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ANNEX II Case Studies in Technology Transfer BIOTECHNOLOGY Simon Glynn and Arthur E. Humphrey Biotechnology is literally a new technology, enabled by rapid expansion of our understanding of cell biology, especially of DNA, and the development of techniques that use this new understanding to physically change the genetic con- tent of cells. The United States dominates in the biomedical sciences and is the source of the vast majority of basic information in biotechnology. The United States has also dominated early efforts to realize the potential of biotechnology. This paper is intended to review the technology flows that have enabled this success. THE TECHNOLOGIES Defining the Scope of Biotechnology Biotechnology is defined by technologies, not outputs. These technologies, especially the sequencing and decoding of genes on a large scale, have trans- formed our understanding of the function of DNA in cells. These advances also enable researchers to manipulate genetic information in cells. For example, us- ing recombinant DNA technologies, the human gene that codes for insulin (a protein) can be isolated and then inserted in a bacterium. The bacterium can be made to synthesize human insulin, which may then be used to treat diabetes. Genetically engineered cells can produce not only human hormones such as in- sulin or growth hormone, but also blood products like clotting factors, vaccines, and new antibiotics. 177

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178 TECHNOLOGY TRANSFER SYSTEMSIN THE UNITED STATES AND GERMANY These new technologies can also be used to create a class of proteins called monoclonal antibodies that are especially useful in diagnostics. These proteins are not created using recombinant DNA techniques, but by fusing a tumor cell to a white blood cell and then cloning this new cell. The resulting cells produce antibodies that are chemically identical. Monoclonal antibodies are used widely in research to identify the presence of specific types of molecules and to detect the presence of disease. HUMAN THERAPEUTICS AND DIAGNOSTICS Data on biotechnology revenues are inconsistent, but total annual revenues to U.S. companies from products developed using biotechnology appear to be about $10 billion and are projected to increase 15 to 20 percent each year over the next few years. Human therapeutics and diagnostics represent over 90 percent of these revenues (U.S. Department of Commerce, 1993~. Table A-1 shows the number of drugs currently in development that use biotechnology techniques. In 1994, there were only 19 biotechnology-based drugs approved for use in the United States. (See Table A-2.) These drugs as a group rely on human hormones that were either understood or thought to be therapeutically useful in the treat- ment of diseases such as diabetes, anemia, and multiple sclerosis. These drugs have about $9 billion in annual global sales, or less than 5 percent of total global sales for pharmaceuticals (Merrill Lynch, 1996~. As of February 1992,640 diag- nostic kits using monoclonal antibodies, DNA probes, and recombinant DNA TABLE A-1 Biotechnology Drugs in Development, 1989-1993 1989 1990 1991 1993 Approved medicines 9 11 14 Medicines or vaccines in development Phase I Phase I\II Phase II Phase II/III Phase III Phase not specified Application at FDA for review 26 12 23 8 11 38 13 32 6 48 16 46 18 41 22 53 6 33 3 2 4 10 19 21 11 TOTAL medicines or vaccines in development 95 126 158 170 NOTE: Total medicines or vaccines in development reflects medicines in development for more than one indication. SOURCE: Pharmaceutical Manufacturers Association (1993).

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ANNEX II 179 TABLE A-2 Biotechnology Medicines or Vaccines Approved for Use by the Food and Drug Administration as of 1993 Product Indication(s) Company Year Approved Beta interferon DNAse Factor VIII IL-2 Indium-111-labeled antibody Aglucerase G-CSF GM-CSF Hyaluronic acid CMV immune globulin Gamma interferon PEG-adenosine deam~nase :-PA Erythropoietin Hepatitis B antigens Alpha interferon Hepatitis B vaccine Human growth hormone Human insulin Multiple sclerosis Cystic fibrosis Hemophilia Renal cell cancer Cancer imaging Gaucher's disease Adjunct to chemotherapy Bone marrow transplant Ophthalmic surgery Prevention of rejection in organ transplants Chronic granulomatous disease Immune deficiency Myocardial infarction, pulmonary embolism Anemia associated with renal failure, AIDS, cancer Diagnosis Cancer, genital warts, hepatitis Prevention Deficiency Type I diabetes Chiron Genentech Genentech, Genetics Institute Chiron Cytogen Genzyme Amgen Immunex Genzyme MedImmune Genentech Enzon Genentech Amgen 1993 1993 1993 1992 1992 1991 1991 1991 1991 1990 1990 1990 1990 1989 Biogen 1987 Biogen, Genentech 1986 Biogen, Chiron 1986 Genentech 1985 Genentech 1982 SOURCE: Read and Lee (1994). techniques had been approved by the U.S. Food and Drug Administration (FDA), including screening tests for the AIDS and hepatitis C viruses (U.S. Department of Commerce, 1993~. The current generation of biotechnology drugs relies on major advances in biotechnology to identify and decode genes. This large-scale sequencing of genes is being done globally and is coordinated through gene databases on the Internet. Sequencing of the entire human genome may be completed by 2005 (Washington Post, 1996~. Two examples of protein drugs based on these techniques are Amgen's obesity drug Leptin and a protease inhibitor for AIDS that has had a dramatic clearing effect on the HIV virus (Merrill Lynch, 1996~. NONMEDICAL USES OF BIOTECHNOLOGY Nonmedical uses of biotechnology are also apparent. Using biotechnology techniques, researchers hope to transfer into plants specific beneficial traits (e.g.,

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180 TECHNOLOGY TRANSFER SYSTEMS IN THE UNITED STATES AND GERMANY resistance to pesticides, tolerance of hostile environmental conditions such as salinity or toxic metals, or higher nutritional content) (National Research Coun- cil,1987~. Bioprocess technologies are also expected to help in diverse sectors of the economy. In the petroleum industry, for example, bioprocessing has potential to degrade wastes or toxic substances (National Research Council, 1992c). Revenues from these nonmedical uses of biotechnology (agriculture, spe- cialties, environmental) are less than 10 percent of total revenues in biotechnol- ogy (U.S. Department of Commerce, 1993~. There are several reasons for this. First, the use of biotechnology in areas other than human therapeutics and diag- nostics presents unique research and technical barriers not addressed by biomedi- cal research. Second, the use of biotechnology is constrained by economics. Drugs developed using early biotechnology techniques have tended to be exceed- ingly expensive. But new opportunities will require technologies to synthesize and purify the biological products at sharply lower cost and higher capacity (Na- tional Research Council, 1992c). Finally, commercial development in biotech- nology in the United States (so far) is directed by the size of the opportunity. The most immediate consequence of this is the current focus on human therapeutics and diagnostics, where the returns to investors are expected to be largest; there is relatively less focus on agricultural or industrial applications. For these reasons, many of the nonmedical uses of biotechnology are not expected to be commer- cially available before 2000 (Table A-3~. New Biotechnology Companies Two different types of firms are pursuing the commercial potential of bio- technology: new biotechnology firms (NBFs), started specifically to exploit opportunities using biotechnology techniques; and large companies in pharma- ceuticals, chemicals, and other sectors for which biotechnology has important implications. The biotechnology sector included 1,272 biotechnology companies in 1993, of which 235 were public (Read and Lee, 1994~. More than 100 of these compa- nies were started in the last 2 years, and 70 percent are less than 10 years old (Read and Lee, 1994~. A large proportion of these NBFs, but certainly not all, are developing human therapeutics and diagnostics. Compared with the larger phar- maceutical sector, NBFs as a group are relatively small. According to a survey by Ernst and Young (1993), revenues for biotechnology companies were about $7 billion in 1992, compared with revenues of $114 billion for pharmaceutical companies. The biotechnology sector is nonetheless a very large funder of bio- medical research. According to the survey, NBFs spent nearly $5.7 billion on R&D in 1992, about half the R&D expenditures of the pharmaceutical sector. As is obvious from these levels of R&D spending, the overwhelming majority of biotechnology companies are research organizations with essentially no revenues. Nearly one-third of NBFs have no approved products, and 70 percent had rev

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ANNEX II TABLE A-3 Selected Nonmedical Uses of Biotechnology 181 Animals Vaccines Therapeutic MAbs Diagnostic tests Plants Diagnostic tests Biopesticides (killed bacteria) Bioprocessing Diagnostic tests Chymosin or renin Alpha amylase Lipase Xylanase Luciferase Environment Diagnostic test Colibacillosis or scours (1984), pseudorables (1987), feline leukemia (1990) Carline lymphoma (1991) Bacterial arid viral infections, pregnancy, presence of antibiotic residues Diagnose plant diseases (turfgrass fungi) Kills caterpillars, beetles (1991) Diagnose food and feed contaminants (salmonella, aflatoxin, listeria, campylobacter, and Yersinia entercolitica) Enzyme used in cheesemaking (1990) Enzyme used in corn syrup and textile manufacturing (1990) Enzyme used in detergents (1991) Enzyme used in pulp arid paper industry (1992) Luminescent agent used in diagnostic tests Detect legionella bacteria in water samples NOTE: MAbs = monoclonal antibodies. SOURCE: U.S. Department of Commerce (1993). enues of less than $5 million in 1992. Moreover, with very few exceptions, development efforts in the majority of these biotechnology companies are several years from approval. Almost all of these small companies will run out of money before their ideas are transferred to clinical practice. This problem becomes critical as the amount of R&D required to move sophisticated medical technologies to commercializa- tion increases. The investment in R&D is also risky. For example, failure to win FDA approval for their sepsis products cost investors in three companies- Synergen, Centocor, and Xoma about $2.5 billion (Humphrey, 1995~. To finance their research and development efforts, the new biotechnology firms have used a variety of funding mechanisms. The most important of these have been investments from venture capital firms, through public financing, and from larger companies. VENTURE CAPITAL The development of the U.S. biotechnology industry has largely been fi- nanced by venture capital firms. Venture capital is available to NBFs because the opportunity to exploit new advances in biotechnology for human therapeutics and diagnostics creates liquidity in public markets (as initial public offerings). Indeed, biotechnology attracted more venture capital financing $261 million

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182 TECHNOLOGY TRANSFER SYSTEMSIN THE UNITED STATES AND GERMANY invested in 95 companies than any other sector of the economy in 1992, except software and services (Venture Economics, 1994~. Venture capital firms are an important reason for the success of NBFs in the United States. In this country, nearly 75 percent of NBFs started as independent firms, compared with only 5 percent of NBFs in Japan, where venture capital is essentially nonexistent (National Research Council, 1992b). This difference may be an advantage for U.S. firms, since venture capital allows NBFs to form earlier and closer to intellectual capital in universities than would otherwise be possible (Zucker et al., 1994~. PUBLIC FINANCING Public markets have also been a valuable source of financing for the higher- quality, larger-capitalization NBFs. In the early 1980s, several start-up biotech firms (Genentech, Cetus) set Wall Street records when they first went public. These firms have also been able to return to the public markets to finance produc- tion scale-ups and clinical trials. It is important to realize that health care reform and regulation impact the availability of venture capital and public financing, since investors focus on the anticipated returns on their investments. For example, regulations that require a certain number of clinical trials to determine the expected time to market of new drugs and therefore the cost of developing them. Health care reform efforts also play an important role by increasing the uncertainty with regard to biotechnol- ogy. Buyers of biotechnology-based drugs are now less often individual physi- cians than health care corporations, and third-party payers are becoming more restrictive, increasing the risk for investors and venture capital. LINKS BETWEEN NBFs AND LARGE COMPANIES Large pharmaceutical companies are an especially important source of fund- ing for new biotechnology firms. Large pharmaceutical companies have been investing in NBFs at an unprecedented pace. These cash infusions are especially important for equity investors in new biotechnology companies, because they reduce the future dilution they face. Linkages to NBFs are important to large pharmaceutical companies for sev- eral reasons. First, major pharmaceutical firms are looking increasingly for new, unique drugs for which there is no analog to treat diseases for which there cur- rently are few or no effective drug therapies. These are diseases such as cancer, Alzheimer's, and AIDS that account for $500 billion in medical expenses each year in the United States (Merrill Lynch, 1996~. Because the technology for developing these drugs is concentrated in the new biotech firms, NBFs have a comparative advantage in developing these new drugs. Second, it is important to recognize that the distinction between pharmaceu- tical companies and biotechnology companies is blurring as pharmaceutical firms

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ANNEX II 183 are increasingly using biotechnology techniques to develop new drugs. Accord- ing to a study by the Boston Consulting Group (BCG) (1993), 33 percent of research projects in major pharmaceutical companies in 1993 were based on biotechnology, compared with only 2 percent in 1980. In some larger pharma- ceutical companies, up to 70 percent of the research projects were based on molecular biology techniques. Equity investments have enabled larger compa- nies to access the technology in these NBFs and to develop internal capabilities in biotechnology. Finally, the special strengths of the large pharmaceutical companies continue to be in traditional drug discovery, manufacturing, marketing, and distribution. Large pharmaceutical firms also are experienced in the drug approval process, which is especially difficult for NBFs. Linkages to large pharmaceutical compa- nies thus let NBFs exploit these competencies. For example, Humphrey (1993), at the inaugural meeting of the American Institute of Medical and Biological Engineering in 1992, observed that failure to integrate process design and engi- neering expertise into the development process for biotechnology drugs prior to phase III clinical trials resulted in many nonoptimal bioprocess designs that did not use leading-edge technology. LINKAGES TO FOREIGN FIRMS Technological links are also expanding between new biotechnology firms in the United States and large foreign firms. Foreign pharmaceutical companies understand that a global orientation is required to ensure long-term competitive- ness and financial returns, and they recognize that the United States is the world's largest health care market. Foreign firms also seek access to advances in biotech- nology developed in the United States (National Research Council, 1992b). From the perspective of NBFs, the need for cash infusions to fund R&D encourages linkages with large, cash-rich foreign firms (National Research Council, 1992b). These linkages so far serve to transfer technology from the United States to foreign countries, although Japan's strength in enzyme related bioprocessing tech- nologies is a potential opportunity for future technology transfer from Japan to U.S. biotechnology firms. Japan's Kirin Brewery provided U.S. biotechnology firm Amgen critical robotic bioprocess technologies for the production of Epogen and Neupogen (Box 1~. But the implication may be that these transfers represent a future competitive advantage for foreign firms in the U.S. and global markets) (National Research Council, 1992b). The Importance of Universities The important advances in biotechnology so far have been made dispro- portionately by researchers in large U.S. research universities and then have dif- fused to the commercial sector, usually through NBFs. In this sense, U.S. univer- sities perform an incubator role for the biotechnology sector in the United States.

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The overwhelming majority of this biomedical funding is directed to U.S. research universities and academic medical centers. To a considerable extent, this support has been concentrated on the emerging genetic engineering techniques in biotechnology, especially for AIDS research. In 1993, the U.S. administration, stating its intention to strengthen the FCCSET (Federal Coordinating Council for Science, Engineering, and Technology) pro- cess, included funding for six presidential initiatives in its initial 1994 budget

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186 TECHNOLOGY TRANSFER SYSTEMS IN THE UNITED STATES AND GERMANY proposal.2 The largest of these initiatives was for biotechnology research, and more than three-quarters of this funding was controlled by the National Institutes of Health (NIH) (National Science Board, 1993~. UNIVERSITY-INDUSTRY RELATIONSHIPS In quite a few instances, the mechanism for technology transfer in biomedi- cal R&D has been the establishment of (usually single-product) biotech start-ups, often with individual scientists and their graduate students literally moving from academia to industry. For this reason, universities have been the locus of innova- tion in biotechnology. For biomedical firms, locating near U.S. research univer- sities provides access to state-of-the-art research in fields essential to their contin- ued success. Indeed, about half of all NBFs in the United States are grouped around three major centers of academic biotechnology research: 21 percent of NBFs are close to Stanford, University of California at Berkeley, and UC San Francisco; 18 percent are near MIT and Harvard in Boston; and 12 percent are located near the NIH campus in Bethesda, Md. (Humphrey, 1995~. The diffusion of basic information and expertise from U.S. universities to new biotechnology firms is essentially complete. Indeed, these laboratory tech- nologies are now widely disseminated, since virtually all of the research that enables biotechnology was performed in U.S. universities and academic medical centers using public money. There are few valuable strategic positions in these techniques (although separation and purification techniques, and process control are critical, as they create an economic advantage) (Gaden, 1991~. Nonetheless, quite a number of interesting case studies seem to indicate that both the number and variety of alliances in biomedical R&D between academia and industry are increasing dramatically. In a recent study, Cohen et al. (1994) identified more than 1,050 research centers at U.S. universities, representing an aggregate budget of $4.12 billion in 1990, exactly half of all federal expenditures on academic R&D that year. Of these university-industry centers, 232, or 22 percent, conducted biotechnology research. Nearly 45 percent of expenditures were for basic research, although this actually represents less of an emphasis on applied research than academia as a whole (Cohen et al., 1995~. Data on individual participation suggest that relationships between research- ers in academia and industry are even more pervasive than information on univer- sity-industry alliances indicates. For example, many NBFs have also established scientific advisory boards that include research scientists from U.S. universities and academic medical centers. Blumenthal (1992) found that 47 percent of bio- technology faculty consulted with industry, that 23 percent were involved in for- mal university-industry relations, and that 8 percent had received equity based on their own research. Biotechnology companies encourage these relationships. Genentech, for ex- ample, provides several million dollars of free recombinant materials to academic

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ANNEX II 187 researchers every year. As a condition of receiving these materials, Genentech requires that any research findings be reported to Genentech, and Genentech as- serts the first right of refusal on any commercial applications developed (Personal communication from H. Niall, chief scientist, Genentech, to Simon Glynn, re- search associate, National Academy of Engineering, August 10, 1993~. These dynamics are important, because federal and industry funding of bio- medical research are not quite the same thing. Industry and universities have increasingly diverging research agendas in biotechnology, and this is reflected in the priorities of academic researchers (Box 2~. Of the individuals interviewed for the Harvard biotechnology project, 30 percent of biotechnology faculty with in- dustrial support said that their choice of research topics had been influenced by the likelihood that results would have commercial application. This compared to only 7 percent of faculty without commercial funding who said so. The terms of funding are also different: For extramural grants from the NIH,92 percent are for 3 years or longer; for industry-funded research in universities, the majority of grants are for 2 years or less, consistent with the shorter time horizon of applied research (Blumenthal et al., 1986b). ECONOMIC INCENTIVES The institutional environment in which academics live is extremely impor- tant for technology linkages. In this respect, the changes in medicine have been faster and more dramatic than in other areas. Few, if any, examples of basic research in academic medical centers attracted commercial interest (unlike phys- ics and chemistry and even music) until the early 1970s and the acceleration of genetic research. Even then, at Stanford, there was significant culture shock (and in some cases even outright hostility) when patents and commercial interest in- truded into these medical departments after the first successful recombination of DNA by Cohen and Boyer in 1973. This is in sharp contrast to the current view of biotechnology at Stanford. Observed a prominent scientist, "The problem [now] is not pushing technology out of the lab; the problem and this is a prob- lem is pushing the technology too early. Technology advances too fast from academia to commercialization. I have a staff of nine, and everyone has a pet cure for cancer that they are pushing" (Personal communication from D. Botstein, Stanford University, to Simon Glynn, research associate, National Academy of Engineering, August 9, 1993~. A critical element in this culture is the use of programs to provide financial incentives to support and encourage innovation by academics.3 At Stanford, for example, 15 percent is subtracted from total license revenues for the technology licensing office budget (this is usually excessive; the excess then goes to the Dean of Research for a research incentive fund for researchers without sponsor- ship). The net royalties are then divided, one-third to the inventors, one-third to their department, and one-third to the school of medicine (Personal communica

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230 TECHNOLOGY TRANSFER SYSTEMS IN THE UNITED STATES AND GERMANY TABLE A-8 Agency Budgets by HPCC Program Components, FY 1994 AgencyHPCS NREN ASTA IITA BRHRTOTAL ARPA151.8 60.8 58.7 71.7343.0 NSF34.2 57.6 140.0 36.0 73.2341.0 DOE10.9 16.8 75.1 21.0123.8 NASA20.1 13.2 74.2 12.0 3.5123.0 NIH6.5 6.1 26.2 24.0 8.371.1 NSA22.7 11.2 7.6 0.241.7 NIST0.3 1.2 0.6 24.0 26.1 NOAA 1.6 10.5 0.312.4 EPA 0.7 9.6 1.611.9 ED 2.0 2.0 TOTAL246.5 171.2 402.5 96.0 179.81,096.0 KEY: HPCS = High-Performance Computing Systems; NREN = National Research and Educational Network; ASTA = Advanced Software Technology and Algorithms; IITA = Information Infrastruc- ture Technology and Applications; BRHR = Basic Research and Human Resources. SOURCE: Office of Science and Technology Policy (1994). based on a now widely used protocol, TCP/IP. By the early 1980s, the success of ARPANET caused NSF to fund its own NSFNET using the same technologies. As demand for advanced computing power has accelerated, other local networks have quickly developed, linked by the NSFNET and connected to other sites and networks around the world. These technologies, as well as the protocols and standards, are collectively referred to as the Internet (National Academy of Engi- neering, 1995b). These ARPA initiatives continue to demonstrate marked spin-on effects. In networking, to extend this example, current ARPA initiatives to develop new technologies are concentrated in the HPCC. One of these initiatives, the National Research and Educational Network (NREN), is expected to advance networking technology in two phases. The first phase of NREN is to increase the communi- cation speed of NSFNET from 1.5 million bits per second to 45 million bits per second. The second phase involves research and development on "gigabit test- beds" to develop networking technology that will enable computer networks that can communicate at speeds of 1 billion bits per second (one gigabit). Most of this R&D is expected to be done in close collaboration with larger telecommunica- tions and computer companies to encourage the transfer of these technologies to commercial high-speed data communications networks (Office of Science and Technology Policy, 1994; U.S. Congress, Office of Technology Assessment, 1993~. These surprising effects of the ARPA research initiatives illuminate a related point: Research and development are relatively "closer" in computer science

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ANNEX II 231 than in other disciplines. U.S. universities in this sense have provided important channels for the dissemination and diffusion of these innovations in software between academia and the defense and civilian research efforts in software. Digi- tal Equipment Corporation (DEC) is an example of the importance of these tech- nology flows. DEC's founder, Ken Olsen, developed many of his ground break- ing ideas for the minicomputer while working as a research assistant at MIT on Project Whirlwind, a DOD-funded project that was the precursor of a massive programming effort to develop the Semi-Automatic Ground Environment (SAGE) air defense system (Lampe and Rosegrant, 1992~. Indeed, some believe that a lack of interchange between military and civilian researchers and engineers weakened British efforts in computers. The Colossus machine built at Bletchley Park during World War II for code breaking, for ex- ample, was never further developed, and some aspects of it are still classified by the British government (Grindley, 1996~. The very different situation in the United States enhanced the competitiveness of the U.S. computer and software efforts (Mowery and Langlois, 1996~. Mechanisms to Encourage Technology Transfer in Academic Computer Science Other formal mechanisms have also been important in the transfer of tech- nology from the military to the commercial sphere. For example, the federal government influenced the development of early automatic programming tech- niques through its support for information dissemination. The Office of Naval Research (ONR) organized seminars on automatic programming in 1951, 1954, and 1956. These conferences circulated ideas within a developing community of practitioners who did not yet have journals or other formal channels of communi- cation. The ONR also established the Institute for Numerical Analysis at UCLA, which made important contributions to the overall field of computer science (Mowery and Langlois, 1996~. Yet another formal mechanism for technology transfer is the Software Engi- neering Institute (SKI) at Carnegie Mellon University. SKI was started by ARPA in 1984. In contrast to the applications-focus of many ARPA initiatives, SKI is intended to encourage the development and dissemination of generic tools and techniques for use in software engineering for defense applications. (For infor- mation on the SKI program, see their Internet home page at http://sei.cmu.org.) Several professional societies have also influenced the development of com- puter science, especially the Association for Computing Machinery (ACM) and the IEEE Computer Society. The publications and conferences of the ACM and IEEE Computer Society are the major channels for dissemination of research and conceptual advances in computer science. The ACM has also shaped the devel- opment of the undergraduate curriculum in computer science (National Research Council, 1992a).

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232 TECHNOLOGY TRANSFER SYSTEMS IN THE UNITED STATES AND GERMANY The Importance of Defense-System Acquisitions The federal government is also a prodigious consumer of information tech- nology. DOD programs to develop new, very complex computer systems had a tremendous influence on the development of U.S. software and computer compe- tencies. Perhaps the most conspicuous example of this is the development of the SAGE air defense system in the 1950s, which far exceeded previous program- ming efforts. SAGE was developed from the Whirlwind project at MIT to coor- dinate the control of radar installations into a national air-defense system. Devel- opment of SAGE was directed by a division of the RAND Corporation, the System Development Corporation (Mowery and Langlois, 1996~. By 1955, RAND already employed 25 people, perhaps 10 percent of the programmers in the United States. By 1960, SDC had spun out of RAND and hired more than 800 programmers for developing SAGE. By 1963, SDC and SAGE had seeded the emerging software and computer industry with more than 6,000 individuals from the SAGE development effort (Mowery and Langlois, 1996~. Indeed, by 1967, the Air Force had started divestiture proceedings to spin out SDC from the federally funded research and development centers, as compe- tition in software made this status unnecessary. SAGE's legacy also includes IBM's development of transistorized comput- ers. In 1955, IBM delivered the XD-1 (patterned after Whirlwind, which also inspired Digital Equipment Corporation and the minicomputer) to serve as the "brain" of SAGE. Critical to its performance was a new memory architecture, called magnetic core memory, that later would appear in IBM's enormously suc- cessful System 360 computer. Also key were magnetic tape drives and flexible software architectures, all developed under government funding and adapted al- most immediately for commercial use. IBM also recruited Emanuel Piore, head of the Office of Naval Research, as chief scientist, and increased research spend- ing to 35 percent in the 1950s, and to 50 percent by the 1960s and 1970s. By the 1960s, IBM's computer R&D budget was bigger than the federal government's. Even as late as 1960, defense spending represented 35 percent of IBM's research budget (Ferguson and Morris, 1993~. More recently, the Software Productivity Consortium (SPC) has performed an analogous (if less dramatic) role in technology transfer to improve U.S. soft- ware and computer competencies. SPC was established by its member compa- nies in 1985, uniting more than half of U.S. aerospace and defense firms in a for- profit consortium. The goal is to develop processes and methods that improve the design and implementation of complex software systems. This includes develop- ing prototypes and technical reports, but not commercial products (Software Pro- ductivity Consortium, 1996~. Until a few years ago, this goal was pursued with something of an ivory tower mentality by SPC, without involving consortium members and usually resulting in products that were off the mark. More recently, the SPC approach has emphasized intensive collaboration with members to de

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ANNEX II 233 velop a technical program more closely aligned to members' needs (Robert K. Carr, consultant in technology transfer, measurement and evaluation, and inter- national technology, unpublished notes, 1993~. The resulting program is seen as a useful resource for U.S. organizations to leverage investments in software de- velopment and to evaluate methods and processes. Software Depends Critically on Innovation in Computer Technologies Opportunities in software also depend on innovation in computer technolo- gies. In this sense, the development of networked personal computers and work- stations marks the transition to a profoundly different environment for software development. IBM is currently the world's largest supplier of software, despite its current difficulties; IBM's revenues from software (including operating sys- tems) in 1992 were $11.1 billion. Several trends have affected IBM's thinking about the software side of their business (and by extension, the thinking of other large computer makers). First, software has developed as an opportunity that is quite distinct from computers. Operating systems and enterprise-scale applica- tions software have become very expensive and complex to develop. For ex- ample, IBM's OS/2 operating system is estimated to have required at least 5 years and 400 programmers and cost as much as $1 billion. In addition, in recent years, independent software companies have pushed advances in several areas of oper- ating systems and applications software. Second, as computer hardware is increasingly commoditized, differentiation is less on the physical performance of the electronics than on the performance of the systems software and the collection of applications software and services available to users. For example, the success of Apple's Macintosh computer (whose development was mainly in sophisticated operating systems software) depended on the commercial availability of software designed and marketed by start-ups and smaller software companies. Consequently, computer makers have learned to encourage independent software companies to develop applications based on their architectures. These dynamics contribute to a first-mover advantage for U.S. software com- panies. In contrast to customized software and systems integration, the personal computer and, more recently, networked computing, are radically changing the demand for software by creating very high-volume markets. Indeed, by 1984, the installed base of PCs was 23 million machines, compared with less than 200,000 for large- and medium-sized systems (Steinmueller, 1996~. These high-volume opportunities easily absorb the fixed costs of software development. Also, stan- dardization of personal computer architectures in the United States has enabled software companies to create software and operating systems that can be incorpo- rated by different computer makers. This is in marked contrast to Japan, for example, where 6 of the top 10 software companies are tied through industrial groups to different computer makers (the top four are NEC, IBM Japan, Hitachi,

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234 TECHNOLOGY TRANSFER SYSTEMS IN THE UNITED STATES AND GERMANY and Fujitsu), each using a proprietary operating system. In the United States, by comparison, none of the top 10 software companies is tied to a computer maker (Friedland, 1993~. These trends reflect the divergence within the overall U.S. software industry between commercial and military applications. The DOD focus on systems de- velopment and on embedded systems doubtless limits the spin-on effects of these technologies for commercial use. The concept of software engineering continues to be relevant to the creation of large-scale, complex defense software systems, especially for embedded applications. But many of these systems are irrelevant to the commercial sector. Small Companies Exploit These New Opportunities In sharp contrast to the computer makers, most of the new independent soft- ware firms are relatively small, entrepreneurial companies. In Utah' s "software valley," for example, three-quarters of the more than 1,120 technology-intensive companies have fewer than 25 employees, and 50 percent have revenues of $200,000 or less (The Economist, 1994~. Several characteristics shape the oppor- tunities for these new software companies. First, the initial capital requirements to start in software are extremely low (with the exception, of course, of intellec- tual capital). This is likely to be as true in the future as it has been in the past. These extremely low barriers to entry, especially in the decentralized, software- intensive low end of the hardware spectrum, limit the amount of risk a software entrepreneur must accept. Second, these emerging software companies often exploit technologies or markets deemed too small or too risky for established players. Thus, new mar- kets and narrow, niche markets that sometimes lead to considerably larger mar- kets let new software companies develop the revenue stream, product, and core competencies of valuable new businesses. On the other hand, once such compa- nies are established in a market niche, they in turn become vulnerable to new players with a better idea. Since the development cycle of sophisticated software is lengthy and requires highly focused skills, reacting to a competitive threat is usually not an easy task. As a result, software companies tend to be divided into three groups. The first group, quite rare, consists of the few that become large and develop the internal resources to have long-term staying power and to stay on the advancing technology curve. The overwhelming majority of start-ups in soft- ware are in the second group, which develops niche-market products, with com- pany revenues in the $5 million to $15 million range. The life cycle of these companies is also quite short. Typically, they will either fail when their product life cycle has run its course or be acquired by or merged with other players to reach sustaining capabilities. The third group includes those new software com- panies that, for a variety of reasons, are not successful and fail.

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ANNEX II 235 Economic and Technological Risk is Encouraged The dynamics of these opportunities for new companies in software are very appealing to venture capital. In 1992, software and related services attracted more venture capital financing than any other sector of the economy, including biotechnology. Some 214 software and services companies received 22 percent, or $562 million, of venture capital invested in 1992. As new software companies demonstrate the viability of new technologies or markets, the risk is less and these opportunities then become valuable to larger companies, creating liquidity by acquisition. Compared with other sectors, the valuations are also relatively high, encouraging the formation of new companies. For example, Microsoft's bid to acquire Intuit for $1.5 billion represented a breathtaking 40 percent pre- mium over Intel' s (then current) market value. The Importance of Large, Technology-Intensive Companies These innovative new software companies tend to be distributed according to a specific geography. That is, technology-intensive communities, for example Boston or San Francisco, that have reached critical mass in software tend to be self-perpetuating. This is because relationships with other, larger technology companies are very important to small software companies. First, the software industry is marked by a large number of spin-off companies or by entrepreneurs leaving larger software companies (or hardware companies) to create their own companies. These new software companies tend to concentrate in areas that in- clude larger, technology-based companies where such spin-offs are common. DEC, for example, has spawned numerous spin-offs. The spin-offs are less well documented in software than in other high-tech fields but occur equally frequent (if not more so). Lotus Development, for example, spun off at least three new firms during its first 3 years, including Iris Associates (which developed the very successful Notes program using venture capital from Lotus). As well as providing a source of entrepreneurs, large, technology-based com- panies also provide a critical base of new technology. There is a broad consensus that concepts are best transferred by the individuals who understand the new technology. To this end, small start-up firms have been responsible in software for an overwhelmingly large share of new commercial applications, often ex- ploiting research and ideas developed elsewhere usually in universities or in large, technology-based companies. The laboratories of IBM and AT&T Bell Labs especially, and also Xerox PARC, have developed software technologies that have been successfully commercialized by new software companies. Unresolved Policy Questions Several unresolved policy questions shape opportunities for companies in software. Concern about the domination of IBM's extraordinarily successful

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236 TECHNOLOGY TRANSFER SYSTEMS IN THE UNITED STATES AND GERMANY System/360 architecture led the U.S. Justice Department to assert that this suc- cess represented an illegal monopolization. In response, IBM decided to "un- bundle" the pricing of its systems instead of including the software in the pricing of the computer, essentially creating the opportunity for Microsoft and other in- dependent software companies to sell competing software. Recently, similar questions have been raised in connection to the extraordinary successes of Microsoft Corp. in personal computer software. Uncertain intellectual property rights (IPRs) are a second problem. Existing mechanisms for securing IPRs assume that something is either an expression of ideas (in which case, the expression of these ideas may be protected by copyright law, but not the ideas themselves), or a patentable process (in which case it may be protected by patent law). But software is both an expression of ideas, as lines of code, and the process that the algorithm describes and that process is valu- able. For this reason, IPRs are an imperfect mechanism (at best) for protecting innovations in software. Intellectual property rights may disadvantage start-ups and smaller software companies. Patents, especially, present special problems in software. Many soft- ware companies are using patents to compensate for recent legal decisions deny- ing them the copyright protection they feel they need. But patents are costly to obtain and difficult to enforce and defend. Large companies are, consequently, more likely to be able to threaten litigation and to defend against litigation. There is also ambiguity about what is and is not patentable. These problems have con- sequences for innovation, because small companies and start-ups are disadvan- taged by the costs and uncertainties of litigation. Also, because larger companies and universities are usually the sources of the technology for spin-offs and smaller companies in software, stronger IPRs for software may actually impede innova- tion as patent portfolios grow but their value remains ill-defined. Remarks on the Future The United States will continue to lead in developing new technologies and markets in software. Most of this innovation will be centered in small software companies. (For large companies, nurturing creativity and innovation has often proved difficult, and the risk-reward equation dictating product development is typically very demanding [Hooper, 19931.) As a result, successful software start- ups will continue to spin out of larger companies led by entrepreneurs with a riskier agenda. These dynamics create an advantage for the United States in software. But even as new technologies present opportunity for new entrants, many of these smaller companies may not have the resources to adopt these innovations and remain competitive. As software programs (including prepackaged software) have become larger and more complex, software developers have started to run into problems of quality and reliability, referred to in the literature as the "soft

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ANNEX II 237 ware bottleneck." Major delays in product releases, including 1-2-3 (Lotus), dBase IV (Ashton-Tate), OS/2 (IBM), and Windows NT (Microsoft) are examples of this trend (Brandt, 1991~. Attempts to address these problems include efforts to replace the current approach to software development with a more rigorous one, using code re-use and object-oriented designs (Brandt, 1991; Ferguson and Morris, 1993~. Tech- nology transfer in these new software technologies (if real) may present an op- portunity for other countries to compete with the United States in software. Japan and Europe, especially, have put a premium on developing process innovations in software design and automation, although they have not yet realized any com- mercial advantage from these initiatives. ELECTRIC POWER RESEARCH INSTITUTE: THE BOILER TUBE FAILURE REDUCTION PROGRAM Jim Oggerino Background The Electric Power Research Institute (EPRI) has been the centralized R&D arm of the U.S. electricity industry since 1972. Its members include over 600 utilities that together provide about 70 percent of the electricity generated in the United States. EPRI manages research projects performed by contractors, in- cluding universities and large and small companies. Typically, there are over 1,000 projects in process at any given time, supported with an annual budget in excess of $400 million. Over its 23-year history, EPRI has developed many technology transfer methods and processes. This case study focuses on boiler tube failures (BTFs) in fossil-fueled power plants and the technology transfer process used to ensure that solutions to the BTF problem reach the electric-power industry. The Issue Roughly 40 percent of the energy consumed in the United States today is in the form of electricity, and in the next 50 years that value could grow to 60 percent. Given the extent of public reliance on electric power, any technical problem or flaw that affects the availability of the boilers that make steam to drive steam-turbine generators is serious. Historically, BTFs represented the largest single source of lost generation in fossil-fueled power plants in the na- tion. According to the North American Electric Reliability Council Generating Availability Data System (NERC-GADS), coal-fired units 200 megawatts (MOO) or larger experienced more than 15,000 boiler tube failures during the 6-year period from 1983 to 1989. These failures represented a loss of 81 million mega

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238 TECHNOLOGY TRANSFER SYSTEMS IN THE UNITED STATES AND GERMANY watt hours (MWh) per year. At an estimated replacement power cost of $10 per MWh, this represented an annual loss of $810 million (McNaughton and Dooley, 1995). Thus, the objective of EPRI's BTF-reduction project was to improve boiler availability at more than 800 EPRI member generating facilities, comprising about 2,000 generating units. At the time, there were 22 known mechanisms of BTF. Solutions for some of those mechanisms were available in other countries, but most had not yet been adopted in the United States. The challenge was to per- form R&D on the as-yet-unsolved failure mechanisms, and to transfer knowledge about BTF solutions to EPRI members. Previous experience indicated that one could not effect technology transfer only by granting users access to the technical information. Face-to-face assistance, organizational and operational changes, and management commitment were required to succeed with a technology transfer challenge of this magnitude. EPRI contracted with General Physics Corp. (GPC) to carry out the research on the unresolved failure mechanisms and to assist with the technology transfer program. Barry Dooley, the EPRI project manager, had come to EPRI from Ontario Hydro (a Canadian utility with a large research department), where he had done considerable work in this area. Dr. Dooley is considered a world-class expert which was, and is, an important technology transfer factor. The contract with General Physics Corp. consisted of cost-plus remuneration and was typical for EPRI at the time. In addition to EPRI and General Physics, the utilities that provided their power plants for technology demonstration were part of the solu- tion teams that were formed. At the time EPRI contracted with GPC, the provisions for intellectual prop- erty were that all rights were to be retained by EPRI. However, in a large number of cases, the GPC investigators were given exclusive, or sometimes nonexclu- sive, licenses to sell the resulting research products in any market except the U.S. utility market. Utilities receive EPRI results free through their membership. Depending on the circumstances, technology licensing for EPRI members may be cost free or require the payment of a considerable fee. EPRI is funded by its member utilities to perform collaborative R&D and be involved in the transfer of research results to members. EPRI generally funds its research projects at the laboratory investigation level. However, at the full-scale demonstration phase, it is often necessary to use a member's generating station. It takes the highest level of trust on the part of a member utility to use an operat- ing plant as a test bed, because any plant unavailability can result in costs of hundreds of thousands of dollars per day. One technology transfer mechanism used to obtain sponsors for demonstra- tion or shared R&D projects is a one-page document called a "host utility." This document is distributed through EPRI's Technical Interest Profile (TIP) system, which member utility staff join by submitting a TIP interest sheet. The interest sheet has roughly 100 technical areas to choose from. Most TIP users check three

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ANNEX II 239 or four items and receive routine mailings on the topics of their choice. Mailing lists in each technical area contain between 2,000 and 7,000 names. To initiate the BTF demonstration program, EPRI distributed a host utility document throughout the industry. Based on the responses it received, EPRI selected 10 utilities, representing about 40,000 MW of capacity, to begin the program. About a year after the project started, EPRI held workshops and semi- nars to announce interim progress to the rest of the industry. This resulted in many additional utilities volunteering to become part of the program, and so EPRI issued another host utility invitation. Two years after the first set of 10, 6 addi- tional utilities (another 20,000 MW of capacity) were added to the project. Prior to inviting utilities to participate, EPRI established criteria for partici- pation. Each utility had to assign a BTF program coordinator for the project; issue a corporate BTF program mandate or philosophy statement; include in the program all fossil-generating units operated by the utility; and form cross cutting BTF program teams for which training attendance was mandatory. After EPRI selected the first 10 utilities, it convened a meeting of BTF coor- dinators. All were asked to obtain senior management signatures on the corpo- rate mandates prior to beginning activities at their utilities. EPRI then held train- ing sessions at each utility for each BTF team, consisting of staff from the utility's engineering, operations, maintenance, and management units. The senior man- ager who signed the mandate had to attend the course for at least one hour. These meetings were held at home offices or at various power stations, with the selec- tion left up to the sponsoring utility. The training material included descriptions of what actions and organizational and operational changes were required to ad- dress each of the 22 failure mechanisms. Six-month follow-up meetings were held by the EPRI team to determine if corrections or additional changes were required. It should be noted that GPC carried out essentially all of the training sessions for EPRI. GPC played a major role in the technology transfer process, freeing the EPRI project manager to focus on the R&D portion of the project. From the outset in 1985, the target for the project was to transfer technology to achieve an average equivalent availability loss (EAL) of 1.45 percent from BTFs. This represents a nearly 60-percent reduction from the national EAL of 3.4 percent in 1985. Figure A-3 shows the EAL reductions achieved from 1985 through 1991. By 1987, the first group of 10 utilities had reduced their EAL from 2.5 percent to 1.8 percent. By 1991, that same group had further reduced their EAL to 1.5 percent. The 10 utilities predict savings of at least $41 million annu- ally for the next 10 years. The second group, which had started 2 years later and at a much higher EAL (3.4 percent) had reduced their average to 2.0 percent. This project demonstrated to the electric-power industry that successful tech- nology transfer does not consist solely of being exposed to research results or technical fixes. Management commitment to support tech transfer programs and, in most cases, organizational rearrangements, also are necessary. In addition, operational chances and training programs are often required.

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240 TECHNOLOGY TRANSFER SYSTEMS IN THE UNITED STATES AND GERMANY 3.8: oh oh a 3.4- . _ <~ 3.0 i~ ~ 2.6 g . _ 2.2 \ \ BTFRP (6 utilities) National Average BTFRP (10 utilities) Target (1.45 percent) 1.0- 1 1985 1986 1987 1988 1989 1990 1991 1992 BTFRP = boiler tube failure reduction program FIGURE A-3 Equivalent availability loss due to boiler tube failure, 1985-1992. SOURCE: McNaughton and Dooley (1995~. The demonstration program and subsequent adoption of BTF solutions by EPRI member utilities led to annual savings in the hundreds of millions of dol- lars. The technology transfer process was so successful it is being used for two other major EPRI programs: Plant Life Extension and Cycle Chemistry. Perhaps more important than resolving the 22 BTF mechanisms (since ex- panded to more then 30), the demonstration project has resulted in utility man- agement recognizing more fully the need to support internal product champions with funding and organizational clout. Thus, three elements research results, a demonstration host site, and senior management support were all required to achieve success.