Panel II
Transitioning SBIR: What Are the Issues for Prime Contractors?

Dr. Gansler, standing in temporarily for the moderator, observed that while the discussion today focused primarily on DoD and NASA—agencies that buy extensively from the SBIR companies they support—the overall National Academies study would also address the programs of the other agencies, which purchase less from their former grantees. For those agencies, he said, the committee would still have to address the question of how to better align the SBIR programs with agency activities.

Moderator:Max V. KidalovSenate Committee on Small Business and Entrepreneurship

Mr. Kidalov began by seconding the remarks of his Congressional predecessor, Mr. Greenwalt, to reaffirm the interest of Congress in the success of the SBIR program in general and in Phase III commercialization in particular. He introduced the panel members and suggested several themes for the discussion. He said Congress was interested in hearing about (1) the challenges and obstacles to integrating SBIR firms and SBIR products into systems and platforms developed by companies, and (2) best practices that had been observed by the panelists. He expressed interest in hearing about minority assistance programs and programs such as the mentor-protégé program, along with any lessons the SBIR program could learn from them. Finally, he encouraged more discussion of intellectual property and its role in the relationship between prime contractors and subcontractors.



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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium Panel II Transitioning SBIR: What Are the Issues for Prime Contractors? Dr. Gansler, standing in temporarily for the moderator, observed that while the discussion today focused primarily on DoD and NASA—agencies that buy extensively from the SBIR companies they support—the overall National Academies study would also address the programs of the other agencies, which purchase less from their former grantees. For those agencies, he said, the committee would still have to address the question of how to better align the SBIR programs with agency activities. Moderator:Max V. KidalovSenate Committee on Small Business and Entrepreneurship Mr. Kidalov began by seconding the remarks of his Congressional predecessor, Mr. Greenwalt, to reaffirm the interest of Congress in the success of the SBIR program in general and in Phase III commercialization in particular. He introduced the panel members and suggested several themes for the discussion. He said Congress was interested in hearing about (1) the challenges and obstacles to integrating SBIR firms and SBIR products into systems and platforms developed by companies, and (2) best practices that had been observed by the panelists. He expressed interest in hearing about minority assistance programs and programs such as the mentor-protégé program, along with any lessons the SBIR program could learn from them. Finally, he encouraged more discussion of intellectual property and its role in the relationship between prime contractors and subcontractors.

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium Richard H. HendelBoeing Corporation Mr. Hendel began with a description of Boeing Corporation. Its largest segment is the Commercial Airplanes Organization, and next in order is the Integrated Defense Systems, created several years ago out of two divisions, Military Aircraft and Missiles, and Space and Communications. The company also has a “Phantom Works” group that performs a large part of the company’s research and development and that initiates engineering technology efforts and new programs. The company manufactures many defense-oriented systems, including military aircraft, transport aircraft, bombers, weapons, space and communications, large-scale, integrated future combat systems, and advanced technology projects. The company functions in many locations in the United States and abroad; the Phantom Works organization is headquartered in St. Louis with personnel in four or five other locations. Phantom Works develops such projects as advanced systems, prototyping, the unmanned combat aerial vehicle, and many exploratory concepts. Long Involvement with SBIR Boeing’s involvement in SBIR dates from the years 1991-1992, before the merger between Boeing and McDonnell-Douglas; since then the joint company’s SBIR activities have been merged as well. Most of Boeing’s interaction with small firms through SBIR has occurred in the Phantom Works (PW) program, which he said had done a good job of supporting them. Boeing personnel were currently working with small businesses on 27 SBIR contracts: 4 in Phase I, 22 in Phase II, and 1 in Phase III. He estimated that over the years, Boeing had worked with nearly 200 SBIR projects. Their interaction included support in the form of follow-on with the companies and tracking the development of their technology. He also participated in national SBIR conferences, such as the recent Navy Opportunity Forum in Reston, Virginia. He said that Boeing’s management had recently decided to increase the emphasis on SBIR. One result of this increase in emphasis, he reported, is that he had been asked two months earlier to increase the time he spends on the program from 25 to 100 percent. Boeing’s SBIR Procedures Boeing had developed its own SBIR procedures. One was to poll all of their technologists and researchers to review the SBIR topics at primarily four agencies—DoD, NASA, Homeland Security, and the National Science Foundation— and report on any that interested them. The office would then assemble a list of those projects and share the list with small businesses, both at conferences and by

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium an external mailing list. The intent is to provide a point of contact at Boeing where small businesses can talk about their interests and those of Boeing, and how they might fit together. The list also helps Boeing track the technologies being developed by the companies. If asked, the company will provide a letter of interest and support for their Phase I and Phase II proposals. Sometimes the companies ask Boeing to collaborate with them, such as when they lack certain facilities or other capabilities. Companies have used the flight simulation labs, for example, and asked for other assistance via a statement of work. Such relationships are advantageous to both parties because Boeing is a potential customer for the technology being developed. The office was trying to track all such involvement, along with the results, and issue to Boeing management a quarterly status or activities report on all interactions with small businesses, including any efforts to advance the program internally. While awareness of the SBIR program was high in the Phantom Works, Mr. Hendel wanted to expand this across the Integrated Defense Systems and its large programs, such as the F/A-18, the Joint Direct Attack Munitions, the C-17s, and the Delta launch vehicles programs. There he had found limited awareness of the SBIR program, and he wants to elicit more involvement from those programs. He mentioned that over the years, Boeing had been involved in submitting topics to the agencies, some of which end up in agency solicitations. The best way to meet technology needs, he said, was to develop more collaboration between the programs, and between the small businesses and the large businesses. He said that both the Multi-mission Maritime Aircraft and Future Combat Systems programs were very interested in having Boeing submit potential topics for them to evaluate as candidates for solicitations. Some Boeing Success Stories He offered some recent Boeing success stories, which reinforced the points that SBIR is not a linear process and that success does require time. First was a Virtual Cockpit Development Program, where Microvision was the prime and Boeing the sub-contractor. They had won Phases I and II awards, an initial Phase III contract was signed in 1999, and additional awards came in 2000 and 2001 from the Army for flight-testing. One goal of the program was to replace all the gauges in helicopters with a helmet-mounted virtual cockpit, and the program had progressed to the stage of flight-testing. Another success was the Advanced Adaptive Autopilot, an Air Force project under the Joint Direct Attack Munitions (JDAM) program. Guided Systems Technology was the prime contractor with Boeing the sub-contractor. Guided Systems worked with Phantom Works to develop this technology so that it could be incorporated into munitions. A third success was the Cruise Missile Autonomous Routing System (CMARS) for the Tomahawk Mission Planning System. Scientific Systems Co.

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium was the prime contractor and Boeing the sub-contractor. Boeing became involved with CMARS from its role as the mission planning system prime on the Tomahawk project, and Boeing had worked with Scientific Systems since 1999 during Phase I and II contracts. This project illustrated the non-linear aspect of development, he said, with Phase II work starting in 1999 and a Phase III award from the Navy not beginning until 2004. Great patience is sometimes required to develop long-term partnerships that pay off. He listed a series of questions that companies need to consider when working with the SBIR program: Is there a champion in the agency who can help from the beginning through insertion and implementation? Does the agency really want the technology, and will it accept it after development? Does the capability offer benefit at a system level? Does the benefit justify the transition costs? Can the prime contractor itself find champions for their programs, and also act as a champion for a technology being developed through Phase I and Phase II awards? Advantages of a Team Approach The funding issues discussed for agencies are relevant for the prime contractors as well, said Mr. Hendel. That is, companies need to find ways to fence off some money that can be earmarked definitely for Phase III projects. This was necessary to develop the technology not only through the Technology Readiness Levels (TRL) 4 and 5, for SBIR Phases I and II, but also to push the TRL higher to levels 7, 8, and 9 so it is ready for insertion into a prime contractor’s program. In consulting with others at Boeing, he had heard suggestions in favor of a team approach in linking the small business, the prime contractor, and the customer early in managing the technology. Such interaction can prevent the isolation of activities in silos and promote collaboration. He said that intellectual property (IP) issues, which concern many participants in SBIR programs, had so far not been an issue for Boeing as it worked with partner companies. The small companies owned the technology, and both companies worked on it. He ended with two points of advice. First, he noted that small businesses with successes in SBIR Phase II did not approach Boeing on a regular basis to inquire about interacting with Boeing programs. Mr. Hendel said Boeing would welcome more such approaches. Second, he noted that a technology can have a negative impact on development logistics when it is inserted inappropriately downstream. He cautioned that this could sometimes be a reason for those working at a logistical support level to resist the insertion of a technology.

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium Mario RamirezLockheed Martin Mr. Ramirez, who is the officer responsible for small business participation on the Joint Strike Fighter (JSF) program of Lockheed Martin, opened his presentation by describing his company as a lead systems integrator and information technology company. Lockheed Martin does 80 percent of its business with the DoD and other U.S. federal agencies, and therefore, he said, “We certainly understand the urgency of establishing a corporate strategy to leverage in the SBIR program.” Currently, Lockheed Martin was in the process of establishing a task force to determine the current levels of SBIR involvement across its five business segments. The initial meeting was due to be held shortly, with the objective of taking the actions necessary to establish and integrate an overall SBIR strategy. He said that SBIR was an important component of the JSF program. To make the SBIR program work, he said, data collection on new programs is critical. This process requires that the customer, the integrated product teams, and the supply chain collaborate to identify needs. These needs, in essence, determine the program’s priorities and long-range needs. A second necessary element is the annual review cycle of technology, which leads to better opportunities to provide feedback in the overall SBIR process. Feedback is critical for both development cycles and integration, he said, and this approach enables the parties involved to align with long-range strategies and technology baselines for technology development. Understanding the Customer’s Needs The company works with both capability roadmaps and technology roadmaps, drawn up by its engineers in partnership with the customer. This process gives Lockheed Martin a better understanding of the customer’s needs, which is critical; enables the development of program priorities; and provides opportunities to integrate SBIR technologies into overall product roadmaps. Drawing up a complete corporate technology roadmap requires that SBIR is part of the picture. The company feels that SBIR awards of significant scope should be brought into product domain working groups and incorporated into the roadmaps, as appropriate. To make successful transitions to Phase III, SBIR technologies must be integrated into an overall roadmap. Among the examples of what is working, he mentioned the Lockheed Maritime Systems and Sensors, which had 10 years of experience working with the Navy and partnering on SBIR technologies. The company planned to take such successes into account when conducting its analysis. Boeing had also had some early successes in the Joint Strike Fighter program, including the award of a Phase III contract for $6 million. They had also done well at integrating their supply

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium chain and had captured an award at a sub-tier supplier for $100,000 plus options. He was proud of these early successes and predicted more. A Need to Improve Procedures At the same time, he saw procedures that could be improved. These included a need for strategic technology portfolios to assess strategic planning and provide clarity on reform acquisition needs. Also needed was better insight into the activities of laboratories, which at times competed with one another. He said that the goal for each laboratory should be to focus on its strengths. Once those are well known, it would be possible to provide a more systematic approach to communicate and share SBIR technologies throughout the company’s engineering community—a critical step in assessing the company’s needs in relation to the topics available. Also, technology transition must be well coordinated and must include the customer, the supply chain, and small businesses. This coordination, he said, should also include advanced technology demonstrations, which should be used to integrate multiple SBIR awards into a complex weapons system. By brokering half a dozen such topics, advanced technology demonstrations could offer significant insight into the challenges of integrating these topics into a major weapons system. Too much leveraging of the advanced technology demonstrations, however, could make programs less risk-tolerant. Sharing Responsibility Another key element was how best to share responsibility. Lockheed Martin’s government partners had many ongoing responsibilities, and SBIR was only one of many tasks. He said that the program could benefit by allowing a prime and/or supplier to share those responsibilities and offer the partnership as a technical point of contact. Another issue that could be improved he called “produceability.” That is, when an SBIR technology is judged to be ready for Phase III, a concern is not only whether the technology is sufficiently mature, but also whether the small business can produce it in the quantity required to sustain production. In addition, does the small business have the capital to make the significant investment required to support production? Finally, although Lockheed Martin had not had difficulties with SBIR partners in assigning rights to intellectual property, the entrance into a Phase III contract would be the time to review any IP issues that need to be addressed. He reviewed several procedures that might be adapted for use in the SBIR program. One was the Navy Advanced Technology Review Board’s process to evaluate across programs to produce more effective transition of new technology. Also, he said he would like to create a version of the Joint Strike Fighter Science

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium and Technology Advisory Board (JSTAB), a high-level S&T board that reviews programs’ priorities. The JSTAB team consists of the program office, the contractor team, and S&T organizations of every service partner. Team members review technologies and establish priorities. He said that during the upcoming business segment analysis, when the company’s five business segments will be evaluated, these two programs would be reviewed for lessons that might be applied to SBIR. Developing a More Strategic Outlook The fundamental challenge to improving the program, he said, was to develop a more strategic outlook. This would include a focus on long-term results, which is not always popular with the small business community. To maximize market impact, small business innovations must be aligned with the needs of government and the prime contractor; doing so can lead to more rapid and collaborative development of new technologies via technology mining. He said that Lockheed Martin had begun to regard this aligning process as an opportunity to engage more small business concerns. This process could be advanced by scouting small innovative research firms at the Navy Opportunity Forum and the DoD Phase II conference, for example, and by a greater commitment to outreach. This outreach should include the company’s small business liaison officers, the technology leads, and business development specialists to produce an integrated effort that can address the concerns of small business. Building a Relationship between Prime Contractors and Small Businesses Lockheed Martin also intended to build more formal business relationships with its small businesses, which are critical to successful Phase III transitions. This process must begin with joint visits to customers when both sides can discuss product discriminators, areas for further investigation and collaboration within Lockheed’s own Independent Research and Development (IR&D) and Cooperative Research and Development Agreement (CRADA) technology culture.27 These relationships would also help integrate the SBIR technologies and 27 The Department of Defense IR&D Program is designed to promote communications between the DoD and industry to increase the effectiveness of independent research and development activities and to ensure effective use of IR&D accomplishments to meet defense needs. A Cooperative Research and Development Agreement (CRADA) is a written agreement between a private company and a government agency to work together on a project. Created as a result of the Stevenson-Wydler Technology Innovation Act of 1980, as amended by the Federal Technology Transfer Act of 1986, a CRADA allows the Federal government and non-Federal partners to optimize their resources, share technical expertise in a protected environment, share intellectual property emerging from the effort, and speed the commercialization of federally developed technology.

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium firms, and allow Lockheed to demonstrate its successes and build formal partnerships. To bring a project to technological maturity, Mr. Ramirez said, it is critical to have adequate funding on hand. When a technology at a TRL of 4 or 5, for example, must be brought rapidly to a 7 or 8 for transition to the warfighter, the contractor needs to be able to deploy a financial incentive rapidly. In summary, he said, Lockheed Martin believes that SBIR collaborations are attractive across the corporation. Initial explorations had created synergies across the five different business segments, and the SBIR task force was seeking to ensure that the necessary support elements are integrated into the strategic plan. This process was evolving, he concluded, with the objective of integrating senior management, mid-management, and operational personnel. This integration is essential because technology acquisitions decisions are made at the intersections of these levels. John P. WaszczakRaytheon Company Mr. Waszczak introduced himself as director of advanced technology and SBIR-STTR at Raytheon Missile Systems (RMS), in Tucson, Arizona. He began by saying that a good deal of consensus had already been built during the conference. He said he would add to the discussion by recounting the process he had followed at Raytheon and some of the lessons that had been learned. Raytheon’s SBIR staff had spent a good deal of time with John Williams of the Navy SBIR program and Douglas Schaffer of the Missile Defense Agency (MDA), attempting to spread the SBIR program across the other services and agencies with which Raytheon worked. He cited a substantial opportunity for not only Raytheon but also for the small business partners who stood to benefit from the $2 billion spent annually on this program. Raytheon, which is divided into seven business units, had 80,000 employees and revenues of $20.2 billion in 2004. In addition to Raytheon Missile Systems, in Tucson, the company consisted of Space and Airborne Systems, Raytheon Aircraft, Integrated Defense Systems, Raytheon Technical Services Company, Intelligence and Information Systems, and Network Centric Systems. One of these divisions, Integrated Defense Systems (IDS), had been working formally with SBIR for about two and a half years. Raytheon Missile Systems had been involved for about one year, and the company was in the process of integrating SBIR relationships across the corporation and corporate offices. His division, Raytheon Missile Systems, was interested in the high-tech capabilities of potential SBIR partners. RMS produces a substantial portion lot of the missile systems procured by the U.S. government and allied nations. RMS products include air-to-air systems, surface Naval air defense, and standard land-to-air missiles, and its activities are classified under areas such as ergonomics,

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium guided projectiles, directed energy weapons, kinetic kill vehicles, advanced programs (Mr. Waszczak’s group), and land combat. Using SBIR to Leverage Emerging Technologies He said that Raytheon was focusing its activities on SBIR and STTR in order to leverage the technology emerging from the DoD portion of those programs (about half the total program value), as well as technology from the other SBIR agencies. SBIR is an integrated part of the company’s strategic plan to enhance supplier diversity; half to two-thirds of a typical program in which RMS participates goes to subcontracts, and more than half of the companies supplying technology to Missile Systems are “small.”28 Raytheon aligns itself with both large and small businesses to ensure that the company is well represented in strategic technologies. Small businesses, he said, represent the “technology engine” of Raytheon and of the country, so that the company needs to develop better ways of integrating SBIR/STTR technologies in order to deliver the best value to its customers. Raytheon sees SBIR as an extension of its R&D program. In Missile Systems, the ratio of development spending to research spending is about 3:1, and a goal is to find and maintain the best balance. While the Technical Director focuses on Internal Research and Development (IRAD), Mr. Waszczak focuses mostly on outside R&D, spending about 90 percent of his time on SBIR or STTR. He is looking for more opportunities for rapid technology development and insertion by establishing long-term relationships with key small businesses and strengthening relationships with customers by helping them get the right technologies to the warfighter quickly. He said that his goal was to better coordinate the activities of the government, the small businesses, and prime contractors like Raytheon. The Need for Integrated Roadmaps To move toward this goal, Raytheon Missile Systems worked with the Technical Director to make sure that an engineer’s technology roadmap includes not just IRAD, but also other areas of R&D, including SBIR and STTR. “That’s very important and critical,” he said. “We’re not funding engineers just to go to IRAD or a program office unless they have an integrated plan and can show how all the pieces fit together.” Each product line vice-president is named a “lead,” including Mr. Waszczak who is the lead for Advanced Programs. The lead’s goal is to interface effectively with the customer on technology roadmaps and to ensure that the company is 28 The Small Business Administration defines a small business as a business employing fewer than 500 people.

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium working on the right technologies. He said that in expanding RMS, the product line leads provide direct links to the program managers in government. The “pull” from program managers or program executive officers is a key to technology development, as well as to effective research. The program offices are backed up by other functional groups, such as engineering. These functional groups drive the execution, based on guidance from the program offices. This organizational system, developed within Raytheon Missile Systems and extended to Integrated Defense Systems, was now being expanded across the rest of the business units. At the corporate level, the vice-president of technology coordinated the leads that had been identified at each unit. He then discussed “key entry points” to the SBIR process, from a prime contractor’s point of view. Raytheon emphasized the entry point of Phase II to form relationships with small firms. But being involved in Phase I and Phase II, while offering near-term opportunities, was not always sufficient, he said. The company must not only discern what is being done now, but also what is about to be done. This stage of proactive involvement he called “Phase Zero,” the time to identify the technologies and projects about to be funded, allowing the company to prepare for future opportunities as well as present ones. (See Figure 16.) FIGURE 16 SBIR key entry points.

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium Benefits of SBIR and STTR to Raytheon He listed many benefits available to Raytheon Missile Systems by working with the SBIR and STTR programs. Among near-term business advantages were the abilities to help program managers solve problems, reduce costs and risks, and find alternative solutions. They worked with the advanced program managers and directors for each product line—the people concerned with tomorrow’s needs rather than just today’s deliveries and customer requirements. Other benefits came from the SBIR’s “phase transition” emphasis where RMS helped small businesses develop new components and worked with new programs to help integrate mission systems. In addition, RMS benefited by exposure to more acquisition candidates. Box A Keys to a Prime’s Success in Leveraging SBIR Technology Effective collaboration between government, small business, and prime. Work with government project managers to achieve “program manager pull.” Make business case through focus on strategic technologies. Show how the SBIR adds value for company. Communicate effectively, internally and externally. Develop streamlined, user-friendly IT processes. Make SBIR part of company and customer tech roadmaps. Identify lead people in each product line. Identify lead people for key technology areas. Show how metrics flow downstream. He showed some of the success metrics he had developed for this conference, with the key metric technology that advances to Phase III. He also focused on technologies that could be considered strategic and those on which RMS worked closely with a small business. One goal was to make sure that Raytheon’s engineer on a particular program was responsible to the program manager within a small business, that the requirements were understood, and that the partners were working in coordinated fashion. For two important metrics—SBIR/STTR technologies leveraged and support contracts from SBIR awardees—RMS goals were exceeded by more than 100 percent. Raytheon had engaged three dozen small businesses in Phase I, two dozen in Phase II and, the key metric, three dozen in “Proposals open,” the threshold to Phase III. Each transition to Phase III would mean creation of a new program and a return on Raytheon’s investment.

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium Making Good Use of Roadmaps Trevor Jones then offered several impressions. First, the program managers in the agencies sometimes served a valuable function as “match-makers” between prime contractors and small firms. At other times, the prime contractors with technology needs might be the matchmakers, finding a capable small business to take to the program managers. Mr. Waszczak said that he has shared some very good exchanges about technology with program offices and Program Executive Office groups. They had then taken the further step of comparing technology roadmaps with that of their primary small businesses to make sure that all three of the organizations were in synch. Mr. Hendel said that Boeing also used technology roadmaps to track the firm’s projects and needs and set priorities for the coming year. He said he knew from his experience with the Multi-Mission Maritime Aircraft Program that programs in his organization worked closely to identify technology needs and topics that could become SBIR projects. Mr. Ramirez said that Lockheed and JSF integrated small business concerns into their overall roadmapping process, opening significant opportunities to SBIR awards. Trevor Jones asked if a subcontractor to an SBIR award winner who has an idea and a product can ultimately become the contractor who sells that product to the agency. In some cases, their work will result in a production product—especially when that organization is the sole source for the procurement. Mr. Williams responded that the Navy had done so with one SBIR company. After the small firm completed Phase II work, the Navy formed a partnership with the firm, which then developed and sold the product on a sole-source contract. He said the Navy’s database had been reviewed and searched for companies to which the Navy had awarded contracts or some type of work. It was not easy to identify all firms in the database that had done SBIR-related work, but the number of such firms appeared to be large. Trevor Jones also asked about first supporting development of a technology to the stage of commercialization, then issuing a request for proposals to learn whether other competitive technologies existed. Mr. Waszczak said that Raytheon, after working with a small business, usually would know that their technology was the best, most cost-effective solution. At the same time, the company would indeed continue to test the marketplace to be sure that this was true. DISCUSSION Mr. Kidalov then invited discussion from the panel members.

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium Incentives for Contracting with SBIR Firms Mr. Kidalov said he had heard that even inside a large company SBIR firms needed a champion, a corporate strategy, and incentives for the company to continue using SBIR firms, even beyond the competitive advantages they provide. He asked whether or not the panelists saw value in a system that would allow for recognition of efforts to contract with SBIR firms, perhaps from Congress and the agencies. Mr. Hendel said that when the agencies award contracts to prime contractors, incentives are built into the contracts. He said it should be possible to offer the prime contractors similar incentives for working with SBIR contractors or development projects. Mr. Ramirez said that incentives are critical to technology transitions, and would stimulate additional competition and more SBIR-type technologies and companies. Mr. Waszczak said that for Raytheon an important incentive would be to streamline and otherwise optimize the SBIR process, which would ensure the development of many technologies needed for the long term. A second incentive would be assurance that customers have realistic plans to support the transition from Phase II to Phase III. Third, companies all have requirements to work with small and disadvantaged businesses, and SBIR relationships would help meet those goals. Mr. Rudolph pointed out that individual business units, like agency program managers, need to see value in what they do, and dislike the risk of new technologies or small companies without a track record. They need incentives and other encouragement to take these risks. Mr. Waszczak repeated from his presentation that metrics are important in any aspect of the business, including measurements across the industry and across the SBIR process. Such metrics might be specific goals for industry, or a more general goal to take SBIR technologies into Phase III. John Williams of the Navy SBIR program reminded participants of the importance of having and implementing incentive and risk-reduction strategies. The DoD, he said, has been promoting spiral development, technology insertion, and similar steps, but he found that funding for technology insertion work was often deleted from acquisition programs when overall program funding is constrained, since both prime contractors and DoD acquisition managers are risk adverse— and new technologies are inherently risky. He asked two sets of questions: Should the review committee recommend that DoD acquisition programs set aside money to perform technology insertion work? How can the DoD measure prime contractors’ Phase III subcontracting activity with SBIR firms, how should the DoD create incentives for this activity, how is technology assessment (“due diligence”) paid for, and

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium how does the DoD ensure that SBIR insertion work is properly budgeted and what steps can be taken to protect those funds? How to Finance Phase III Mr. Waszczak addressed the question of how the government should provide funding to help SBIR firms make the transition from Phase II to III. He advised against tapping the fund of set-aside money, preferring to have program managers realize the value of SBIR activities. Steps to encourage acceptance include basic education about how small businesses can be technology engines for important technologies. Managers also need to realize that it can take three or four years to bring new value, unless a project is on a fast track, and that not all SBIR firms will make it into Phase III. Once managers do see the added value of the program, he suggested, the transition process would begin to take care of itself. The Need to Educate Program Managers about SBIR Mr. Rudolph agreed on the importance of articulating the value of SBIR to the program office and the Program Executive Office. A small company cannot be expected to do this, because it is focused on developing and explaining the technological aspect of its work. He had found it useful to sit down with the technical staff and show them how a technology would be used, which helps the staff to develop the right technology. This, in turn, leads to the buy-in of the program managers and the program executive officers. Mr. Hendel agreed that education for program managers was needed, so that they see the need for the SBIR program and understand how it can improve performance and lower cost. Only then will they develop pools of money that could be utilized on a regular basis for Phase III awards from a prime. He called it “an education process by the government to us, and by us internally, and when we get to a certain point, the processes all fall into place and happen naturally.” A Changing Role for Prime Contractors? Dick Reyes, president of a small technology company, raised the question of changing the environment that had made it possible for the large prime contractors to dominate his market space. He recalled that in 2003, the top 100 DoD firms had 89.9 percent of the total federal R&D budget, with Boeing and Lockheed Martin together accounting for more than half. He asked the group whether they thought it would be desirable and possible to change the contractor environment, or whether this would be blocked by the large prime contractors in their desire to dominate the marketplace. Or, is it the responsibility of the DoD to bring about change? Why would the prime contractors change unless the government forced them to change?

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium Mr. Waszczak said the SBIR program was part of a larger cultural change affecting all three entities—the government, the prime contractors, and small businesses. He said that for most companies, the future would bring more horizontal versus vertical integration. The prime contractors were getting out of the business of building and designing everything. Two-thirds of their costs were now going out to suppliers, and because half of those suppliers were small businesses, the prime contractors were motivated to take advantage of that technology engine and work with them. “We don’t see you as competition 95 percent of the time,” he said. “We see you as enabling technology to allow us to bring the total system to the government.” Mr. Rudolph added that five years ago, Lockheed, Boeing, Raytheon, ATK, and others would not have gathered as they had today to discuss how better to deal with SBIR and small business. Such a dialogue would not have occurred, or it would have occurred only at a governmental level. In addition, he said, having been a supplier to the larger prime contractors, “I can tell you they’re interested in diversifying their supplier base so that one single supplier does not become the single point of failure. I work mightily to get around that attitude, like you do.”

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium Keynote Speech Accelerating Innovation: The Luna Innovation Model Kent MurphyLuna Innovations Dr. Murphy began by saying his firm was in the business of “driving innovations to equity, creating actual corporate value.” His firm had built several successful businesses, has a continuous pipeline of opportunities, and pursued the objective of “accelerating the whole innovation process.” He said that he began his career as a teenager, working as a janitor at an ITT laboratory. While at the laboratory, he was introduced to the nascent field of fiber optics, and by age 19 had learned enough to earn several patents for fiber-optic telecommunications components. Recognizing this talent ITT allowed him to work not only as an inventor, but also to build manufacturing equipment that helped develop these inventions into marketable products. He then earned a degree in engineering at the Virginia Polytechnic Institute and, while completing a master’s program, invented a fiber-optic sensor that was licensed from Virginia Tech even before the university had a technology transfer process. He published a paper, and several large defense contractors began buying the devices. Later, Dr. Murphy and his partners began performing contract R&D work for the defense contractors and then for other Fortune 500 companies. At that point they learned about the SBIR program and won their initial SBIR awards, which helped move their products more rapidly into the marketplace. Reflecting on their business model of moving innovation to the marketplace, Dr. Murphy and his colleagues realized that they did not have to invent everything they needed themselves. They realized that the laboratory shelves of universities and federal laboratories across the county held an undeveloped backlog of interesting technology. They knew that there was a wide gap, however, between those inventions and the ability of university professors and scientists to write business plans and find corporate sponsors or venture capitalists to fund

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium these ideas to commercial fruition. Recognizing this opportunity, they built a network of researchers and developed their company into what is now Luna Technologies. Their work was supported by licenses and patents from products developed through R&D contracts and equity in the spin-off company themselves. Today, Luna today consists of: Luna Technologies. This parent company is headquartered in Blacksburg, Virginia, where it was formed, and has divisions in Roanoke, Danville, Charlottesville, and Hampton Roads, and, most recently, northern Virginia. While the locations in south and central Virginia attracted little venture capital, even during the “bubble days,” the SBIR programs helped the company grow and create hundreds of jobs in rural parts of Virginia where high-technology employment is scarce. The parent company employs more than 135 full-time scientists and engineers who work on contract R&D projects. It also funds 40 to 45 full-time people at Virginia Tech, most of them experts in materials and integrated systems. Dr. Murphy noted that he spent most of his time in what he called the “Luna Triangle,” bounded by Baltimore, Maryland; Blacksburg, Virginia; and Research Triangle Park, North Carolina. This area, he added, supports some $15 billion in federally funded research. About a third is done at the top research universities and two-thirds at federal laboratories. He said that his company had much to offer in moving the worthy technologies produced by that research into commercial products. Luna Innovations. This first spin-off company grew out of a technology developed at NASA Langley. It was brought into Luna Technologies, which combined its own money with an SBIR award to build a prototype technology that was then sold to Lucent. Even with this customer acceptance, Luna was unable to find funding for the model it was building, so it commercialized a simple product for the telecommunications market that the financial community could understand. It raised two rounds of venture capital, totaling $12 million, and built a line of telecommunications products that competed with products from Agilent, JDS Uniphase, and other large companies. Luna Energy. This spin-off is based on a technology that was part of Dr. Murphy’s original master’s thesis. Dr. Murphy and his group steadily developed the technology with early funding from Boeing, Northrop Grumman, and Lockheed Martin. Luna later won SBIR awards from the Air Force to develop strain gauges, and from NASA to develop skin friction balances based on this new technology. Even though NASA products typically have a small market, the skin friction gauges caught the interest of the oil and gas industry because of their potential for use in harsh environments—the high pressures and temperatures of deep wells. These energy companies invested $12 million to build a product line, and eventu-

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium ally bought the organization, named Luna Energy, and located a division in Blacksburg, Virginia. Luna iMonitoring. Founded in 2002, Luna iMonitoring, developed beta prototypes of harsh environment wireless sensors that won SBIR Phase I and Phase II awards from the Navy. While the firm was working to integrate this technology into the Navy, it was acquired by HIS Energy, an information-handling company that is part of a $20 billion European conglomerate. This Luna spin-off, given $2 million in operating capital, $1 million in up-front capital, and a 10 percent royalty stream on the product line, moved into an abandoned warehouse in Roanoke, where it manufactures these products and continues to expand the product line. Luna Analytics. The founding technology for this spin-off was discovered “on the shelf,” this time at Lucent, which had developed it for the telecommunications industry. Luna was interested in using it for life sciences and won SBIR awards to develop and build prototype systems. The products were sold to life sciences companies to study protein-protein interactions, which led to an agreement with a biotechnology firm to keep the company in Blacksburg as it continued to introduce products commercially. While Luna does some basic research, its main emphasis is to tap into federal and commercial markets and use market-driven knowledge to educate the university and federal laboratory partner about potential markets and their needs. It also works with many corporations that have intellectual property that they would like to develop for the market. Luna takes those ideas and tries to fund them through R&D contracts with either federal or commercial partners. After the proof-of-concept stage it seeks additional funding, which is usually supplied by venture capital, corporate partners, or internal investments. (See Figure 17.) Luna’s objective is to accelerate the innovation process in this way; the outcome may be a spin-off, a stand-alone company, a licensing agreement with a bigger partner that has better access to markets, or a product that Luna keeps at the parent company. As the company continues to grow, it accumulates more expertise internally, both at identifying markets and the tech transfer process, including how to raise financing and how to build sales and marketing channels. Dr. Murphy illustrated how his products move through the “technology flow pipeline” from basic research to applied research to prototype to product, by describing several current programs: Flame Retardant Additives. Luna responded to a Phase I opportunity for flame retardant additives by gathering unique data during Phase I that led to a Phase II award and then a prototype. This prototype consisted of a simple composite panel of carbon fiber and resin to which a fireproofing polymer was added. Unlike most flame retardants, which emit toxic smoke

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium FIGURE 17 The Luna business model. when burned, this additive emits only a low-toxicity smoke and is suitable for use with bedding, bed clothing, and other fabrics. Luna nanoWorks. Luna has been working with nano-materials for four years, using a trademarked base molecule called a “trimetasphere.” This is a carbon-80 “cage” with three metal ions and a nitrogen atom at the center. The key to the technology is to place Gadolinium chelates securely inside this cage, which mitigates the reliability and safety problems that have beset current nano-technologies. The company hopes to use this technique to develop a more effective, safe, and durable contrast agent for use in magnetic resonance imaging. Another hope is to achieve the long-sought goal of safe cell targeting to combat cancers and other diseases. Currently, cell targeting has not succeeded because attaching the cell-targeting molecule to the outside of existing contrast agents allows the Gadolinium to remain inside the body long enough to be toxic. Luna has demonstrated the ability to securely attach binding molecules to the trimetaspheres. Dr. Murphy emphasized the value of building not only several successful businesses but, more importantly, maintaining “a great continuous pipeline of

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium opportunities and a way to utilize the research already in the federal labs and the universities and to help them move it into the marketplace more rapidly.” He said that an important tool was the flexibility to use multiple mechanisms for funding, including SBIRs, venture capital, corporate partners, and profits from Luna’s work. In summary, he emphasized the need to pay attention to the whole innovation process, not just segments of it. Within his organization, some people enjoy the research world more than the products world, he said, but in every meeting, Topic A is always “where are we on the research, development, and product pipeline. There’s always a need for basic research, but there’s also a need to make sure we’re pushing all these things toward a market.” This, he concluded, is what is meant by accelerating the innovation process. DISCUSSION Dr. McGrath began the discussion by noting that the role of venture capital had barely come up in the context of SBIR. He noted that several of Luna’s spin-offs had attracted venture funding, and asked whether venture backers had owned more that 50 percent of the company, which would make them ineligible for SBIR. Dr. Murphy said that of Luna’s spin-offs, only one did not qualify for SBIR, but none had actually sought an SBIR award. Once the firms found venture capital or a corporate partner, they had focused on the technology around which they had been formed. He said he had mixed feelings about using venture capital. Small VC firms should not be disqualified from the SBIR process, he said, but he was not sure that the largest investment firms, such as GE Capital, had a role. In such cases, he saw potential difficulties with ownership, control, and organization size. Dr. Gansler said that distinguishing between operating companies that have a venture investment group and those that were “pure” ventures was now under debate, and would be one of the issues addressed in the Academies’ studies. A questioner asked what the panel thought of (1) offering a 20 percent tax credit for angel investing, and (2) changing the fiduciary rules regarding foundations so they could take higher risks on angel/seed capital investments. Dr. Murphy agreed that both suggestions had merit, and said that he supported other creative suggestions for strengthening American innovation, such as tax incentives for purchasing capital equipment. He said that many industries had outdated capital equipment, but felt strong pressure to value their quarterly profits more highly than investing in the company’s long-term future.

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium SBIR as a Factor in Luna’s Success Dr. Wessner asked whether the Luna model was likely to have developed without SBIR support, or ATP support. Dr. Murphy replied, “Absolutely not. There’s no way we would have built the company that we’ve done today, and had the successes that we’ve had, without both the ATP and SBIRs.” He said that he had tried “multiple times” to raise venture capital, but that the only two venture capital investments they received came just at the end of the late-1990s “bubble” days. Since then, he said, the dollars invested by venture capitalists had declined sharply, and venture capital companies were interested only in firms geographically located near their own offices. One venture capital company had expressed interest in investing in Luna’s nano-technology company—provided Luna would move the operation to Silicon Valley. Luna had also had offers to sell operations to companies located outside the United States. Only the SBIRs had allowed them to keep the operations and jobs where they were. The Need for Patience in Developing Technologies James Rudd of the National Science Foundation congratulated Dr. Murphy on his company, which had some NSF funding for magnetic resonance imaging (MRI) work. He asked about the amount of time small business people should expect to spend developing an invention and introducing it successfully to the marketplace. Dr. Murphy said that the time required varied by technology and by market. For example, their development of skin friction gauges took 10 years, from the time of discovery when he was a master’s student to the time it was proven useful in oil wells. From the time the technology was proven useful, it took another two and a half years to complete the sale to oil and gas companies. In the case of the MRI contrast agents, four years of work were necessary to produce amounts sufficient for animal and other testing, and another four years would be necessary to receive FDA approval, produce the product, and generate revenues. Dr. Gansler added that some software products might be developed in 18 months, while a new vaccine might require 18 years. The Innovation Continuum Kevin Wheeler of the Senate Committee on Small Business and Entrepreneurship staff asked for suggestions to increase the number of Phase III awards. Dr. Murphy suggested better use of market-driven research—evaluating market needs, especially in the Defense Department, and communicating those needs rapidly to the researchers. Ms. Wheeler asked if Luna placed greater emphasis on its innovation or on its business activities, and Dr. Murphy said that Luna saw the

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SBIR and the Phase III Challenge of Commercialization: Report of a Symposium two as parts of a continuum, and the company’s mission was to facilitate the entire process. He described a need to sharpen the whole technology innovation process, bringing market information back to the researchers as rapidly as possible and helping to guide them. Even though not all discoveries and inventions end up as products, Luna tries to select the most promising technologies more quickly and reduce the cycle time. Ms. Wheeler also asked whether there was a difference between STTRs and SBIRs in the Phase III stage. Dr. Murphy said that awards differed by agency, and even by individuals within agencies, and changed over time, so a general answer was difficult to give. Dr. Wessner added that Dr. Murphy’s firm is a remarkable example of the interaction of regional strength and federal support. Because it is locally rooted in areas where market funds are not likely to reach, its success owes a great deal to the SBIR program. He also raised the issue of the 20 percent tax credit for angel funding. While this incentive might benefit many small businesses, such as restaurants, few angel investors were attracted to the complex high-tech areas needed to strengthen and revitalize the industrial base and offer high-tech employment. The SBIR and STTR awards are more specifically designed for high-technology firms.