2

The Elements of Success

Many things must come together for innovation to succeed. During the two workshops hosted by the Committee on Science, Engineering, and Public Policy (COSEPUP), participants identified a few general themes multiple times (see Box 2-1).

Box 2-1
Major Themes of Workshop Speakers

•    The knowledge and experience of individuals are the primary drivers of innovation.

•    Science and technology expertise alone is not enough to ensure innovation; the skills of finance, business development, production, and management are useful.

•    Innovation is stimulated by the movement and interaction of individuals from different sectors.

•    The culture of a region and its institutions shapes the nature of these interactions.

•    Openness to new ideas and a tolerance for failure are important.

•    Culture is not easily changed, and creating clones of Silicon Valley might be the wrong strategy.

•    Innovation is a contact sport and might be facilitated by a concentration of talent that increases the rate of interaction.

•    General principles do not explain everything. Significant differences exist among institutions, regions, industries, and sectors.

Various speakers emphasized the importance of three critical factors: culture, people, and experience. The remainder of this chapter provides some highlights on these topics from the speakers at the California workshop.



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2 The Elements of Success Many things must come together for innovation to succeed. During the two workshops hosted by the Committee on Science, Engineering, and Public Policy (COSEPUP), participants identified a few general themes multiple times (see Box 2-1). Box 2-1 Major Themes of Workshop Speakers  The knowledge and experience of individuals are the primary drivers of innovation.  Science and technology expertise alone is not enough to ensure innovation; the skills of finance, business development, production, and management are useful.  Innovation is stimulated by the movement and interaction of individuals from different sectors.  The culture of a region and its institutions shapes the nature of these interactions.  Openness to new ideas and a tolerance for failure are important.  Culture is not easily changed, and creating clones of Silicon Valley might be the wrong strategy.  Innovation is a contact sport and might be facilitated by a concentration of talent that increases the rate of interaction.  General principles do not explain everything. Significant differences exist among institutions, regions, industries, and sectors. Various speakers emphasized the importance of three critical factors: culture, people, and experience. The remainder of this chapter provides some highlights on these topics from the speakers at the California workshop. 5

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6 WORKSHOPS ON TRENDS IN THE INNOVATION ECOSYSTEM THE IMPORTANCE OF PEOPLE Innovation is almost never an isolated occurrence. It tends to take place in an environment characterized by personal interactions, an entrepreneurial spirit, a variety of supporting institutions, adequate funding, and the vibrant development and exchange of ideas. Many analysts have used the metaphor of an ecosystem to describe such an environment, but the speakers at the California workshop tended to speak instead of a culture that fosters innovation. Culture includes the expectations that people hold about how they and others will interact. For example, David Mowery, Milton W. Terrill Professor of Business at the Walter A. Haas School of Business, University of California, Berkeley, observed that the U.S. university system is unusual among industrialized countries in having a long history of interaction with industry. Furthermore, the flow of ideas and people occurs in two directions, not just one. Many of the innovative activities within universities rely on input from industry of both ideas and people. As an example, Mowery cited work done at Berkeley on a major component of the Unix operating system that relied on people from Bell Laboratories spending time on the campus. Similarly, Mowery reported that a vigorous scientific instrument complex has grown up around the University of California, Santa Barbara, because of the two-way flow of individuals and ideas back and forth between the university and businesses. Such interactions have been very rare in western Europe or Japan, though they may become more common in China as the university sector there develops. An aspect of the ecosystem and of the culture in Silicon Valley that was examined extensively at the workshop is the venture capital industry. Venture capital grew from a tiny industry in the 1960s to a peak in the year 2000, after which it has undergone major changes. Prior to the 1960s, entrepreneurs tended to approach individuals, families, and privately owned companies with an interest in science and technology as a source of funds for innovation. Since then, they have more frequently turned to venture capitalists for early-stage investments. Many venture capital firms cluster around Stanford and the other universities in the Bay Area, where they have quick access to the faculty members and students who have ideas to commercialize. These venture capitalists are themselves intermediaries between limited partners who provide the capital and the innovators who use that capital to create, develop, produce, and market new products and services. Physical proximity between venture capitalists and entrepreneurs is often critical. Steven Quake, Professor of Bioengineering at Stanford and an investigator with the Howard Hughes Medical Institute, explained that one of the companies he helped found grew from a boat ride with a college friend who wanted to leave his position in a large company and become an entrepreneur. Though they had great difficulty raising money because of a slump in venture capital funding for biotechnology, they eventually were connected with an angel investor by the technology transfer office at the California Institute of Technology. That initial investment led to future investments and, as the venture

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THE ELEMENTS OF SUCCESS 7 capital market for biotechnology recovered, “the VCs were calling us,” said Quake. However, other companies that Quake helped found have different roots. In one case, venture capitalists who had read his scientific papers contacted him about the ideas they contained. The investors in this case brought in a chief executive officer to provide expertise in running the company. In another case, a large company funded a startup to the point where a decision could be made about whether or not to acquire the company, which is becoming a popular model in the pharmaceutical industry, according to Quake. Since the bursting of the dot-com bubble in the year 2000, the venture capital industry has gone in new directions, according to Michael Borrus, Founding/Managing General Partner at X/Seed Capital Management. For example, venture capitalists have made poor returns on investments in hardware since then, and they have reduced their investments accordingly. As a result, a crunch has emerged in the funding of hardware development, raising the question of how America can maintain its leadership position in hardware when other governments are willing to nurture their hardware industries. (Chapter 4 looks at shifts in investment priorities in greater detail.) Venture capital also has reacted to changes in the distribution of success. For example, John Hennessy, the President of Stanford University, pointed out that the information technology industry has become more bimodal in its success rates, with a smaller percentage of companies succeeding. In the past, perhaps 70 percent of the spinoffs from Stanford in the information technology sector got to the breakeven point, he said. Today the percentage is much smaller -- perhaps 30 percent. Investors seem to be searching for the occasional company that produces very large returns, even if small investments are lost in the majority of startups. “If you get a Google or Facebook, you pay off the last four funds with one company,” Hennessy said. He also noted that, as venture capital firms have matured, an angel investor network has developed in Silicon Valley that devotes time, energy, and capital to small companies. Borrus described his small venture capital company as an example of some of the trends affecting the industry. His first investment fund was divided roughly equally among three sectors: the life sciences; energy and resources; and information technology, which includes both hardware and predictive analytics (i.e., what has come to be known as “big data”). A more recent and larger fund is devoted almost exclusively to information technology, despite Borrus’s interest in technology across the board. But ecosystems that support the commercialization of innovations that require long timeframes and large amounts of capital in areas such as the life sciences and energy are in “disarray,” he said. X/Seed is typically the first institutional investor in the technologies it supports, though other funds and angel investors also may be involved. But many of the companies in which it invests eventually need larger pools of follow-on capital from larger venture funds or other sources. In some fields,

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8 WORKSHOPS ON TRENDS IN THE INNOVATION ECOSYSTEM including energy and the life sciences, sources of follow-on capital have largely dried up. “There aren’t very many life science venture funds that have raised capital in the last 18 months,” Borrus said. And without follow-on investors, the company in which he invests can become stranded. The venture capital industry is based on the idea of profiting from risk. But it also points to one more aspect of culture that was discussed by several participants at the workshop: the willingness to accept failure. In many other countries, acceptance of failure is much more limited, which constrains the ability to invest in risky ideas. THE IMPORTANCE OF CULTURE Technology transfer is a misnomer, said Hennessy. Technologies generally are not transferred from one institution to another, such as from a university to a company. Rather, people are transferred, and those people bring ideas and experience with them or the ability to innovate if provided with the opportunity to do so. For example, some of the greatest success stories of Silicon Valley involved the transfer of people from Stanford, said Hennessy, including William Hewlitt and David Packard (the founders of Hewlitt- Packard), Jerry Yang and David Filo (the founders of Yahoo!), and Larry Page and Sergey Brin (the founders of Google). Other successful innovators who have contributed to the success of Silicon Valley have come from the University of California, Berkeley, from the University of California, San Francisco, and from companies and other institutions throughout the Bay Area. The transfer of technology often takes place through the creation of small startup companies that attract talented and experienced innovators. Small companies can turn an invention into a working prototype, build customer interest, and take a technology to scale or be acquired by a larger company that can do so, Hennessy observed. In that way, they function as a bridge between academia and industry. Transferring technology directly to a large company tends to be much more difficult. When a new product starts generating profits for a large company, it may change the bottom line for that company very little. Also, a fundamentally new technology may threaten an existing product line or business. Large companies even may kill an internal development project that threatens an existing business only to see that business undermined by a small startup company anyway. THE IMPORTANCE OF EXPERIENCE A final element of success that workshop participants discussed is experience. Among the great advantages of Silicon Valley are the number and experience of its entrepreneurs, said Borrus. For more than 40 years, entrepreneurs in Silicon Valley have been learning how to build high-growth companies, often with venture-backed funding. They have had experience not

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THE ELEMENTS OF SUCCESS 9 only with university research but with research and development in companies, from which many innovative ideas emerge. People know how to start and run small businesses, which is a very different experience than being part of a large company. Many people have connections with both universities and with industry, and these dual affiliations are a prominent part of the Silicon Valley culture that can be difficult to replicate elsewhere. People also are willing to move among institutions and sectors, thereby bringing their experience to new endeavors. University faculty may be smart and creative, Hennessy said, but many have no idea of what it means to deliver a product to the world, how to set up and run a company, how to handle sales and marketing, and so on. Engineers with a new invention tend to see the glass as half full, but they often need help convincing potential investors that the glass is not in fact half empty, Yi Cui, Associate Professor in the Department of Materials Science and Engineering at Stanford University, agreed. They need to learn management skills or hire people with those skills to be successful. In such cases, a small company may need to learn how to work with a large company, especially in areas such as energy that require large investments. That is one key to Silicon’s valley success, said Hennessy -- each successful company creates a group of skilled and experienced people who then can train the next generation of successful entrepreneurs. As Mowery pointed out, managerial talent may be less mobile geographically than capital or labor. “Part of what you develop as a venture capitalist is a good Rolodex of people within 50 miles, and that talent is a very important part of what VCs are bringing to these new firms, especially new firms founded by relatively inexperienced entrepreneurs in their first spinouts.” Small companies may even move from other countries to take advantage of the managerial expertise in the United States.

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