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An Assessment of the Small Business Innovation Research Program in New England: Fast Track Compared with Non-Fast Track Projects*

John T. Scott

Dartmouth College

EXECUTIVE SUMMARY

This paper provides case studies for 14 research and development projects funded in 13 New England companies by the Department of Defense Small Business Innovation Research (SBIR) program. The performance of the six Fast Track projects, each conducted by a different company, is compared with the performance of eight non-Fast Track projects. The primary conclusions from the study of the New England cases are

  • The collection of 14 New England SBIR projects studied here exhibited, at the outset of Phase I, high risk—both technical and market risk, high capital costs, and often expectation of a long-time before commercialization of the resulting technology.

  • In the absence of the SBIR funding, the research projects would not have been undertaken in the same way or at the same pace. Outside investors, at the outset of Phase I, would have required too high a rate of return to make it possible for the project to proceed with only private financing.

  • On the whole, the projects, both Fast Track and non-Fast Track, met both the funding agency’s mission and the company’s strategy. All fit the general scenario for socially valuable research projects that would have been underfunded in the absence of the SBIR program. In particular, the projects appear to be ones for which the private rates of return in the absence of SBIR funding would have fallen short of the private hurdle

    *

    This paper was prepared for presentation at the National Academy of Sciences Symposium on the Assessment of the SBIR Fast Track Program, May 5, 1999.



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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE An Assessment of the Small Business Innovation Research Program in New England: Fast Track Compared with Non-Fast Track Projects* John T. Scott Dartmouth College EXECUTIVE SUMMARY This paper provides case studies for 14 research and development projects funded in 13 New England companies by the Department of Defense Small Business Innovation Research (SBIR) program. The performance of the six Fast Track projects, each conducted by a different company, is compared with the performance of eight non-Fast Track projects. The primary conclusions from the study of the New England cases are The collection of 14 New England SBIR projects studied here exhibited, at the outset of Phase I, high risk—both technical and market risk, high capital costs, and often expectation of a long-time before commercialization of the resulting technology. In the absence of the SBIR funding, the research projects would not have been undertaken in the same way or at the same pace. Outside investors, at the outset of Phase I, would have required too high a rate of return to make it possible for the project to proceed with only private financing. On the whole, the projects, both Fast Track and non-Fast Track, met both the funding agency’s mission and the company’s strategy. All fit the general scenario for socially valuable research projects that would have been underfunded in the absence of the SBIR program. In particular, the projects appear to be ones for which the private rates of return in the absence of SBIR funding would have fallen short of the private hurdle * This paper was prepared for presentation at the National Academy of Sciences Symposium on the Assessment of the SBIR Fast Track Program, May 5, 1999.

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE rate required by outside financiers to whom the small businesses would have had to turn for financial support. Yet the social rates of returns to the projects are large and exceed the hurdle rates. The funding from the SBIR program changes the ordering of rates of return anticipated at the outset of Phase I. With the SBIR program providing funds, the expected private return relative to just the private portion of the total project costs is sufficient to move the private rate of return above the hurdle rate, and then the socially valuable research investment is undertaken. Taken as a group, the Fast Track projects show higher prospective lower-bound social rates of return—a measure that is based upon expected profits to the innovator and other producers benefiting from the innovation. The average duration of additional development beyond Phase II and before commercialization is somewhat less for the Fast Track projects, suggesting that at least on average they are somewhat closer to commercialization at the end of Phase II than the non-Fast Track projects. The respondents were unanimous in their appreciation of the SBIR program and in their belief that the program generally works well. They did have several recommendations to improve the working of the program, and those recommendations are listed in this paper. Among other things, the respondents cautioned that the Fast Track program is often simply not useful for companies pursuing socially valuable high-risk research, because at the end of Phase I, such projects often do not yet have the characteristics of projects that allow outside private investors to be attracted. In summary, the SBIR program has funded innovative projects with high social rates of return that would not have been undertaken in the absence of the program. Further, the non-Fast Track as well as the Fast Track projects appear to be quite valuable, although the non-Fast Track projects typically do not exhibit private commercial potential as quickly as the Fast Track ones.

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE INTRODUCTION As part of a National Academy of Sciences study of the Department of Defense (DoD) Small Business Innovation Research (SBIR) Program, six SBIR Fast Track projects from six companies in New England are studied here along with SBIR non-Fast Track projects from different New England companies matched by similarity of location, size, and project duration. A total of seven projects from six non-Fast Track companies are studied—one project for each of five companies and two for the sixth. Additionally, the study includes a non-Fast Track project of a thirteenth company, Foster-Miller, which is much larger than the other companies in the sample and has been successful with an unusually large number of SBIR awards. In all, the study covers 14 projects at the 13 firms shown in Table 1. All of the SBIR projects studied were awarded both Phase I and Phase II funding. The goal of the study is to describe the SBIR projects and compare the Fast Track projects with the non-Fast Track projects, determining the effect that Fast Track has had on SBIR performance and firm behavior. The 14 projects are high-risk research projects performed by small businesses, or with Foster-Miller in the sample, what the technology literature calls SMEs—small and medium-sized enterprises. The study finds that these risky SBIR-funded projects have high prospective, expected social rates of return. The social rates of return are calculated as lower bounds based solely on anticipated innovative investment profits for companies rather than on the sum of those profits (producer surplus) and consumer surplus (economists’ measure of the value above and beyond what they actually pay that consumers receive from a product or service). Thus, the study’s finding that the Fast Track projects as a group have TABLE 1 The Firms Company Name Date Founded Initial Sizea Brock-Rogers Surgical 1995 3 Cape Cod Research 1982 18 Foster-Miller, Inc. 1956 260 Hyperion Catalysis International 1982 20 Lithium Energy Associates, Inc. 1989 3 Materials Technologies Corp. 1986 5 Mide Technology Corp. 1989 3 Optigain, Inc. 1991 8 QSource, Inc. 1982 3 SEA CORP (Systems Engineering Associates Corp.) 1981 93 Spectra Science Corp. refounded 1997 (originally 1989) 7 Synkinetics, Inc. 1994 8 Yardney Technical Products, Inc. 1940 155 aEmployees at the time of application for Phase I.

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE higher social rates of return supports the perception that their prospects for generating profits for innovating firms are especially good. However, some non-Fast Track projects have higher lower-bound expected social rates of return than some Fast Track projects, despite the fact that consumer surplus is not measured. Fast Track and non-Fast Track projects alike have lower-bound social rates of return exceeding the private rates of return in the absence of SBIR funding. Each of the studied projects is the type of research project in which the market would fail to invest in a socially valuable innovation in the absence of SBIR or similar public funding. For the 14 New England SBIR projects studied, the average value of the lower bound for the prospective (i.e., at the start of Phase I) expected social rate of return is estimated to be 60 percent. The estimate would be much higher if consumer surplus could be measured. HISTORY OF THE FIRMS AND THE PROJECTS Table 2 provides some background information about the 13 companies as a group. The sampled firms have similar histories in the ways reviewed in the table, except that the Fast Track respondents are less likely to have had a previous SBIR award. Not surprisingly, the companies are not Advanced Technology Program (ATP) award winners; the ATP projects require substantial contributions of private funds from the outset of the projects. As seen in Table 2, the sampled companies are typically small businesses facing severe capital constraints for internal financing of research. Somewhat more than half of the respondents indicated locational advantages. A variety of other competitive advantages were cited; representative examples include “large patent base,” “patented core tech- TABLE 2 History of the Firms. (The number of respondents indicating each category) Characteristic Fast Track Non-Fast Track Locational advantages   Near universities 2 3 Near corporate research centers or research parks 1 2 Previous SBIR awards prior to Phase I of current award*a   Yes 3 6 No 3 1 Previous or current ATP Aawards   Yes 0 0 No 6 7 a One company discussed the details of two awards. For purposes of this table, the two awards are considered as one award; their periods of performance are essentially concurrent, and both are non-Fast Track projects.

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE nologies,” “small and lean,” “twenty five years experience in the underlying technology,” “trade secrets and know-how.” As discussed in detail later, the research projects on the whole are characterized by both high technical risk and high market risk. At the outset of Phase I, there is considerable uncertainty about whether the research will resolve outstanding technical problems. Furthermore, the acquisition plans of DoD are not typically firm at the outset of the research, and although the potential for spillovers to the nonmilitary commercial sector is present, many uncertainties remain about the form of the nonmilitary applications and about the market success of those applications. Table 3 lists the companies along with the titles of the SBIR projects studied in this paper and their Fast Track status. The following paragraphs are brief overviews of the technologies being created by the sampled SBIR projects, along with discussion about the relationship of the project to the mission of the funding agency and to the strategy of the company. TABLE 3 The Projects Company Project Title Fast Track Status Brock-Rogers Surgical Development of a Force-Reflecting Laparoscopic Telemanipulator Fast Track Cape Cod Research, Inc. Multilayer Capacitors Based on Engineered Conducting Polymers Non-Fast Track Foster-Miller, Inc. Tunable Sting Net Non-Fast Track Hyperion Catalysis International Ultracapacitors Based on Nanofiber Electrodes Fast Track Lithium Energy Associates, Inc. Lithium Copper Chloride Inorganic Electrolyte Battery for More Electric Aircraft Systems Non-Fast Track Materials Technology Corp. Life Prediction of Aging Aircraft Wiring Systems Non-Fast Track Mide Technology Corp. Development of Distributed Area Averaging Sensor Non-Fast Track Optigain, Inc. Single Longitudinal Mode Distributed Feedback Fiber Optics Laser Non-Fast Track QSource, Inc. Multiple Rectangular Discharge CO2 Laser Fast Track SEA CORP (Systems Engineering Associates Corp.) Rapid Prototype Portable Combat and Launch System Non-Fast Track   Second project also discussed: Modular Gas Generator Launch Canister Non-Fast Track Spectra Science Corp. Quantum Dots: Next Generation of Electronic Phosphors Fast Track Synkinetics, Inc. High Precision Gimbal System Fast Track Yardney Technical Products, Inc. Low Cost, Lightweight, Rechargeable Lithium-ion Batteries Fast Track

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE Brock-Rogers Surgical. Development of a Force-Reflecting Laparoscopic Telemanipulator. Fast Track. The technology merges electronics, mechanics, computer networking and software to create a telerobot to be used for surgery. The technology allows the surgeon to feel as if he or she were one inch tall and inside the patient. DoD is interested in such computer-augmented remote connections to allow medical personnel to operate on the front lines from remote locations. Beyond the military applications, such technology will change the face of surgery. A deep infrastructure technology is being created—a sophisticated electronic, mechanical, software-networked machine. In that sense, the technology is an enabling one with wide applications outside of medicine. The robot no longer needs to “see”—recognition and reception problems are handled by the human controlling the process. Cape Cod Research, Inc. Multilayer Capacitors Based on Engineered Conducting Polymers. Non-Fast Track. The technology uses electrically conductive polymers to store energy to power electric cars. The project involves the development of novel and useful materials, and it provides the funding agency with improved energy storage for a variety of applications. Foster-Miller, Inc. Tunable Sting Net. Non-Fast Track. The technology is the latest in a line of “NETS”—nonlethal entanglement technology systems—developed as SBIR projects by Foster-Miller in response to DoD’s interest in funding research about capture mechanics. The family of nets developed by Foster-Miller are compact, light-weight, far-ranging, fast, and can be fired from conventional weapons. The “Sting Net” delivers a remotely controlled electric charge for use with especially aggressive targets and is anticipated to have military applications only. Less physically active versions range from nets that simply entangle to nets using pepper irritant powder to subdue more dangerous targets. The less harsh nets will have use in nonmilitary police operations. The Sting Net project fits with Foster-Miller’s highly successful corporate strategy of inventing and licensing patented technologies, and spinning off subsidiary companies to manufacture and market the innovations. Numerous SBIR projects have contributed to that strategy, although the company gets only about 20 to 25 percent of its revenues from the SBIR awards. Hyperion Catalysis International. Ultracapacitors Based on Nanofiber Electrodes. Fast Track. Electrochemical capacitors, sometimes called ultra-capacitors or supercapacitors, are being developed for potential applications in hybrid electric vehicles and other automotive electronic and military systems. To be cost- and weight-effective compared to batteries, these “supercaps ” must have adequate energy and power with a long life cycle and must meet cost targets. Hyperion has a proprietary line of nanofibers that have desirable properties and a cost advantage over competing materials. During Phase I, the Hyperion nanofibers showed great promise regarding their power and now in Phase II the nanofibers are being used to design, fabricate, and test electrochemical capacitors. Hyperion would make the nanofiber electrodes and sell them to the manu-

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE facturers of supercaps. Beyond the potential for a large commercial market for supercaps and the fact that the military has specialized needs for them that explain the DoD funding of the research, there are other potential applications including uses in boom boxes, electric motor starters, defibrillation medical devices, and in cell phones in combination with batteries where power from a small supercap can allow the use of a smaller battery and a better product than results using a large battery alone. Lithium Energy Associates, Inc. Lithium Copper Chloride Inorganic Electrolyte Battery for More Electric Aircraft Systems. Non-Fast Track. The batteries developed by Lithium Energy Associates are rechargeable and have high energy density and extraordinary low-temperature performance. They have military applications in small, light-weight, remote-controlled reconnaissance aircraft equipped with TV cameras and in solar planes that fly to high altitudes, charge during the day, and then keep flying at night. The batteries have other military applications as well; for example, after using conventional power to get equipment to a battlefield, the engines could be turned off and the batteries could reposition vehicles quietly and without infrared detection. The batteries will have applications for a variety of military electronics applications such as radios. The low-temperature performance of the batteries also makes them the potential power source for applications in space, such as powering robot stations on the moon or Mars, and research in progress will push the low-temperature capabilities of the batteries into the range making them suitable for lunar or Mars missions. Customers, apart from DoD and NASA, should include original equipment manufacturers of military electronics or civilian police equipment. Materials Technology Corporation. Life Prediction of Aging Aircraft Wiring Systems. Non-Fast Track. The technology allows safe, accurate, and efficient diagnostic tests of the wiring in airplanes to ensure that the wiring is defect free. With the current technology the inspector opens a panel door and examines bundles of wires with the naked eye. If the 12- to 18-inch section of wire that can be seen looks okay, then the entire wire is judged to be safe. In some cases, the inspector may use a mirror to try to look at the back side of the wires, but because of visibility and space limitations it is rare that the back side is inspected well. The wires themselves are rarely a problem; instead, the insulation on the wires is what degrades; becoming brittle with age, it begins to crack. The plasticizer vaporizes and, over time, the insulation degrades, becomes brittle, and begins to fall apart, exposing bare wire; if two wires are exposed, a short circuit is possible. The new technology developed by Materials Technology Corporation is the first approach to inspecting for damaged insulation of wiring that allows viewing of all sides of the wiring and does not risk damaging the wires as typically occurs if the wires are bent or disturbed in trying to examine their back side. The technology uses embedded optical sensors in a device that can be put around the bundle of wires and used to get a 360-degree view of the wires. The information

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE gathered by the handheld device is signaled to a computer that pinpoints and displays precisely where on the 360-degree surface a crack is located. New optical imaging technology is used. With the press of a button the image can be recorded and the data transported for use at other sites. It is expected that the system will allow the entire wiring history of the aircraft to be stored on a zip drive that will be carried in the aircraft. Planes will not have to return to a home base to be inspected and repaired. Historical data, supplemented with a visible image, will allow the inspector to see what the wiring looked like at the last inspection and calculate the progression of changes. In addition to examining aircraft wires and cable, the technology can be used to examine the connections and to detect corrosion more generally in aircraft and other objects. There are many applications beyond those for military and commercial aircraft. The optical scanning procedure is expected to be relevant for dealing with vision problems caused by macular degeneration. And, of course, what is good for aircraft inspection is also good for inspecting bridges and other infrastructure. Mide Technology Corporation. Development of Distributed Area Averaging Sensor. Non-Fast Track. The technology eliminates harmful vibrations in structures by use of active materials that respond to stimuli; for example, if voltage is applied, the active material expands or contracts. The vibrations of structures have several natural frequencies, and the technology developed by Mide Technology Corporation uses shaped sensors to filter out noise, focusing on a desired frequency to eliminate the associated vibrations. The area averaging sensor simplifies a higher-dimension multi-input/multi-output information problem to a lower-dimension control system that characterizes more simply the necessary information about the natural frequencies causing vibrations, despite a complex set of underlying information. The frequencies that really transmit the noise through the structure of interest can be isolated using a control system with active fiber composite actuators; the smart material is used to simplify the control problem and, ultimately, to allow the elimination of the vibrations from the structure. The immediate application of the technology is to protect launch satellites from damage from structural vibrations. Alternatively, one could protect the launch satellite with blankets—thin ones to protect against high-frequency noise, and thick ones to protect against lower-frequency noise. The Mide technology is the active way of dealing with the problem. Commercial potential extends beyond the protection from vibration of components in space launch vehicles. The commercial potential comes from using area average sensors with flexible circuitry, and Mide has four commercial products using that technology. The products range from generic technology such as sensors on a flexible circuitry for signal conditioning, a high-voltage amplifier to drive active fiber composites, and sensors connected in various ways on a small matrix board, to a specific application that uses sensors on a the shaft of a golf club to detect club head speed and provide feedback. The generic applications range from military uses such as protecting the launch of a spacecraft or quieting torpedoes in a submarine to

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE nonmilitary commercial uses such as vibration control for the blades of a gas turbine or in air-conditioning ducts. Anything that vibrates and has a dynamics problem with the vibration and noise can potentially benefit from the technology. Optigain, Inc. Single Longitudinal Mode Distributed-Feedback Fiber Optics Laser. Non-Fast Track. Optigain’s technology provides a fiber version of a signal source that is similar to a semiconductor laser. Optigain ’s fiber laser is a distributed laser induced in a fiber rather than a semiconductor. Transmission systems need a high-quality signal source, and Optigain’s technology provides a narrow, high-quality low-noise laser that can potentially capture some of the market for semiconductor lasers used in communications markets. The company ’s strategy is to develop various fiber-based devices, and the product here is a fiber-based component that can be put into other systems. Several lasers, each a different wavelength, have been developed, and communications markets where Optigain’s fiber-based laser will be preferred over the semiconductor lasers are being sought. The superior performance of the fiber-based laser is in the linewidth of the laser and its spectral purity, which should lead to applications in sensor markets as well. Regarding the relationship between the project and the mission of the funding agency, in this case the agency was quite open about different topics, with awards going to further technology for high-speed communications networks quite generally. The goal of the funding was to enable new technologies for such networks, and the concern was with the overall strength of the solutions rather than a specific set of narrow requirements. QSource, Inc. Multiple Rectangular Discharge CO2 Laser. Fast Track. QSource’s CO2 laser technology generates high power and efficiency and has specialized military uses. There are also nonmilitary commercial applications with large market potential. QSource’s laser features higher power, smaller size, and an advantage in cost. CO2 lasers are used in laser radar to bounce a pulse off an object, its high sensitivity allowing detailed information to be obtained about a tank or an aircraft many miles away. The laser system along with a DC battery source can be built in the size of a small suitcase. The CO2 laser has very high efficiency, transmitting substantial distances with very little power loss; it is compact, uses a simple gas, and is very efficient. The technology is dual use. For example, the basic transmitter unit in the laser radar has applications for heating, cutting, and trimming, for example, in conjunction with one of the lasers used in eye surgery that was developed initially in another DoD SBIR project trying to track objects at great distance. The laser is inherently sterile, and so, it is ideal for cutting tissue. It can be used for cutting teeth, working on teeth, and as a mechanical drill. It is more expensive than a drill, but it eliminates the risk of transmitting hepatitis or other viruses. A laser dental system has a detachable head in the optical system that delivers the laser and is easy to clean. The surgery is painless; there is no need for anesthesia. The dental market alone over the next 10 years is projected to sell 100,000 dental laser

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE systems once the procedure for hard tissue is approved. A CO2 laser dental system will sell for about $20,000. The energetic CO 2 lasers that QSource technology improves upon should have a market of $2 billion in the dental market alone. The medical therapeutic uses include the dental applications, skin resurfacing, and microsurgery in the ear. Further markets have been identified for sealed CO2 lasers in materials processing and various research applications. There are a large number of CO2 lasers available and, over the past decade, they have become more functional. The cost of producing them in terms of dollars per watt is not great, but more than half of that cost is in the basic power source needed to energize the laser (i.e., powering the basic laser itself, not the entire system). The big advance provided by QSource technology is to reduce the cost of the power supply. Some of the older technology can achieve the same level of efficiency as the new QSource rectangular discharge laser, but those technologies result in products that are very big and not very sturdy. SEA CORP (Systems Engineering Associates Corp.). Rapid Prototype Portable Combat and Launch System. Non-Fast Track. The technology is a software based-fire control system that allows a submarine to fire various types of torpedoes. Modern submarine systems are not compatible with all types of torpedoes. SEA CORP has created a system in a suitcase that can be plugged in and will allow the submarine to use different types of torpedoes. Modular Gas Generator Launch Canister. Non-Fast Track. This second technology developed by SEA CORP is a launcher for torpedoes that uses automotive air-bag technology rather than a conventional gas system. It is modular, environmentally friendly, and uses a commercial off-the-shelf item to meet a specialized military purpose. Other commercial applications of both technologies are being considered, and the technologies will allow SEA CORP to diversify its activities into profitable new lines of business that are very different from its historical focus. Spectra Science Corporation. Quantum Dots: Next Generation of Electronic Phosphors. Fast Track. The technology centers on better phosphor that results in a brighter image on large-screen projections. The technology combines the three core technologies of Spectra Science. First, the company has laser paint technology using disordered lasers. Conventional lasers use mirrors as the gain source, but laser paints use scatters such as titanium particles. So, a composite system is used to create the gain source; the laser excites the material and the feedback is from materials rather than from mirrors. The laser paint technology is used for identification or authentication, for example, via a label on a fabric or in a document. The second core technology came from Phase I of this SBIR award. In that research, Spectra developed the ability to make smaller phosphor particles with surfaces for the composite systems that could exhibit gain and could be used in a laser paint. The difficulty to be surmounted was that the surfaces of the particles have a large number of defect sites, which trap light, preventing its emission. The third core technology is the focus of the SBIR project’s Phase II. It is a

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE combination of the first two technologies. Phase I resulted in development of quantum dot phosphors for display applications—better phosphors that could be driven harder with the result of a brighter image. Phase II then shifted gears and focused on developing what had been discovered. Spectra Science has merged its work on display technologies and materials for laser paints to develop a lasing projection system. With previous technologies, large-screen projections can be viewed only in the dark. With Spectra Science’s new technology, the phosphors are excited and emit higher energies than previously, overcoming this limitation. DoD’s SBIR award here meets their mission in terms of improved images for large-screen projection systems. That goal remained the same even when Phase II was refocused, and the project clearly satisfies Spectra Science’s strategic mission of seeking potential applications for its core technologies. Synkinetics, Inc. High Precision Gimbal System. Fast Track. The Synkinetics technology is an innovative system of gears that provide cost-effective, sturdy, precision devices for positioning and pointing armaments. Such devices are used, for example, in missile control systems. Synkinetics’s new speed conversion technology improves current high-precision pointing and positioning transmission equipment at a reasonable cost. The technology features flat-plate cam gears in an in-line mechanism that combines the rolling aspects of bearings with the transmission aspects of gears to obtain a versatile, robust, compact, reduced-weight, high-precision, efficient, and cost-effective drive mechanism. The technology is generic and has countless applications. The transmissions will have uses for pointing and precision positioning of various payloads for industry and the military. Applications of reliable, low-cost, and low-maintenance precision positioners are expected in the medical, electronics, marine, mobile satellite communications, and aerospace industries. Yardney Technical Products, Inc. Low Cost, Lightweight, Rechargeable Lithium-Ion Batteries. Fast Track. Yardney has developed the battery using the prismatic cell technology identified in Phase I of the project and plans to deliver a prototype to its sponsoring agency. The battery has a 25 percent improvement in capacity compared to the battery that the military now uses and would represent a major jump in performance for the DoD uses for the particular style of battery. The market for the lithium-ion battery has grown rapidly from nothing in 1990 to current sales of $1.2 billion. Currently, the market is growing at 30 percent a year, and there is much opportunity for new technologies. The technology will be useful to other governments; with approval, sales to armies of U.S. allies are expected. Nonmilitary commercial applications are expected as well. COMPANIES’ EXPECTATIONS FOR SBIR PROJECTS AND REASONS THAT SBIR SUPPORT WAS NEEDED As Table 4 shows, the SBIR awards made possible research that otherwise would not have been undertaken or would have been done on a smaller

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE own technology to another level without going crazy looking for outside investors. There must be somebody willing to put money into the project. Plenty of people will give lip service to the idea and take your time. But the probability of actually getting the money is less than 5 percent. To spend 80 percent of the time for the 5 percent chance of financial support is not a good use of our time. . . ., to support our Phase I project, we tried to find support from other companies and venture capitalists. The venture capitalists want too high a rate of return and want returns too quickly. Joint ventures don’t work either. You need their money, so they want lots of rights. You must sell your soul to them. These partner companies are providing capital basically, and sometimes distribution networks. We cannot use large companies or venture capitalists to fund our research. We protect our intellectual property with trade secrets rather than patents. We must stay out of the grips of the venture capitalists in order to protect our intellectual property. Thus, at the outset of the SBIR project, the required rate of return for outside financing is not met. Had the expected rate of return exceeded the rate of return required to secure outside financing, the deal for outside financing could have been struck. However, uniformly, the respondents explain that, at the outset of the SBIR, such funding could not be obtained. The SBIR award allows the SBIR project to proceed and ensures that socially valuable research is not lost because of imperfect financial markets, incomplete appropriability, and substantial downside risk. The required rate of return for the outside investors is simply not expected at the outset of the project. Now, as Phase II draws to an end for the sampled projects, upward of a million dollars or much more has been spent to resolve uncertainties —technical and market uncertainties and also uncertainties about the small business doing the research. Now, after Phase I and Phase II, the logic of our construction of the expected cash flows below would not necessarily hold. We have estimated prospective rates of return at the outset of Phase I, and these show the market failure and show the reason for the SBIR awards. Without the SBIR funding, socially valuable research would not be undertaken because the required rate of return for outside private investors could not be expected to be achieved, and the small business would not have been able to finance the research itself. The calculation of the lower bound for the social rates of return uses the information summarized in Table 10; the information was developed from the interviews that were conducted with the SBIR award winners. Some of the information is also available in the DoD files; however, the information was verified with the respondents and updated to reflect any changes from the DoD files. Variables for duration, total costs, and SBIR funding were combined into one figure for both Phase I and Phase II of the project. Typically, there is an extra period of development after Phase II is completed and during which further work with prototypes and initial production lines is done. The length of that additional development period and the extra costs that the company would incur were obtained in the interviews.

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE TABLE 10 Definition of Variables for Determining the Prospective Expected Social Rate of Return Variable Definition d Duration of the SBIR project in years C Total cost of the SBIR project A SBIR funding r Private hurdle rate z Duration of the extra period of development beyond Phase II in years F Additional cost for the extra period of development T Life of the commercialized technology in years L Lower bound for average expected annual private return to investing firms U Upper bound for average expected annual private return to investing firms v Proportion of value appropriated period of development after Phase II is completed and during which further work with prototypes and initial production lines is done. The length of that additional development period and the extra costs that the company would incur were obtained in the interviews. Companies cannot expect to appropriate all of the value created by their innovations. First, the innovations will generate consumer surplus that no firm will appropriate, but that society will value. Our estimates of the social rate of return are conservative because we do not attempt to estimate the value of consumer surplus generated by the SBIR projects. Second, some of the profits generated by the innovations will be captured by firms other than the innovators. Larger companies, for example, will observe the innovation and some will successfully imitate it and produce the commercial product in competition with the small business innovator. Respondents were asked to estimate the proportion of the returns generated by their anticipated innovation that they expected to capture. Then, in an extended conversation, other possible applications of the technology developed during the SBIR project were explored. The respondent was then asked to estimate the multiplier to get from the profit stream generated by the immediate applications of the SBIR project’s technology to the stream of profits generated in the broader applications’ markets that could reasonably be anticipated. Finally, the responding company estimated the proportion of the returns in those broader markets that it anticipated capturing. From the discussion, we were then able to estimate the proportion of value appropriated by the innovating SBIR award winner. The lower bound L for the average annual private return is found by solving Eq. (1) for L, because that will be the value for L such that the private firm just barely earns the hurdle, or required, rate of return on the portion of the total investment that the private firm must finance. The firm would not invest in the SBIR project unless it expected at least L for the average annual private return.

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE (1) To find the upper bound U for the average annual private return, solve Eq. (2) for U, because any expected annual return greater than U would imply that the rate of return expected by the private firm would be more than its hurdle rate in the absence of SBIR funding, and therefore SBIR funding would not be required for the project. (2) Our estimate of the average expected annual private return to the firm is (L + U)/2. The average expected annual private return to the firm equals v times the average expected annual return that will be captured by all producers using the technology (producer surplus). Knowing the average expected annual private return is (L + U)/2 and knowing the portion of producer surplus that is appropriable, v, then we find that the total producer surplus equals (L + U)/2v and hence this value is a lower bound for the average expected annual social return. It is a lower bound because consumer surplus has not been measured. The private expected rate of return without SBIR funding would be the solution to i in Eq. (3): (3) The lower bound on the social rate of return is found by solving Eq. (4) for i: (4)

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE The private expected rate of return with SBIR funding would be the solution to i in Eq. (5): (5) Table 11 provides the various prospective expected rates of return for the New England projects as a group and for the Fast Track and the non-Fast Track projects. Table 12, Table 13, and Table 14 provide the summary statistics for the data. It seems clear that the Fast Track cases are much different from the non-Fast Track cases. Although they begin with a Phase I where a small business needs outside support, they exhibit sufficient commercial potential to attract outside funding quickly, and as a result these are likely to be projects that, relative to non-Fast Track projects, have higher lower bounds for social rates of return (recall that the social rates of return measure only producer, not consumer, surplus). Furthermore, because there will be more of the project investment cost paid by private funds, the private rates of return given SBIR support will be lower for the Fast Track projects. CONCLUSIONS In all, the collection of 14 New England SBIR projects studied here exhibited high risk at the outset of Phase I—both technical and market risk, high capital costs, and often a long expected time before commercialization of the resulting technology. Comments suggest fairly substantial appropriability problems for some projects, even within the narrower applications of the technology. Appropriability problems typically are greater when broader potential applications are considered. Uniformly, in the absence of the SBIR funding, the research projects would not have been undertaken in the same way or at the same pace. TABLE 11 Prospective Expected Rates of Return (ROR) for New England SBIR Projects Region Number of Cases Private ROR Without SBIR (prvnosbr) Social ROR, lower bound (soclwrbd) Private ROR with SBIR (prvsbr) New England 14 0.31 0.60 0.58 Fast Track 6 0.33 0.68 0.53 Non-Fast Track 8 0.30 0.55 0.61

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE TABLE 12 Data for New England Observations (Fast Track and Non-Fast Track) Variable Obs Mean Std. Dev. Min Max d 14 777,857 0.3833893 2.17 3.5 C 14 1,285,053 692,912.4 717,873 3,450,000 A 14 785,715.6 144,072.6 507,873 1,099,966 T 14 16.32143 8.111263 5 30a z 14 1.535714 1.456442 −0.375b 5 F 14 1,063,929 2,597,688 0 1.00e+07 rc 7 0.3821429 0.1222312 0.2 0.5 v 14 0.3053929 0.1992511 0.025 0.6 L 14 1,009,056 1,185,032 79,185 4,486,450 U 14 2,370,090 2,174,385 413,400 8,666,330 prvnosbr 14 0.31 0.0689481 0.19 0.43 soclwrbd 14 0.605 0.1754445 0.28 0.82 prvsbr 14 0.5757143 0.2172455 0.21 1.03 aOne company responded that T would be several decades, and another reported that T would be forever. In both cases, T was conservatively entered as the value 30 years. However, because the relevant discount rates are so high, the difference between 30 years and “forever” is not significant. In the integrals, the term with T entered negatively as an exponent would become zero, but with a large value of T, the term is very small in any case. bThis observation has a negative value because commercial returns started before the end of Phase II. cHalf of the respondents were uncomfortable estimating the private hurdle rate that outside financiers would apply to their projects at their outset. For those, the average value of r was used in the calculations. TABLE 13 Data for the New England Fast Track Observationsa Variable Obs Mean Std. Dev. Min Max d 6 2.578333 0.3279888 2.17 3.17 C 6 1,659,609 926,636.1 850,000 3,450,000 A 6 855,436.5 170,450.7 598,700 1,099,966 T 6 18.75 9.585145 7.5 30 z 6 1.208333 0.7486098 0.25 2.5 F 6 500,000 411,096.1 100,000 1,000,000 r 3 0.4 0.0901388 0.325 0.5 v 6 0.2379167 0.1296767 0.1575 0.5 L 6 971,784.8 673,530.7 533,085 2,237,640 U 6 1,962,022 654,443.7 1,125,230 3,036,360 prvnosbr 6 0.3266667 0.0388158 0.3 0.4 soclwrbd 6 0.6783333 0.1553598 0.44 0.82 prvsbr 6 0.53 0.1749286 0.35 0.86 aSee notes to Table 12.

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE TABLE 14 Data for the New England Non-Fast Track Observationsa Variable Obs Mean Std. Dev. Min Max d 8 2.9275 0.3693527 2.5 3.5 C 8 1,004,136 260,581.3 717,873 1,419,895 A 8 733,424.9 102,491.9 507,873 820,000 T 8 14.5 6.907553 5 25 z 8 1.78125 1.838028 −0.375 5 F 8 1,486,875 3,454,596 0 1.00e+07 r 4 0.36875 0.1546165 0.2 0.5 v 8 0.356 0.2342849 0.025 0.6 L 8 1,037,010 1,510,587 79,185 4,486,450 U 8 2,676,142 2,867,886 413,400 8,666,330 prvnosbr 8 0.2975 0.0856488 0.19 0.43 soclwrbd 8 0.55 0.1784857 0.28 0.78 prvsbr 8 0.61 0.2503141 0.21 1.03 aSee the notes to Table 12. Not surprisingly, then, respondents reported that outside investors, at the outset of Phase I, would have required too high a rate of return to make it possible for the project to proceed with private financing. For example, one respondent reported that the outside investor wanted one-half of the rights to the profits for contributing one-third of the investment cost. Another reported that the outside financiers wanted so much of the company that he would have lost control of the company and ultimately of its intellectual property. Many other comments along those lines are provided in detail earlier in this paper. The projects on the whole met both the funding agency’s mission and the company’s strategy. All fit the general scenario for socially valuable research projects that would have been underfunded in the absence of the SBIR program. In particular, the projects appear to be ones for which the private rates of return in the absence of SBIR funding would have fallen short of the private hurdle rate required by outside financiers to whom the small businesses would have had to turn for financial support. Yet the social rates of returns to the projects are large and exceed the hurdle rates. The funding from the SBIR program changes the ordering of rates of return anticipated at the outset of Phase I. With the SBIR program providing funds, the expected private return relative to just the private portion of the total project costs is sufficient to move the private rate of return above the hurdle rate, and then the socially valuable research investment is undertaken. In the foregoing ways, the Fast Track and non-Fast Track projects are essentially similar. Nonetheless, taken as a group the Fast Track projects show higher prospective expected lower-bound social rates of return—just as we would expect, because the measure includes only expected profits to the innovator and

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE other producers, rather than including consumer surplus as well. Thus, the Fast Track projects have higher expected private profits, and we expect that to be the case because these are the projects that attracted outside investors at an early stage in the research. Furthermore, the average duration of additional development beyond Phase II is somewhat less for the Fast Track projects, suggesting that at least on average they are somewhat closer to commercialization at the end of Phase II than the non-Fast Track projects. The respondents and the rate-of-return calculations make clear that although the Fast Track program selects projects that are different from SBIR projects more generally, projects that do not qualify for the Fast Track designation are typically no less deserving of SBIR support, but rather are high-risk projects with potentially great social value that would go unfunded in the absence of the SBIR program. The respondents suggest that, typically, the Fast Track program is simply not useful for companies pursuing socially valuable high-risk research because at the end of Phase I, most such projects do not yet have the characteristics of projects that attract outside private investors. Finally, two things must be emphasized in conclusion. First, the high social rates of return estimated and reported for the SBIR projects are very conservative, lower-bound estimates because they do not include consumer surplus in the benefit stream. Consider, for example, the non-Fast Track innovation of Materials Technologies that will allow safe, accurate, and efficient diagnostic tests of the wiring in airplanes. The profits that will be generated by the technology are obviously a tiny proper subset of the social benefits that the technology will generate, but the estimation method used measures only the returns in the form of profits to the innovator and to other producers of the technology. Second, some readers will be skeptical about the SBIR award recipients’ earnest belief that without SBIR funding the projects would not have been undertaken or at least would not have been undertaken to the same extent or at the same speed. With the SBIR program in place, certainly the pursuit of SBIR funding would perhaps be a path of least resistance. However, if the research would have occurred without the public funding, the estimated upper bound and hence the average of the upper and lower bounds for expected private returns would be too low, and the actual lower bounds for the social rates of return would be even higher than we have estimated. Further, the gap between the social and private rates of return would remain, although that would not in itself justify public funding of the projects. To summarize in a concise manner, Table 15 offers a comparison of costs and benefits of Fast Track and non-Fast Track projects over the same time frame. Other differences between the Fast Track projects and non-Fast Track Projects in the New England comparison groups include the following: A smaller proportion of Fast Track companies have had previous SBIR awards (3 of 6 vs. 6 of 7).

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE TABLE 15 Fast Track and Non-Fast Track Projects: New England Comparison Groups   Averages for Timeline of Costs and Benefits Variable Fast Track Non-Fast Track Total SBIR project cost $1.7 million $1.0 million SBIR funding $0.9 million $0.7 million Additional period of development 1.2 years 1.8 years Costs for additional development $0.5 million $1.5 million Lower bound rate of return to society (including benefits to SBIR firm and its investors and also to other firms) 68% 55% A smaller proportion of Fast Track companies expressed difficulties bridging a gap in time between Phase I and Phase II (0 of 6 vs. 4 of 7). A larger proportion of Fast Track companies said that the SBIR award facilitated the attraction of outside investors (4 of 6 vs. 1 of 7). Fast Track projects show commercial potential earlier and, by the end of Phase I, outside third-party investors are found. Fast Track projects have a higher lower bound for the social rate of return (based on the benefits for the collection of firms using the technology created by the SBIR project). Similarities between Fast Track and non-Fast Track projects in the New England comparison groups include the following: Barriers to investment (such as high technical risk and high capital costs) imply the need for partial public funding to carry out the SBIR projects. None of the companies has received ATP awards. All of the companies expect long-run strategic benefits from the SBIR award in the form of increased company size (sales or employment) or a more diversified product line. The SBIR projects are socially valuable: The social rate of return is greater than the rate of return needed for a worthwhile project. Respondents in the New England comparison groups expressed concerns about and recommendations for improving the SBIR program. From the Fast Track project respondents came the following: Small businesses should be encouraged to acquire expertise to ensure proper business administration to go along with the competence in scientific work.

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE Nonmilitary commercialization should not be the defining basis for the merits of the SBIR program because many valuable projects develop information with narrow applications within DoD. The Fast Track program may cause worthwhile projects to have a low priority for Phase II awards simply because they entail research that does not by the end of Phase I reach the stage that attracts outside funding. Some SBIR projects appear to be the sort of routine R&D and procurement that used to be done at large companies. Fast Track is a great innovation because it puts money into truly innovative small business projects with a high chance of commercialization. A Phase III for developing manufacturing technology, for ramping up production, might be quite helpful given the difficulties in negotiating the third-party investments. Funding should be provided for a Mentor/Consultant as a part of Phase II, with the SBIR firm identifying in the Phase II proposal a large corporation or marketing consulting firm that would work with the SBIR firm during Phase II and provide expertise about commercializing the technology. From non-Fast Track project respondents came these observations: Fast Track is not useful when the SBIR funding is needed to support high-risk research that does not result in a commercially viable technology before Phase II. Without having such an early result, attraction of outside funding is not possible in time for a Fast Track award. Key technology areas should be assigned to a lead agency, which would fund all proposals in that area. There is agreement that improvements are needed in certain key technology areas. However, better coordination of the efforts of various agencies administering SBIR awards, each trying to achieve the same broad goals, is needed. Of the 25 pages in the application, only about 5 are needed for technical evaluation. The other 20 could be filed separately, electronically, and would be used only in the event the application is being considered for an award. The SBIR program could help to complete the process of commercialization. Continuing support for a successful Phase II project, the SBIR program could support a bridge to commercialization. The SBIR program now is aimed at establishing technical feasibility, not commercial feasibility. Phase II funding for the DoD project monitor to travel to our location and interact with us should be provided. This would ensure that the technical monitor is actively involved in the project. Phase II awardeed should be allowed to spend funds over three or four years instead of just two years.

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE TABLE 16 Fast Track and BMDO-Matching Projects Compared with Others in the New England Samplea   Averages Type of Projectb d (years)c z (years)d soclwrbd (%)e F 2.43 1.00 69 B 2.72 2.04 67 Both F & B 2.72 1.42 67 Neither 3.05 1.62 48 aSample consists of 14 New England projects; 3 F, 3 B, 3 F & B, 5 neither F nor B. bF denotes Fast Track and B denotes BMDO-matching. cd is the duration of the SBIR project (Phase I + Phase II) without including the gap between the two phases and hence d is the duration of performance. dz is the length of the additional period of development beyond the end of Phase II and until commercialization. esoclwrbd is the lower bound rate of return to society, including benefits to the SBIR firm and its investors as well as to other firms. Table 16 provides additional insight by distinguishing the projects of the Ballistic Missile Defense Office (BMDO), where matching funds are required although, unlike Fast Track, the matching funds can come from the SBIR company itself. Fast-Track and BMDO-Matching SBIR projects are of shorter duration than other projects, even ignoring the gap between Phase I and Phase II. The additional period of development beyond the end of Phase II and until commercialization is less for Fast Track projects than for BMDO-matching projects. The lower-bound rate of return to society (including benefits to the SBIR firm and its investors and also to other firms) is greater for Fast Track and BMDO-matching projects. In sum, Fast Track Projects take less time to reach commercialization; both Fast Track and BMDO-matching projects have more commercial potential in the sense that they are expected to generate greater returns to the SBIR firm and its investors and also to other firms. Further investigation, available on request from the author, showed that the qualitative differences among the projects remain the same when controls for technology categories are added in a regression model. The conclusion is that the SBIR program has funded innovative projects with high social rates of return that would not have been undertaken in the absence of the program. Further, the non-Fast Track as well as the Fast Track projects appear to be quite valuable, although the non-Fast Track projects typically do not exhibit private commercial potential as quickly as the Fast Track projects. ACKNOWLEDGMENTS I would like to thank the following individuals for generously giving of their time for the interviews underlying the study. David Brock of Brock-Rogers Sur-

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE gical; Myles Walsh of Cape Cod Research; Adi Guzdar of Foster-Miller, Inc.; Bob Hoch of Hyperion Catalysis International; Frederick Dampier of Lithium Energy Associates, Inc.; Yogesh Mehrotra of Materials Technologies Corporation; Marthinus C. van Schoor of Mide Technology Corporation; Steven P. Bastien of Optigain, Inc.; Peter Chenausky of QSource, Inc.; David Miller, Larry Willner, and Gregory Lane of SEA CORP (Systems Engineering Associates Corp.); Timothy J. Driscoll of Spectra Science Corp.; Frank Folino of Synkinetics, Inc.; and Grant M. Ehrlich of Yardney Technical Products, Inc. I am grateful to David B. Audretsch, William L. Baldwin, Albert N. Link, and Nancy A. Scott for helpful comments and suggestions. REFERENCES Link, Albert N., and John T. Scott. 1998. Overcoming Market Failure: A Case Study of the ATP Focused Program on Technologies for the Integration of Manufacturing Applications (TIMA). Draft final report submitted to the Advanced Technology Program. Gaithersburg, MD: National Institute of Technology. October. Link, Albert N., and John T. Scott. 1999. “Estimates of the Social Returns to SBIR-supported Projects,” this volume. Tassey, Gregory. 1997. The Economics of R&D Policy ( Westport, Conn., and London: Quorum Books.