Understanding Private-Sector Decision Making for Early-Stage Technology Development A “Between Invention and Innovation Project” Report

I. INTRODUCTION

MOTIVATION FOR THE STUDY

Corporations are the largest funders and performers of research and development in the United States. In 2000, U.S. corporations reported to NSF investments in R&D totaling $180.4 billion. According to the traditional three-tiered R&D classification scheme, firms allocated $6.0 billion of their R&D investments to basic research, $36.1 billion to applied research, and $138.3.4 billion to development.⁷

Only a small and unidentified portion of these massive investments is directed at the kinds of early-stage technology development (ESTD) activities that transform lab bench inventions and discoveries into new radical innovations for the marketplace.⁸ ESTD investments are critical because they measure the level of support for radical innovations that open up new markets, create new opportunities for learning, and sustain long-term economic growth.

There is extensive literature on related topics. Corporate venturing activity has been examined in detail (most notably by Gompers 2002); however, this body of work only quantifies corporate investment in innovation activity external to the corporation and it does not attempt to distinguish investments in ESTD from other R&D funded by corporate seed venture capital. A vast literature exists on corporate resource allocation methodologies focusing on internal project investment and portfolio management (including such techniques as real options valuation); however, it is difficult to apply these methodologies when assessing allocation of resources toward highly speculative ESTD activity, which by its definition cannot be valued quantitatively. Others, such as Lazonick and O’Sullivan (1998), recognize the limitations of these approaches to the innovation process and prescribe alternative frameworks for corporate governance; however, they do not attempt to quantify the allocation of corporate resources to this type of activity.

The specific objective of this research was to develop an empirically based estimate of the total level of funding for ESTD activities by US companies, to estimate ESTD funding levels across industry sectors, to better understand differences in ESTD funding levels across firms, and to better understand the drivers of these funding levels.

In addition to the objectives above, this report also covers insights from the interviews on the R&D management processes and priorities within U.S. corporations as they relate to ESTD activities, and identifies emerging strategies that corporations are adopting to deal with changes in the R&D environment and how this relates to ESTD investment.

• What are the major trends in the organization and prioritization of R&D activity and how do these affect ESTD investment?
• What strategies are firms adopting to maintain and strengthen their innovative capacity?
• What variations exist in ESTD activities across industries and firms? Why?
• How do companies obtain value from breakthrough laboratory inventions outside of their core business?

CORPORATE INNOVATIONS AND THE DEFINITION OF EARLY-STAGE TECHNOLOGY DEVELOPMENT

Early-stage technology development is a subset of corporate innovation activity. Innovations are created from inventions or other ideas whose novelty may trace to new science, to new engineering concepts, or even to new and different business models. Figure 1 on the previous page illustrates the paths through which these new commercial ideas may flow.

There are three kinds of technical innovations that may arise within established firms:

1. Type A innovations address a market within the core business of the firm and, despite their technical novelty, are sufficiently compatible with existing business models and technical capabilities that they are highly likely to be supported by an existing business unit.
2. The intended market for Type B innovations is sufficiently alien to the company’s existing business models and technical capabilities that, if the innovations are developed at all, they will be spun off outside the firm.
3. Type C innovations that address a market within the core business of the firm, but face serious obstacles from incompatibilities or displacement of current products, may nonetheless be pursued in a “skunk works” or some other form of protected environment.

Type A innovations take place within the normal functioning of businesses and might be thought of as a more discontinuous kind of progress than is normally characteristic of evolutionary progress. We do not conceive of ESTD as applying to this situation.

Type B innovations may be “excubated”⁹ through partnerships outside the firm, but they are rare as J. McGroddy argues. Here the ESTD characteristics are closest to the circumstances surrounding new firm creations based on the ideas of technical entrepreneurs.

An example of a Type C innovation is the IBM PC, which as a computer product certainly lay within the strategic interests of IBM, but had to be developed in a specially formed organization free of the normal business practices of the company.

Our definition of ESTD and the data reflecting it in this paper apply to Type B and Type C innovations but not to Type A. By early-stage technology development we mean the technical and business activities that transform a commercially promising “invention” into a business plan that can attract enough investment to enter a market successfully, and through that investment become a successful innovation.

We define ESTD in the corporate context to refer to early development of fundamentally new products or processes that lie outside of or might be in conflict with the firm’s current technology strategy or that deploy current technology outside of the firm’s current core businesses. ESTD must address functional specifications, product manufacturability and costs, and the initial market for entry of an innovation must have at least one of the following characteristics:

• its technical novelty promises the possibility of exclusive advantages but poses a significant risk that technical obstacles cannot be overcome;
• the intended innovation either addresses a market that lies outside the core business interests of the firm, or challenges the current business model, the current technical base, or competes with current products.

Thus, the concept we advance for ESTD applies to new business activities that have the characteristic of destabilizing markets, if the innovation hopes to create a market not already in existence, or destabilizing customer behavior—posing serious barriers to acceptance—or destabilizing the internal operations of the firm. This last obstacle might reflect a novel and unfamiliar business model,¹⁰ a technical incompatibility,¹¹ or a significant impact on the sale of current mainstream products.¹²

While corporate R&D numbers are regularly reported to NSF and other agencies, these numbers alone tell us little about how companies support and invest in truly radical technological innovations. The traditional categories of ‘basic research,” “applied research,” and “development” do not correspond in any meaningful way to the nature and level of risk or value of commercial investments in new product innovation. A new approach is required, therefore, to track the levels of corporate funding and support for activities aimed at bringing disruptive innovations to market.

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7. National Science Foundation, Science and Engineering Indicators 2004 (Arlington, VA, 2004) (NSF–04–01), tables 4–5, 4–9, 4–13, and 4–17.

8. ESTD does not correspond uniquely to any of the three categories used by the National Science Foundation (NSF) and the Organization for Economic Cooperation and Development (OECD) to categorize industrial R&D. In fact, there are no statistical collections of ESTD data in the United States.

9. McGroddy, “Raising Mice in the Elephant’s Cage,” 2001.

10. H. Chesborough and R. Rosenbloom, “The Dual-Edged Role of the Business Model in Leveraging Corporate Technology Investment,” in L. M. Branscomb and P. Auerswald, Taking Technical Risks (MIT Press, 2001).

11. John Cocke invented the Reduced Instruction Set Computer (RISC) in IBM Research. Despite its functional advantages as a target for optimized compilers, and despite the best efforts of the company’s technical executives, product divisions rejected RISC because of its incompatibility with the IBM 370 architecture. Hewlett Packard produced the first native RISC machine under the leadership of the former head of the IBM computer research group where RISC was developed. Later IBM did sell RISC processors and was successful using them as elements of a super computer.

12. In the 1980s Xerox Corporation suffered heavily from Asian competition at the low end of their copier product line. In the next decade Xerox introduced all digital copiers in the quest to regain lost market share.

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Date created: October 7, 2005
Last updated: October 12, 2005

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