NIST GCR 05-879 —Photonics Technologies: Applications in Petroleum Refining, Building Controls, Emergency Medicine, and Industrial Materials Analysis

6. BENEFIT-COST ANALYSIS FOR THE CLUSTER OF PROJECTS

Cluster analysis uses a hybrid approach combining the advantages of detailed case studies and overview studies for a richer assessment of empirical relationships between public-private investments in industry-led science and technology projects and the resulting benefits to industry and end-users.

• Detailed case studies are used to develop insights into market dynamics and technology commercialization pathways and to provide a credible basis for estimating benefit cash flows and associated probabilities.
• Cash flow estimates are used to compute performance metrics to quantify the relationships of investments and resultant benefits.
• Overview studies are used to extend the analysis beyond individual projects and to generate lower-bound performance estimates for the entire cluster.

PHOTONICS PROJECT CLUSTER

Of the five projects in the photonics cluster, one project, Capillary Optics for X-Ray Focusing and Collimating, has reached full commercialization. Another project, MEMS-Based Infrared (Photonic Crystal) Micro-Sensor for Gas Detection, is approaching full commercialization. Near-term, high-probability public benefits are quantifiable.

For the remaining three projects, Infrared Cavity Ring-Down Spectroscopy, Optical Maximum Entropy Verification, and Integrated Micro-Optical Systems, uncertainties exist concerning the nature and size of public benefits, and only project costs, without quantitative benefit estimates, are included in benefit-cost analysis.

Given that this study uses benefit cash flows from only two case study projects in combination with ATP-investments in five projects and that the remaining three projects may yield significant public and private benefits in time, cluster analysis results in this study represent conservative, lower-bound performance estimates as of 2005.

BENEFITS, INVESTMENTS, AND PERFORMANCE METRICS

Once fully commercialized, ATP-funded photonics technologies will generate both public and private benefits. Our emphasis in this study is on measuring public benefits to industry users and to the general public that are attributable to ATP relative to ATP's investment. Public benefits, excluding benefits to the innovating firm will be realized by:

• Health care institutions and industrial and commercial users of new photonics technologies
• Consumers of improved medical services, industrial products, and commercial services
• Society at large, enjoying, among other benefits, reduced environmental emissions

The resulting performance metrics provide a direct indicator of ATP success in addressing its mission to fund high-risk technology development projects with potential for broad economic benefit to the nation.

Figure 20 illustrates the general flow of public benefits in the cluster study process. Public benefits attributable to the ATP are combined with ATP investments to yield economic measures of the return on ATP's investment.

More specifically, Capillary Optics for X-Ray Focusing and Collimating and MEMS-Based Infrared (Photonic Crystal) Micro-Sensor for Gas Detection, two of the five projects in the cluster (in Chapters 3 and 4) associated with quantifiable, high-probability cash flow estimates from medical, petroleum refining and distribution, advanced materials, and commercial real estate applications, are connected with solid line arrows to the Combined Benefit Estimates box in the middle of Figure 20.

Cash flow benefit estimates for the remaining three projects are currently unavailable, as indicated with broken-line arrows to the Combined Benefit Estimates box. Broken line arrows denote possible future cash flows should longer-term benefits from these three projects become more certain through ongoing commercialization efforts. While beyond the scope of the current study, cash flow estimates for these three remaining projects could be developed at a future date.

The Cluster Performance Metrics circle represents the calculation of performance measures by comparing combined cash flow benefits from two projects with ATP's investment in the cluster of five projects. The metrics generated for the cluster, net present value, benefit-to-cost ratio, and internal rate of return, measure public returns attributable to ATP against ATP's public investment.

We will also introduce the social rate of return, which is a broader measure of ATP project impact. This measure combines public and private benefits relative to combined public and private investments, including those of the innovating firms.

Figure 20: Public Benefits, Investments, and Performance Metrics for Cluster of Related ATP Projects

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Note: Solid line arrows denote high probability public benefits, currently quantified as cash flow estimates. Broken line arrows denote potential benefits that are currently more speculative but could, in the future, be quantified as probable cash flow estimates.

BASE-CASE CLUSTER ANALYSIS

Conservatively estimated benefit cash flows from the two case study projects, capillary X-ray optics utilization in advanced materials and petroleum refining applications, starting in 1997 and continuing until 2014 (Chapter 3), and photonic crystal gas sensor utilization in emergency medicine and commercial real estate internal air quality control applications, starting in 2006 and continuing until 2015 (Chapter 4), were combined as cluster analysis benefit streams (Table 10, column 2).

ATP's combined investment in the cluster of five projects was $7.47 million. Normalized to 2004 dollars, the combined ATP cluster investment was $8.7 million (Table 10, column 1). Industry partner investment, not included in public return on ATP investment metrics, was $ 6.3 million.

In Table 10, column 4, retrospective cash-flow performance of ATP's investment over the 1997-2003 period is isolated from the combined retrospective and prospective cash-flow performance over the 1994-2000 period.

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Note: Benefit cash flows in column 2 are computed from Total Cash Flows columns in Tables 3 and 8. The sharp drop in year 2015 "combined benefit cash flows" reflects a period of analysis for X-Ray Optics extending to 2014 while the period of analysis for Ion Optics extends through 2015.

BASE-CASE CLUSTER PERFORMANCE METRICS

Combined cash flows (retrospective plus prospective) over the 1994-2015 period (Table 10, column 3), representing estimated benefits attributable to ATP from the two case studies netted against ATP investments in the five projects, are used to compute performance metrics for the cluster of projects. These cluster performance metrics (net present value of $276 million, benefit-to-cost ratio of 33:1, and internal rate of return of 48 percent) are indicated in Table 11, column 1.

Cash flow time series over the 1994-2003 period composed of ATP investments in the five projects and realized benefits from one of the two case study projects are used to compute retrospective performance metrics for the cluster of projects. As indicated in Table 11, column 2, base-case retrospective performance metrics show a net present value of $2.9 million, benefit-to-cost ratio of 1.9:1, and internal rate of return of 16 percent.

STEP-OUT SCENARIO CLUSTER ANALYSIS

The step-out scenario is based on more optimistic projections of future benefits from ATP-funded technologies. Benefit estimates per unit sold are somewhat higher, in combination with higher unit sales assumptions. ATP investments are the same as for base-case analysis.

Cash flow time series over the 1994-2015 period composed of ATP investments in five projects and both realized and expected benefits from the two case-study projects are used to compute step-out performance metrics for the cluster of projects. As indicated in Table 12, column 2, cluster performance metrics show a net present value of $345 million, benefit-to-cost ratio of 41:1, and internal rate of return of 51 percent.

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Note: A 1994 base year and an OMB-designated 7 percent discount rate were used for analysis. Performance metrics were computed from time series representing ATP investments over the 1994-2000 period and retrospective and prospective cash flow benefits from 1997 to 2015.

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Note: A 1994 base year and an OMB-designated 7 percent discount rate were used for analysis. Performance metrics were computed from time series representing ATP investments over the 1994-2000 period and retrospective and prospective cash flow benefits from 1997 to 2015.

FUTURE EXTENSION OF CASH FLOW BENEFITS

Over time, additional projects in the cluster, and many other ATP-funded photonics projects, will be successfully commercialized. As that occurs, the estimation of cash flow benefits can be expected to lead to an upward adjustment of performance metrics presented in the current study. Given this potential for additional cash flow benefits from future analysis, the levels of performance reported in this study (based on cash flows from only two ATP-funded projects) represent conservative, lower bound estimates of cluster performance.

ADDITIONAL PERFORMANCE METRIC: SOCIAL RATE OF RETURN

ATP-funded projects are cost-shared with innovating companies in the private sector. They benefit the innovating companies, suppliers, customer industries, and end-users— in essence, all taxpayers. Therefore, a measure of the total benefits relative to total costs provides a broader, more complete picture of project performance than public returns on ATP's investment alone. The social rate of return is such a measure and has been used by leading economists as an important indicator for broad social benefits that result from new technologies and innovations (Griliches, 1958; Mansfield, et al., 1977; Jaffe, 1996; Mansfield, 1996).

Economists compare social rates of return to private rates of return (i.e., rate of profit received by innovating companies that use ATP funding to complement their own investment in cost-shared projects). The gap between social and private rates of return is an indication of the project's value to society compared with its value to the innovating company that executed the project in the expectation of a return, or to private investors that might help finance technology investments.

This comparison is a cornerstone of economic justification for government-funded technology development. Broad-based societal benefits, as a point of reference for the widespread benefits that R&D can generate for society, are contrasted to private returns (profits) that innovating firms are typically able to capture and retain, i.e., appropriate for themselves (Mansfield et al., 1977; Yager and Schmidt, 1997).

The "excess of the social rate of return over the private rate of return is the spillover gap" (Jaffe, 1996). A large gap tends to signify the innovating firm's inability to appropriate most technology benefits to itself in the form of additional profits and can lead to private sector under-investment and associated loss of benefits to downstream firms, end-user customers, the economy, and society.

ATP compensates for the spillover gap by partially funding the development of high-risk, innovative technologies that private firms are unable to fund owing to R&D technical risks and appropriability risk.

To estimate social rates of return from ATP's investment in the two case study projects, both public and private benefit cash flows are estimated and combined. Combined benefits are then compared to combined public and private investments using an internal rate of return calculation.

Given the company-sensitive nature of private return information, proxies are used to estimate private returns.

Social rates and spillover gaps for the two case study projects are then estimated as follows:

• Private benefits (profits) are computed from projected X-Ray Optical Systems and Ion Optics unit sales and associated revenue projections. Revenue projections are multiplied by 12.3 percent or the reported Q3 2004 average inflation-adjusted profit margin for U.S. technology firms (Business Week, 2004) to arrive at estimated profits of ATP industry partners. These profit estimates are a proxy for private benefits from industry partner technology investments.
• Private benefits or profits to be realized by ATP industry partners are combined with projected public benefits to arrive at total benefits.
• Public investments by ATP and other public agencies are combined with industry partner matching funds and with additional private investments that supported the completion of technology and product development, initial marketing, and production ramp-up to arrive at total costs.
• A time series of all investments, public and private, and all benefits, public and private, are used to compute an internal rate of return for each project (the project's estimated social rate of return).

As indicated in Table 13, social rates of return from new X-Ray Optics and from Ion Optics technologies substantially exceed average expected industry returns and can be associated with spillover gaps ranging from 18 to 46 percent. These reported spillover rates are generally consistent with Mansfield's empirical findings, which identified the median spillover gap ranging from 31 to 34 percent (Mansfield et al., 1977; Mansfield, 1991).

Reported spillover rates from the cluster of ATP-funded photonics technologies, in combination with the magnitude of the social rates of return, indicate substantial benefits to the general public beyond that received by ATP grantee companies. Given that these projects would not have been funded at all without an ATP cost-share, the results indicate a fulfillment of the ATP mission to fund high-risk technologies with a potential for large-scale economic benefits to the nation.

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Date created: July 12, 2006
Last updated: September 14, 2006

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