Below are the first 10 and last 10 pages of uncorrected machine-read text (when available) of this chapter, followed by the top 30 algorithmically extracted key phrases from the chapter as a whole.
Intended to provide our own search engines and external engines with highly rich, chapter-representative searchable text on the opening pages of each chapter. Because it is UNCORRECTED material, please consider the following text as a useful but insufficient proxy for the authoritative book pages.
Do not use for reproduction, copying, pasting, or reading; exclusively for search engines.
OCR for page 165
An Assessment of the SBIR Program at the Department of Energy Appendix D Case Studies Airak, Inc.1 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 1 This case is based on primary material collected by Nicholas Vonortas and Jeffrey Williams during 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 technology 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.
OCR for page 166
An Assessment of the SBIR Program at the Department of Energy 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 quality 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 monitoring, the commercialization possibilities turned out to be insufficient to maintain 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 sensing and monitoring solutions as there are a wider range of commercial possibilities 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. Currently, 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 exclusively on SBIR grants for long-term growth. At first, the model worked well.
OCR for page 167
An Assessment of the SBIR Program at the Department of Energy 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 commented 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 developed 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
OCR for page 168
An Assessment of the SBIR Program at the Department of Energy 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 application 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.2 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 Technology Program, for funding but has not been awarded a grant. One major change to the SBIR program that Airak would support is additional 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 benchmark—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. 2 The Fastlane submission system of the U.S. National Science Foundation was also mentioned in very favorable terms.
OCR for page 169
An Assessment of the SBIR Program at the Department of Energy 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 application. 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 funding, 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.
OCR for page 170
An Assessment of the SBIR Program at the Department of Energy Atlantia Offshore Limited3 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 platform 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 technologies existed to probe small fields for oil discoveries and pump them for production. 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 potential for addressing this issue, Atlantia contacted Steve Kibbee. Kibbee, with a 3 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.
OCR for page 171
An Assessment of the SBIR Program at the Department of Energy 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 services. In 1992 the company received a patent for its SeaStar® tension leg platform (TLP).4 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 technology, 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- 4 For detailed information on the SeaStar® platform, visit Atlantia’s Web site at <http://www.atlantia.com>.
OCR for page 172
An Assessment of the SBIR Program at the Department of Energy 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 installation 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 services 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
OCR for page 173
An Assessment of the SBIR Program at the Department of Energy 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 conference. 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.5 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 external 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 5 According to Kibbee, the solicitation topics focused on natural gas issues.
OCR for page 174
An Assessment of the SBIR Program at the Department of Energy flexibility for firms to connect their research to DoE’s interests.6 As Kibbee pointedly 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 SeaStar® technology. Kibbee adamantly argues that the SeaStar® research would not have occurred without SBIR funding. At that time, Atlantia had approximately 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 funding. 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 Kibbee, Dawnbreaker proved “tremendously helpful” in Atlantia’s initial negotiations 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 approximately $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 direction of the company, shifting it away from its previous focus on shallow-water operations to deep-water TLPs. In addition, the SeaStar® technology developed 6 Note that this perception of topic solicitation is based on Atlantia’s limited experience with the SBIR Program in the early 1990s.
OCR for page 175
An Assessment of the SBIR Program at the Department of Energy 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 disseminates 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, especially 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 advantage in their markets.
OCR for page 216
An Assessment of the SBIR Program at the Department of Energy 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 supporting 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. 28 This case is based on primary material collected by Nicholas Vonortas and Jeffrey Williams during 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.
OCR for page 217
An Assessment of the SBIR Program at the Department of Energy 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 products, 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 environmentally 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, dedicated 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 outside 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” situation, where moving from Phase II prototype to product development and commercialization 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 29 Significant start-up costs.
OCR for page 218
An Assessment of the SBIR Program at the Department of Energy 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 patenting. 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 intellectual 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 information. 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 connection 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 significantly 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 innovations, though some improvements could be made to increase fairness.
OCR for page 219
An Assessment of the SBIR Program at the Department of Energy 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 possess more information about the nature and characteristics of their products and processes than potential financiers. In addition, the intangible nature of innovative 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 assessment 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 breakthrough 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 personal 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 functionality, 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- 30 Lewis Branscomb and Philip Auerswald, Taking Technical Risks: How Innovators, Executives and Investors Manage High-Tech Risks, Cambridge, MA: The MIT Press, 2001.
OCR for page 220
An Assessment of the SBIR Program at the Department of Energy 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.
OCR for page 221
An Assessment of the SBIR Program at the Department of Energy Thunderhead Engineering31 Philip E. Auerswald George Mason University September 2006 OVERVIEW Thunderhead Engineering is a simulation software company located in Manhattan, 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 Mechanical 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 Sciences Division of Lawrence Berkeley National Laboratory.32 Using its expertise in developing intuitive graphical user interfaces (GUIs) for complex engineering 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 Thunderhead 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 31 This case is based primarily on primary material collected by Philip Auerswald during an interview 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. Research 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. 32 Notably, the TOUGH2 and TOUGHRREACT software packages.
OCR for page 222
An Assessment of the SBIR Program at the Department of Energy 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 probably 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, Kansas, has narrowed the range of Hardeman’s career options. “Brian is someone that could have gone somewhere else and gotten a good job.” Building Thunderhead 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 Technology 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 attitude “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
OCR for page 223
An Assessment of the SBIR Program at the Department of Energy 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 simulation packages developed at the Lawrence Livermore, but at the same time they complained that the programs were excessively difficult to use—typically requiring 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 opportunity 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 program. 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 outcome 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
OCR for page 224
An Assessment of the SBIR Program at the Department of Energy 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 support of agency mission. Basing their marketing on a tightly knit group of contacts had the disadvantage 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 significantly 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 engineering 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 Laboratory at the Department of Energy to add new capability to PetraSim to support methane 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 33 Hardeman 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.
OCR for page 225
An Assessment of the SBIR Program at the Department of Energy 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 continual 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 consequence 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.”
OCR for page 226
An Assessment of the SBIR Program at the Department of Energy 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 interested in and try and make living at it rather than look for that great huge opportunity 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 decision 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 Engineering has developed software that is meeting market opportunities. Both commercial 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.