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An Assessment of the SBIR Program at the Department of Energy (2008)

Chapter: Appendix D: Case Studies

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Suggested Citation:"Appendix D: Case Studies." National Research Council. 2008. An Assessment of the SBIR Program at the Department of Energy. Washington, DC: The National Academies Press. doi: 10.17226/12052.
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Appendix D Case Studies Airak, Inc. Nicholas S. Vonortas Jeffrey Williams The George Washington University March 2005 The Company Established in 1998, Airak is based in Ashburn, Virginia, and is currently focused on the development and commercialization of optical current and voltage transducers. To date, the firm has been granted a total of eight Phase I awards, five Phase II awards, and one Phase IIB supplemental award, from NASA, the National Science Foundation, and from the U.S. Department of Energy. The company’s first major commercialized innovation, a fiber optic electrical current This case is based on primary material collected by Nicholas Vonortas and Jeffrey Williams dur- ing an interview with the owner and president of Airak, Inc., Mr. Paul Duncan. It is also based on preliminary research on the company carried out by the authors. We are indebted to Mr. Duncan for his willingness to participate and his generosity in offering both a wealth of information to cover the various aspects of the study and his broad experience with the SBIR program and with high technol- ogy development in the context of small business. All opinions in the document are solely those of Mr. Duncan. The authors are responsible for remaining mistakes and misconceptions. 165

166 APPENDIX D transducer, has been picked up by the U.S. Navy and other industrial concerns, and completed products are to be shipped to these clients starting in early 2005. Airak was originally conceived as a company that would focus on water q ­ uality monitoring innovations. In fact, their first SBIR award, a Phase I grant, was for a fiber optic remote monitoring system intended to measure dissolved oxygen levels in aquatic environments. Paul Duncan, the founder and owner, was working on his master’s thesis at Virginia Polytechnic Institute at the time he developed the fiber optic dissolved oxygen sensor. He was familiar with the SBIR program through previous employment, and sought a Phase I award in order to get his company up and running. A Phase I award was granted by the DoE, and Airak was quickly formulated to take advantage of the opportunity. Without SBIR, the interviewee doubted that Airak would have been established. While Airak’s original concentration was intended to be water quality moni- toring, the commercialization possibilities turned out to be insufficient to main- tain the firm. Potential buyers were found, but never for more than a few of the dissolved oxygen sensors at one time. As the sensors are relatively inexpensive, a profit margin that would sustain the company could not be maintained. However, the inherent nature of fiber optics, most importantly the insulating effects of the glass inner structure, are well suited to electrical applications. The company began to develop several patents in the area of fiber optic electrical sensors and monitors. In the process, the firm has grown from only having one employee (the interviewee) to five at this point in time. The company now focuses primarily on the electrical end of fiber optic sens- ing and monitoring solutions as there are a wider range of commercial possibili- ties in this area. While water quality monitoring innovations are not currently at the fore, the company goal is to one day be able to innovate and commercially develop their original product types. Funding and Commercialization SBIR grants have been vital to Airak. Not only would the company most likely not have started had the grants not been awarded, but Airak has continued to use Phase I and Phase II awards to keep the company moving forward. Cur- rently, SBIR awards make up 95 percent of Airak’s revenue, totaling $3.7 million. The management, however, is well aware of the problems inherent in long-term reliance on SBIR funding: The successful transfer of products to the marketplace is perceived as the only way for an innovation company to survive and grow in the long term. To that end, Airak is expected to probably seek, at most, two more SBIR grants in the next year. Besides these, the company will focus all of its energies on the commercialization of the core products. Prior to founding Airak, Paul Duncan was employed at another innovation firm. The business model for his previous employer was to rely almost exclu- sively on SBIR grants for long-term growth. At first, the model worked well.

APPENDIX D 167 SBIR grants are intended to help fledgling innovation companies get off the ground. During his tenure at his prior employer, the company grew from four to thirty-five employees.. Engineers were unable to follow-up on Phase II successes because funds were diverted to hiring new researchers who were to bring in new Phase I and Phase II awards, especially as ideas moved outside of the realm of the company’s current knowledge base. The lack of focus, leverage between contracts, and large competition for internal resources became a significant issue for Duncan, and was a significant contributor to his departure. With this earlier experience serving as an object lesson, Airak’s management is reportedly fully devoted to the idea of commercializing products, and relying on future product revenues to grow the company. There is a gap here, though, that makes the transition to commercialization difficult for some firms. Government grants will typically help a company up to the production phase, but not into the marketing phase. Venture capitalists would rather invest in an innovation that has at least some proven track record. The hazards of this funding gap (the “valley of death”), in which an innovation may remain stuck if the company is unable, on its own, to market the product are well understood. To that end, the interviewee com- mented in favor of the ability to devote at least some fraction of the SBIR awards to marketing efforts, though he does understand the government’s reluctance to become involved in the marketing matters of private companies. External, nongovernment funding is considered a very important asset by Airak. One source of support is through the Virginia Tech Intellectual Property (VTIP) contract. While a graduate student at Virginia Tech, Airak’s founder devel- oped the dissolved oxygen sensor that was to earn the company its first SBIR award. VTIP, which owns rights to a related innovation, has licensed the product exclusively to Airak, in exchange for a 2-percent ownership of the company. As the company grows, VTIP will also receive a 2-percent share of the profits. Banks are also more likely to be willing to provide business loans to companies that have received a Phase II grant. The institutions reportedly recognize that a Phase II award is a good indicator of potential marketability of an innovation, and are thus more willing to provide funds that may be used for the commercialization of that product. The SBIR Process As stated earlier, Paul Duncan first became aware of the SBIR program through his previous employer. He was thus well aware of the application and granting procedures when he applied for the Phase I grant that was to serve as the launching platform for Airak. Originally, Airak applied for a Phase I grant from pretty much all of the agencies, hoping that someone would find the dissolved oxygen sensor innovation worth further investigation. Now, however, the company focuses mainly on the Department of Energy and the Department of Defense, especially the Navy, for

168 APPENDIX D SBIR grants. The fiber optic sensor technology in which the company specializes seems to best fit the needs of these two government agencies. And while the appli- cation process itself has not determined agency selection, the interviewee noted very pronounced differences among the various SBIR application processes. For example, the USDA, at least until recently, required several hard copies of the application and had no online functionality. As a contrast, the Department of Defense application process is completely online, and seems to be the most efficient in Airak’s experience. As for the relationship between application cost and award funding, there is not a clear correlation. Even a Phase I award of $100,000 is insufficient to add another engineer or researcher to the payroll. First, few people will accept to work at one location for only six months, or until the Phase II application is ready to go. Second, even if there was a researcher willing to work for such a short stint, it is not likely that this individual could be adequately compensated from the Phase I award monies, as those funds must be divided among other employees, lab space, equipment, etc. Phase II, however, can potentially provide a robust grant, allowing for the long-term employment of one or more additional researchers and engineers. The application is longer for the Phase II awards, but, as noted by the interviewee, the time spent on the application is more than made up for by the potential for a large grant. The cost of applying for a Phase II award is the opportunity cost of missing out on an estimated one or two weeks of product work. Airak has applied to one other federal program, NIST’s Advanced Technol- ogy Program, for funding but has not been awarded a grant. One major change to the SBIR program that Airak would support is addi- tional commercialization assistance. Commercialization being the ultimately desired outcome for SBIR funding, the interviewee noted that for many DoD SBIR grants, there is a built-in buyer, thus decreasing the amount of energy that the awardee will need to put into commercialization. For other agencies, however, there is a much less robust built-in market. Another possible change would be an effort to limit companies from using SBIR as their sole source of funding. Certainly, for those just getting off the ground, the SBIR program will be their major, if not only, source of revenue for some time. But established companies should have to clear some kind of b ­ enchmark—perhaps revenues from previous Phase II products, or at least an active commercialization effort—before they are allowed to apply for future awards. Ideally, this would force more innovations out of the workroom and into the marketplace. There should not be a limit to the overall number of SBIR awards to a company, assuming an effort is made to develop the products. Companies can innovate all the time, and all those innovations should still be encouraged. The Fastlane submission system of the U.S. National Science Foundation was also mentioned in very favorable terms.

APPENDIX D 169 Airak would certainly support an increase in submission frequency from once per year to at least twice per year, which is already a standard at the SBIR program of the U.S. Department of Defense. Technology moves quickly, and future market opportunities can come and go rapidly. If a company were to have a proposal ready one week after the deadline, then for most agencies, they would need to wait nearly a year for the application process to begin. Additionally, combining the SBIR/STTR applications at all agencies would be time and effort saving for the applicants. Regarding the award time frame, it was indicated that the four years from Phase I application to Phase II completion is too long. If there were a way to speed up the process, or at least give the grantee the option to work more quickly, then that could aid in future commercialization efforts. For example, the National Science Foundation requires a business plan to be submitted with a Phase II appli- cation. Future market models, as predicted by the grantee, might be more accurate if the application occurred temporally closer to the commercialization phase. Airak did face a problem with some of the proposal requirements for third- party participation. In their case, the third party wrote a letter of intent that worded the innovation support in too loose of a fashion, prompting the reviewing agency to turn down the application. It was felt that third parties should not have to submit this item, as it is unnecessary to the actual granting of the award. Overall, Airak is very satisfied with the SBIR program. Without the grants, there would most likely not be an Airak today. Additionally, SBIR grants have allowed the company to maintain a steady growth, both in employees and fund- ing, over the last five years. And just as is intended by the program, Airak will soon focus almost all of its energy on commercialization efforts, and limit its application for SBIR awards. Example Innovation from Airak Airak’s most successful innovation to date is the fiber optic electrical current transducer. Working on the Faraday effect, the sensor is designed to provide direct measurements of magnetic field intensity, current, and temperature in moderate to high-voltage environments. Potential markets include naval vessels, in which each ship is a self-contained power plant and electric grid, and civilian power companies, which need current and temperature monitors in environments such as switching stations, transformers, power lines, etc. The electric current transducer earned Airak a Phase II grant from the DoE. Subsequently, the Navy awarded Airak a Phase IIB supplementary award. At present, Airak is set to deliver completed products to the Navy in 2005.

170 APPENDIX D Atlantia Offshore Limited Grant C. Black Indiana University South Bend September 2004 The Company Atlantia Offshore Limited began as a family-run small business located in Houston, Texas. Atlantia was founded in 1979 by husband and wife team, Joe and Pat Blanford. The company was created to provide full engineering services related to the design of shallow-water, low-tech platforms in the offshore oil industry. These fixed offshore minimal-production platforms were marketed to independent gas and oil companies operating in the Gulf of Mexico and North Sea. During the early years of the company, Joe Blanford was Atlantia’s only fulltime employee. As projects required, additional consultants were hired to assist Mr. Blanford. The location of the company in Houston, Texas, was believed to be vital to the success of the company. Houston is the center of the oil industry in the United States, with at least 80 percent of firms that design offshore platforms having operations there. Geographic proximity to these other firms provides close contact to most participants in the offshore industry. This proximity can reduce the costs of marketing to and working with other companies as well as providing access to a large, skilled labor pool familiar with the industry. Atlantia’s initial efforts were successful. The first shallow-water fixed plat- form designed by Atlantia was delivered in 1984, five years after the inception of the company. Since then Atlantia has designed more than 150 shallow-water fixed platforms. These platforms were constructed for approximately $2 million per platform. As Atlantia gained success in the shallow-water market, it began to recognize a need in the deep-water segment of the industry. A recurring problem faced the industry: No viable cost-effective technolo- gies existed to probe small fields for oil discoveries and pump them for produc- tion. Leases on these fields frequently expired with little or no activity on them. This motivated small oil enterprises to move into deeper water which was less competitive. Traditional deep-water platforms, however, are more expensive than shallow-water ones and were unviable for many small fields. To explore its poten- tial for addressing this issue, Atlantia contacted Steve Kibbee. Kibbee, with a This case is based on an interview with Steve Kibbee, vice president of technology at Atlantia Offshore Limited. All opinions expressed in this report are solely those of Mr. Kibbee. Sincere thanks are expressed to Mr. Kibbee for his enthusiastic willingness to participate in this study.

APPENDIX D 171 history of deep-water research at large oil companies including British Petroleum, Texaco and Shell, was involved in early conceptual research on new discoveries. Kibbee joined Atlantia in 1990; the company employed approximately ten people at this time. Beginning in the early 1990s, Atlantia began research that would shift the focus of the company away from shallow-water to deep-water engineering ser- vices. In 1992 the company received a patent for its SeaStar® tension leg platform (TLP). By this time, Atlantia had expanded further, employing approximately 15 people. This new technology was designed to increase efficiency and reduce cost compared to existing technologies. The SeaStar® TLP can be adapted to wet- or dry-tree applications, is vertically moored to minimize the vertical heave and horizontal roll and pitch of the platform, has a monocolumn hull that can be built to any size, is modular by design so that production can take place at any fabrication facility or shipyard, and does not require the use of an expensive derrick barge for installation. These innovations in the SeaStar® TLP provided a new platform mechanism that substantially reduced the cost of developing small oil fields in deep water, allowing new development of fields that otherwise would not have been developed. After the introduction of the SeaStar® TLP, Atlantia focused its marketing to relatively small European oil companies with undeveloped fields in the Gulf of Mexico. U.S. oil companies were initially hesitant to explore this new tech- nology, so Atlantia quickly targeted its efforts to the more receptive European market. Sales soon followed. Atlantia completed installation of the first wet-tree SeaStar® TLP in 1998 for Agip’s Moreth oil field. Trust in Atlantia’s abilities based on previous shallow-water efforts was instrumental in securing this first sale of its innovative deep-water platform. Additional sales quickly followed. Agip purchased a second wet-tree SeaStar® TLP for its Allegheny field that was installed in 1999. Chevron Texaco purchased a wet-tree SeaStar® TLP for its Typhoon field that was installed in 2001. In 2001 the French company, TotalFinalElf, selected the SeaStar® TLP for its Matterhorn field in the Gulf of Mexico. TotalFinalElf desired nine dry-tree TLPs to develop this field. The first dry-tree SeaStar® TLP, which was much larger than the previous platforms, was installed in 2003. This platform was also the first platform project in the Gulf of Mexico purchased under a fixed-fee basis. This lump-sum fee covered all costs including production, installation, and accompanying services. To successfully manufacture and install these platforms, Atlantia needed a far broader range of skills than the current small number of employees could provide. Therefore, Atlantia rapidly expanded its staff to over 100—including additional managers, drafters and engineers—and heavily subcontracted the fab- For detailed information on the SeaStar® platform, visit Atlantia’s Web site at <http://www.atlantia. com>.

172 APPENDIX D rication process to other companies. Based on the experiences of these early installations, Atlantia has developed a flexible employment process. Atlantia maintains a core staff of approximately 15-20 employees necessary to optimally maintain its operations. Atlantia’s core staff encompasses expertise in metocean, naval architecture, process facility, riser design and integration specialization, fabrication, and installation. Over 50 percent of Atlantia’s employees hold a masters or doctoral degree. Employment is temporarily expanded as needed for large ­projects, with substantial use of subcontracting for areas of expertise and capabilities outside Atlantia’s scope. The SeaStar® technology has allowed Atlantia to provide a cost effective alternative for the development of relatively small oil fields in deep water. The SeaStar® TLP provides an efficient, low-cost mechanism to develop fields that would otherwise not be. The efficient design, production methods, and installa- tion processes used for SeaStar® TLPs have also translated into the shortest time between project initiation and tapping the first oil from a new platform—only 21 months on average. After installation of its platforms, Atlantia continues its relationships with customers by providing custom services for the maintenance and efficient performance of its platforms. Atlantia believes these ongoing ser- vices strengthen important customer relationships and provide data to improve its research on existing and potential technologies. Given the success of the SeaStar® technology, Atlantia found itself as a small company trying to sell a big product to big companies. While successful, Atlantia recognized that it could benefit from help in marketing on a grander scale in the international market. Atlantia’s owners decided to sell the company to IHC Caland. IHC Caland is a Dutch holding company comprising companies broadly involved in marine technology. This group specializes in offshore oil services (including floating production systems), dredging, and shipping. Atlantia continues to operate relatively independently and has partnered well with sister company, Single Buoy Moorings (SBM), to market on an international basis by drawing on SBM’s extensive marketing and sales operations. The strength of this merger is that Atlantia can benefit from the larger scale and scope of resources of the parent company, particularly access to finances, greater market presence, resources, and other technologies. Atlantia’s expects an optimistic future for the company, with sales and overall growth of the company predicted to continue to rise. For instance, Atlantia currently has a contract to build and install the world’s deepest platform (approximately 8,200 feet). It has recently completed its fifth platform and has proposals for three to four more new platforms in the near future. DoE SBIR Experience Atlantia is an exception compared to most companies that have participated in the SBIR program. Atlantia pursued funding for only one research project—the

APPENDIX D 173 SeaStar® technology—which resulted in receiving one Phase I award and one Phase II award. This project was funded through the DoE SBIR program. Atlantia has not pursued SBIR funding from any other agencies. Atlantia first became aware of the SBIR program in 1990. Steve Kibbee saw a brochure about SBIR at an oil industry trade show. After gaining interest in learning more about the program, Kibbee attended an SBIR informational confer- ence. Given its involvement in the oil industry, Atlantia believed DoE would be the most appropriate possible fit for its research activities. Atlantia investigated the solicitations from DoE’s SBIR program but believed none of the solicited topics easily fit its ideas developing around tension-leg platforms. However, given the small size of the company and the steady business generated from its shallow-water products and services, Atlantia decided to apply to the SBIR program in an attempt to raise much needed financial support for its changing research direction. With no background in the SBIR application process and no help from exter- nal sources, Kibbee virtually single-handedly prepared Atlantia’s SBIR Phase I application, which was submitted in fall 1990. According to Kibbee, the company faced considerable difficulty trying to maintain its responsibilities and work on the SBIR application, let alone allocating the necessary time to work on the SBIR research once the project was funded. Kibbee estimates that he spent at least one calendar month of time preparing the Phase I proposal. Atlantia was awarded a Phase I grant for its SeaStar® technology and continued on this research through 1993 at the completion of its successive Phase II award that continued this research. It received the Phase II grant from DoE in 1991 as part of DoE’s “early award” Phase II process. Kibbee found the Phase II proposal significantly more difficult and time consuming to prepare compared to the Phase I proposal. He estimates that approximately two calendar months of work time were devoted to this proposal. The transition between Phase I and Phase II went smoothly. Atlantia faced no significant disruption in its SeaStar® research between phases. A challenge, though, was the time needed to develop sufficient results from Phase I to use in justifying its Phase II proposal. While time was needed to prepare proposals, especially given the company’s inexperience with SBIR, Atlantia found participation in the SBIR program to be surprisingly straightforward and simpler than other types of research funding, such as acquiring funds in the private sector and other government programs. After receiving its SBIR awards, DoE sent checks for the amount of the awards and required little oversight. Atlantia benefited from this speedy, loose format; however, Kibbee recognizes that this lack of strict supervision could generate incentives for abuse of the SBIR program. Kibbee also strongly recommends that SBIR solicitations, at least from DoE, be more broadly defined to allow greater According to Kibbee, the solicitation topics focused on natural gas issues.

174 APPENDIX D flexibility for firms to connect their research to DoE’s interests. As Kibbee point- edly remarked, Atlantia “almost did not do a proposal” because of feeling like its SeaStar® research did not seem to fit a published solicitation topic. SBIR funding was vital to the success of the development of Atlantia’s ­ eaStar® technology. Kibbee adamantly argues that the SeaStar® research would S not have occurred without SBIR funding. At that time, Atlantia had approxi- mately ten employees and the level of work from the shallow-water projects required considerable efforts from this small staff. Without financing through SBIR, Kibbee does not believe that Atlantia could have sufficiently diverted engineers involved in the developing SeaStar® research from other duties—and without their involvement this research would not have succeeded. Near 1990, SBIR funding contributed approximately 50 percent to Atlantia’s research fund- ing. The SBIR awards alone provided at least 1-2 months of revenues that were instrumental in keeping necessary staff employed. Atlantia also benefited from commercialization-stage initiatives in DoE’s SBIR program. Atlantia utilized Dawnbreaker, who is contracted to help SBIR firms at the commercialization stage. Dawnbreaker frequently helps firms develop business plans to commercialize their SBIR research, but Atlantia required other services as it tried to commercialize its SeaStar® technology. According to K ­ ibbee, Dawnbreaker proved “tremendously helpful” in Atlantia’s initial nego- tiations with British Borneo. This highlights the usefulness of providing flexible services to SBIR companies in trying to commercialize outcomes from their SBIR research. SBIR Outcomes Atlantia is an exemplary case of what the SBIR Program was envisioned to achieve. SBIR provided necessary short-term funding so that innovative research with significant commercial potential could be realized. The Department of Energy touts Atlantia as an SBIR success story, evidenced by its inclusion in the handful of companies listed on DoE’s Web site as SBIR successes. Atlantia had minimal participation in the SBIR program—one Phase I and one Phase II award from DoE—but directly developed a commercial product from this SBIR sponsored research that quickly reaped substantial returns. According to ­Kibbee, before the SeaStar® technology created through its SBIR research, Atlantia earned approxi- mately $10 million in revenues and employed approximately ten people. After the early commercialization of this technology, revenues jumped to $100 million and employment rose to over 100. This research rapidly transformed the direc- tion of the company, shifting it away from its previous focus on ­shallow-water operations to deep-water TLPs. In addition, the SeaStar® technology developed 6Note that this perception of topic solicitation is based on Atlantia’s limited experience with the SBIR Program in the early 1990s.

APPENDIX D 175 through SBIR research opened the door for innovations in Atlantia’s shallow- water business. Revenues related to the first four SeaStar® TLPs alone exceeded $500 million for Atlantia. Moreover, the accompanying new services provided by Atlantia for these platform customers yield approximately $100,000 in increased revenues per platform. This can more than triple if unforeseen difficulties require more complex services. Along with ongoing services, Atlantia has developed new products related to its SeaStar® technology that also provide revenues. For instance, Atlantia has recently developed a $2 million riser that is nearly ready for its first order for the Matterhorn platform. These financial returns not only have been captured by Atlantia but have also benefited the federal government. The U.S. government receives royalties from the oil production. The new platforms that tap into oil fields that would have otherwise not been developed yield real net gains in revenues for the U.S. government. It is estimated that the existing SeaStar® TLPs installed by Atlantia generate at least $100 million per year for the U.S government. These revenues from increased oil production will only climb as fields continue to be developed using Atlantia’s SeaStar® technology. The commercialized products and services resulting from Atlantia’s SBIR research has yielded beneficial outcomes outside of revenues. Approximately four patents were granted directly from the SBIR research, including Atlantia’s first successful patent. More than 100 foreign and U.S. patents have been granted to Atlantia based on its deep-water technologies that directly or indirectly stemmed from the initial SBIR research in the early 1990s. Atlantia has even patented designs to protect ideas for potential markets that have not developed yet. Moreover, 20-30 professional papers have been written related to the ­SeaStar® technology and the existing TLPs that have been installed. Each new project generates a series of technical papers specifically related to it. These papers are frequently presented at oil industry conventions and other meetings, which dis- seminates new knowledge traced to the original SBIR research. Atlantia received the Tibbetts Award in 1997 for its SBIR-related success. Kibbee believes that receiving this award generated considerable publicity for Atlantia, improving its marketing potential. Touting such SBIR successes, espe- cially by the U.S. government, can be instrumental in providing a visible “stamp of approval” on companies such as Atlantia that can create a competitive advan- tage in their markets.

176 APPENDIX D Creare, Inc. Philip E. Auerswald George Mason University August 2005 Overview Creare, Inc. is a privately held engineering services company located in Hanover, NH. The company was founded in 1961 by Robert Dean, formerly a research director at Ingersoll Rand. It currently has a staff of 105 of whom 40 are engineers (27 PhDs) and 21 are technicians and machinists. A substantial percent- age of the company’s revenue is derived from the SBIR program. As of Fall 2004, Creare had received a total of 325 Phase I awards, 151 Phase II awards—more in the history of the program than all but two other firms. While its focus is on engineering problem solving rather than the development of commercial prod- ucts, since its founding it has been New Hampshire’s version of Shockley Semi- conductor, spawning a dozen spin-off firms employing over 1,500 people in the immediate region, with annual revenues reportedly in excess of $250 million.  Creare’s initial emphasis was on fluid mechanics, thermodynamics, and heat transfer research. For its first two decades its client base concentrated in the turbo-machinery and nuclear industries. In the 1980s the company expanded to energy, aerospace, cryogenics, and materials processing. Creare expertise spans many areas of engineering. Research at Creare now bridges diverse fields such as biomedical engineering and computational fluid and thermodynamics. At any given point in time Creare’s staff is involved in approximately 50 projects. Of the 40 engineers, 10-15 are active in publishing, external relations with clients, and participation in academic conferences. The company currently employs one MBA to manage administrative matters (though the company has This case is based primarily on primary material collected by Philip Auerswald during an interview at Creare, Inc. in Hanover, New Hampshire, on September 16, 2004 with Robert J. Kline-Schoder (Vice President, Principal Engineer), James J. Barry (Principal Engineer), Nabil A. Elkouh (Engi- neer). It is also based on preliminary research. A source on the early history of Creare was Philip G ­ louchevitch, “The Doctor of Spin-Off,” Valley News, December 8, 1996, pp. E1 and E5. We are indebted to Creare, Inc., for their willingness to participate in the study and in offering both a wealth of information to cover the various aspects of the study and his broad experience with the SBIR program and with high technology in the context of small business. Views expressed are those of the authors, not of the National Academy of Sciences. The other two firms are Foster-Miller (recently sold, and no longer eligible for the SBIR program) and Physical Science, Inc. A list is given in the annex of this case study.

APPENDIX D 177 operated for long periods of time with no MBAs on staff). As Vice President and Principal Engineer Robert Kline Schoder states, “Those of us who are leading business development also lead the projects, and also publish. We wear a lot of hats.” The company’s facilities comprise a small research campus, encompassing over 43,000 square feet of office, laboratory, shop, and library space. In addition to multipurpose labs Creare’s facilities include a chemistry lab, a materials lab with a scanning electron microscope, a clean-room, an electronics lab, cryogenic test facilities, and outdoor test pads. On-site machine shops and computer facili- ties offer support services. Firm Development Founding and Growth Creare’s founder, Robert (Bob) Dean, earned his PhD in engineering (fluid/ thermal dynamics) from MIT. He joined Ingersoll Rand as a director of research. Not finding the research work in a large corporation to his liking, he took an academic position at Dartmouth’s Thayer School. Soon thereafter, he and two partners founded Creare. One of the two left soon after the company’s founding; the other continued with the company. But for its first decade, Robert Dean was the motive force at Creare. Engineer Nabil Elkouh relates that the company was originally established to “invent things, license the inventions, and make a lot of money that way.” Technologies that would yield lucrative licensing deals proved to be difficult to find. The need to cover payroll led to a search for contract R&D work to cover expenses until the proverbial “golden eggs” started to hatch. The culture of the company was strongly influenced by the personality of the founder, who was highly engaged in solving research and engineering problems, but not interesting in building a commercial company—indeed, it was precisely to avoid a “bottom line” preoccupation that he had left Ingersoll Rand. Thus, even the “golden eggs” that Bob Dean was focused on discovering were innovations to be licensed to other firms, not innovations for development at Creare. As Elkouh observes “the philosophy was—even back then—that what a product business needs isn’t what an R&D business needs. You’re not going to be as creative as you can be if you’re doing this to support the mother ship. . . . Products go through ebbs and flows and sometimes they need a lot of resources.” Furthermore, Dean was a “small organization person,” much more comfortable only in companies with a few dozen people than in a large corporation. A case in point: In 1968, Hypertherm was established as a subsidiary within Creare to develop and manufacture plasma-arc metal-cutting equipment. A year later Creare spun off Hypertherm. Today, with 500 employees, it is the world leader in this field.

178 APPENDIX D By 1975, an internal division had developed within Creare. Where Dean, the founder, continued to be focused on the search for ideas with significant commercial potential, others at Creare preferred to maintain the scale and focus consistent with a contract research firm. The firm split, with Dean and some engineers leaving to start Creare Innovations. Creare Innovations endured for a decade, during which time it served as an incubator to three successful compa- nies: Spectra, Verax, Creonics. The partners who remained at Creare, Inc. instituted “policies of stability” that would deemphasize the search for “golden eggs”—ultimately including policies, described below, to make it easy for staff members to leave and start companies based upon Creare technologies. The nuclear power industry became the major source of support for Creare. That changed quickly following the accident at Three Mile Island. At about the same time, the procurement situation with the federal government changed. Procurement reform made contracting with the federal government a far more elaborate and onerous process than it had been previously. As research funds from the nuclear industry disappeared and federal procurement contracts became less accessible to a firm of Creare’s size, the company was suddenly pressured to seek new customers for its services. In the wake of these changes came the SBIR program. The company’s presi- dent at the time, Jim Block, had worked with the New Hampshire Senator Warren Rudman, a key congressional supporter of the original SBIR legislation. As a consequence, the company knew that SBIR was on its way. Creare was among the first firms to apply for, and to receive, an SBIR award. Elkouh notes that “early in the program, small companies hadn’t figured out how to use it. Departments hadn’t figured out how to run the program.” The man- agement of the project was ad hoc. The award process was far less competitive than it is today.” Emphasis on commercialization was minimal. Program manag- ers defined topics according to whether or not they would represent an interesting technical challenge. There was little intention on the part of the agency to use the information “other than just as a report on the shelf.” Impacts From the earliest stages of its involvement in the SBIR program, Creare has specialized in solving agency initiated problems. Many of these problems required multiple SBIR projects, and many years, to reach resolution. In most instances, the output of the project was simply knowledge gained—both by Creare employees directly, and as conveyed to the funding agency in a report. Impacts of the work were direct and indirect. As Elkouh states: “You’re a piece in the government’s bigger program. The Technical Program Officer learns about what you’re doing. Other people in the community learn about what you’re doing—both successes and failures. That can influence development of new programs.”

APPENDIX D 179 Notwithstanding the general emphasis within the company on engineer- ing problem solving without an eye to the market, the company has over thirty years generated a range of innovative outputs. The firm has 21 patents resulting from SBIR funded work.10 Staff members have published dozens of papers. The firm has licensed technologies including high-torque threaded fasteners, a breast cancer surgery aid, corrosion preventative coverings, an electronic regulator for firefighters, and mass vaccination devices (pending). Products and services devel- oped at Creare include thermal-fluid modeling and testing, miniature vacuum pumps, fluid dynamics simulation software, network software for data exchange, and the NCS Cryocooler used on the Hubble Space Telescope to restore the operation of the telescope’s near-infrared imaging device. In some cases, the company has developed technical capabilities that have remained latent for years until a problem arose for which those capabilities were required. The cryogenic cooler for the Hubble telescope is an example. The technologies that were required to build that cryogenic refrigerator started being developed in the early 80s as one of Creare’s first SBIR projects. Over 20 years, Creare received over a dozen SBIR projects to develop the technologies that ulti- mately were used in the cryogenic cooler. Additionally, Creare has been awarded “Phase III” development funds from programmatic areas that were ten times the magnitude of the cumulative total of SBIR funds received for fundamental cryo- genic refrigerator technology development. However, until the infrared imaging device on the Hubble telescope failed due to the unexpectedly rapid depletion of the solid nitrogen used to cool it, there had been no near-term application of the technologies that Creare had developed. The company has built five cryogenic cooler prototypes, and has been contacted by DoD primes and other large corpo- rations seeking to have Creare custom build cryogenic coolers for their needs. 11 Cooling systems for computers provide another example. The company worked intensively for a number of years in two-phase flow for the nuclear industry. This work branched into studies of two-phase flow in space—that is, a liquid-gas flow transferring heat under microgravity conditions. In the course of this work, the company developed a design manual for cooling systems based on this technology. The manual sold fifteen copies. As Elkouh observes, “there aren’t that many people interested in two-phase flow in space.” A Creare-­developed computer modeling program for two-phase flows under variable gravity had a similar limited market. Ten years later, Creare received a call from a large semiconductor manufacturing company seeking new approaches to cooling its equipment because fans and air simply were not working any more. This led to a sequence of large industrial projects doing feasibility studies and design work 10Numbers as of Fall 2004. 11See NASA, 2002 (July/August). “Small Business/SBIR: NICMOS Cryocooler—Reactivating a Hubble Instrument,” Aerospace Technology Innovation, 10(4):19-21. <http://ipp.nasa.gov/innovation/ innovation104/6-smallbiz1.html>. See also <http://www.nasatech.com/spinoff/spinoff2002/goddard. html>.

180 APPENDIX D to assist the client in evaluating different possible cooling systems, including two-phase approaches. The work covered the spectrum from putting together complete design methods—based on work performed under SBIR awards—to building experimental hardware. Most recently, NASA has contacted Creare with a renewed interest in the technology. From the agency standpoint, there is a benefit to Creare’s relative stability as a small firm: They don’t have to go back to square one to develop the technologies, if a need disappears and then arises again years later. As academic research in the 1990s demonstrated the power of small firms as machines of job creation, the perception of the program changed. In the process, the relationship of perennial SBIR recipient firms such as Creare changed as well. These new modes of relationship, and some recommendations for the future, are described below. Spin-off Companies The success of the numerous companies that have spun off from Creare natu- rally leads to the question: Is fostering spin-offs an explicit part of the company’s business model? The answer is no to the extent that the company does not normally seek an equity stake in companies that it spins off. The primary reason has to do with the culture of Creare. Elkouh states that, as a rule, Creare has sought to inhibit firms as little as possible. “If you encumber them very much, they’re going to fail. They are going to have a hard enough row to hoe to get themselves going. So, generally, we’ve tried to institute fairly minimal encumbrances on them. We’ve even licensed technology to companies who’ve spun off on relatively generous terms for them.” Does the intermittent drain of talent and technology from Creare due to the creation of spin-off firms create a challenge to the firm’s partners? According to Kline-Schoder, no: “It has not happened all that often and when it has, opportuni- ties for people who stay just expand. It’s not cheap [to build a company] starting from scratch. So there’s a barrier to people leaving and doing that. The other thing—in some sense, is that Creare is a lifestyle firm. Engineers are given a lot of freedom—a lot of autonomy in terms of things to work on. We think that Creare is a rather attractive place to work. So there’s that barrier too.” Role of the SBIR Program The founding of Creare pre-dated the start of the SBIR program by 20 years. However, SBIR came into being at an extremely opportune moment for the firm. It is very difficult to say whether or not the firm would have continued to exist without the program, but it is plain that the streamlined government procurement process for small business contracting ushered in by the SBIR program facilitated

APPENDIX D 181 its sustainability and growth. In the intervening years, the SBIR program and technologies developed under the program have become the primary sources of revenue for the firm. What accounts for the company’s consistent success in winning SBIR awards? Kline-Schoder relates that “I’ve come across companies that have spun out of a university or a larger organization. I routinely receive calls—five years or more after I met these start ups—calling us and asking ‘We were wondering, how have you guys been so successful? Can you tell us how do you do it?’” As reported by the firm’s staff members, Creare’s rate of success in competi- tions where it has no prior experience with the technology or no prior relationship with the sponsor—“cold” proposals—is about the same as the overall average for the program. However, in domains where it has done prior work, the company’s success rate is higher than that of the program overall. In some of these cases the author of the technical topic familiar with Creare’s work may contact the firm to make them aware of the topic (this phenomenon is not unique to Creare). Where the company has success with “cold proposals,” it is often because the company successfully bridges disciplinary boundaries. In these instances, as Elkouh states, “we may have done something in one field. Someone in a differ- ent field needs something that’s related to our previous work and we carry that experience over.” Improving the Administration of the SBIR Program According to Creare’s current staff members, the single most significant determinant of the Phase III potential of a project is the engagement of the author of the technical topic. Kline-Schoder states: “If your goal is to, at the end, have something that transitions (either commercially or to the government) having well written topics with authors who are energetic enough and know how to make that process happen. Oftentimes we see that you develop something, it works—it’s great—and then the person on the other side doesn’t know what to do. Even if you sat it on a table, the government wouldn’t know how to buy it. There’s no mechanism for them to actually buy it.” It is something of an irony that today, forty years after its founding, Creare is increasingly fulfilling the original ambitions of its founder: earning an increasing share of its revenue from the licensing of its technologies. Here, also, the active engagement of the topic author is critical. In one instance Elkouh worked with a Navy technical topic manager who saw the potential in a covering that had been developed at Creare with SBIR funds. This individual introduced him to over 300 people, and helped set up 100 presentations. That process led to Creare making a connection with a champion within a program area in the Navy who had the funds and was willing to seek a mechanism to buy the technology from Creare for the Navy’s use. However, even in this instance, concluding the license was not a simple

182 APPENDIX D matter. The appropriation made it into the budget—but that funding was still two years away. Elkouh: “The government funded the development of the technology because there was a need. Corrosion is the most pervasive thing that the Navy actually fights—a ship is a piece of metal sitting in salt water. There were reports from the fleet of people saying ‘We want to cover our whole ship in this.’ So now you have the people who use it say they want it, but who buys it? There is this vacuum right there—who buys it?” With regard to contracting challenges, the SBIR program has largely solved the problem of a small business receiving R&D funds. From the standpoint of the staff interviewed at Creare, the contracting process directly related to the award is straightforward. What the SBIR program has not solved is the challenge of taking a technology developed under the SBIR program and finding the place within the agency, or the government, that could potentially purchase the technology. Large corporations are no more willing to fund technology development than are government agencies. Kline-Schoder reports being approached by a large multinational interested in a technology that had been developed at Creare. The company offered to assist Creare with marketing and distribution once the technology had been fully developed into a product. However, the company was unwilling to offer any of the development funds required to get from a prototype to production. Further obstacles to the commercial development of SBIR funded technol- ogy are clauses within the enabling legislation pertaining to technology transfer. Kline-Schoder: “FAR clauses were in existence before the SBIR program. They were inherited by the SBIR program, but they don’t fit. For instance, they state that the government is entitled to a royalty-free license to any technology devel- oped under SBIR. But there has never been a clear definition of what that means.” In one instance Creare developed a coating of interest to a private company for use in a specific product. The federal government was perceived ultimately to be the major potential market for the product in question. The issue arose: Could the company pay a royalty to Creare for its technology, given that it would be prohibited from passing on the cost to the federal buyer? Contracting challenges related to the FAR clauses created a significant obstacle to the commercialization of the technology, even when two private entities were in agreement on its poten- tial value. “We could potentially be sitting here now looking at fairly substantial licensing revenues from that product as would [the corporate partner] and it’s not happening because of that IP issue.” A second issue pertaining to the intellectual property pertains to timing. As the clause is written, a company that invents something under an SBIR is obliged to disclose the invention to the government. Two years from the day that the company discloses, it must state whether or not it will seek a patent for the invention. However, the gap between the start of Phase I and the end of Phase II is most often longer than two years. So the SBIR-funded company is placed in the awkward position of being compelled to state whether or not it intends to seek a

APPENDIX D 183 patent on a technology essentially before it is clear if the technology works. Pres- sure to disclose inventions has increased over time, as the commercial focus of the program has intensified. The time pressure is even more severe when Creare seeks to find the specific corporate partner who wants to use the technology in a product. The requirement also, importantly, precludes the SBIR-funded com- pany from employing trade secrets as an approach to protecting its intellectual p ­ roperty—in certain contexts, a significant constraint. Kline-Schoder: “Patenting is not the only way to protect intellectual property. The way things are structured now, you don’t have that choice. No matter what invention you disclose, you have to decide within two years whether or not to patent. If you don’t patent, then the rights revert to the government.” In this context, Creare has a much longer time horizon that most small companies. The view expressed by the Creare staff members interviewed was that the size of awards is adequate for the scope of tasks expected. The variation in program administration among agencies is a strength of the program—although creating uniform reporting requirements for SBIR Phase III and commercializa- tion data would significantly reduce the burdens on the company. Finally, from an institutional standpoint, no substitutes exist for the SBIR program. Private firms often will not pay for the kind of development work funded by SBIR. Once the scale of a proposed project grows over $100,000, a private company will question the value of outsourcing the project. Lack of control is also a concern. Conclusion Creare appears to occupy a singular niche among SBIR funded companies. The company’s forty year history as a small research firm is one characteristic that sets it apart from other SBIR funded firms. The many spin-offs it has pro- duced is a second. However, from the standpoint of its ongoing success in the SBIR program and in providing corporate consulting services, Creare’s most significant differentiating characteristic may be its range of expertise. The scope of the SBIR funded work at Creare is very broad. The reports of staff members suggest that the firm’s competitive advantage relative to other small research firms is based to a significant extent on that breadth. “A lot of companies com- partmentalize people,” as Elkouh observes. “Everybody here is free to work on a variety of projects. At the end of the day, the companies I work with think that is where we bring the value.” The same factor may account for the longevity of the firm. “We diversified internally by hiring people in different areas. That is when the cross-pollination happened.” Areas come and go. Small product companies or small start-up companies focused in one area will struggle when the money disappears for whatever reason. Having evolved into a diversified research firm, Creare has endured.

184 APPENDIX D CREARE—ANNEX Sample of Independent Companies with Origins Linked to Creare • Hypertherm, now the world’s largest manufacturer of plasma cutting tools, was founded in 1968 to advance and market technology first developed at Creare. Hypertherm is consistently recognized as one of the most innovative and employee-friendly companies in New Hampshire. • Creonics, founded in 1982, is now part of the Allen-Bradley division of Rockwell International. It develops and manufactures motion control systems for a wide variety of industrial processes. • Spectra, a manufacturer of high-speed inkjet print heads and ink deposi- tion systems (now a subsidiary of Markem Corporation) was formed in 1984 using sophisticated deposition technology originally developed at Creare. • Creare’s longstanding expertise in computational fluid dynamics (CFD) gave birth to a uniquely comprehensive suite of CFD software that is now m ­ arketed by Fluent (a subsidiary of Aavid Thermal Technologies, Inc.), a Creare spin-off company that was started in 1988. • Mikros, founded in 1991, is a provider of precision micromachining ser- vices using advanced electric discharge machining technology initially developed at Creare.

APPENDIX D 185 Diversified Technologies, Inc.12 Philip E. Auerswald George Mason University September 2006 Overview Diversified Technologies, Inc. (DTI) is a founder-owned engineering product and services company located outside of Boston in Bedford, Massachusetts. DTI was created in 1987 by Dr Marcel P. J. Gaudreau, previously the director of the Advanced Projects Group at MIT’s Plasma Fusion Center, one of the founders of Applied Science and Technology, Inc. (ASTeX), in Woburn, Massachusetts. Created initially as a vehicle for Dr. Gaudreau’s extramural research and con- sulting work, DTI had by the late 1990s developed into an industry leader in the application of solid-state devices to high-power, high-voltage opening and closing switches. Today DTI has annual revenues of approximately $11 million and is growing at approximately 20 percent per year. The company currently employs 63 people (57 full-time and six part-time) including 13 with doctoral degrees. More than 90 percent of DTI’s business is derived from its proprietary PowerMod™ solid-state switching technology, for which it has received two R&D 100 Awards—the first in 1997 and the second in 1999.13 These solid-state modulators turn high power systems on and off at submicrosecond speeds in a repeatable and controllable way.14 Potential applications for the technology exist in an array of markets from military radar to the commercial food industry. The company sells both to private and government customers through more than 50 different concurrent projects, ranging in size from multimillion dollar, multiple- year contracts to small, short-term contracts, on the order of $10,000. It also sells its products overseas, with representation by local distributors in France, Japan, and Korea. 12This case is based primarily on primary material collected by Philip Auerswald during an inter- view at Diversified Technologies Inc, on September 7, 2004, with Michael Kempkes, Vice President for Marketing. We are indebted to Diversified Technologies, Inc. for their willingness to participate in the study. Research assistance by Kirsten Apple is gratefully acknowledged. Views expressed are those of the authors, not of the National Academy of Sciences. 13The R&D 100 Awards as given on an annual basis by R&D Magazine. For additional information, including a description of the method by which award winners are selected, see <http://www.rdmag. com/awards.aspx>. Accessed September 26, 2006. 14From talk given by Dr. Marcel Gaudreau to the Aerospace and Electronic Systems Society on March 6, 2003.

186 APPENDIX D From its inception, DTI has employed awards from the Small Business Innovation Research (SBIR) Program in a strategic manner. To date, DTI has been the recipient of 19 Phase II awards, with 15 of these from the Department of Energy and four from the Department of Defense. All but three of these awards have been received in the past seven years. The company’s founder initially used the process of applying for SBIR awards as a way to engage graduate students in working through potential applications of academic research. In 1991, after many unsuccessful attempts, the company received its first award. That award was the basis for its proprietary solid-state switching technology. The company used later SBIR awards to demonstrate that the technology could be employed reliably in industrial settings, and to develop new technologies and markets. Firm Development 1987-1996: From a Diverse Consulting Practice to a Company with a Product Focus From its creation in 1987 until it received its first SBIR award in 1991, DTI was something of a “virtual company,” run out of the home of Dr. Marcel Gaud- reau, the company’s founder, while he worked full time as a researcher at MIT. At the time he started DTI, Gaudreau was already an experienced academic entre- preneur, having been involved in the founding of another company—Applied Science and Technology Inc. (ASTeX), which merged with MKS Instruments in January 2001. With DTI, Gaudreau was not seeking to create a high-growth firm, but rather a vehicle for his varied extramural consulting and research activities. A core activity of the company was the writing of SBIR proposals with graduate students, most of which were unsuccessful. Current DTI Vice President Michael Kempkes observes that “If the SBIRs hadn’t existed, our company for sure would be a lot smaller. It probably would have remained in Marcel’s house—more of a consulting company.” When DTI won its first SBIR in 1991, a Phase I award from the Department of Energy to develop a solid-state switching device, the company began to shift from wide-ranging consulting to tightly focused product development. The tran- sition was slow and fitful. When DTI applied for a Phase II award from DoE to continue the solid-state switching project, the proposal was initially rejected. A second submission was, however, successful. By 1993, the company had com- pleted the solid-state switching project and applied for a patent on the technology it developed. The initial motivation for the solid-state switching project was purely aca- demic. At the time the project was conceived, the concept appeared more like “science fiction” than a workable idea. Gaudreau was committed to proving that his concept could work in practice. The Department of Energy was interested in the project for possible application use in its fusion research program. As Kempkes

APPENDIX D 187 describes: “He (Gaudreau) had a very good idea of where he thought the tech- nology needed to go in the future. It was the combination of belief that this was something that was needed and that he could do it, and convincing the DoE to agree. That took a couple of steps. The tenacity was not so much ‘we needed the money’ as it was that Gaudreau was convinced this was a good idea and it should be done.” During this time frame, Gaudreau remained employed at MIT. Having proved the concept with the completion of the SBIR Phase II award, DTI began the initial marketing of products based on this technology, with lim- ited success. The majority of DTI’s work during this period remained consulting efforts for unique applications, performed mainly for acquaintances from MIT. One of these projects, a laser cutting system for a local manufacturer of photovol- taic arrays, was sufficiently large to require leasing of industrial space, and transi- tion of the company into a full-time concern for Gaudreau and approximately a dozen of his students. Among the key hires made at this time was that of Michael Kempkes, who joined as Vice President for Marketing in 1996. Kempkes faced the challenge of finding the element or elements in DTI’s activities and history that could form the basis for a viable company. Most of the projects in which DTI was engaged were still consulting efforts or “one-off” prototypes in many different fields. DTI’s patent for a solid-state switching device was one clear focal point within this otherwise confused set of activities. It was on this technology that Gaudreau and Kempkes decided to place their emphasis. 1996-1998: Proving Technology Viability and Generating Market Acceptance While the potential market for DTI’s solid-state switches was small, it was well defined. The performance and size advantages of the technology were evident. Working against DTI was that the product would be used to power expensive ­vacuum tube amplifiers, such as klystrons and gyrotrons. Potential customers resisted adopt- ing DTI’s switches for the simple reason that they had not been proven to work reliably with the tubes, and a failure in the switches could damage or destroy the tubes themselves. As Kempkes notes, “people are nervous about doing anything but what the tube vendor thinks is acceptable. . . . We had cus­tomers, flat out tell us that they could not use the technology without the tube vendor’s blessing. It took an awful lot of our time and effort to get over that hurdle.” The strategy forward gradually became self-evident. Again, DTI sought sup- port from the SBIR Program. This time the objective of the project was not to prove the concept, but rather to work with a major RF-tube vendor to demonstrate that the technology was scalable for industrial use and superior in practice to available alternatives. With Phase I SBIR support from the Department of Energy, DTI partnered with Communications and Power Industries (CPI) in Palo Alto, a major manufacturer of RF vacuum tubes. DTI build a large switch that was

188 APPENDIX D incorporated into the CPI testing facility. Customers who visited CPI could see the PowerMod™ switch in use. Clearly, if the tube vendor used this technology itself, it must be acceptable. In this way the company overcame a major impedi- ment to market acceptance. A second major opportunity emerged out of a Navy SBIR, where two sepa- rate Phase I contracts were awarded to DTI and another small business in 1998. This SBIR required a switch for an advanced radar system under development at NRL that was simply not possible using conventional technology. After demon- strating a new version of DTI’s solid-state switch in Phase I, DTI was awarded the sole Phase II contract from the Navy in 1999. This legitimized DTI’s technology in the radar market, and led to DTI’s first radar upgrade contract from the Navy later that same year. Another breakthrough occurred in 1998, when DTI made a presentation on its technology at a conference hosted by the Stanford Linear Accelerator ­Center (SLAC). The focus of the conference was identifying the technologies and devel- opments required to build a major new particle accelerator, the NLC. While the majority of this conference focused on conventional switching technologies, DTI was able to present its solid state technology to this group. The event drew consider- able attention to DTI’s technology. Not everyone was a fan—one senior manager stated that the NLC accelerator ‘would go solid state over my dead body,’ and DTI failed to win any SBIRs in 1998 related to this project. Over the next year, how- ever, DTI’s evangelism of the promise of solid state switching, combined with the delivery of the first system to CPI (only a few miles from SLAC), turned the tide towards solid state switching for the NLC. DTI won five Phase I SBIRs from DoE related to solid state developments for NLC applications in 1999, with four of these selected as Phase II efforts in 2000. This resulted in a considerable boost to DTI’s R&D efforts, and significant growth for the company overall. A further boost to DTI came with the receipt of the R&D 100 Awards in 1997 and 1999. While less important than the demonstration of the product achieved through the partnership with CPI, the initial radar efforts, and the reach achieved through the SLAC conference presentations, the R&D 100 Awards were nonethe- less of value in generating additional attention for the company and validating its industry leadership. 1999-2004: Revenue Growth and Search for New Markets With market acceptance of its core technology, DTI turned its attention first to consolidation of its revenue base, and then the exploring additional market opportunities. As the company’s focus has become increasingly well defined and its techni- cal leadership better established, it has had increasing success with its applica- tions to the SBIR Program. Of the 19 Phase II SBIR awards DTI has received since its founding, all but three have come since 1999. The company’s success

APPENDIX D 189 rate in Phase II proposals is close to 80 percent, well above the DoE average of approximately 40 percent. The company’s experience with the program has allowed it to construct proposals that fit consistently within the SBIR Program’s feasible funding range. Kempkes articulates the general lessons this way: “If the proposal is too far out, and you have no experience, you’re never going to get it. And if too close, if it is a done deal, then you’re also not going to get it.” Proposals that fit between these two extremes—extending past successes in novel ways—have the best chance of being awarded. “There’s a knee of the curve where this extends what you’ve already done, and you have experience in this area, but you haven’t done the full thing. You’ve maybe done 50-60 percent of the work. That’s where you have the best chance of getting the award.” This strategy of continual technology development and deepening of exper- tise in a core area of specialization has permitted DTI to find an entirely new and promising market application for its technology in the food services industry. An Army dual-use project at Ohio State University employed proprietary DTI technology and resulted in a prototype unit for removing bacteria from food at a commercial scale. As of 2006, the company was building a number of systems for both the food and water/wastewater processing markets based upon this new application of its switching technology. The commercial applications of this technology have led to considerable commercial success. DTI’s SBIR efforts have remained fairly constant since 1999, with approximately four to five Phase I and three to four Phase II efforts in process at any given time. The percentage of revenues DTI receives from SBIR funding, however, has decreased from nearly 75 percent of total revenues to less than 20 percent today. Key Issues and Lesson Learned When Loans Are Not an Option: The SBIR Program as an Alternative to Equity Financing As a consequence of his prior experience as a co-founder of a technology company, Gaudreau approached the founding of DTI with a commitment to build- ing his new company without equity investments. As Kempkes relates: “From the outset [Gaudreau was determined that] DTI was going to be his, 100 percent. There would never be any equity. There would never be any investors There would never be any partners. He wanted to be able do with the company whatever he wanted to do, and not have to answer to anybody. And the company is still that way. We have shooed venture capitalists out the door.” The preferences of the founder, Dr. Marcel Gaudreau, with regard to potential funding strategies have been a significant determinant of development of DTI. Gaudreau’s determination to grow his company without equity investment, and the infeasibility of obtaining bank lending to fund the sort of high-risk, long time horizon work in which the

190 APPENDIX D company was and is engaged, left DTI with two feasible paths to funding: revenue from the sale of products and services, and competitive awards. DTI has completed well over 1,000 consulting and development projects over two decades, including prototype development for DNA analysis, remote powering of robot devices, EMI analysis and control, underwater power and communication design, solar-powered vehicles, and turnkey product develop- ment and electronics manufacturing. Consulting services have focused on cost reduction, accelerated entry into new markets, and removal of technical barriers. Yet as Kempkes notes, a flexible upper limit exists to such corporate consulting contracts: Once the contract gets to be $100,000 or more, a company is likely to take the view that it can hire a full-time staff member internally to do the work, and doesn’t require the outside engineering expertise. Consulting does not typi- cally allow the consultant to retain intellectual property rights, making it difficult to leverage into other efforts. In recent years, consulting has been reduced to a very small fraction of the company’s revenues. While the company now has robust product sales, it could not sell a product until it had one. To develop its product, and demonstrate its application, competi- tive awards from the SBIR Program were essential. The Importance of a Global Patent Strategy Kempkes notes one potentially damaging error made by the company in the development of its PowerMod™ technology: only seeking patent protection in the United States. The company let pass a decade ago the one-year window for filing a patent overseas. As Kempkes notes: “At the time, no one thought to patent in Europe or Asia. No one knew if we should patent at all.” The lack of an over- seas patent appears to leave the company open to a competitive challenge from a potentially lower-cost non-U.S. producer. While a small group of U.S. and foreign competitors have emerged in the last two years, they have served to validate rather than erode DTI’s market leadership. The competitive threat is mitigated by three factors that serve to strengthen DTI’s competitive position: • The product is both technologically complex and under constant develop- ment. The company undertakes a major reversion every year. As a consequence, reverse engineering or other forms of copying are not easily accomplished. • The existing market for DTI’s core technology is small—approximately $100 million in the United States, and double that worldwide. Given the potential for technical failure of an attempt to imitate a DTI product and the associated costs, the incentive to imitate is not very large. New applications, such as food processing, however, are emerging which may considerably increase the future size of this market. • Increasingly, it is knowledge of the customer applications, rather than just the underlying technology, which provides DTI’s competitive advantage. As

APPENDIX D 191 the first-mover in this area, DTI has more expertise and experience in applying solid state switching technology to a range of applications than any of the newer companies attempting to enter this market. The Unresolved Challenge of Supporting Small Company Development of Commercial Products While DTI was able to create a prototype of its technology with its first SBIR Phase I and Phase II awards—nearly a decade, and a number of additional SBIR awards, were required to advance the technology from a prototype to a stable product earning regular revenue. Moving a new technology into production generally takes $3-4 million—considerably more than the cost of developing the prototype. Kempkes notes, “the gulf between having the technology and having it in production in the market is probably bigger than the one between ‘here’s an idea, and here’s a prototype.’” As the company enters new product areas, it once again faces the obstacles to commercialization of technologies developed with the assistance of SBIR funds—“Phase III” support in the parlance of the SBIR Program. It has only been since 1999, when the company’s revenues passed $3 million annually, that DTI could afford to develop new products and markets from its product revenues—while continuing technology developments within the SBIR program. While the SBIR Program is valuable in getting to the prototype stage, it cannot help with the refinement of products and associated processes required for mass-market production. Two SBIR proposals written by the company for product development were both declined for funding. Kempkes characterizes the reasoning on the part of reviewers and/or program managers as follows: “The technology exists, and if someone wants it they will fund it.” Furthermore, the SBIR process is too lengthy. From proposal formulation to completion of Phase II can take four years. In many markets, that is too much time. However, in DTI’s experience as related by Kempkes, large corporations are hesitant to fund development of new production or process equipment unless they acquire full rights to the intellectual property. This reluctance creates an impenetrable barrier if the new technology could have potential industry-wide application. Understandably, in these cases, large companies would prefer for the development to be funded by others. Furthermore, even when the product is available, they would prefer not to depend on a sole-source supplier for a critical production component. As Kempkes put it: “The big companies do not want to spend the money. They don’t want to develop the product; they just want to buy it once it is cheap.” While understandable from the perspective of the large corpora- tion, such reasoning creates a formidable set of obstacles to market entry—not only to develop the new product, but to await the emergence of a competitor in the same market. The government is often the only large customer willing to fund development of these technologies.

192 APPENDIX D Summary The SBIR program has been essential to DTI’s success and growth beyond the “garage” stage without external capitalization. The ability of the company to use the SBIR program to develop its technology, and to demonstrate it to potential customers in highly visible applications, provided the platform for the company to grow. Multiple awards from the SBIR program, in turn, allowed DTI both to broaden the application of its technology, and to achieve the ‘critical mass’ required to pursue commercialization and grow well beyond the SBIR program. Using the SBIR program in this way, however, required considerable persever- ance on the part of the company’s founder, as the transition from the garage to viable company took nearly a decade.

APPENDIX D 193 Eltron Research, Inc.15 Nicholas S. Vonortas Jeffrey Williams The George Washington University March 2005 The Company Eltron Research, Inc. undertakes basic and applied research in the areas of energy, chemical processing, and environmental processes and products. The company was founded in 1982 in Naperville, Illinois, and is presently based in Boulder, Colorado. Currently, there are approximately sixty employees, half of whom have Ph.D. degrees. Since 1983, Eltron has been the recipient of over 100 Phase I and Phase II SBIR awards from NASA, DoD, DoE, NSF, and NIH. This interview centered primarily on the company’s DoE-related work. There are six areas of focus within Eltron; catalytic membrane reactors, catal- ysis, fuel cells, materials research, electrolytic processes, and chemical sensors. Catalytic membrane reactors are used to isolate and extract gases, such as oxygen, hydrogen, and carbon dioxide, by simultaneously transporting electrons and ions through nonporous membranes. The membranes separate gases at low production costs via exothermic reactions, requiring no electrical or thermal energy inputs. Conversion of natural gas to synthesis gas is one application of this technology, yielding benefits of up to a 25-percent decrease in production costs, and eventual production of high-grade, crude-oil-competing liquids for $20 per barrel or less. Other applications, specific to oxygen separation, include coal gasification, H 2S removal, aromatic upgrading, atmospheric O2 sequestering, alkanes to olefins, liquid fuel reforming, and environmental controls. Hydrogen and carbon dioxide each have associated commercializable applications, as well. Catalysis has been a focus of Eltron Research since the inception of the company. Possible applications include converting synthesis gas into liquid fuels, inexpensive post-production removal of nitrogen oxides, low-temperature removal of volatile organic compounds from gaseous waste streams, shifting 15This case is based on primary material collected by Nicholas Vonortas and Jeffrey Williams dur- ing an interview with the founder and president of Eltron, Inc., Dr. Anthony Sammells at Boulder, Colorado, on February 23, 2005. It is also based on preliminary research on the company carried out by the authors. We are indebted to Dr Sammells for his willingness to participate and his generos- ity in offering both a wealth of information to cover the various aspects of the study and his broad experience with the SBIR program and with high technology development in the context of small business. All opinions in the document are solely those of Dr. Sammells. The authors are responsible for remaining mistakes and misconceptions.

194 APPENDIX D c ­ arbon dioxide and hydrogen molecules to carbon monoxide and water mol- ecules, advanced ignition catalysis for monopropellant fuels, devulcanizing tire rubber, and reduction in volatile organic compound emissions. Fuel cell technol- ogy revolves around using Eltron proprietary oxygen transport solid electrolytes to convert natural gas into electricity. Materials research is extensive, and is used to support the catalytic membrane reactors, catalysis, and fuel cell technologies. Electrolytic processes are being applied to disinfection and sterilization, organic contaminant destruction, biofouling removal in filtration units, and removal of nonindigenous species from ballast water. Chemical sensors focus on chemical defense, environmental monitoring, industrial hygiene and occupational safety, and process control applications. Many of the innovations at Eltron Research are geared towards applica- tions in the energy processing industry. An example of a suite of such innova- tions, ­centered on membrane separation technology, will be discussed in a later section. SBIR and Eltron Research Eltron Research received its first SBIR from the Department of Energy in 1983, about one and a half years following its founding. The firm owner first heard of SBIR at a conference held in Illinois, and Eltron Research was one of two recipients in the state during SBIR’s first year. While SBIR was not the r ­ eason for founding Eltron, SBIR grants have been instrumental in the develop- ment of the company, especially by allowing it to build a much broader and deeper technology base in a more thorough manner than would have been other­ wise possible. SBIR awards have served as seed money to begin new projects, with multiple awards in complex areas allowing the building up of capabilities in more than one complementary technology. Those projects have in turn attracted significant research funding from the private sector. Eltron’s principal source of financing is investment by private energy con- cerns, such as oil companies, and to a lesser extent government contracts. SBIR grants, while instrumental in the sense mentioned above—seed money allowing the establishment of new complex projects and continuing until attracting private funding becomes a possibility—have never been the principal form of funding for the company. The company has intentionally shunned private venture capital in its effort to maintain full control, escape stringent ownership conditions imposed by venture capitalists, and continue on the long-term trajectory of a cutting-edge organization. The primary commercialization strategy of the firm is to create partnerships with users of its technology whereby it provides licenses for a fee, but also frequently for a percentage of the purchasing firm’s earnings that are related to the innovation. As such, the relationships tend to be more collaborative than a straight sale.

APPENDIX D 195 In summary, a long-term strategy appears in which support from multiple sponsors—including SBIR awards—allows the company to build up internal capabilities in new complex technology areas while keeping full control of the operation. As the base grows, the firm is able to apply its novel technologies and applications to different situations, providing prospective customers with a wider range of solutions and solution techniques, raising the chances for commercial application (take-up). In such an event, the company stays with the customer long enough for a successful transfer of earnings returns from partnerships established around technology licensing agreements. Specific Commercial Application Eltron Research has received numerous grants in a wide variety of fields. One of the more successful resulted in the now-maturing technology of oxygen separation membranes. This technology isolates oxygen and nitrogen through the use of catalysis membranes. Development of the innovation began with a Department of Energy SBIR award in 1995. Eventually, two Phase II awards were associated with this technology, which has now generated a sizable income stream for the company. Oxygen separation from the atmosphere occurs when air passes through a specially designed mixed ionic and electronic conducting membrane. Membranes are three-layered constructs; on the air side is a reduction catalyst, followed by a mixed conducting membrane, followed by a partial oxidation catalyst on the output side. This technology is a replacement for cryogenic oxygen separation which is very energy intensive. The membrane conducts electrons and ions at high temperature. Eltron uses internally designed, low-cost thin film membranes to increase the flux for oxygen separation. Oxygen is available for a wide variety of industrial uses. Processes such as coal gasification rely on the use of pure oxygen. Coal gasification has the ability to use coal more efficiently than traditional firing processes; 42-50 percent utilization versus 34 percent utilization in alternative processes. In addition, by-product emissions are significantly lower with coal gasification. Currently, oxygen is the third largest volume chemical used in the United States in general, at approximately 800 billion cubic feet in 2002. Use of ­oxygen is expected to grow, adding $1 billion to the oxygen market between 2002 and 2007. Eltron has licensed this innovation to the energy industry for further development. The interview made apparent that Eltron is keenly focused on technology commercialization. Not surprisingly, patents are a key aspect of the firm’s com- mercialization strategy. For example, it owns twenty-six core patents for the oxygen separation membrane technology. The typical procedure is for Eltron to cover the costs for U.S. patents of its technologies, while its licensing partners, which frequently are large energy concerns with extensive international interests,

196 APPENDIX D file foreign patents. This is considered especially helpful as the patent filing and maintenance fees, as well as other financial requirements for being able to cred- ibly defend intellectual property rights in foreign markets tend to be prohibitively high for small companies.16 The company collaborates with universities and research laboratories fairly infrequently. The reason seems to be differences in culture towards the marketplace. Views on SBIR Eltron’s management is, on the whole, happy with the SBIR award process. The company has received multiple awards, both Phase I and Phase II, from nearly all SBIR-granting agencies. The programs at the Department of Defense and the Department of Energy are seen as the best ones to work with, while the National Science Foundation can be more difficult. For example, while the DoD proposal submission process was viewed as streamlined, Eltron has reportedly encountered difficulties with the NSF Fastlane process. In addition, limitations on the number of allowable proposals per company per year by the NSF are an issue. While there does not seem to be a clear separation of focus in the type of technological knowledge supported by the SBIR awarding agencies, the NSF is perceived as pursuing proposals for more basic and long-term research, while the DoD may be at the other end, looking for much more specific, solution- oriented proposals. The interviewee stressed the importance of the fact that real technological progress often occurs when a bunch of complementary innovations are pursued at the same time.17 To the extent that this happens in a company, featuring funding from multiple sources to pursue related aspects of research, it complicates attribution of exact return streams to specific innovations and specific research projects, especially when those involve more basic, long-term research. Such questions were reported to be tricky and difficult to answer, especially when one tries to take into account the social value of an innovation on top of its value in terms of revenue to the producing organization.18 The management of Eltron does not see a need for much change in the SBIR application process, in general. Cost and time spent on the applications are not major concerns at Eltron as the firm has acquired experience in the process and 16An interesting observation was made during the interview. In the early stages of the company, scientific publications were reportedly a focus. This is expected given the high concentration of doc- torates in the company’s roster of employees. More recently, however, the emphasis on such channels of free knowledge dissemination has been downgraded in favor of formal channels of knowledge ownership affording the company the ability to commercialize ideas. 17Note that this issue has been amply stressed in the extant business and economic literature on technological advance (“network spillovers”). 18This refers to the difference between social rates of return and private rates of return in economic jargon.

APPENDIX D 197 always has a backlog of prospective successful ideas that have not yet found alter- native sources of support. The system is viewed as being fair in terms of awards granted. While the interviewee is aware of the extent of subjectivity involved in selecting proposals for support, this is understood as a general weakness of the peer-review system as a whole that one has to live with, and not as a specific weakness of the SBIR award process. Regarding the actual funding process, the grants usually arrive in a timely manner. DoE was considered to be the most prompt agency in that respect, with payments occurring fairly rapidly. Besides that agency, the average time lag between invoicing and receiving the funds was estimated to be between 60 and 90 days. It was observed that this delay should be looked at and shrunk as much as possible, since it adversely affects smaller companies with intense cash flow problems. A possible increase in funding was considered appropriate given that the funding ceilings have not changed for a long time. For example, $75,000 for a Phase I award does not go as far as it used to. It is reportedly becoming very difficult to fully fund Phase I activities solely from a Phase I award. Cash flow is, of course, a major issue for small innovative firms. Many projects need large amounts of money up front, not only for salaries but also for complex instrumentation. It was at this point that the interviewee made a very important, in our view, observation. This has to do with the perceived unevenness of competition between academic off-shoots and independent small, private com- panies for the same award in areas requiring significant scientific instrumentation. At a university setting, it was argued, a grantee is able to hire post-docs for little money and often has access to university equipment at no extra charge. Private firms, on the other hand, need to purchase or rent all of their equipment and must hire researchers at a significantly higher salary range. The potential disparity in the ability to compete for a grant should be taken into consideration by policy decision makers. One would think from the above that a dollar in grant funding going to a company with a strong academic affiliation would have a magnified impact due to leveraged resources. Not necessarily so, according to the interviewee, because of vastly different incentives. The incentive structure of an academic environment may be such that it does not foster the most efficient use of resources when the ultimate purpose of the funding program is commercialization. In the private sec- tor, according to the interviewee, researchers work in earnest under the market discipline: They may lose their jobs in case of a commercial flop. In an academic environment, however, if the innovation is not commercialized, there are few or no repercussions. As a consequence, funding that goes to academic grantees was perceived to stand a lower chance of generating a commercializable good that contributes directly to the economy. The arguments above raise important points about the SBIR program that may deserve to be reconsidered:

198 APPENDIX D • Is there a level playing field between independent, small private com- panies and their counterparts with strong academic affiliations at the proposal stage? • Is the rate of commercialization of technologies from SBIR awards between these two kinds of companies significantly different? • If so, should the phenomenon of multiple awards by a single company be looked at differently on the basis of the type of company involved? With respect to the latter question, the interviewee emphasized the forced- efficiency nature of working in a private firm that contributes to a relatively high degree of successful innovation research. In his words, the company owner is “fueled by insecurity and self-doubt.” Since reliance on a single innovation to carry the firm is unrealistic, the firm must constantly build on old technologies and strive to create new, commercially viable ones. It should be stressed at this point that the question of multiple awards also links directly to the earlier observation of the complexity of the technological area pursued by a company.19 The more complex the technology is, the larger the number of complementary pieces that need to be advanced in order for the technology to be of practical use. This has implications for the number of SBIR awards a company may need before reaching the point of commercialization of what may widely be perceived as a single innovation. Finally, it was observed that procuring risk financing for early stage research outside of an SBIR-style grant is difficult. Commercial banks ask for collateral to back up expectations of future knowledge and technology, while venture capitalists demand at least partial control and look for near-term results. SBIR awards fill the vacuum. It was considered desirable for Congress to raise the SBIR earmark above the current 2.5 percent of the R&D budgets of research-intensive federal agencies, thus allowing the SBIR program to increase the grant amounts. Characteristically, the interviewee observed that ‘the SBIR represents the most efficient use of R&D money in this country. There is an incredible amount of activity under this program.” 19Technological complexity in this sense does not imply high tech. Rather complexity relates to the different pieces necessary for a technology to function. Complex technologies relate to products or processes that cannot be understood in full detail by an individual expert. In contrast, simple tech­ nologies, which may be quite advanced, can be fully understood by an expert (e.g., chemical, phar- maceutical compounds). See Don Kash and Robert Rycroft, “Technology policy in the 21st century: How will we adapt to complexity?” Science and Public Policy, 25(2):70-86, 1998.

APPENDIX D 199 IPIX, Inc.20 Nicholas S. Vonortas Jeffrey Williams The George Washington University July 2005 The Company IPIX markets proprietary technology for the creation and manipulation of still and video imaging for government and private industry clients. The nine- teen year-old company is publicly traded on NASDAQ, and currently employs approximately sixty-five people at its headquarters in Oak Ridge, Tennessee, and offices in Reston, Virginia. During the past couple of decades, IPIX has received several Phase I and Phase II awards but no Phase IIB grants. IPIX now relies on commercially sold, mature iterations of its immersive imaging technology for nearly 100 percent of company income. In 1986, a group of researchers at Oak Ridge Laboratories got together to establish the company that would later be known as IPIX. The firm came into being with the assistance of SBIR funding from the Department of Energy, granted for the development of a specialized camera to withstand the highly demanding environment that would theoretically exist inside of a fusion reactor. In the early days SBIR grants kept the company alive and allowed it to maintain operations. According to Dr. Egnal, however, SBIR funds earned have not been intrinsic to the growth of the company since then. Instead, the firm has relied on external investors to supply the vast majority of growth capital. Private investment has been the driving engine for expansion through most of the company’s history. For example, at one point in the late 1990s, the company 20This case is based on primary material collected by Nicholas Vonortas and Jeffrey Williams during an interview with the Chief Technology Officer of IPIX, Inc., Mr. Geoffrey Egnal. It is also based on preliminary research on the company carried out by the authors. As a newcomer to the company, Mr. Egnal expressed his reservations about being able to accurately reproduce historical details ­ regarding the role of the SBIR program in the relatively long history of the company. The interviewers accepted his concerns and continued the interview given: (a) that he has a good grasp of the more recent developments and could access company SBIR records easily; and (b) the fact that the company has gone through important gyrations in the past 5-10 years as a result of market conditions with significant employee turnover which makes it very difficult to locate other sources of organizational memory. We are indebted to Mr. Egnal for his willingness to participate and ­generosity in offering both a wealth of information to cover the various aspects of the study and his broad experi- ence with the SBIR program and with high technology development in the context of small business. All opinions in the document are solely those of Mr. Egnal. The authors are responsible for remaining mistakes and misconceptions.

200 APPENDIX D employed nearly 1,200 people and was worth about $2.7 billion in the market. In reaching this stage, the firm mirrored the growth of the Internet, changing its name from TeleRobotics to OmniView, to Interactive Pictures Corporation, to Internet Pictures Corporation, and finally to IPIX. As the dot.com industry suf- fered, so did IPIX. Today, the firm, now with only 65 employees, is once again eligible for SBIR grants. Having only arrived at IPIX approximately four months prior to the inter- view, Mr. Egnal was not certain he could draw the relationship between earning SBIR awards and the firm’s ability to secure other financing. However, based on his experience with the SBIR program at previous companies, Mr. Egnal could confidently claim that the awards typically lend credibility to a firm and also enable the firm to be eligible for, and earn, other federal grants and contracts. In terms of research and development (R&D) funding, Mr. Egnal believes that the combination of SBIR awards and extensive commercialization has, historically, allowed IPIX to obtain private funding, and that some combination of these f ­ actors will continue to work to the firm’s advantage in the future. Example of an SBIR Related Innovation A combination of SBIR grants, other federal contracts, and private funding has enabled IPIX to expand its technological base. The firm’s current product lines, made up of the software and hardware used to create and process still and video immersive images, stems directly from an innovation related to early DoE and NASA SBIR grants obtained in the late 1980s and early 1990s. That innova- tion was a software technique called fish-eye image de-warping. IPIX products, both still and video, combine in real time several images taken by fish-eye lenses to provide a 360-degree view from a single viewpoint. The SBIR grants assisted in the development of a technology that allowed the translation of the warped fish-eye image into a conventional, flat-perspective image. The flat-perspective images then appear in a 360-degree panoramic format, which is considerably easier to view as it lacks the distortion caused by the fish-eye lens. All of IPIX’s current products utilize the de-warping technology in order to render easily discernable images. Currently, all of these products are available in the commercial market and are produced in-house. IPIX manages all of the marketing and sales of its own product lines. The original de-warping technology, which was patented by the firm, has also formed the basis of more than twenty additional patents issued to the company. While the company has published several scientific papers, publication is not actively pursued as a knowledge dis- semination strategy. Technology utilizing, and derived from, the SBIR-funded de-warping inno- vation is being applied in a number of different venues. Both the still and video imaging technologies provide users with a 360-degree view from a single point of reference. Applications include security cameras, which involves a single camera

APPENDIX D 201 capable of viewing an entire room, and real-time video monitoring. De-warping technology appears on real estate Web sites, allowing customers to view room interiors and exteriors as if they were actually standing in that position. Benefits to users of the technology include lowered costs due to decreased maintenance as there are no moving parts to the camera systems, and increased efficiency due to decreased blind spots and increased compatibilities associated with using digital images. Dr. Egnal felt unable to answer questions regarding future market projection for IPIX products because of the publicly traded nature of the company. Impressions Regarding the SBIR Process Being new to the firm, Mr. Egnal was not familiar with all of the details regarding IPIX’s experience with the SBIR process. However, by drawing on SBIR exposure from previous job assignments and learned knowledge of IPIX’s history, he was able to provide a good amount of background information. Geography and familiarity with the needs of the agency were considered to be important factors in initiating the original award: The company founders were all employed at the Oak Ridge National Laboratories, one of the large research labo- ratories of the Department of Energy. Mr. Egnal also believed that, at least during the first few years of the firm, personal and professional networking among IPIX and former colleagues at Oak Ridge must have influenced extensively the firm’s focus on DoE as the target application agency for SBIR awards. In Mr. Egnal’s experience, there are marked differences among the SBIR granting agencies. DARPA, for example, allows the program manager to review the SBIR applications, while other agency applications will go directly to a review- ing committee. DARPA program managers are more empowered than those in other agencies, and can be quite influential in selecting projects for funding. Agencies also differ in what exactly they want from SBIR applicants, influenced in this respect by their mandates. According to Mr. Egnal, the DoD is ultimately looking for finished products that it can procure, DARPA shifts between less focused research and specific product-oriented R&D projects, and NSF is more likely to support innovative ideas grounded in basic research. Other agencies fall in between. As such, IPIX alters the choice of projects selected for the SBIR applica- tion process depending on the target agency. Innovations closer to implementation may be more appropriate for DoD or DARPA, while other agencies might be more appropriate for innovations still in their early stages. Echoing other interviewees of ours, Mr. Egnal stressed the importance of business/professional networking for success: If a firm has connections within an SBIR-granting agency, meaning that agency managers are aware of the firm’s capabilities and expertise, then there is occasionally a chance to influence the scope of a specific call (for proposals) when it is judged that agency needs will be better met. In such cases, there is an opportunity for that firm to apply for that round of funding.

202 APPENDIX D Overall, Mr. Egnal felt that the SBIR application process is satisfactory and requires no major changes. Feedback was judged to be quite good and informa- tive, telling the applying firm exactly what is missing or lacking in the application or innovation. Costs associated with application are more than made up for by the benefits, though he did caution that firms with no connections will find the process less easy to navigate and more cumbersome than in firms with an estab- lished network. Requirements of third-party investing for applying for Phase IIB funding are also not a problem for IPIX.21 However, Mr. Egnal did say that for smaller firms, of between one and ten employees, attracting outside investors may stretch a firm’s resource limits. Regarding topic specification, the interviewee clearly recognized that each agency has its own mission, and thus, it is difficult to generalize as to whether topics should be tighter or more open. Nevertheless, the preference was for lesser definition of the topic specifications in order to increase transparency, ease topic selection for applying firms, and allowing easier entry by smaller participants. Regarding transparency, this preference goes along with the suspicion that, occa- sionally, very tight definition of specifications could imply a lock on the grant by a particular applicant whose orientation and capabilities are better reflected in the specifications.22 Obviously, powerful program managers that exercise strong control over their programs could more easily impose tight specifications. IPIX has applied for, and received awards from, federal R&D programs out- side of the SBIR process. The firm has experienced differences among programs, which it assumes are natural given the different program goals. For example, ATP awards tend to have a better ratio of funding per proposal than does SBIR, but the SBIR process is more geared towards encouraging commercialization. And broad area announcement programs may have larger award amounts, but they are also geared towards satisfying an individual agency’s needs rather than establishing commercial potential for an innovation. Concerning funding, Mr. Egnal sees little problem with the funding structure for the SBIR program. In his experience, funding delays, if existent, have been inconsequential. He also felt that the level of funding and number of awards are at a good ratio, and does not see a need for change towards a system that grants fewer awards for larger amounts of money. The current funding and award ratio, he said, allows for a wide variety of topics to be presented by the agencies while also encouraging firms to keep applying for SBIR grants. A large increase in funding might lead to complacency on the part of the applying firms, as they would be able to stretch the award over a longer period of time. Nonetheless, Mr. Egnal thought that a small increase in Phase II awards, perhaps up to $1 mil- 21Recall that the firm has no Phase IIB awards, though. 22The interviewing team has met this opinion in several of its interviews with other companies. It must be emphasized that this is not an issue just with SBIR awards, but with all calls for proposals anywhere in the world. For example, it has been an important concern in the R&D programs of the European Union.

APPENDIX D 203 lion, would help defray higher costs of operating in today’s commercial climate while not allowing the firm to become dependent on the award monies. Overall, Mr. Egnal felt that the SBIR program is strong. There are very few methods by which small companies can raise funding without giving up equity or control. SBIR funds make it possible for those companies to take risks on an innovation without worrying too much about losing ownership of the firm itself. The program’s emphasis on commercialization is also seen as a strong positive quality, as it really supports the long-term stability and growth of the grantees. Mr. Egnal expressed his belief that, due in large part to the push for commercial- ization, the process enjoys a very high metric of success. In turn, this metric of success creates social benefits: Innovations that would otherwise remain unreal- ized can be developed into commercializable products. Along those same lines, the technology produced as a result of an award is a benefit in and of itself to the innovating company, as the firm is able to develop that technology and then apply it to new, company-growing technologies and innovations. Finally, Mr. Egnal reiterated some features of the SBIR process possibly amenable to changes. As mentioned earlier, he felt that it is of the utmost impor- tance to maintain transparency in the generation of RFP’s, and in the award process itself, as this would help ensure a level playing field, especially for the smallest or newest firms that do not have established networking capabilities. The influence of networking and the benefits associated with being familiar with the government contracting system and having personal contacts within grant- ing agencies have been mentioned by several firms over the course of the DoE SBIR investigations, and Mr. Egnal echoed these thoughts by mentioning pos- sible disadvantages for unconnected firms. A second area that requires attention in the SBIR process, in his opinion, would be the time gap between the Phase I and Phase II rounds, as it is difficult for some firms to maintain employees or facilities during the intervening time. He closed by stressing that these issues are overshadowed by the benefits, both to society and the individual firm, associated with the SBIR program.

204 APPENDIX D NanoSonic, Inc.23 Nicholas S. Vonortas Jeffrey Williams The George Washington University July 2005 The Company NanoSonic, Inc, is a privately owned research and development concern based in Blacksburg, Virginia, with offices in Seattle, Washington, and Dayton, Ohio. The research focus of the firm is in the area of advanced materials and nanotechnology applications. A principal goal of the firm is to scale-up nanoscale properties, that is, transitioning nanoscale materials into macroscale materials that retain the characteristics of the original product. Such a process allows the macroscale material to retain the unique physical properties of its nanoscale base, properties that cannot easily be generated in macroscale materials. The firm was founded in 1998 with three part-time employees, and has since grown to fifty-six employees and has received nearly fifty Phase I and over twenty Phase II SBIR awards from NASA, the Department of Energy (DoE), the Department of Defense (DoD), and the National Science Foundation (NSF), and has one Phase IIB with the NSF. Metal RubberTM, a highly plastic and highly electrically conductive nanocomposite film, is one of NanoSonic’s premier prod- ucts and is based on one of the firm’s original SBIR-funded innovations, the modified self-assembly process. The firm has generated several patents as a result of SBIR/STTR funded research. In 1998, Dr. Claus, a professor at Virginia Tech, was working on a materials contract with an entity from outside of the university. In order to pursue work on this project, Dr. Claus formed NanoSonic, an independent company outside of the purview of Virginia Tech. Even though the SBIR program was not the reason for establishing the company, it was soon to play a very important part in the company’s development. Just after the company’s creation, NanoSonic became aware of an Air Force solicitation, and the company responded, eventually earn- 23This case is based on primary material collected by Nicholas Vonortas and Jeffrey Williams during an interview with the president of NanoSonic, Inc., Dr. Richard Claus, and the Vice President of Busi- ness Development, Dr. Jennifer Lalli. It is also based on preliminary research on the company carried out by the authors. We are indebted to Dr. Claus and Dr. Lalli for their willingness to participate and generosity in offering both a wealth of information to cover the various aspects of the study and their broad experience with the SBIR program and with high technology development in the context of small business. All opinions in the document are solely those of Dr. Claus and Dr. Lalli. The authors are responsible for remaining mistakes and misconceptions.

APPENDIX D 205 ing a Phase I award from the DoD in 1998. Since that time, SBIR awards, which account for approximately 80 percent of the firm’s current revenue, have been important for the continued growth of NanoSonic. Typically, the company reinvests a portion of internal funds into product development. This also includes patent acquisition from the U.S. Patent and Trademark Office. In the past couple of years, as the company transitions from an R&D concern to a fully developed company, NanoSonic has also accelerated its direct marketing efforts with reportedly successful results. Funding and Commercialization An important facet of SBIR applications and awards is reportedly a firm’s familiarity with the government contracting process as a whole. Accordingly, it was indicated that an important factor to NanoSonic’s success in obtaining awards has been Dr. Claus’ prior exposure to government contracting, as that allowed the firm to navigate the process more confidently. His government security clearance and broad familiarity with how agencies, such as DoD, promote and solicit SBIR projects has seemingly been helpful, as well. Prior working experience with dif- ferent federal agencies has allowed NanoSonic to anticipate agency needs and to know where to look for commercialization possibilities. NanoSonic has experienced differences among SBIR-funding agencies in terms of efficiencies in working with scientists and engineers. Expectations can also differ about how materials will eventually get into the marketplace. Agencies with their own labs and intramural R&D tend to be more technologically focused. Further specifics were not provided by the interviewees—apart from the fact that some agencies, reflecting their mandates, are more science-oriented and some more application-oriented. But DARPA was singled out as the as the best agency with which to work for scientists and engineers. Success in the SBIR program has also allowed NanoSonic to access addi- tional sources of funding. Most importantly, it was felt that awards allow smaller companies to get inside the doors of the larger government contractors. An SBIR award is helpful because it raises flags for the prime contractor and instills con- fidence that the smaller firm, and its product, have been vetted to some degree, thus raising interest. Once one large prime contractor becomes aware of the small firm, then the reputation travels and others are likely to hear about it, its product, and area of expertise. R&D-intensive companies were also said to have more opportunities to get to know each others’ products through the SBIR process. For example, DARPA has previously hosted conferences for specific areas of technology, at which the prime contractors and smaller contractors displayed their work. While those conferences are not related to SBIR, they provide a venue through which firms interact, and a previous SBIR award will help set firms apart. NanoSonic has, until now, not pursued venture-capital (VC) backing for

206 APPENDIX D any of its research projects. It was felt that venture capital is not an appropriate venue for research funding because VC firms often have unrealistic milestones for project development. They try to streamline companies by exercising extensive control (taking equity). When milestones are missed, repercussions can include losing additional ownership to the VC firm which, in extreme cases, assumes full control over the company and can break it up or change its focus. On the other hand, it was indicated that VC firms are more acceptable for product develop- ment, especially during the commercialization phase. They have the resources necessary to spread product information to the marketplace, and might have com- mercial connections of which the research firm is unaware or unable to utilize. NanoSonic has also not pursued financing through bank loans. Banks are considered to know next to nothing about the business of small, R&D-intensive companies. The existence of an SBIR award would mean little in the consider- ation of financing opportunities. In addition to providing NanoSonic with funding, SBIR awards have helped to build the company’s technology base. They have allowed the company to pur- sue a whole suite of research projects and have allowed it to bring in researchers with various kinds of expertise that offer new points of view and knowledge that can be used to the company’s benefit. Naturally, it was felt that not all ideas that receive SBIR funding turn out to be great. Some work perfectly and some don’t work that well, with the majority falling somewhere in the middle, thus, forming a normal distribution of success. Example Innovation from NanoSonic An important example of innovation success stemming from the SBIR process for NanoSonic has been the so-called modified self-assembly process. Modified self-assembly is a process that allows the formation of multiple, ultra- u ­ niform, nanometer-thick layers of various materials into functional thin films. An early Air Force SBIR award in 1998 helped NanoSonic first develop the modi- fied self-assembly process and apply it to the production of a special, transparent, electrically-conductive coating. This coating was composed of nanoparticles and could be applied to a wide variety of surfaces. Building on the patented process resulting from the initial SBIR grant, NanoSonic has managed to increase the vol- ume of the material and the manufacturing speed of the modified self-­assembly process. A more recent SBIR award from DoE has allowed the company to apply this now-mature technology towards the creation of a product called Metal ­Rubber. This product, formed from many layers of nanoparticles, combines the electri- cal conductivity of metals with a high level of plasticity, a reportedly unique combination. Additionally, the product is virtually optically transparent. Metal Rubber has applications in strengthening flexible electrical connections, such as those that power laptop screens and connect the flip panels of mobile phones.

APPENDIX D 207 It may also be used in areas such as electromagnetic shielding, numerous bio- medical applications, and in measuring large mechanical deformations. This product, for which the company is very upbeat, is currently commercially avail- able, through NanoSonic, for research and development applications in end-user processes only, or, by contract, for other development purposes. Lockheed Martin has signed an alliance agreement with the firm in order to study the potential applications of nanocomposites in commercial and defense aerospace applications. Additionally, NanoSonic is associated with compa- nies such as Motorola, General Dynamics, Dow Corning, Honeywell, IBM, and Northrop Grumman through partnerships, programs, contracts, or other agreements. The firm has nine patents that have stemmed from the original, SBIR-spon- sored, modified self-assembly process. It also has numerous other patents in other areas of nanoscale research. The modified self-assembly patents are exclusively licensed from Virginia Tech Intellectual Property, Inc. NanoSonic has separately developed its own intellectual property to allow for process, material, and prod- uct commercialization of outputs stemming from the modified self-assembly process. Views on the SBIR Process As stated earlier, NanoSonic was first exposed to the SBIR process very early in its history through an Air Force solicitation. According to the interviewees, the SBIR program is so well knows that it is difficult for any lab that performs tech- nical research to miss it. In relation to the application process, NanoSonic does not feel that geography is important and it did not perceive important differences among the various agency application processes. The firm directs applications to the agency that makes the most sense for each specific research/innovation idea. NanoSonic indicated that the costs associated with applying for SBIR fund- ing are easily handled, as the learning process involved in putting together a strong application can actually be very beneficial, sometimes more than any eventual reward. As the company gathers information for completion of the pro- posal, it will contact a wide variety of industry representatives. The application process thus becomes a networking vehicle. It was indicated that well-prepared R&D firms can generate extensive intangible benefits from this networking, as potential research partners and future product marketers become more familiar with a specific innovation. Overall, NanoSonic appeared quite satisfied with the SBIR application pro- cess. If anything, it was considered that providing instructions and incentives to small and large companies to facilitate pre-proposal networking would be very beneficial to all sides. NanoSonic’s management perceives the SBIR program as a vehicle for getting small and large firms to cooperate, especially through the com-

208 APPENDIX D mercialization requirements attached to the grants. Agencies with an emphasis on commercialization should make every effort to strengthen such links. No changes to the basic SBIR process were recommended. Topic specifica- tion, though it may vary in specification level across agency and program, was considered appropriate for each of the agency missions. The selection process is perceived as fair, with only a few cases where grantees seem to have had an early lock on the award. Feedback for rejected applications has tended to be straightfor- ward and helpful. For innovations earning grants, the funding usually arrived in a timely manner, especially with the use of online filing. The interviewees encour- aged all agencies to move to purely online filing, as this is a much more efficient method of grant application. Faced with the choice of fewer, larger grants or more, smaller grants, the interviewees thought current funding ratios appropri- ate: Moving to a smaller number of awards with larger funding was considered undesirable. The funds for testing feasibility in Phase I and testing production in Phase II were thought to be at more or less appropriate level. All in all, NanoSonic sees the SBIR process as a very important framework that supports innovation in the United States. One of the reported strengths of the program is the requirement for feasibility studies. This requirement allows small companies to work alongside of, and network with, larger technology and production companies. Small companies benefit through the potential of aid from the large company resource base, and large companies benefit by being exposed to innovative technologies and products of smaller, nimbler firms. According to the interviewees, strengthening the program would mean further extending networking opportunities, for example, by granting small pre-proposal awards to test for product commercial potential. Conversely, NanoSonic sees few weak- nesses in the overall program. Earlier problems regarding the timing of funding and application submission have been cleared up, principally due to a strong communication network. The firm did suggest that perhaps there could be more flexibility when it comes to spending grant monies on production. Otherwise, no significant changes were recommended.

APPENDIX D 209 NexTech Materials, Ltd.24 Nicholas S. Vonortas Jeffrey Williams The George Washington University August 2005 The Company NexTech Materials is located in Columbus, Ohio, and is focused on the development and manufacture of fuel cells and fuel-cell materials and compo- nents. Fuel cells use hydrogen or other fuels to produce electricity without gen- erating pollutants. The company was founded in 1994 with only two employees and, having outgrown its 8,500-square-foot building in Worthington, recently moved into a 56,000-square-foot facility in Delaware County. It has about forty employees and sales of between $4 million and $5 million—both roughly double from two years ago. Fuel-cell cars, although a potentially large market, are expected to be years away. Significant barriers remain, including how to best produce the needed hydrogen and make it available at service stations. NexTech works on various applications such as fuel cells for laptop computers, generators and other power sources. NexTech’s first major commercial application of fuel-cell technology could be the home energy appliance in a few years; it is developing fuel-cell components for an appliance that would power and heat a home. The com- pany expects demand for its products to increase as demonstration projects test fuel-cell technology. One project in Westerville will use fuel cells to generate e ­ lectricity for 250 homes. Fuel-cell materials and components are sold as either individual products, or combined and sold as a completed fuel cell. In 2000, Fuel Cell Materials was formed as a wholly owned subsidiary of NexTech in order to commercialize innovative ceramic materials technology and products developed by NexTech. The Fuel Cell Materials unit caters to other companies in the fuel cell industry through the leveraging of internal knowledge and production know-how. NexTech offers a range of partnership opportunities for other firms that operate in the fuel- 24This case is based on primary material collected by Nicholas Vonortas and Jeffrey Williams dur- ing a telephone interview with the President of NexTech Materials, Ltd., Mr. William Dawson. It is also based on preliminary research on the company carried out by the authors. We are indebted to Mr. Dawson for his willingness to participate and generosity in offering both a wealth of information to cover the various aspects of the study and his broad experience with the SBIR program and with high technology development in the context of small business. All opinions in the document are solely those of Mr. Dawson. The authors are responsible for remaining mistakes and misconceptions.

210 APPENDIX D cell industry. Partnerships can include the provision of material components by N ­ exTech as well as cooperative R&D based out of NexTech’s facilities. Currently, the firm’s projects include solid oxide fuel cell and oxygen generation compo- nents, fuel-cell processes and materials development, catalysts for fuel processing, sensors for fuel cells and fuel processing, and lead-free ceramics development. NexTech has received numerous Phase I awards and five Phase II awards. It has never applied for Phase IIB but has applied unsuccessfully for Fast Track consideration from the Department of Defense. NexTech has successfully com- mercialized the results of a number of SBIR-funded projects, mostly with private- sector clients but also with federal agencies. SBIR and the Firm The SBIR program has had a profound impact on the founding and subse- quent success of NexTech. In 1994, Mr. Dawson started the company with his own money and funding from a Phase I SBIR contract with the U.S. Navy.25 Without the SBIR funding, he argued, the firm would have probably never been incorporated, much less turned into a profitable enterprise. NexTech has main- tained a close relationship with the SBIR program ever since, and the grants have been instrumental in seeding technology development and introducing the firm to commercial activities. Grant funding has made up between 6-25 percent of ­ NexTech’s revenue every year. That share is generally declining as com- mercializable innovations reach maturity. Mr. Dawson, however, indicated that SBIR awards may again account for an increased fraction of revenue in the future because fuel-cell technology makes up an emerging market. It is also currently difficult to accurately predict market opportunities in that area. SBIR awards have assisted the company in attracting other forms of financing, such as funding opportunities from the state of Ohio’s Third Frontier Fuel Cell Program and the Commerce Department’s ATP program. The SBIR program has also been instrumental in introducing the firm to federal agencies, through Broad Area Announcements, as well as to other private firms. Contracts have been forth- coming from both of those interactions. Primarily, however, it has been private companies with which NexTech has developed the strongest commercial ties. The SBIR program has contributed significantly to enhancing NexTech’s technological base. Now that NexTech is more established and has a more focused portfolio, it is able to channel the SBIR funding into the development of new products in the firm’s specialty base, as well as products derived from some of NexTech’s existing innovations. 25Prior to founding the firm, Mr. Dawson worked as a project manager at the Battelle Memorial Institute. Since the inception of NexTech, he has earned three patents and authored numerous papers related to fuel cell technology. He also sits on the board of the U.S. Fuel Cell Council, the Ohio Fuel Cell Coalition, and the Edison Materials Technology Center.

APPENDIX D 211 Example of an SBIR-Derived Innovation The product selected for discussion was NexTech’s low temperature solid oxide fuel cell. Improvement on the properties and performance of solid oxide fuel cells (SOFC) has been one of the main goals of the company since its incep- tion. SOFC’s directly convert chemical energy into electrical energy. Typically, a SOFC generates electricity by passing charged oxygen ions across a membrane. During the process, the oxygen ions are stripped of some electrical energy, which is then collected and transmitted as electricity. In this way, fuel cells function in a manner similar to that of regular, dry-cell batteries. However, fuel cells can be replenished when their chemical source of charged oxygen is depleted, thus allowing for a longer lifespan than traditional batteries.26 SOFC’s are argued to be the most desirable form of fuel cell for a variety of reasons. First, SOFC’s are more compact than other fuel cells because they use a solid electrolyte membrane, which negates the need for the pumps that are used in other cells to circulate the liquid membrane. Second, SOFC’s are relatively highly efficient, transforming around 50 percent of chemical energy into ­ electricity. Third, both carbon monoxide and hydrogen can be used as fuel sources. Being able to utilize more than one chemical as a fuel source ensures that the fuel supply for these cells is relatively inexpensive and plentiful.27 One of the drawbacks to SOFCs until now has been that they operate at high temperatures (at least 650° Celsius). At these temperatures, fuel cells require s ­ everal minutes of start-up before being able to generate power, thus elimi- nating the possibility of use in instant-need electrical configurations, such as automobiles. NexTech, however, has created a SOFC that runs at comparatively lower temperatures, allowing them to be used in a wider variety of applications. N ­ exTech SOFC’s are currently used as power sources not only for stationary users, such as homes, hospitals, and other buildings, but also as continuously- running, auxiliary power sources for heavy trucks, as well as in a number of military applications. The firm’s fuel cells confer a number of benefits to their users. To begin with, given that the fuel-cell market is still relatively new, customers gain access to the new performance capabilities accompanying innovative products. NexTech’s SOFC’s also provide increased operating lifetimes and power output per unit weight over previous fuel cells. Many customers looking to use fuel-cell technol- ogy will be replacing traditional, entrenched forms of power generation. These fuel cells need then to not only match existing forms of power output but to appeal to users on different levels. In this case, fuel cells provide ­environmentally- friendly results, as they are nonpolluting, have zero negative emissions, and aid in the reduction of greenhouse gases. 26Azon.com Web site. Accessed at <http://www.azom.com/details.asp?ArticleID=919&head=­ Solid%2BOxide%2BFuel%2BCells>. 27Ben Wiens Energy Science. Web site. <http://www.benwiens.com/energy4.html>.

212 APPENDIX D NexTech is currently selling the materials used to build SOFCs on the global commercial market. For fuel-cell parts, the firm has approximately 170 cus­tomers in over thirty different countries. Complete SOFCs are also for sale globally. However, NexTech had only been selling complete cells on the open market for a few months at the time of the interview. Consequently, the market only covers Australia, Japan, Taiwan, and parts of Europe and North America. In addition to the commercial market, NexTech also sells fuel cells and fuel-cell components to the Department of Defense and to NASA. Not only does NexTech develop and market their own products, they also offer commercial development services to other companies under contract. Other firms with their own fuel cell materials and products will approach NexTech for materials and development assistance that will improve those fuel-cell products and help them better penetrate the commercial marketplace. As such, NexTech can be considered a complete manufacturing and development concern built around fuel-cell technology. NexTech’s strategy for the commercialization of their low-temperature solid oxide fuel cells has been to remain a free agent. The firm supplies products and services to companies of all sizes, and seeks to supply the entire marketplace rather than concentrating on a small number of buyers. Under the assumption that, in the future, demand for fuel-cell products and services will increase, N ­ exTech is also seeking strategic alliances through which manufacturing output can be increased. To date, the firm has not licensed its technology to other com- panies, but may consider doing so if the market grows beyond the point at which internal manufacturing capabilities can keep pace with demand. NexTech sees much more interest today for fuel-cell technology than in 1994 when the firm was founded, as fuel cells were a new innovation at that point. And while the market is not completely mature, current trends seem to support continued market growth, including steady annual increases in investment in fuel-cell development. The firm sees a future fuel-cell market that will eventually grow to the size of multiple billions of dollars. That market, however, will not emerge at the same time for all applications of fuel cells. Areas in which NexTech is already active, such as heavy trucks and some military applications, are expected to reach maturity within five to ten years, while other areas, such as U.S. automotive and home markets, are still a long way from maturity. Parts of foreign fuel cell markets tend to be more mature than they are in the United States. For example, Germany, Switzerland, and Japan are already using fuel cells in residential power generation, an area that has been difficult to commercially penetrate in the United States. NexTech indicated that this is due to differences in the way marketplaces are structured, and that some sections of the U.S. market, such as fuel cells in heavy trucks, are probably more open than their foreign counterparts. NexTech has published scientific papers related to the SOFC innovation. Frequently, NexTech publications occur as part of conferences in which the firm participates, rather than directly in peer-reviewed journals. The company is care-

APPENDIX D 213 ful not to give away too much know-how, and focuses on publishing research results instead. Interestingly, Mr. Dawson indicated that it is more difficult for newly formed companies to preserve trade secrets in published materials. Con- sequently, when NexTech was first founded in 1994, the firm published very little in order to preserve its internally-generated tacit knowledge. In addition to published papers, two patents resulted from the SOFC innovation, and more are likely to come in the future. Views on the SBIR Process Before founding NexTech, Mr. Dawson was employed by the Battelle research consortium of Columbus, Ohio, a group that is active in support of entrepreneurial firms. It was there that he first heard of the SBIR grant process. Additionally, the State of Ohio actively promotes the SBIR program through conferences, as well as through email alerts distributed to innovation firms throughout the state. While the SBIR program may be intended to have uniform functional- ity, ­NexTech does see differences among the granting agencies in a number of different areas. First, the firm generally applies for SBIR grants to the agency with which the specific technology has the best fit, as each agency has an indi- vidual technology focus. As has been also noted in other interviews, NSF tends to look for more basic research, DoE prefers a mix of basic and applied, and DoD looks for more applied technology. In terms of the SBIR applications, the only appreciable, difference according to the interviewee, is that some agencies, such as NSF, look for more formal commercialization plans than do others. One important area in which differences do occur is in the evaluation periods between payments. While switching to electronic filing and payments has sped up the overall process, some agencies do take longer than others in making pay- ments. In ­NextTech’s experience, the DoD is structured so that each individual SBIR-­granting unit has its own payment process, which can cause delays from time to time. On NexTech’s first SBIR grant, for example, Phase I was awarded in ­ October of 1994, but payment for Phase I was not received until March of 1995. DoE and NSF, on the other hand, tend to be very responsive in payment distribution. Another interesting issue brought up by Mr. Dawson also echoes comments in previous interviews. NexTech would prefer to see some sort of formal SBIR struc- ture in place that helps prospective applicants before the agencies announce their topics. Having more information on the upcoming topic and on the indi­viduals who will be reviewing applications reportedly results in much more success­fully tailored proposals. In this interview, it was highlighted that being able to talk to people within the granting agency regarding the topic really helps the firm tailor their application and come forward with the most appropriate innovation. Given the significant proposal preparation costs, it was argued, it would be helpful to have an early indication of whether the granting agency would be interested at all

214 APPENDIX D in the innovation. The above concern is driven by the fact that, once a topic has been announced, firms are not permitted to communicate with program ­managers. Another possible change would be to increase the frequency of the rounds of topic specification. Especially in the DoD, it would be helpful if firms had more oppor- tunities to respond to topic announcements during each year. Regarding topic specification, NexTech recognizes that different agencies have different missions and must use topic specifications that are most ­appropriate for their needs. However, in the opinion of the interviewee, it is not enough for a firm to just respond to the topic announcement. Without having a working relationship with a program manager inside of the granting agency, there is little perceived chance that a firm will earn an SBIR award. This ties into NexTech’s view on the overall fairness of the SBIR process. For the most part, the company sees it as very fair, but it considers that there is room for improvement. One drawback of the process is when a firm’s application is assigned to a program manager who does not have a lot of clout. In this case, equally effective innovations may suffer, as the more influential program managers are able to get their firms’ innovations pushed through at the expense of other firms. Occasion- ally, there also might be cases in which application reviewers are specifically selected because they are known to typically give high or low marks. One final comment on fairness, which has been also heard in other interviews, is that some topics are so specific as to be only possibly filled by a single firm. While this is overall an undesirable action, NexTech did concede that defense agencies, in particular, need to find a way around budget restrictions and sponsor specific technologies that they cannot produce in-house. Overall, NexTech sees SBIR as a very effective, very important program. However, some changes were suggested. While NexTech does not have experi- ence with Phase IIB programs, they have applied once for a Fast Track award. A major roadblock was that the agency required the innovator to show proof that an investor had deposited third-party funding in the innovating firm’s bank account before Fast Track could proceed. Letters of commitment are insufficient, and without the deposited funds, Fast Track contracts are canceled. Unfortunately for NexTech, investors with whom the firm has spoken are unwilling to deposit funds without a guarantee from the granting agency, thus making it difficult for the firm to participate in Fast Track programs. Combined with the lack of contract mechanisms to bridge Phase II and Phase III development, a number of innova- tions thus stand to remain unrealized. Another suggested change was in the award amounts. Over the last ten years, SBIR grants have not increased in dollar value, making it harder for the money to be effective. If the funding were adjusted for inflation, that would go a long way towards eliminating the disparity. The relationship between Phase I and Phase II awards was also mentioned as an area that could use improvement. Specifically, the process needs to be more transparent in order to allow a firm to better understand its chances of earning a Phase II award after completing Phase I

APPENDIX D 215 research. For NexTech, it seems that, sometimes, a great Phase I does not make it to Phase II, while a mediocre Phase I will earn Phase II funding. Building on that last point, Mr. Dawson described the strategy of basing a company’s revenues on SBIR awards as a bad business model due to its unpre- dictable nature. In a commercial contract, the customer and supplier have a clear indication that the relationship will involve an exchange of goods and services, allowing for a relatively accurate picture of income flow. With SBIR awards, it is more difficult to predict income flow, especially when the relationship between Phase I and Phase II is not transparent. Just as have many of the other interviewed firms, NexTech management does not support a business existing solely to earn SBIR grants. Not only does that operation plan suffer from the bad business model described above, but those firms also tend to disregard commercialization, which is the overall goal of the SBIR program. Mr. Dawson sees the SBIR program today as being very different from 10 years back. No longer is it purely a policy system through which innovations are introduced into the marketplace. Instead, different agencies use the grant pro- cess to achieve different goals. NSF, for example, seeks to expand basic scientific knowledge with a strong emphasis on commercialization. DoD relies on these grants to get internal innovation projects going. The changing scope of military programs demands a large investment in innovative technology, but the DoD budget cannot support all of the innovation that the agency wants. Therefore, the SBIR program becomes a sort of contract vehicle through which specific firms and specific innovations are developed. This last observation is related to a point that has been repeated in a number of the interviews: Having a personal relationship with the procurement side of an agency is essential to earning an SBIR award. NexTech employees dealing with the SBIR program are told that three things are required for a proposal to be successful: A great innovation idea, the innovation must to be important to the granting agency, and the program manager reviewing the proposal needs to have clout within the agency and be willing to push it through to contracts. At the end, Mr. Dawson strongly reiterated his position that the SBIR pro- gram has been a boon for the nation’s innovation industry. NexTech’s history, he thought, is part of the proof.

216 APPENDIX D Princeton Polymer Laboratories, Inc.28 Nicholas S. Vonortas Jeffrey Williams The George Washington University July 2005 The Company Princeton Polymer Laboratories, Inc (PPL) is primarily a contract research and development company based in Union, New Jersey. The firm was founded in 1969, well before the SBIR program came into being. Since the establishment of SBIR, PPL has earned five Phase I awards, from the Air Force and Department of Energy, and one Phase II award from the DoE. PPL has not fully commercialized any of its innovations. The rights to the Phase II innovation, a biopolymer, were purchased by Dupont-Conagra, but were subsequently returned to PPL when the buyer underwent a restructuring. PPL is 50 percent female-owned, and currently employs a mix of five full-time and contract researchers. Aside from R&D, firm employees frequently serve as expert witnesses in legal cases involving biotech issues. SBIR and the Firm As the firm was founded in 1969, the SBIR program played no part in its establishment. And with only five Phase I awards and one Phase II award since the inception of SBIR, the program has played only a modest role in directly support- ing the company financially. PPL’s financing is currently derived entirely from the private sector. While the funding dollars themselves from SBIR have not made a large impact on the firm, the other benefits of the program have been more keenly felt. Most importantly for PPL, an SBIR award (to be discussed in the following section) allowed the firm to expand its technology base to include the biotech industry, which now comprises the bulk of its R&D activities. PPL was also able to secure funding, in the form of bridge grants, from the State of New Jersey at least partially due to the enhanced reputation associated with SBIR awardees. 28This case is based on primary material collected by Nicholas Vonortas and Jeffrey Williams dur- ing an interview with the President of Princeton Polymer Laboratories, Inc., Dr. Peter Wachtel. It is also based on preliminary research on the company carried out by the authors. We are indebted to Dr. Wachtel for his willingness to participate and generosity in offering both a wealth of information to cover the various aspects of the study and his broad experience with the SBIR program and with high technology development in the context of small business. All opinions in the document are solely those of Dr. Wachtel. The authors are responsible for remaining mistakes and misconceptions.

APPENDIX D 217 Example of an SBIR-Derived Innovation Dr. Wachtel elected to discuss a biopolymer associated with the single Phase II award granted by the DoE. As background, a biopolymer is a biological, or biologically derived, synthetic polymer. In this case, the biopolymer is called chitosan, a naturally occurring material derived from the chitin of certain types of sea shells. Chitosan is used as a bulking agent in a number of commercial prod- ucts, such as face creams, puddings, and diet supplements. It may also be used to aid in the extraction of heavy metals from waste-water, as it binds to the metals and causes them to clump and sink through the solution. There are also uses in the remediation of nuclear waste, as chitosan performs the same thickening action on uranium and plutonium that it does on other metals. The major drawbacks to the biological chitosan are that its production requires a lot of raw material—it takes around one ton of seashells to produce one pound of chitosan—and there are hazardous by-products associated with its production. PPL sought to create a chitosan that performed as well as the existing type but did not have the toxic by-products. Through Phase I and Phase II funding from DoE, the firm created an insect-based form of chitosan that had no envi- ronmentally hazardous side effects. This product was initially licensed to the Dupont-Conagra cooperative concern. Unfortunately, however, Dupont-Conagra experienced financial difficulties soon thereafter and the new management decided to abandon the specific product development. The license was returned to PPL without having been commercialized. Although promising, the form of chitosan developed with the Phase II award requires further development in order to be put into productive use. And like the seashell derived chitosan, it is still expensive to produce. Manufacturing can only be economically feasible when produced in industrial quantities at a large, dedi- cated facility and with round-the-clock staffing.29 The firm is unable to produce the biopolymer in sufficient quantities in-house, and has not found any other out- side enterprises willing to invest in its production. Currently, PPL has no specific plans for commercial development, though they would be interested in working with a corporate or government sponsor should the opportunity arise. Should such an arrangement occur, PPL would most likely sell the license to its chitosan, as it would be too large of a project for the firm to handle internally. With respect to this product, PPL seems to be in a “Valley of Death” situa- tion, where moving from Phase II prototype to product development and com- mercialization requires resources well beyond what the firm can muster (see annex of the case study). Were it able to secure sponsorship from an outside large firm or a government agency, PPL sees the potential market for its chitosan product as being very large, especially in the area of nuclear waste remediation. But it first requires a “patient” investor who can stay the course. Dr. Wachtel is 29Significant start-up costs.

218 APPENDIX D not optimistic that this role would be filled by a large company under pressure for fast returns. The chitosan process is a trade secret, and there are no plans for patent- ing. As a rule, PPL does not patent. It perceives process patents as particularly unnecessary to the scientific community in that they do not assist to retain intel- lectual property rights to processes. As a case in point, it was mentioned that one of PPL’s previous owners spent large amounts of time and money on acquiring patents, but saw almost no return on those efforts. Along the same lines, PPL does not publish scientific papers out of concern of giving away proprietary informa- tion. PPL relies on its reputation and personal connections to attract clients, of which around 80 percent are repeat customers. Impressions of the SBIR Process Dr. Wachtel first became aware of the SBIR process in 1988, the same year in which he purchased PPL from his partners. PPL had a metal-polymer blend that had received some interest from the commercial sector. A personal connec- tion at the Air Force then informed PPL of the SBIR program, and suggested that the firm submit the metal-polymer blend during the next round of SBIR funding, leading to PPL earning its first Phase I award. The firm has garnered awards from both DoD and DoE since 1988, and feels that there are some operational differences between the agencies. DoD, for example, rapidly issues an approval decision and funding for accepted submissions. DoE, on the other hand, is sig- nificantly slower to respond to inquiries or submissions. PPL has not submitted any proposals for at least three years because the SBIR process is no longer seen as being cost effective: the amount of work necessary to submit proposals outweighs the resulting funding of those that are successful. Accordingly, Dr. Wachtel suggested two changes to the SBIR process. First, the approval process needs to be more transparent. It is difficult to tell what happens between proposal submission and the final decision by the granting agency. When asked about whether feedback helped in these instances, Dr. Wachtel indicated that the feedback is often very general, and mostly unusable. Even if the feedback were helpful, the SBIR process does not allow for a proposal to be reworked and resubmitted. Second, the submission topics are often too specific. Some are so precise that it gives the impression of the granting agency having a specific firm and technology in mind before announcing the submission round. However, he does acknowledge that some agencies need to be more specific than others as they have different needs and missions. Overall, the impression is that SBIR is a good program because it is an important vehicle by which small firms are able to commercialize some innova- tions, though some improvements could be made to increase fairness.

APPENDIX D 219 PPL—ANNEX Knowledge-intensive, innovative firms offer a return on investment that is skewed and highly uncertain, with risk characteristics and default ­probabilities that are hard to estimate. The likely existence of substantial informational ­ asymmetries between such companies and investors make it difficult to come up with a mutually agreeable financing contract, since entrepreneurs may pos- sess more information about the nature and characteristics of their products and processes than potential financiers. In addition, the intangible nature of innova- tive activities makes the assessment of their monetary values difficult before they become commercially successful and offers little salvage value in the event of failure. Regarding the firms, smaller companies tend to have limited ­market power, a lack of management skills, a higher share of intangible assets, an absence of adequate accounting track records and few assets, if any. The assess- ment can therefore be made that the more knowledge-intensive the firm, and the smaller its size, the harder it will be for it to gain access to capital. This challenge of successfully moving from achieving a scientific break- through to creating a market-ready prototype is often referred to as the “Valley of Death.” On one side of this valley stand the scientists and technologists, the innovators undertaking the research and development work; prior to reaching the “valley,” they were funded through corporate or government research funds or— more rarely—from personal sources. On the other side stand innovation managers and investors, experts in financing and management of business enterprises; they possess development funds and expertise for turning an idea into a market-ready prototype supported by a validated business case. Crossing the “Valley of Death” involves bridging three fundamental and interrelated gaps:30 • A financing gap between research funds—typically received from per- sonal assets, government agencies or corporate research—that support more basic research and the investment funds to turn the idea into a market-ready prototype. This gap is usually bridged by risk financing through equity or by government programs specifically constructed for this purpose. • A research gap between the scientific or technical breakthrough and the basis for a commercial product. Often, more research is needed on functional- ity, affordability, and quality before an idea can develop into a product that can compete in the marketplace. • An information and trust gap between the scientist/technologist and the investor, each with a different understanding of the innovation and with dis- 30Lewis Branscomb and Philip Auerswald, Taking Technical Risks: How Innovators, Executives and �������������������������������� Investors Manage High-Tech Risks, Cambridge, MA: The MIT Press, 2001.

220 APPENDIX D similar expectations of what it is to accomplish. The technologist knows what is technically feasible and what is novel in the proposed approach; the investor knows the process of bringing new products to market. The two must be able to communicate effectively and to trust each other fully.

APPENDIX D 221 Thunderhead Engineering31 Philip E. Auerswald George Mason University September 2006 Overview Thunderhead Engineering is a simulation software company located in M ­ anhattan, Kansas, two hours to the west of Kansas City. The company was founded by in 1998 by Daniel Swenson, a professor in the Department of Mechan- ical and Nuclear Engineering at Kansas State University (K-State), in partnership with Brian Hardeman, then a master’s degree student in the same department. Thunderhead is located in university town and was founded by academics in order to realize the commercial potential of capabilities developed in the process of university-conducted research. Though working far from both the technology centers on the two coasts and the oil industry hub in Houston, ­Thunderhead has succeeded in utilizing awards from the SBIR program to develop a simulation software product with stable customer base of major oil companies in the U.S. and overseas. Specifically, the company has built its business on tailoring for corporate use highly sophisticated simulation software developed at that Earth ­ ciences Division of Lawrence Berkeley National Laboratory.32 Using its exper- S tise in developing intuitive graphical user interfaces (GUIs) for complex engineer- ing software, it has developed two relatively new products related to fire modeling and building design that have also achieved international sales. Firm Development Resisting the “Brain Drain:” Two Academics Create Opportunity Where They Live As much as it is about a technology, the story of the development of T ­ hunderhead Engineering is about a place: K-State and Manhattan, Kansas. Company founder Swenson recalls his move from Sandia National Laboratory to Manhattan KS in mid-1980s: “I came to K-State primarily for family. My ­family 31This case is based primarily on primary material collected by Philip Auerswald during an inter- view at Thunderhead Engineering on September 30, 2005, with Dan Swenson and Brian ­Hardeman. We are indebted Thunderhead Engineering, Inc. for their willingness to participate in the study. R ­ esearch assistance by Kirsten Apple is gratefully acknowledged. Views expressed in this case study are those of the authors, not of the National Academy of Sciences. 32Notably, the TOUGH2 and TOUGHRREACT software packages.

222 APPENDIX D is from Kansas and I was looking for a place to get closer to them.” Having chosen to live in Kansas for reasons unrelated to his professional development, Swenson sought upon his arrival to build up a research activity. Brian Hardeman comments on the “brain drain” affecting Manhattan: “I used to say ‘my wife and I are alone in this town because there is no one between the age of 22 and 40 because everyone graduates and they go get jobs elsewhere because there are not a lot of jobs here. There are not a lot of innovative high-tech companies. There are some manufacturing and services.’ ” For a young engineer a commitment to staying in Manhattan, Kansas—where Hardeman’s wife is an elected local official—meant the need to get creative. Quips Hardeman: “I prob- ably would not have a job if I did not have this company.” Swenson is quick to qualify the comment, emphasizing that only the commitment to ­ Manhattan, K ­ ansas, has narrowed the range of Hardeman’s career options. “Brian is some- one that could have gone somewhere else and gotten a good job.” Building T ­ hunderhead in Manhattan, Kansas, was matter of choice, not necessity. The partnership between Swenson and Hardeman began with a Department of Energy funded project on which the pair began work in 1996, with Swenson as the Principal Investigator and Hardeman the researcher. The objective of the project was to write software to model fluid flow and heat transfer in porous and fractured rocks. In the midst of that work, Swenson participated in a research conference in Japan. As a consequence of a presentation made during the trip, he received an offer to consult for a Japanese client. As a vehicle to perform this work, Swenson and Hardeman founded Thunderhead. Using Open Source Code as the Basis for a Proprietary Software Package Swenson and Hardeman began to consider the possibility of commercializing their software. “We did not have any clear plan,” Hardeman recalls. The initial thought was “just to do something on the side in the evenings.” As an initial step, they approached the K-State Technology Licensing Office. The response they received was “eye opening,” Hardeman recalls. The Tech- nology Licensing Office was highly assertive of its claims on the software. “‘If you want to use anything that has been developed at K-State, if you think there is even an inkling of money in it, we want licensing,’” Hardeman recounts as the essential message they received in their meeting. The university insisted that Thunderhead bear the cost of protecting the technology—a requirement that would have translated into a $10,000-$20,000 up-front payment. It was an atti- tude “that really shied us away from commercialization any of the work we had specifically done at K-State.” Soon thereafter, however, the two came across a Department of Energy SBIR solicitation with a topic they saw as “tailor-made” for their nascent company. The topic involved using software developed at Lawrence Livermore Lab—the leading competitor to the software that Swenson and Hardeman had developed

APPENDIX D 223 at K-State—and building a graphical user interface to make it more accessible to commercial users. Hardeman recounts: “We had the company but we did not have a clear direction. Then this [SBIR solicitation] came along and provided us with perfect seed money for our company.” The motivation behind the solicitation was straightforward. Geothermal industry practitioners praised the technical quality of TOUGH and other simula- tion packages developed at the Lawrence Livermore, but at the same time they complained that the programs were excessively difficult to use—typically requir- ing a technician to train for three months before he or she could run the program and accurately interpret the results. Swenson and Hardeman appreciated the rigor and technical sophistication of the Lawrence Livermore code, but saw an oppor- tunity in the relative ease of use of the program they had developed. The Thunderhead Phase I application was successful. The company had cleared the most difficult hurdle, statistically, in participating in the SBIR pro- gram. The company’s successful pitch in its Phase II application to DoE was that, although their simulation software did not have the potential to become “a huge money maker,” the project leaders had demonstrated the capabilities needed to turn their work in Phase I into “a self-supporting continuing product that would be a great service to industry,” with eventual applications in markets beyond geothermal. From the standpoint of the development of the firm, the timing of the receipt of the first Phase II award was excellent. Swenson was due for a sabbatical year, having recently been granted tenure. Kansas State University covered half of Swenson’s salary; the SBIR award covered the other half. The company had the resources to rent a modest office space, at a rate of $200/month, and to hire two K-State students to assist with programming. For two years, with little revenue beyond that from the SBIR award, the team focused on software development. The award came to an end, but Swenson and Hardeman did not think that the product was ready to sell. “We continued to put in our own money and the 6 percent profit you get off a Phase II, to develop the product further. We worked with our students for about another six months.” Finally, after nearly three years of effort, the team had a product that they could show to potential customers. Once a product was ready, identifying potential customers was not difficult. “We knew everyone in geothermal,” Swenson recalls. The greater challenge was arriving at a price for the product. “With any software product, pricing is kind of like throwing a dart at the wall.” Without a clear point of reference, Thunderhead simply sought a price that they felt was fair to both them and their clients. Two dozen corporations signed on to annual agreements. The resulting income was modest from the standpoint of an SBIR Phase II award-recipient firm. From a pure commercialization standpoint, Swenson and Hardeman concede that the out- come would not have qualified the firm as a success if judged by the metrics used by the National Science Foundation’s SBIR program—the funding agency for the company’s subsequent awards in the program, noted for its particular focus

224 APPENDIX D on significant commercial outcomes.33 However, from the Department of Energy standpoint, Thunderhead was an arguable success along other dimensions—in particular, making use of the outputs of research at a National Laboratory in sup- port of agency mission. Basing their marketing on a tightly knit group of contacts had the disadvan- tage that once that initial list of contacts was exhausted, the company struggled to reach additional potential customers. After 24 months during which sales reached a plateau, Thunderhead was able to “jump to the next level” after reaching an exclusive marketing arrangement with RockWare, Inc., a software distributor located in Golden, Colorado. Despite giving up 40 percent of every sale to the marketer, the company has realized a modest growth in revenue, achieving sig- nificantly greater reach with their product with substantially reduced effort. Further validation of the value to industry of the company’s software came in 2004 when Thunderhead reached an agreement with geothermal engineer- ing teams at Shell, Exxon-Mobil, and Japan Power to jointly fund $45,000 of further development of the software—in part to take advantage of continued development of the underlying code by the Lawrence Berkeley Laboratory. Along similar lines, the value to agency mission was affirmed in 2004-2005 when the company received a $50,000 grant from the National Energy Technology Labora- tory at the Department of Energy to add new capability to PetraSim to support m ­ ethane hydrates. The company complemented these external sources of funds with investment of some of its internal resources to develop modules to extend the functionality of the core program. Making the Transition from a Self-sustaining Product to a Self-sustaining Business Even before their core product was utilized among geothermal engineers in the oil industry, Swenson and Hardeman were seeking the next challenge. “We were always looking for other opportunities because we knew [ours] was a niche product. . . . There was not a huge, great business case for this user interface for this geothermal software. People in industry were yearning for it. But there were not thousands of them—there were dozens.” “During our DoE Phase II we started to look at other things. NIST put out an SBIR solicitation for an interface for a fire modeling software,” recalls Hardeman. The technical area was new to the team, but the match to their core capabilities was obvious. “It was a user interface again around core code software. So we responded.” This 2002 Phase I application was not successful. However, the signal back 33Hardeman elaborates: “NSF would not have funded [our first software development project] with out a larger business case. They are focused on a higher return business plan. They are really operating like venture capitalists.” Accordingly, the pair notes that NSF SBIR topics are much more broadly defined than those in the DoE SBIR solicitation.

APPENDIX D 225 to them concerning their application was not clear, as NIST made only five awards for more than forty solicitations that year. After taking to the program manager they learned that, although the solicitation had appeared, the internal interest level for the topic was very low. The lack of commitment to the topic was frustrating. “I don’t know how the topic got in there,” Hardeman states. “They really did not intend to give an award.” Despite this frustration, the process of submitting the SBIR proposal did yield some benefits. Foremost among these was the set of contacts within the fire modeling industry that the company had made. When the proposal to NIST did not lead to an award, the group that Thunderhead had brought together decided to seek alternative sources of support for the project. Partnering with, Rolf Jensen & Associates, a fire engineering company, Thunderhead resubmitted the proposal to the National Science Foundation’s SBIR program for a project in fire simulation. The company was on deck to enter a market an order of magnitude larger than that for their geothermal software. At that point, Swenson, states “we believed we could have a self-sustaining business not just a self-sustaining product.” The Innovation Element While Thunderhead began with the objective of realizing the commercial value of federally funded research in geothermal simulation software, its con- tinual development of a core product and entry into new markets has required it to innovate new approaches to modeling, simulation, and interface development. The resulting software “is not just an interface. It is quite applied.” Have entered the fire modeling market, Thunderhead is now, according to Swenson, “starting to see the possibility of putting together a suit of building design fire protection tools.” Thunderhead is now developing a companion product to model emergency egress from buildings. This couples the egress simulation to the fire model results, including blocked egress paths due to the fire. A Tangible but Difficult to Measure SBIR Outcome: The Contribution to Community Having made the commitment to Manhattan, Kansas, over a decade ago, Thunderhead’s founder is now gratified to see that the company is beginning to function as a model to others in the community. “There is something that has really changed,” Swenson reflects. After we received second Phase II, we began to earn reputation at K-state of being a legitimate company. This was partly a con- sequence of our interactions with our NSF program manger, who really wanted us to show that we could commercialize. So now I have faculty members coming to them asked would you go in with us and write a proposal—SBIR, STTR or another.” The team has declined most of these offers, wanting to maintain a clear business direction instead of just being “the grant writers for Manhattan.”

226 APPENDIX D Patience and a focus on specific core capabilities have resulted in consistent success and steady growth. “We go after things that we (believe in or) are inter- ested in and try and make living at it rather than look for that great huge oppor- tunity and go after that,” Hardeman notes. The focus has resulted in a Phase I success rate of 50 percent—more than double the program-wide average. The sales and contracting work that have accrued to the company from its PetraSim software developed with the DoE Phase I and Phase II awards admittedly do not qualify it as “a huge phase III with venture capital,” in Hardeman’s words. Yet the more $195,000 of sales and $100,000 of contract work that Thunderhead have earned on PetaSim have been enough to seed it as one of the relatively rare viable small technology companies operating in its environment. With the company having earned 45 percent of its lifetime revenues in the last 24 months, its growth clearly has not slowed. The company has three full-time employees and three part-time, with an increased focus on marketing. Student employees at Thunderhead are often eager to stay with company after their graduation. To maintain continued growth the company’s founder made the difficult deci- sion in September 2005 to transition operational control to Hardeman. “I have made my decision—I am going to go back to K-State,” Swenson states. “I am going to be phasing out from daily operations at Thunderhead. I will still be an owner and a board member. But it costs a lot to pay me or match my salary at K-State. We have a limited amount in the company and when I look at it, it would be better for me to back off. I think this is a better way to make it go.” Summary Because of the support provided by the SBIR program, Thunderhead Engi- neering has developed software that is meeting market opportunities. Both com- mercial products, PetraSim for simulation of flow in porous media and PyroSim for modeling of fires in buildings, were built around software developed at national laboratories, Lawrence Berkeley National Laboratory and the National Institute of Standards and Technology. This represents a leveraging of previous federal R&D investments to provide service a much broader set of beneficiaries than would otherwise be possible. Thunderhead Engineering is now on track to be self-supporting through sales. Sales of PyroSim are steadily increasing and the new emergency egress software will integrate with the existing product. There is every reason to believe that Thunderhead Engineering will continue to grow, thanks to the initial SBIR support.

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An Assessment of the SBIR Program at the Department of Energy Get This Book
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The Small Business Innovation Research (SBIR) program is one of the largest examples of U.S. public-private partnerships. Founded in 1982, SBIR was designed to encourage small business to develop new processes and products and to provide quality research in support of the many missions of the U.S. government, including health, energy, the environment, and national defense. In response to a request from the U.S. Congress, the National Research Council assessed SBIR as administered by the five federal agencies that together make up 96 percent of program expenditures. This book, one of six in the series, reports on the SBIR program at the Department of Energy. It finds that, in spite of resource constraints, the DoE has made significant progress in meeting the legislative objectives of SBIR and that the program is effectively addressing the mission of the Department of Energy. The book documents the achievements and challenges of the program and recommends programmatic changes to make the SBIR program even more effective in achieving its legislative goals.

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