Click for next page ( 57


The National Academies | 500 Fifth St. N.W. | Washington, D.C. 20001
Copyright © National Academy of Sciences. All rights reserved.
Terms of Use and Privacy Statement



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 56
5 How Governments Can Nurture Small Companies and Technological Innovators Numerous federal, state, and local policy mechanisms, includ- ing federal R&D fundirlg, technical assistance programs, business incubators, loan guarantee programs, and university-~ndustry col- laborative ventures promote small company formation and growth. These initiatives are motivated by a variety of objectives, including the desire to assist specific segments of the economy such as small businesses or high-tech companies. As discussed earlier, this study did not specifically evaluate government programs to support small high-tech businesses. Rather, the committee has asked, How well do government poli- cies (a) help technological innovation in small companies, or (b) inadvertently affect small high-tech companies (e.g., regulation or tax policy)? This section provides an overview of three types of federal policy mechanisms: 1The material in this section is derived from several sources, including the Eco- nomic Report of the President 1994 (U.S. Government Printing Office); Guide to NIST (U.S. Department of Commerce, Technology Administration, October 1993~; The State of Small Business: A Report of the President 1993 (U.S. Government Printing Office); Small Business Innovation Development Act Tenth Annual Report 1993 (U.S. Small Business Administration Office of Innovation, Research, and Technology); and conversations with staff at the National Institute of Standards and Technol- ogy, the Small Business Administration, the Advanced Research Projects Agency, and the House Committee on Small Business. 56

OCR for page 56
NURTURING Same COMPANIES AND TECHNOLOGICAL INNOVATORS 57 Those aimed at helping small business. Those aimed at fostering technology clevelopment. Those that assist companies that are both small and technol- ogy-intensive. This chapter also provides an overview and examples of state and regional efforts.2 The closing sections describe some of the unintentional effects of government policy on entrepreneurial, high-tech companies and proposes some basic principles for poli- cies intended to encourage small high-tech company formation and operation in the United States. Many of the policy mechanisms described in this chapter- either directly or indirectly play an enormous role in creating and destroying opportunities in many sectors of the economy that de- pend for their development on small high-tech companies. Gov- ernment programs that directly support R&D in advanced displays can reduce technological risk, for example. But the indirect conse- quences of government actions are often poorly understood by policymakers-compliance with health and safety regulations, for example, in many instances is especially difficult for small compa- nies and start-ups. These indirect consequences of government policies on innovation, and the extreme diversity of external condi- tions for small technology-intensive companies, need to be care- fully considered. r FEDERAL POLICIES: SMALL BUSINESS ASSISTANCE The Small Business Administration (SBA) is the federal gov- ernment's economic development agency for small business. The SBA's primary task is to guarantee loans, but it also provides pro- curement assistance and other business development programs and conducts research into the operations of small business. The SBA's second-largest program after loan guarantees is the Small Business Development Centers (SBDC) program. The program issues matching grants to participating academic, private, and pub 2An excellent reference work on state technology activities is Partnerships: A Compendium of State and Federal Cooperative Technology Programs. Published by the Battelle Memorial Institute in 1995, the Compendium profiles the cooperative tech- nology programs of the 50 states and 10 federal agencies.

OCR for page 56
58 RISK AND INNOVATION kc institutions, of which there are more than 750 across the coun- try, to provide training and counseling to sharpen management skills for owners of small businesses. The program also offers specialized services designed to meet local needs in the areas of international trade, procurement, rural development, and techni- cal assistance. The SBA currently also has a cooperative agreement with the National Institute of Standards and Technology (NIST) to help the SBDCs access on-line technical and business information. The SBA licenses Small Business Investment Companies (SBICs) to provide government-guaranteed loans and other types of financing to small companies that cannot obtain financing else- where. SBICs have invested more than $10 billion in nearly 70,000 small businesses. During the savings and loan crisis of the late 1980s, more than 160 of the SBICs were liquidated, in many cases because their assets were less than they had led the SBA to believe. The Small Business Innovation Research (SBIR) program, which will be discussed below, provides competitive opportunities for small companies to win federal R&D contracts. NtST administers the Manufacturing Extension Partnership (MEP) program, which promotes the commercialization of tech- nologies and the diffusion of technological information. This pro- gram consists of four major elements: Manufacturing Technology Centers (MTCs), Manufacturing Outreach Centers (MOCs), the State Technology Extension Program (STEP), and LINKS. The Manufacturing Technology Centers program was estab- lished in 1988 to help small- and medium-sized manufacturers upgrade their technological practices and performance. MTCs, of which there are currently seven across the country, are selected from competing proposals submitted by prospective sponsoring organizations. They provide a variety of services, ~nclucting indi- vidual project engineering, training courses, demonstrations, and assistance in selecting and using software and equipment. Awards for Manufacturing Outreach Centers started in FYI994. These centers, like the MTCs, help manufacturers adopt appropriate, modern technologies, but they offer more limited ser- vices. They will be affiliated with existing technical or training institutions, such as vocational institutes, technical colleges, state or university technical assistance centers, in areas not servect by MTCs and with lower concentrations of industry. The State Tech- nology Extension Program provides support to state and local tech

OCR for page 56
NURTURING Same COMPANIES AND TECHNOLOGICAL INNOVATORS 59 nology-outreach organizations to enhance coordination among ex- isting technology-assistance programs and help to improve deliv- ery of those services. STEP grants, which are generally in the range of $50,000 to $200,000, are awarded to nonprofit institutions or organizations that must provide matching funds for the project. The purpose of LINKS is to identify and "network" sources of assistance, information, and technology. A key feature is the elec- tronic linkage of MTCs, MOCs, and other organizations such as federal laboratories and universities. Rapid communication and access to databases and information on manufacturing practices and technical experts in intended to be enabled by LINKS. in addition, small businesses are the beneficiaries of contract set-asides from the federal government that totaled $12.9 billion in 1994 alone. The aim of such set-asides is to ensure that small busi- nesses get a fair share of federal business. Among federal "quota" programs, the one for small businesses is by far the largest the $12.9 billion in federal contract set-asides for small business in 1994 was double that for minority-owned businesses. FEDERAL POLICIES: TECHNOLOGY INITIATIVES Technology initiatives strive to promote the development and diffusion of growth- and productivity-enhancing technologies as well as correct market failures that would otherwise generate too little investment in R&D. in general these programs work by at- tempting (a) to share risks during start-up phases by providing partial funding for a technology development or refinement that is selected and also supported by the private sector; and (b) to stimu- late the diffusion of new technologies among small firms by pro- viding small amounts of resources and information. There are a number of programs in place to accomplish these purposes. The Advanced Technology Program (ATP), which is adminis- tered by the NIST, provides grants to industry consortia and start- up firms involved in precommercial R&D. The program helps firms develop breakthrough technologies that will have substan- tial long-term economic benefit but may be considered too risky by venture capitalists. Projects are selected based on technical and business merit by independent panels of experts. The competition is rigorous. Single- company awards are limited to $2 million to be spent over no more

OCR for page 56
60 RISK AND INNOVATION than three years and must be used only for direct R&D costs. Joint ventures may receive up to $5 million, but they must also provide matching funds. The ATP supports development of laboratory prototypes and proof of technical feasibility but not commercial prototypes or proof of commercial feasibility. Award recipients are allowed to patent inventions or copyright software that is de- veloped using ATP awards, but the government retains a nonexclusive license. Begun in the 199Os, ATP has made 89 awards to 66 companies and 23 joint ventures since its inception. Including the private- sector funds, the awards have totaled $500 million. In 1994 it was announced that $745 million over the next five years would be dedicated to 11 strategic areas of technology: tools for DNA diag- nostics, catalysis and biocatalysis technologies, materials process- ing for heavy manufacturing, motor vehicle manufacturing. ad- vanced vapor-compression refrigeration, ~ ~ software, digital video information networks, digital data storage, information infrastructure for health care, manufacturing compos- ite structures, and computer-integrated manufacturing for electron- ics. Government investment in these strategic areas is expected to leverage an equal investment by industry. This support is in addi- tion to ATP's general competition for all areas of technology. In 1995 Congress rescinded about $90 million in FYI995 funds from the ATP budget. As a result, NIST delayed the announcement and implementation of new focused programs and decreased the num- ber FYI995 awarders. Launched on March Il. 1993, the Technology Reinvestment Project's (TRP) mission is to promote the development of dual-use (commercial and military) technologies and to help small defense firms make the transition to commercial production. A six-agency council representing the Departments of Commerce, Energy, Trans- portation, and Defense, NASA, and the National Science Founda- tion implements the program. The TRP funds three types of projects: technology development, technology deployment to small businesses, and manufacturing education and training. As of De- cember 1993, 162 projects had been selected for TRP support total- ing $! billion in public and private funds. a, comDonent-based ~, The intent of Cooperative Research and Development Agree- ments (CRADAs) is to leverage the technical expertise resident in the country's 726 federal laboratories to enhance U.S. competitive

OCR for page 56
NURTURING Sail COMPANIES AND TECHNOLOGICAL INNOVATORS 61 ness through jointly financed collaborations with companies and industry consortia. The agreements cover joint research efforts in which both the federal lab and the cooperating company provide staff, equipment, facilities, or funds in any number of possible com- binations. In the Department of Energy's 31 laboratories alone, there are 650 agreements totaling $~.4 billion in combined public and private funds. The Advanced Research Projects Agency (ARPA) manages selected basic anc] applied research and development projects for the Department of Defense and pursues R&D in areas where there is high risk and payoff as well as significant potential for both military and commercial applications. ARPA does not carry out research in its own facilities but acts as a technology broker and venture capitalist by contracting work to industry, academia, and branches of the armed services. The FYI995 budget for ARPA was $2.6 billion. FEDERAL PROGRAMS THAT SUPPORT SMALL HIGH-TECH COMPANIES The Small Business Innovation Research program, adminis- tered by the Small Business Administration, was established in 1982 and requires each federal agency with an external R&D bud- get of at least $100 million to set aside 2 percent of these research funds for SBTR in fiscal years 1995 and 1996 and 2.5 percent there- after. Currently 11 federal agencies participate. According to the Tenth Annual Report on the Small Business Innovation Develop- ment Act, since the program's inception, 25,000 awards have been made to small high-tech companies worth more than $3.2 billion. Each agency participating in the SBTR program issues a solicita- tion at least once a year indicating its R&D needs and inviting R&D proposals from small companies. In Phase I, small companies may apply for agency funding up to $100,000 for feasibility testing of an innovative idea or technology. In Phase Il. award winners whose ideas show promise may receive up to $750,000 and two years to develop the concept. Following completion of Phase 11[, small com- panies are expected to obtain Phase [~l funding from private sources or non-SBTR federal sources to develop the concept into a commercial product. The SBA classifies SBIR awards into various technology areas. Roughly 36 percent of all SBIR awards made

OCR for page 56
62 RISK AND INNOVATION during the 1983-1992 period involved electronics, while another 36 percent were computer related. A secondary but distinct program created by the 1992 Small Business Research and Development Enhancement Act is the Re- search and Research & Development (R&R&D) Goaling Pro- gram. Federal agencies with a fiscal year budget for research or research and development in excess of $20 million are required to establish small business goals for awarding R&R&D funding agree- ments to small companies. Seven other agencies, in addition to the 11 SBIR agencies, participate in the goaling program. As part of the Small Business Research and Development En- hancement Act of 1992, the Small Business Technology Transfer Program (STTR) was established. This is a three-year pilot pro- gram at five federal agencies- Department of Defense, Department of Energy, Department of Health and Human Services, National Aeronautics and Space Administration, and the National Science Foundation- with extramural R&D budgets over $! billion. The program was started in FY1994, with steadily increasing set-asides: 0.05 percent in FYI994, 0.10 percent in FYi995, and 0.15 percent in FYl996. It will peak in 1996 at $75 million. Under this plan, the federal government allocates the above percentages of its external R&D budget to fund cooperative R&D projects involving a small company and a researcher at a university, federal laboratory, or nonprofit research institution. Not less than 40 percent of the work must be performed by the small business and not less than 30 percent by the research institution; however, the small company is the primary contractor with overall management and performance responsibilities. The intent is to combine the entrepreneurial talent of small business and the innovative ideas of engineers and scien- tists in research institutions. Like the SBIR, the STTR is a competitive, three-phased pro- gram. Phase ~ awards of $100,000 are to determine the scientific and technical merit and feasibility of an idea. The most promising Phase T efforts will be able to continue the research through a Phase ~ award, averaging $500,000. In Phase Ill, the awardees are ex- pected to use private capital or non-SBTT funds to pursue commer- cial applications of the R&D. The Advanced Technology Program is not explicitly targeted to smaller companies, but such companies are often the beneficia- ries of the program. In the first three competitions, over half the

OCR for page 56
NURTURING SMALL COMPANIES AND TECHNOLOGICAL INNOVATORS 63 ATP awards were led by small companies with many more acting as subcontractors to larger company awarders. A substantial number of participants in CRADAs are small firms, although this program as well is not specifically targeted to small companies. For example, approximately 44 percent of NTST's 250 CRADAs are with small businesses. ARPA is a source of support for small business through its participation in the STIR and TRP programs and through the grant- ing of other R&D contracts. STATE AND REGIONAL ASSISTANCE PROGRAMS From a national perspective, the value of state and local eco- nomic development efforts are uneven. On the one hand, competi- tion among states for plant location using tax breaks and economic development bonds may do little for the national economy. On the other hanct, state and local manufacturing extension the provi- sion of management and technical assistance to small and mecTium- sized manufacturers can be of considerable value, depending on how the programs are designed and managed. Also, state and local efforts to develop regional, technology-intensive, entrepre- neurial economies do have the potential to strengthen the national economy and, perhaps, help drive technical innovation of value to consumers and citizens. Each region's approach needs to be different and will depend on the region's current assets and weaknesses. A region with a high density of technical facilities of larger companies will need to develop different assets than one that has few such facilities but one or more first-rank technical universities. A region that has a strong tradition of skilled manufacturing (and therefore a regional density of skilled technical manufacturing personnel) will need to develop different assets than a region with little manufacturing history but with a substantial biological research institute. State technology assistance programs, also referred to as tech- nology or industrial extension programs, encompass a variety of initiatives offering assistance to small firms. Although not explic- itly mandated to serve small companies, most of the firms using these services are small- or meclium-sizedL companies. The funding is mixed, with state governments, universities, industry, and user fees providing most of the funding and federal government contri ~. , ~.

OCR for page 56
64 RISK AND INNOVATION buttons making up the balance. The types of services provided include review of current or proposed manufacturing methods and processes, productivity and quality assessments, assistance with plant layout and operations, advice on the acquisition and imple- mentation of equipment, assistance with total quality management programs, access to databases, and business networking. A 1991 National Governors' Association study of 42 programs in 28 states founct that half of the programs are administered by universities or community colleges and the remainder are admin- istered by state agencies, quasi-public organizations, or private nonprofit organizations. The programs often target for assistance industries with a large concentration in the state. Although the majority of the programs serve existing manufacturing operations, they sometimes aid small start-up companies.3 Most states also have a package of assistance programs de- signed to nurture start-ups, particularly in high-tech industries. Such programs include small business incubators and a variety of financial assistance instruments such as low-cost loans and loan guarantees, grants, venture capital trust funcls, and pooled bond programs. It is difficult to determine exactly how much is being spent by states on programs of this sort since state technology efforts are broad and encompass a range of company sizes. By virtue of the fact that many of these programs nurture start-ups, however, they are nurturing small companies. The most visible and studied examples of regional concentra- tions of high-tech companies are Silicon Valley in California and Route 128 in Massachusetts with areas like Austin, Texas, and Re- search Triangle In North Carolina also receiving considerable at- tention. The Capital Region of New York State (Albany, Troy and the surrounding communities) is a less developed high-tech region and, therefore, provides a less cluttered example of the range of assets a region can bring to bear and the type of issues an emerging center of technical entrepreneurship faces. Among that region's sources of entrepreneurs and innovations are the following: 3M. Clarke, and E. Dobson, Increasing the Competitiveness of America's Manufac- turers. A Review of State Industrial Extension Programs (Washington, D.C.: National Governors' Association, 1991~.

OCR for page 56
NURTURING Same COMPANIES AND TECHNOLOGICAL INNOVATORS 65 Rensselaer Polytechnic Institute (RPT), a 170-year-old re- search university that has graduated 3,120 B.S. engineers, 1,470 M.S. engineers, and 550 Ph.D.'s in science and engineering over the last five years. Further, RensselaerJs School of Management spe- cializes in Technology and Management and offers five-year double degrees in management and science or engineering. General Electric Corporate Research Laboratories, a facility employing 1,110 research personnel. The State University of New York, Albany, a public univer- sity that graduated 1,610 B.S, 455 M.S., and 157 Ph.D.-leve! scien- tists during the last five years. The Wadsworth Center, a basic research facility of the New York State Department of Public Health, that has spawned a ven- ture firm in the last decade. There are over 70,000 college-level students in the region attending more than a half dozen colleges and universities in addi- tion to RET and SUNY-Albany. The region has more than 800 high-tech or manufacturing firms, ranging from a division of General Electric to small entrepre- neurial ventures. Over the course of the last 15 years, the region's community leaders have focused on creating a set of assets to support the start- up and growth of technology-based firms. in 1980 RPT formally established an on-campus incubator facility that provides low-rent space, shared services, and some business assistance to qualified start-up companies. Since its inception, the incubator has spawned more than 90 start-ups, with a high record (greater than 80/O) of survival, that currently employ almost 900 people and generate almost $100 million in revenue. The incubator itself is currently being expanded. in 1982 RPI established a technology park, a I,200- acre real estate development aimed at attracting young technol- ogy-based companies, and the technologically intensive operations of larger companies and state agencies. This park now hosts 45 establishments employing more than i,600 people. While neither the incubator nor the technology park requires a business to have a formal connection to the university, there is a strong predisposi- tion in the' behavior of the two enterprises to favor and encourage those businesses that build on, or contribute to, RPT's strengths. A significant attractor for many companies to locate in either the in

OCR for page 56
66 RISK AND INNOVATION cubator or the technology park is the location of companies in simi- lar stages of development or with similar technical orientations. in actdition to RPI's efforts, both the state of New York, through its Science and Technology Foundation, and the Capital Region's Center for Economic Growth, through its Technology Develop- ment Council, offer considerable assistance to technology-based start-ups. For example, the New York State Science and Technol- ogy Foundation supports joint university-inclustry centers for ad- vanced technology at New York universities. These centers are explicitly designed to support the development of industrially rel- evant technologies with high potential for commercialization. Two such centers are located in the Capital Region, the Center for Ad- vancect Thin Films and Coatings at SUNY-Albany and the Center for Advanced Technology in Automation and Robotics at Rensselaer. The Foundation also operates a Manufacturing Tech- nology Center, supported by federal, state, and private funds, that assists small- and medium-sized companies in adapting new manu- facturing technology to their needs. Additionally, the Foundation operates a small venture seed capital func! to invest in New York- basecl start-ups and a venture/financing referral service to put start-ups in touch with potential investors. The Capital Region Technology Development Council's is a regional (~-county) economic development agency funded prima- rily by the state of New York and private funds. While the Tech- nology Development Council offers a range of networking and business services, the flagship service is a business advisory pro- gram that enlists experienced technical and business people as vol- unteers to serve as senior level management consultants (about 300 volunteers) to provide services such as legal, risk assessment, com- mercialization, and business planning for client companies. Some of these people also invest in the small firms. The aid supplied these firms is often in the form of workshops and networks, as well as individual consultation. The Technology Council also plays an important role in providing information about, and a connection to, resources outside the region. One of the most visibly successful efforts they have undertaken in recent years is to assist companies in the region in applying for federal Small Business Innovative Research grants, more than $5 million in such grants having been won by small, local ventures in 1994. In short, the Capital Region seems to have much of the basic

OCR for page 56
NURTURING Same COMPANIES AND TECHNOLOGICAL INNOVATORS 67 infrastructure in place to develop as a regional, high-tech entrepre- neurial center. The region is succeeding in starting companies, but it now faces new issues in learning to help these firms grow to significant size. Several of these firms have begun to make that transition and must now find skillect business managers willing to take a risk to join a new company; banks familiar with the prob- lems of high-tech, rapid-growth companies and able to evaluate their prospects; and larger equity investors with knowledge of anct experience in the region. The activities in the Capital Region are representative of activi- ties in many regions of the United States that have marshalled their resources to create and develop new businesses and industries. While regional approaches vary and are necessarily tailored to specific regional assets such as universities and large company re- search facilities it is clear that geography matters a great deal. The policies and programs of local, state, and regional govern- ments are important aspects of the local and regional business en- vironment for high-tech companies. The best are responsive to local conditions and reinforce the strengths of the region by pro- moting technologies and industries of national economic impor- tance. v THE NATIONAL BUSINESS ENVIRONMENT The opportunity set for small high-tech businesses and start- ups is heavily dependent on industry-specific issues and regional characteristics. There is also, however, an important set of na- tional-scale, and even international, concerns affecting small U.S.- based, technology-driven companies. In many cases, these issues are identical to those affecting the opportunities and performance of larger companies. For example, the first-order impacts of trade barriers, employment laws, government policy on interest rates, international standards, and intellectual property rights fall in simi- lar ways on both larger and small companies, on both technologi- cally sophisticated companies and those with little technical capa- bility or orientation. A number of national policy matters that have been widely recognized as having significant effects on the pros- perity and performance of industry generally can have especially profound influences on the viability of small high-tech businesses.

OCR for page 56
68 RISK AND INNOVATION Maintenance of open and accessible public equity markets. These are key to liquidity for small companies and an important source of capital for growth. The tax structure, especially capital gains taxes, which affect the relative attractiveness of longer-term investments such as those necessary to develop new technologies or markets for new prod- ucts. Lower capital gains taxes (especially for technically risky investments held for longer periods of time) could provide a stimu- {us for investment in small high-tech companies. Regulatory burden on small companies and especially start- ups. It is too easy for well-intentionecT regulation from different levels and parts of government to accumulate to the point of crush- ing a small business or, especially, a start-up. Maintenance of a vigorous national portfolio of government- supported and university-based research. Research and related advanced technical education done in a largely nonproprietary set- ting, in an environment that is favorable for entrepreneurship, are an important national resource for high-tech start-ups. The legal environment, especially product liability laws and, for high-tech and high-growth companies, securities fraud liability laws. The national business environment was not a major focus of this study, but certain aspects of the findings about the role of small business have important implications. For example, a focus on the role of small high-tech companies in pioneering markets and new applications can free them from the burden of expectation that they be the nation's primary job creators; it is much easier to show that important new directions for commercial products and services originated in garages in the Silicon Valley/StanforcT nexus than to argue that Intel and Hewlett-Packarct are important em- ployers on a national scale. The benefits to consumers of techno- Togical advances brought to market by those two companies are large, and would be whether they employ 100,000 people or 50 people. It is the committee's judgment that the federal government can help maintain the vigor and contribution of small high-tech businesses in the following ways: Working to ensure that financial market regulation, bank

OCR for page 56
NURTURING SMALL COMPANIES AND TECHNOLOGICAL INNOVATORS 69 ing laws, and securities regulatory agencies are sensitive to the particular demands of small high-tech companies. Monitoring, and when possible reducing, the total federal, state, and local regulatory burden on small high-tech companies. Maintaining, especially in light of prospective cut-backs in research and development spending, a rich portfolio of univer- sity research as a source of potential new commercial opportuni- ties for start-up companies. UNINTENDED EFFECTS OF GOVERNMENT POLICYMAKING A wide variety of government actions aimed at and justified by other missions public safety, environmental quality, and national defense, for example also have an enormous impact on small tech- nology-intensive companies by affecting the cost of innovation or the risk of failure. For example, in sporting goods and medical devices, suppliers of materials critical for the manufacture of these products have restricted or ceased sales to these sectors to elimi- nate their exposure to product liability lawsuits. Legislative re- forms, in this context, could markedly affect a company's product strategies and posture toward innovation.4 Government regulatory actions affect all businesses but they often have a disproportionate effect on small or new companies. These companies may find it more difficult to sustain their busi- nesses under new conditions, financial and otherwise, imposed by regulatory changes. indeed, part of the risk that small high-tech businesses often shoulder is the risk created by the possibility of unintended consequences of government actions. For this reason, actions that affect the opportunities for such companies directly or indirectly should be informed by knowledge of the likely con- sequences, and those consequences shouIcl be weighed against the other, intended consequences of policies and regulations. It is important to recognize, as well, that the effect of regulation on innovation is not always negative. Government actions regu- larly create as well as destroy opportunities for small companies. 4See National Academy of Engineering, Product Liability and Innovation. J. Hunziker and T. Jones, eds. (Washington, D.C.: National Academy Press, 1994~.

OCR for page 56
70 RISK AND INNOVATION in environmental testing, for example, regulation is responsible for the creation and sustenance of an entirely new set of opportunities for technically oriented new companies. Nonetheless, it is useful to ask whether it may be possible to lessen the negative effects of government actions (and therefore risk) without taking away from the clear benefits of government actions, for example, in health and safety. Several examples may help to make this clear. Medical Devices: Innovation as an Investment Decision Technological innovation depends critically on risk taking by entrepreneurial individuals and small companies. This risk-in various forms links market size and expected growth, and the impact of size and expected growth on innovation, to external sources of financing. This is especially important in the medical device industry, where the economics of innovation high techno- logical risk and fragmented markets tend to be unattractive to larger companies. Recently, radical changes in the regulatory and policy environ- ment for medical devices appear to be increasing this risk. Food and Drug Administration regulation of medical devices requiring increased numbers of trials and evaluation is increasing the ex- pected time to market for new devices as well as the cost of demon- strating these new devices. The basic rationale for these govern- ment actions, of course, is not disputed-regulation of the health and safety of medical devices is an objective of government policy. But it is important to recognize that even as regulation of medi- cal devices is not directly concernec! with economic factors, it may have unforeseen (and expensive) consequences for innovation in medical devices, especially by small and new companies. For ex- ample, delays weaken incentives to undertake new product intro- ductions for small firms that need to recoup their investments more quickly than large firms. By increasing the risk and therefore the difficulty of attracting external financing these regulatory changes draw into question the viability of innovation by small companies for specialized, low-volume mectical devices.

OCR for page 56
NURTURING Salt COMPANIES AND TECHNOLOGICAL INNOVATORS 71 Environmental Testing Labs: Created and Constrained by Environmental Regulation In contrast to medical devices, the comprehensive set of envi- ronmental laws directed at air and water pollution has created enormous opportunities for small and new, technically oriented companies. Demand for environmental testing services in the United States, now between $1.5 billion and $1.6 billion annually, is almost entirely in response to environmental legislation and regulations. Equally, the opportunities for 1,400 to 1,600 compa- nies virtually all of these small-that provide these services are in large measure determined by the degree to which future legisla- tion and regulations create new markets and a demand for innova- tions in testing technology and methodology. Paradoxically, however, a more subtle effect of regulation in this area has been, in many cases, to remove incentives to explore innovative approaches to improving monitoring capabilities for pollutants. The sources of pollution that the government requires be measured or monitored vary enormously. But the imperative to provide legally defensible data precludes experimentation with new techniques or pollution-reclucing technological advances. In- stead, approved analytical methods are followed so closely that new innovative techniques, which may be developed by innova- tive firms and are demonstrably superior to current techniques, are not explored. The objectives of environmental regulation, of course, are not primarily to encourage innovation, but it is possible that innova- tion in this area would advance these objectives. There is no ques- tion that environmental legislation has created enormous demand for pollution control technologies, for example. In addition, the Environmental Protection Agency has been active in recent years- through initiatives such as Superfund Innovative Technology Evaluation, called the SITE program in attempting to promote a more flexible approach to the use of new technologies and the use of problem-based methods to replace at least some of the rigid, highly prescriptive testing methods now in use. It is not clear that cTirect regulation is the best approach to encourage the develop- ment of new technologies and reduced levels of pollution.

OCR for page 56
72 RISK AND INNOVATION Networks: Evolution of Regulatory Schemes The astonishing new complexity of communications and infor- mation networks, and the speed of their transformation, is driven to a large extent by new technologies. Chief among these new technologies are advances in computers, which enable the digital encoding (and compression) of information, and in photonics, which enable massive increases in network bandwidth using fiber optics. These technological advances create enormous opportunity for network companies to create proprietary network technologies and to realize the opportunities video-on-demand, games, and data services are examples-that will drive demand in these new networks. The question is whether regulation will enable small compa- nies to exploit this new competitive environment. In contrast to medical devices or environmental testing services, which are domi- nated by large numbers of small competitors, regulation in tele- communications has historically focused on economic regulation of a "natural" monopoly, AT&T. Now, new technologies have enabled companies of all sizes to compete for new opportunities in telecommunications by creating software or the physical assets to create services over these new networks. Consequently, what these opportunities and technologies will look like, and the speed at which this happens, depends to a large extent on changing regulatory structures. The consent clecree that broke up the Bell system in 1982 deregulated long-distance ser- vices and regulations have relaxed for almost all sectors of commu- nications. Delays in making regulatory decisions may impede op- portunities in networks. For example, pressure on their monopolies in the local loop has left the Bell operating companies anxious to compete with cable television providers by sending video over the telephone network. The current regulatory structure in telecom- munications is under a great deal of scrutiny. What items should be providect as universal service and at what cost? With respect to content, to what extent will regulations control the content avail- able to consumers? Given the risk that government policies will have inadvertent negative consequences for small high-tech businesses, it is impor- tant that policymakers concerned with economic growth under- stand the specific roles that entrepreneurial, high-tech companies

OCR for page 56
NURTURING Sail COMPANIES AND TECHNOLOGICAL INNOVATORS 73 play in the development of industrial sectors and of the economy. Policies should be based on the premise that maintaining a na- tional portfolio of high-tech entrepreneurial companies is impor- tant. IMPLICATIONS FOR POLICY The contribution of this study to policy debates is to ask the question, Given the contributions of small technology-oriented companies to the economy, what principles distinguish good policy and programs from bad? The central findings of this study are that small technically oriented companies assume risks that other com- panies-large and small will not and that such risk takers play a particularly important role in technically new and small markets. The relevant question for policymakers, therefore, is, What types of policies substantially encourage (reduce the risk of, or increase the likely return on) commercial technical experimentation by small companies and start-ups? As the industries studied in this project show, the fecleral gov- ernment is either purposefully or inadvertently an important force in many industries that depend for their development on small high-tech companies. With regard to purposeful support, government programs that share technological risk by supporting R&D can alleviate some new and small market risks. Also, actions that ensure financing alternatives or facilitate linkages with indi- viduals or institutions that can provide assistance and advice to nascent companies are also important. Government programs like TRP, ATE, and STIR, are created with the best of intentions and bridge gaps not addressed by private-sector financing for higher- risk ventures. But much ambivalence about these programs re- mains, as eviclenced by talk of cutbacks in funding for the ATE and TRP. The SBIR program was both widely praised and widely criti- cized during the industry workshops held as part of this study. Praise centered on the fact that funds are available from a number of agencies for exploratory technological work and on the examples of companies successfully founded with SBIR funds. Criticism focused on the way the program has created "SBIR houses" (i.e., companies whose only revenues are from SBl[Rs and never from products) and is too rigidly oriented on the mission of the agency providing funding. The comments in the workshops mirror the

OCR for page 56
74 RISK AND INNOVATION results of a recent General Accounting Office report that reviewed the SBTR program.5 That report concluded that the quality of sub- mitted and funded proposals remains high but that duplicate fund- ing companies receiving funding for the same proposals twice, three times, ant! even five times has become a problem. Participants in several of the industry-specific workshops, soft- ware and meclical devices in particular, noted that programs such as TRP, ATE, and SBTR that could provicle financing for small high- tech companies were less useful because of the long review cycles and time delays inherent in highly bureaucratic programs. With regard to the inadvertent impact of government actions, it is clear that government itself is a substantial source of risk for some small companies; part of the risk that small high-tech busi- nesses often shoulder is the risk created by the unintended conse- quences of government actions. In the committee's judgment, the consequences of government actions for technically oriented start- ups and small companies and by implication for their ability to bear technological risk and drive innovation are often poorly un- derstoocl both by the public and bypolicymakers. State and fed- eral actions aimed at, and justified by, other missions public safety, environmental quality, antitrust, commercial standard set- ting, and national defense, for example often have the most pro- found impact on the opportunities for small high-tech companies. Federal and state actions such as these regularly both create and destroy opportunities for small high-tech businesses. Given the extreme budget consciousness that appears to per- vade Congress, the committee suggests that federal activism on behalf of small business and technology initiatives focus first on establishing mechanisms within government many of them off- budget that can improve the general environment for innovative enterprises. Because the structure and implementation of regula- tions affect the character and speed of innovation (through the risks they can create or remove for companies), regulatory ap- proaches across a wide variety of government functions need to be carefully considered with regard to their impact on small high-tech companies. 5General Accounting Office, Federal Research: Interim Report on the Small Business Innovation Research Program, March 1995.

OCR for page 56
NURTURING SMALL COMPANIES AND TECHNOLOGICAL INNOVATORS 75 With regard to programs for active support of small technically orientec! businesses, the committee suggests that the central issue is whether federal support will make a difference in the economy's technological development. Private investment is likely to be much greater than any imaginable level of public investment in frag- mented, technically dynamic industries with low barriers to entry and a history of (or widely perceived prospect of) successful entre- preneurship. in such industries the important question is, How can government research, development, and demonstration complement the huge private investment (risk taking) to the ben- efit of the national economy? The challenge in program design and implementation is to articulate and adhere to an industry-specific rationale for government support in light of substantial private- sector activity: What is the evidence that market capital is not available to this industry? What leads policymakers to believe that public funds are necessary to drive commercially important technical advance in this industry? is development in this industry amenable to the kind of dy- namic, iterative, failure-ridden process that characterizes the most rapidly developing technologies and industries? if so, how can a government program constructively seed or accelerate such a process? Finally, in the committee's judgment, many government policy mechanisms to promote economic growth some types of federal R&D funding, technical assistance programs, local incubators, uni- versity-industry collaborative ventures need to be designed and managed regionally or locally. Local and regional programs may have an advantage in that they are closer to the resources that small companies need and are potentially more able to adapt to the needs of small high-tech companies.

OCR for page 56