ph.D.

Conclusions 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 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 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 Charles W. Wessner, Ph.D.

END Charles W. Wessner, Ph.D. http://www.nationalacademies.org/step 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 Charles W. Wessner, Ph.D.