Dr. Charles W. Wessner

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Dr. Charles W. Wessner
Director, Technology InnovationThe National
Academies of Sciences, USA
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• Advisor, US Congress Executive Agencies
• Adjunct Professor, George Washington University
  University of Nottingham, England Max Planck
  Institute, Germany
• Advisor, OECD Committee on Science and Technology
  Policy
• Advisor, Mexican National Council on Science and
  Technology
• Advisor, Finland National Technology Agency
  (Tekes)
• Advisor, Sweden National Technology Agency
  (VINNOVA)
• Member, Norwegian Technology Forum

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Fostering Knowledge InnovationAn Overview of
the United States Innovation System

• ?
• Innovation Competitiveness Practitioners
  Workshop
• Istanbul, Turkey
• April 19, 2004
• Charles W. Wessner, Ph.D.
• Director, Technology and Innovation
• National Research Council

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The U.S. National Academies
National Academy of Sciences

• NRC Mission
• The NRC is the Operating Arm of the National
  Academies it includes 1300 Staff and a Budget of
  160 Million
• The NRC Mission is the Advise the Government on
  Science, Engineering, and Medicine 270 Reports
  Each Year

National Academy of Engineering
Institute of Medicine
National Research Council
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What is a National Innovation System?

• A network of institutions in the public and
  private sectors whose activities and interactions
  initiate, develop, modify, and commercialize new
  technologies
• Increasingly, governments around the world view
  the development and transformation of such
  systems as an important way to promote innovation
  thus improving the competitiveness of domestic
  industries and services
• Can be better understood as an Eco-system

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Why National Innovation Eco-Systems?

• Eco-Systems Because Innovation Systems Grow and
  Evolve
• They are not constructed by an engineering team
  to reach a fixed point
• The Good News New policies and institutional
  change can help ecosystem to grow in new ways for
  new needs
• Ecosystem characterized by dynamic linkages among
  multiple sub-systems

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National Innovation Eco-Systems

• Ecosystem strengthened through linkages among a
  Nations
• Human Resource base,
• Information Infrastructure
• Universities and Research Institutes,
• A Positive Business Environment
• Enabling Government Policies and Programs
• The Policies drive the System

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U.S. Innovation EcosystemStrengths Weaknesses

• Strong Aggregate Commitments to RD
• Distributed system with multiple paths of Inquiry
  and Trial
• Culture of Inquiry Entrepreneurship
• Entrepreneurship-friendly Business Environment

• Distribution of research portfolio can cause gaps
  shortfalls, and can reduce the impact of RD
  investments
• Political myths about the primacy of markets
  inhibit commercialization mechanisms
• Dominance of Military RD, Capacity Constraints
  Waste lowers return on RD investments

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Presentation Topics

• Trends and Anomalies in US RD Funding
• Strong Aggregate Commitments
• But Linkages to Commercial Realization are less
  robust
• Myths and Market Realities about the US
  Innovation System
• Myth of Perfect Markets mean that Promising New
  Ideas are often not adequately funded
• The Path to Commercialization is Complex
• Sustaining Innovation-Led Growth
• Fostering an Enabling Business Environment
• Government Awards to Spur Growth The SBIR Model
• Innovation Transfer from Universities
• Concluding Points

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Trends Anomalies in U.S. RD FundingThe Good
News and theBad News
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Strong U.S. Commitment to RDShares of Total
World RD, 2001

• Total World RD 746.7 billion
• U.S. share 276 billion
• EU share 187 billion
• Source OECD Main ST Indicators, 2004 AAAS,
  2004
• Calculated using purchasing power parities, Jan
  2004

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Trends in U.S. RD FundingThere is Good News,
butTotal RD is Rising (but Federal RD
Spending is flat)
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U.S. Industry and Federal RD 2000Industry RD
is More Focused on Development than Basic or
Applied Research
Expenditures in Billions of U.S. Dollars
Source AAAS
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More Good NewsPublic Research has Surged in
Health A National Decision to Increase our Bet
Source, AAAS, 2003
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Trends in U.S. RD FundingThe Bad News An
Uneven Record
Changes in Federal Research Obligations for All
Performers and University/College Performers FY
19931999
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The Really Bad News
Random Disinvestment Real Declines for Research
in Physics, Chemistry, Engineering Risk a Lag
Effect
FY 19931999 constant 1999 dollars
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Anomalies in RD Fundingin U.S. Innovation System

• RD Investments in IT-Related Disciplines Dropped
  in Real Terms in the 1990s
• Yet, IT Innovation is the Main Driver of U.S.
  Productivity Surge
• Investments in Biomedicine are Up
• But complementary IT investments are needed to
  capitalize on biomedical progress
• Super Computers needed for DNA Analysis
• Imaging Technologies and Diagnostics rely on IT
  advances
• Multi-disciplinary Approaches, e.g.,
  Bioinformatics are required

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Criticisms of the U.S. Innovation System

• Overall RD Spending is Inadequate
• Insufficient RD investment in the future
• 2 in the 1960snow 0.8 of GDP
• Too Much Concentration on Military RD 52
• Low-utility for civilian economy
• Slow or No spin-out for most RD investments
• Too Much Focus on Health Research at NIH and Not
  Enough on the Necessary Information Technologies
• Surge in Bio-terrorism funding faces capacity
  constraints
• Inadequate Commercialization Mechanisms
• Ideological/political blockages for effective
  programs
• U.S. myths about perfect markets and role of
  venture capital prevent effective policy making
• U.S. programs are too few and under-funded

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Policy Myths Market Realities

• The Myth of Linear Innovation
• The Myth of Military Spin-Offs
• The Myth of Perfect Markets
• The Myth of the Venture Capital Solution

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The Myth of the Linear Model of Innovation

• Myth Innovation is a Linear Process

Basic Research
Applied Research
Development
Commercialization

• Reality Innovation is a Complex Process
• 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
• Technological breakthroughs may precede, as well
  as stem from, basic research

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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

• New
• Unanticipated
• Applications

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

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
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The Myth of Military Spin-Offs

• Euro Myth U.S. Defense Research/Procurement
  Directly Funds Civilian Technologies
• Reality Very few technologies proceeded
  effortlessly from defense conception to
  commercial application.
• Secrecy, military specs, and long lead times slow
  diffusion of new defense technologies
• Billions for Stealth Technologies What civilian
  market?
• Even efforts to use low-cost civilian
  technologies for defense use, i.e., spin-ins,
  are often blocked by complicated military
  procurement system
• Beyond Spin-off, John Alic, Lewis Branscomb, et
  al.

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The Myth of Military Spin-Offs

• Defense Industry Contracted Sharply in Ten Years
  after End of Cold War
• Major American Contractors dropped from 15 to 5
• Industry is detached from mainstream U.S. economy
• Dedicated programs with limited spin-off now
  compounded by long-term, slow moving contracts
• Defense RD Funds Concentrated on Small Number of
  Engineers with Strong Applied Focus
• Issue of scale Intel at 100 Billion value vs.
  top three defense groups combined is 50 Billion
• Spin-Off of Platform Technologies is Diffused
• Semiconductors and Internet applied widely
• Engines and Airframe Spillovers are substantial

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The Myth of Perfect Markets

• Strong U.S. Myth If it is a good idea, the
  market will fund it.
• Reality
• Potential Investors have less than perfect
  knowledge, especially about innovative new ideas
• Asymmetric Information leads to suboptimal
  investments
• This means that it is hard for small firms to
  obtain funding for new ideas

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Reality 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
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The Valley of Death

• A Series of Gaps
• Gap in Available Cash Necessary to develop
  technology to Proof of Principle, Prototype,
  and/or Product
• Gaps in Information between Entrepreneur and
  potential Investor and Partner about
• TechnologyWhat is it?
• Potential of TechnologyWhat can it do?
• Business OpportunityWhat size market?

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The Cash Flow Valley of Death
Adapted from L.M. Murphy P. L. Edwards,
Bridging the Valley of DeathTransitioning from
Public to Private Sector Financing, Golden CO
National Renewable Energy Laboratory, May 2003
Technology Creation
Technology Development
Early Commercialization
Successful
Cash Flow
Cash Flow Valley of Death
Moderately Successful
Time
Unsuccessful
SBIR ATP
Unsuccessful
Federal Agencies, Universities, States
Entrepreneur Seed/Angel Investors
IPO
Typical Primary Investors
Venture Capitalists
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The Myth of U.S.Venture Capital Markets

• Myth U.S. VC Markets are broad deep, thus
  there is no role for government awards
• Reality Venture Capitalists have
• 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

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Sustaining Science-Based Growth Firm Creation
Job Growth
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Basic Research and Small Companies Drive
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
• Basic research is Essential, but not Enough
• Innovations can become Commercial Products
  driving Growthwith the Right Policy Support
• Developing Incentives to spur Innovative Ideas
  for New Products is a Central Policy Challenge
• Small Companies are Key Players

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Importance of Small Businesses to the U.S. Economy

• Small Businesses are a Key Driver of the U.S.
  Knowledge-Based Economy
• Generating 60 to 80 of Net New Jobs Annually
• 2.5 million of the 3.4 million Total
  Jobs1999-2000
• Employs 39 of High-Tech WorkersScientists,
  Engineers, Computer Workers
• Producing 14 times more Patents per Employee than
  Large Patenting Firms
• Patents are of High Quality
• Twice as Likely to be Cited

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Small Businesses

• Grow Jobs
• Generate Taxable Wealth
• Create Welfare-Enhancing Technologies
• Transform the Composition of the Economy,
  Developing Products to Ensure our Well-Being and
  Productivity in the Future

This is Why we Punish Them!
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Challenges Facing Small Firms in the United
States Regulation Finance

• SMEs Face High Regulatory Burdens
• Very small firms (less than 20 employees) spend
  60 more per employee than large firms to comply
  with federal regulations
• New Firms Struggle for Adequate Financing
• Start-Up funds from Friends, Family, and Fools
• Over 80 of small firms in U.S. rely on credit
  but banks hesitate to lend

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VC Markets More Risk Averse
Source PriceWaterhouseCoopers/Venture
Economics/National Venture Capital Association
Money Tree Survey, 2004
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Breakdown of U.S. Venture Capital by Stage of
Development-2001
799 million
Total 41.284 billion
Source PricewaterCoopers, Venture Economics,
National Venture Capital Association, 2003
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Breakdown of U.S. Venture Capital by Stage of
Development-2003
Startup/Seed
354.3 million
Total 18.2 billion
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Why Do Funding Gaps Matter?

• Because Equity-Financed Small Firms are a Leading
  Source of Growth in Employment in the United
  States
• Equity-Financed Small Firms are One of the Most
  Effective Mechanisms for Capitalizing on New
  Ideas and Bringing Them to the Market
• Audretsch and Acs

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Significance of Pubic Support forEarly-Stage
Technology Development
Collapse in Venture Funding Revealed Importance
of Other Sources of Early-Stage Finance
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New Research U.S. Funding Sources for
Early-Stage Technology Development
Multiple Actors Multiple Sources of Finance
Focused on Different Stages Government Role is
Significant
Branscomb Auerswald, Between Invention and
Innovation An Analysis of Funding for Early-Stage
Technology Development, NIST, 2002
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Surprising Role of U.S. 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 Angel investors,
• Corporations, and
• Federal Government
• Not Venture Capitalists!
• Federal Technology Development funds Complement
  Private Funds
• More important than we thought

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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 penalties for failure Gentle Bankruptcy Laws
• Low Regulatory barriers for entry
• Ease of company formation
• Access to early-stage financingvery important
• Pace of activity increases the effective value of
  capital

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U.S. Policy Framework

• Strong but Uneven RD Commitment
• Spending Helps Record funding for federal RD
• FY 2005 RD131.9billion
• DoD RD up 6.7 to 69.9 Billion
• But funding for basic research remains flat
• NIH has doubled over five years to 28.8 Billion
• NSF to increase to 5.7 Billion
• DOE to increase to 8.9 Billion
• DHS rapidly expanding to 1.2 Billion
• Problems with expenditure
• Large increases in RD funding for weapons
  development and homeland defense, but flat or
  declining funding for the rest of the RD
  portfolio
• Focus on military development misstates figures
  and reduces return on RD portfolio

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Positive Policy FrameworkMicroeconomic
Incentives

• Positive Incentives for Entrepreneurs
• Strong Intellectual Property Regime Personal
  Incentive for Invention
• Tax Policy Potential High Returns are the Best
  Incentive for High Risks
• Regulatory Policy Low Regulation for New
  Entrants Lower Cost, Faster to Market
• Labor Flexibility Hire and Fire as Needed
• Firms that Cant Fire, Will not Hire (or Invest)
• Good Goals do not Guarantee Good Policy

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Positive Policy FrameworkIntermediating
Institutions

• Public-Private Partnerships
• Innovation Awards SBIR, ATP
• ST Parks
• University-Industry Clusters
• Industry Consortia

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U.S. Policies for Innovation-Led Growth
Government Awards to Spur Innovation-Led
GrowthSBIR
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Programs to Bridge the Valley of Death
Pre 2002
Uncertainty and Distance to Market
Startup Friends, Families Fools
Strategic research Curiosity research Applied
research
Seed Angel Investors
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
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U.S. Innovation Curve
Post 2002
Uncertainty and Distance to Market
Startup Friends, Families Fools
Curiosity research Strategic research Applied
research
Seed Angel Backers
The Financial Valley of Death The Focus of
SBIR and ATP
SBIR? Procurement and ATP are More Important
Need for Supportive Policy Framework
Prototype Product development Commercialisation
1st Round VC
Capital Allocation Curve
2nd Round VC
Business development Investment
Expansion
Total Allocated Resources
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• The SBIR Program
• Created in 1982, Renewed in 1992 2001
• Participation by all federal agencies with an
  annual extramural RD budget of greater than 100
  million is mandatory
• Agencies must set aside 2.5 of their extramural
  RD budgets for small business awards
• Currently a 2 billion per year program
• Largest U.S. Partnership Program

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SBIR Critical Source of Predictable Funding for
Early-Stage Finance

• SBIRMain Source of Federal Funding for
  Early-Stage Technology Development

SBIR

• SBIR over 85 of Federal Financial Support for
  Early-Stage Development
• SBIR over 20 of Funding for Early-Stage
  Development from all sources

Estimate of Federal Government Funding Flows to
Early-Stage Technology DevelopmentBased on total
funding for ATP, SBIR STTR programs by
Branscomb and Auerswald 2002
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SBIR Model
Social and Government Needs
Private Sector Investment
PHASE III Product Development for Govt
or Commercial Market
PHASE I Feasibility Research
PHASE II Research towards Prototype
RD Investment
750K
100K
Tax Revenue
Federal Investment
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SBIR Goals Vary Among Agencies

• Multiple Program Goals
• Commercialization and Research
• Multiple Agency Goals
• NIH
• Research Tools, Medical Devices, Drug
  Development, and Audio-Visual Health Materials
• DOD
• Special Forces Equipment
• Neural Network Processors for remotely piloted
  jets
• Wireless Communications for Divers
• Low-cost, High-performance Drones

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SBIR Differs Among Agencies

• Multiple Administrative Systems
• Each agency typically has its own manner of
  choosing awardees and screening applications
• Different metrics reflecting unique agency
  missions and needs
• Different Metrics by industrial sector, e.g.,
  software vs. drug development vs. weapon
  components
• Commendable Flexibility Diversity
• Not Harmonization!

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SBIRs Attraction to Policy Makers

• Catalyzes the Development of New Ideas and New
  Technologies
• Capitalizes on Substantial RD Investments
• No Budget Line stable program
• Addresses Gaps in Early-Stage Funding for
  Promising Technologies
• Attractive to Small Firms political support
• Certification Effect government endorsement of
  technical quality

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SBIRs Attraction to Entrepreneurs

• Features that Make SBIR Grants Attractive
  include
• No dilution of ownership
• No repayment required
• Grant recipients retain rights to IP developed
  using SBIR funds
• No royalties are owed to government
• Certification effect for technology/firm

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Contributions of SBIR to the Nation

• Provides a Bridge between Small Companies and the
  Agencies, especially for Procurement
• Contributes New Methods and New Technologies to
  Government Missions
• Provides a Bridge between Universities and the
  Marketplace
• Encourages Local and Regional Growth,
  increasingly through the University connection
• Creates jobs and justifies RD investments to the
  general public

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Contributions of SBIR Concept

• Catalyzes the Development of New Ideas and New
  Technologies
• Capitalizes on Substantial U.S. RD Investments
• Addresses Gaps in Early-Stage Funding for
  Promising Technologies
• Certification EffectGovernment Endorsement of
  Technical Quality

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The Enabling Role of Universities

• A Major U.S. Asset

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University-Industry Cooperation is Key

• Cooperative Research
• University research draws ideas from commercial
  trends more than ever before
• Feedback loops from industry to universities are
  important
• Major contribution to training for real jobs
• Regional Growth
• Regional economies need their research
  universities more than ever before
• Firm Formation
• University innovation early government funding
  have been key to the growth of many successful
  technology companies
• Supportive University Culture Incentives are
  crucial

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How Ideas are CommercializedTransferring
University Technology to Firms
ROYALTIES or EQUITY PAYOUT
SBIR

• Licensing to existing companies brings royalty
  
• New company formation brings royalties and/or
  equity
• Other, less direct, contributions to regional
  economic activity 5,000 Good New Jobs in
  Pittsburgh Area

Drawn from C. Gabriel, Carnegie Mellon University
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The Benefits of University-Industry Cooperation
SBIR Role

• SBIR Innovation Awards Directly Cause Researchers
  to create New Firms
• Jobs and Regional Growth
• Cooperation creates High-Tech Jobs
• Universities help diversify and grow the job base
• Increasingly universities are the largest
  regional employer for all types of employment
• Cooperation validates Research Funding
• Returns to Society in Health, Wealth, Taxes
• SBIR is a proven mechanism in an uncertain game

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Changing Role of Universities

• Their Role is Important and Changing
• Universities Economic Contributions
• Idea Creation Basic Applied Research
• Effective University Leadership and Supportive
  Policies Make Universities
• Poles for Growth of High-Tech Clusters
• Centers for Employment of All Types

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To Make the University a Nexus of Growth

• Requires Real Changes in
• Culture and Values This requires new leadership
  and new incentives
• Status of Professors permissive environment to
  encourage innovations, collaboration with
  industry, and pursuit of innovation awards and
  wealth
• Institutional Practices Parallel research
  institutes with self-select mechanism

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Incentives and Impacts in the U.S. University
Model

• Structure
• Multiple sources of funding
• Different Types of Institutions for different
  needs
• High cost tuition for private schools State
  schools 3,500 to 6,000 per year
• Significant Student funding of studies
• Many needs-based scholarships provided
• Licensing obstacles to technology transfer

• Characteristics
• Curriculum responsive to market needsie,
  industry
• Adaptable, Differentiated programs for students
• High range of student choice
• High percentage of class attendance
  participation
• High percentage of college-age cohort attending
• Globally high returns to RD investments, but
• Analytically suboptimal returns to public
  investments in university research

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Incentives in the European University Model

• Structure
• Centrally managed University budgets
• Faculty are Civil Servants
• Student fees paid by the State
• Centralized State funding
• No University Endowments

• Characteristics
• Curriculum not responsive to market needs nor
  scientific opportunity
• Faculty job security means little incentive to
  innovate
• Low levels of Student engagement dont seek
  moneys worth
• Lack of financial autonomy limits Universities
  flexibility, adaptability accountability
• Fewer new initiatives

65
Consequences of the U.S. Model

• The US system is more demand driven, and
  therefore more adaptable
• Multiple private participants, not state
  controlled
• No single model for higher education
• Transfers allows upward mobility across
  institutions for bright students from different
  socio-economic backgrounds
• Research is often focused on problem-solving
  rather than pure theory
• Tax laws encourage cooperation with industry
• Donations of building and endowments

66
Characteristics of Successful University-Industry
Partnerships

• University-Industry Cooperation involves
• Complementary Objectives, Mutual Respect
• Active, Routine Communication for
  Cross-pollination of ideas
• Growing Perception of University as Major
  Regional Economic Player
• SBIR brings Research out to the Market
• SBIR links Universities, Small Companies, and
  Large Companies

67
Concluding Points
68
Understanding Innovation Ecosystems

• National Innovation Systems are Different in
  Scale and Flexibility
• Flexibility is a differentiator
• It is less how much is spent but how well
• All Systems Have Common Challenges
• Need to justify RD expenditures by creating new
  jobs new wealth
• Need to reform institutions (or invent new ones)
• Need to recognize that project failure does not
  equal program failure
• Linkages strengthen Innovation Ecosystems
• E.g., SBIR draws together small businesses,
  universities, and government agencies

69
Lessons from the US Innovation System

• The US Innovation System is one of the most
  productive in the world
• Its first lesson is its diversity of approaches
  there is no one right answer and no one right
  model
• What we do know is that centrally planned and
  funded technology development programs and
  University systems work less well
• Uniformity of approach is not equality of
  opportunity
• User driven systems are more responsive
• Therefore students industry should be involved
  in decisions and share costs in the cooperative
  efforts of education and innovation

70
Lessons from the US Innovation System

• What does this mean in practice?
• Universities should be allowed to differentiate
  to meet different market needs in training,
  education cooperation with industry
• To do this, universities need financial autonomy,
  incentives to cooperate with industry, and strong
  local rewards
• Awards to industry (and universities) should be
  competitive, limited in size and duration, and be
  performance based

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Lessons from the US Innovation System

• Most important, a powerful institutional
  mechanism, e.g., a Science, Technology, and
  Innovation Council, is often needed to adjust the
  innovation system to new needs, and new
  opportunities, while drawing on best practice and
  encouraging diversity.
• Mechanisms like SBIR can change behavior in
  Universities Labs while addressing the Early
  Stage Funding Gap
• Close cooperation with strong innovation systems,
  e.g., the U.S. and European nation states, should
  be pursued to acquire resources network
  advantages

72
THANK YOU

• Charles W. Wessner, Ph.D.
• Board on Science, Technology, Economic Policy
• National Research Council
• 500 Fifth Street NW
• Washington, D.C. 20001
• cwessner_at_nas.edu
• Tel [phone]
• http//www.nationalacademies.org/step