NIST GCR 02–841
Between Invention and Innovation
An Analysis of Funding for Early-Stage Technology Development

INTRODUCTION

In the context of the Between Invention and Innovation project, the Booz Allen & Hamilton (BAH) team completed thirty-nine interviews with respondents from randomly⁽⁹⁵⁾ selected firms: thirty-one with corporations across eight industry sectors and eight with venture capital firms. This section outlines our findings, including key trends that are influencing the research and development (R&D) environment, resultant pressures these trends have created, and emerging structural solutions. The role and approach to managing ESTD in this changing environment is addressed throughout.

TRENDS

The interviews revealed three key trends that are shaping the environment for corporate R&D, including its approach to ESTD investments. These include the increasing complexity of technology development, increased pressure to demonstrate financial value from R&D investments, and differences in industry and company life cycles.

R&D PROCESS EVOLUTION: INCREASING COMPLEXITY AND WEB-LIKE PROCESS

Most interviewees generally agreed with the classification of R&D into the four steps in the innovation framework used in our discussions (Basic, Concept/Invention, ESTD, Product Development). However, there were many reactions to the linear simplicity of the framework, compared to the typical path from invention to commercial innovation that the participants have experienced. The four-step framework represents an idealized view of technology progression, while the actual pathway includes multiple parallel streams, iterative loops through the stages, and linkages to developments outside the core of any single company.

Rapid advances and the increasing breadth and depth of knowledge available across all scientific fields have also contributed to the acceleration of this complexity in recent decades. To many, the invention to commercial innovation pathway has reached the point where the process is more web-like than linear. Consequently, the ability of any one company to develop all of the technological elements required to deliver significant advances has rapidly diminished. There are simply too many potential ideas and too few resources to go it alone.

PRESSURE FOR MEASURABLE RESULTS: FINANCIAL RETURN

Increased pressure on R&D to deliver measurable results was also cited as a key force that has driven corporations almost entirely away from basic R&D, and makes it difficult to justify many activities that do not support existing lines of business. Projects that did not have demonstrable financial benefits were not funded, and the R&D portfolio shifted dramatically toward product development. This trend transcended all of the industries that we covered.

INDUSTRY AND COMPANY LFE-CYCLE INFLUENCES

The final major influence we observed was differences in R&D investment related to industry and by company that are in part linked to life-cycle positions. Overall, ESTD spending was estimated at $13.2 billion annually, 9 percent of total corporate R&D spending. However, the level of spending on ESTD differs widely by industry, and by company within specific industries. For example, the estimated ESTD spending in the computer software industry is essentially zero, while the bio-pharmaceutical industry spends about 13 percent of its R&D funds on ESTD. Within the bio-pharmaceutical industry, spending on ESTD ranged from 0 percent to 30 percent at the companies interviewed.

We believe that the key driver of these differences is the life-cycle position of the industry and the individual company. More mature industries such as automotive tend to invest a smaller percentage of R&D into earlier stages such as ESTD than do industries at an earlier stage of development such as biotech. However, individual companies may make disproportionate investments in early-stage R&D compared to their peers as an attempt to break out of their existing positioning or to rejuvenate their innovation resource base. Several companies that we interviewed described how they reached a deliberate decision to rebalance their investments toward ESTD and earlier stages after recognizing that they were not positioned for growth. In some cases they have managed complete transformations out of a historical line of business and into high-tech sectors in which they did not participate a decade ago.

IMPLICATIONS

The observed trends in R&D have resulted in two critical problems that are forcing organizations to re-evaluate their approaches to funding and managing the innovative process. Technology complexity has altered the scale and scope tradeoff of R&D while financial and life-cycle pressures have created a bias toward supporting product development for established firms.

SCALE AND SCOPE CHANGES FOR R&D

ESTD projects can generate tremendous value due to their potential broad applicability as new enabling technologies. However, most large corporations are interested in ESTD for a few specific applications related to their core businesses, and are often not interested in fully exploiting ESTD in other markets.

There is nothing new about this scope dilemma that stems from R&D; it is widely recognized and is called by many names, including spillover effect and options value. However, there is a strong sense among the companies interviewed that the scale of opportunity required to justify ESTD investments has increased with technology complexity, while the ability of corporations to exploit the full range of such potential opportunities is the same or less. Further, the cost of bringing an ESTD to market is significant. Consequently, constructing a compelling business case for allocating funding to ESTD becomes extremely important.

BIAS TOWARD PODUCT DEVELOPMENT AND KNOWN MARKETS

The combination of financial pressure and industry and company life-cycle issues has also created a bias toward product development and support. Table 3 clearly shows that the bulk of R&D spending is concentrated in these later stages.

BIAS TOWARD PRODUCT DEVELOPMENT AND KNOWN MARKETS

The combination of financial pressure and industry and company life-cycle issues has also created a bias toward product development and support. Table 3 clearly shows that the bulk of R&D spending is concentrated in these later stages.

In addition, most corporations interviewed expressed a bias toward focusing their R&D on their existing businesses rather than creating new technology that might enable entry into new markets. Thus, as shown in Figure 5, most R&D funds flow into the left-hand side, with the bulk serving existing markets and existing technologies. Very little spending flows to drive breakout developments that represent new technology for new markets.

Interviews with venture capitalists also revealed a strong preference for investments targeted to exploiting a technology in a specific market application. Seed funding often goes to help develop a commercial prototype, but the largest rounds of funding are concentrated on taking the product commercial.

FIGURE 5. Typical corporate R&D spending profile

EMERGENT RESPONSES

Formalized approaches to managing R&D portfolios and an increased reliance on alliances, acquisitions, and joint-venturing to obtain access to ESTD and earlier stage technologies were cited as the most common reactions to the changing R&D environment and resultant pressures. In most cases a key stated objective was to maintain access to critical new ideas, while maximizing the leverage that could be obtained from any such investment.

PORTFOLIO MANAGEMENT MODELS

Most of the companies interviewed described a formalized R&D portfolio management process that they used to select investments. Many have revisited the issue of how the portfolio should look over time, especially as they hit discontinuities in their core businesses. Several described how they consciously made an effort to restructure the process to increase funding allocated to earlier stage work like ESTD, after discovering that they had allowed their technology portfolio to swing too far toward the product development end of the spectrum. Others felt that the portfolio process at their company helped maintain a bias toward the near term.

While no two companies appeared to be using the same approach to managing their R&D portfolio, several common elements were apparent. These include defining a set of technical core competencies to guide investment decisions, a split of funding control between business units and a central corporate organization, and some discretionary funding mechanism that can be used to foster new ideas (for instance, granting senior scientists slush funds, or creating central investment funds dedicated to long-term investments). Many also had established dollar or percentage spending targets for specific types of investment and used a classification system similar to the four-steps model or new and existing model as illustrated in Figure 5. Overall, the companies that appeared most active in investing in earlier stages of R&D appeared to have more formal mechanisms in place to sustain this type of funding.

ALLIANCES AND ACQUISITIONS AND VENTURE FUNDS

Alliances, acquisitions, and other external ventures were cited as an increasingly common way of maintaining access to a steady flow of new technologies and ideas, including ESTD. The companies interviewed also indicated that they have become increasingly targeted in selecting partners and technology rights. Adopting a market-like approach to acquiring early-stage technologies as opposed to developing it internally helps limit the scale of R&D required to sustain their organization and to pay for only the portion of the ESTD scope that they intend to use.

Several different types of partnership are typically pursued, each with a differing objective. Most outright acquisitions or licenses of ESTD result from interactions with other corporations or start-ups. An alternative is to establish some form of alliance, such as a joint venture with these types of partners.

Most interviewees also indicated that they had partnerships with universities and sometimes government labs. These interactions can be somewhat broader than an outright alliance, but are generally targeted to provide a window into more basic or concept level research in specific fields of interest. Several interviewees indicated that they have become much more targeted in these investments, and tend to be more interested in establishing a relationship with a specific professor or scientist rather than an academic department or entire school.

Establishing a relationship with venture funds as another form of alliance was frequently described. In some cases, an internal venture fund was formed to help profit from and foster start-ups in fields of interest to the company. Alternatively, companies invested in established private funds and obtained rights to more actively participate in offerings that become commercially interesting to them.

SPIN-OUT OF R&D FUNCTION: STD ENGINES FOR HIRE

An alternative solution to the ESTD funding barrier faced by corporate R&D was demonstrated by one of the companies interviewed. This company had been the corporate R&D arm of a Fortune 500 firm, but was spun out as a private entity that is now in the business of contract R&D. Compared to the portfolio of firms with captive R&D, this company works disproportionately on ESTD research; nearly 80 percent of its R&D spending is allocated to ESTD type research. Essentially, this spin-out company has become an ESTD engine for its client companies. Because its business plan is not captive to a single business or focused in a specific industrial sector, it is better able to exploit the scope potential of ESTD by structuring its contacts to maintain rights in fields of use that are not of interest to its clients. It then either licenses or commercializes products in the untapped areas.

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94. This summary was authored by a team at Booz Allen & Hamilton led by Nicholas Demos (Vice President, Strategy Practice), Gerald Adolph (Senior Vice President), Rhonda Germany (Vice President, Consumer and Health Practice), and Raman Muralidharan (Vice President, Consumer and Health Practice). The full report is available on the Advanced Technology Program’s website, <http://www.atp.nist.gov>.

95.By use of the term “random,” we mean to say that the criteria by which firms were selected were not correlated in a direct or obvious way with any questions or issues or interest in this study. Among the key biases in the firm selection process was a strong tendency on the part of the project team to select for interviews respondents from firms with which Booz Allen & Hamilton has an existing or past business relationship.

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