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Revisiting the Department of Defense SBIR Fast Track Initiative Summary BACKGROUND OF THE STUDY In October 1995, the Department of Defense launched a Fast Track initiative to attract new firms and encourage commercialization of SBIR funded technologies throughout the department.1 The goal of the Fast Track initiative is to improve commercialization through preferential evaluation and efforts to close the funding gap that can occur between Phase I and II of the SBIR program. Reducing this funding gap can help small innovative businesses maintain their momentum while crossing the early-stage funding Valley of Death, a term that describes the period of transition when a developing technology is deemed promising, but too new to validate its commercial potential and thereby attract the capital necessary for its continued development.2. The time-lag between the conclusion of Phase I and the receipt of Phase II funds can create cash-flow problems for small firms. The Fast Track initiative seeks to address the gap by providing expedited review and essentially continuous funding from Phase I to Phase II as long as applying firms can demonstrate that they have obtained third-party financing for their technology. Shortly after initiating the Fast Track program, the Department of Defense asked the National Research Council (NRC) to assess this initiative in 1 As early as 1992, DoD’s Ballistic Missile Defense Organization (BMDO) began to reward applications whose technologies demonstrated commercial potential. This BMDO initiative called “co-investment” was effectively an informal “fast track” program. Under this approach, the evaluation process for Phase II proposals gave preference to applicants who could demonstrate that they would commit internal funding or that they had financial or in-kind commitments from third parties to bring the technology to market in Phase III. With that commitment, applicants received essentially continuous funding from Phase I to Phase II. 2 See Lewis Branscomb and Philip Auerswald, “Valleys of Death and Darwinian Seas: Financing the Invention to Innovation Transition in the United States,” The Journal of Technology Transfer, 28(3-4), August 2003.
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Revisiting the Department of Defense SBIR Fast Track Initiative comparison with the operation of its regular SBIR program. The resulting report, The Small Business Innovation Research Program: An Assessment of the Department of Defense Fast Track Initiative, was the first comprehensive, external assessment of the Department of Defense’s SBIR program.3 The study, which involved substantial case study and survey research, found that the SBIR program was achieving its legislated goals. It also found that DoD’s Fast Track Initiative was achieving its objective of greater commercialization and recommended that the program be continued and expanded where appropriate.4 In 1999, the Department of Defense initiated the Phase II Enhancement program (in the Army and OSD—Phase II Plus)5 as a three year pilot program.6 The goal of Phase II Enhancement was to concentrate SBIR funds on those R&D projects most likely to result in viable new products that DoD and others will buy. As a part of the 2000 reauthorization of the SBIR program, Congress called for a review of the SBIR programs at the Department of Defense, the National Institutes of Health, the Department of Energy, the National Aeronautics and Space Administration, and the National Science Foundation. Capitalizing on the ongoing assessment, the Department of Defense requested the NRC to conduct a follow up assessment of its SBIR Fast Track program. The NRC accordingly developed and deployed a survey that drew on and refined the methodology developed in its 1999 study of SBIR Fast Track.7 This report presents the NRC review of the operation of the goals, operations, and achievements of the SBIR Fast Track program in operation at the Department of Defense. Building on the results of a 2000 NRC report on the DoD Fast Track program and drawing on survey and case study analysis, the NRC Committee will assess the Fast Track program in light of its goals, taking into account the program’s administrative and other costs, and possible alternatives (e.g., Phase II Enhancement). The report, including empirical analysis and case study results, provide the basis for the Committee’s findings and recommendations. 3 See SBIR Reauthorization Act of 2000 (H.R. 5667, Section 108). 4 See National Research Council, The Small Business Innovation Research Program: An Assessment of the Department of Defense Fast Track Initiative, Charles W. Wessner, ed., Washington, DC: National Academy Press, 2000. Given that almost no published analytical literature existed on SBIR at that time, this Fast Track study pioneered research in this area, developing extensive case studies and newly developed surveys. 5 Although both Army and OSD SBIR name their Phase II Enhancement programs Phase II Plus, DoD refers to the overall program as Phase II Enhancement in their solicitations, hence this report uses the term Phase II Enhancement to include all DoD components that participate. 6 Although the Phase II Enhancement program was announced in 1999 in solicitation 99.2, the first few awards were made on Phase II that had been awarded their Phase II contracts in 1997. The first Phase II Enhancement that was let on a topic contained in Solicitation 99.2 was not awarded until 2002. In general, a Phase II Enhancement awarded this year is a modification to the Phase II contract that was let two years ago. 7 See National Research Council, The Small Business Innovation Research Program: An Assessment of the Department of Defense Fast Track Initiative, op. cit.
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Revisiting the Department of Defense SBIR Fast Track Initiative BOX S-1 SBIR Fast Track and the Phase II Enhancement Programs at DoD The Fast Track Program: Closing the Gap between Phase I and Phase II Initiated in 1995, DoD’s Fast Track program seeks to improve commercialization by reducing significant gaps in funding between Phases I and II for SBIR projects. The time lag between the conclusion of Phase I and the receipt of Phase II can create cash flow problems for small firms. Fast Track addresses this gap by providing expedited review and essentially continuous funding from Phase I to Phase II as long as applying firms can demonstrate that they have attracted outside investors who will match Phase II funding, contingent on the project's selection for Phase II award. Projects that qualify for the Fast Track receive interim funding of $30,000 to $50,000 between Phases I and II. The Phase II Enhancement: Transitioning Beyond Phase II Since 2000, DoD Components have developed policies to further encourage the transition of SBIR research into DoD acquisition programs and/or the private sector. Under this policy, DoD Components provide an eligible firm with additional Phase II SBIR funding (up to $500,000) to match investment funds that the firm is able to obtain from non-SBIR sources (such as DoD acquisition programs or the private sector.) Among the DoD Components, the Navy and Army focus on funding additional research and development, and the Air Force focuses on overcoming unforeseen technological barriers. All three services and the Missile Defense Agency direct their enhancement programs to transition into acquisition programs. While the text of the original statement of task refers to Fast Track and the Phase II Enhancement programs as alternatives, it is important to note that they are in fact complements. The Fast Track program is designed to improve commercialization by reducing significant gaps in funding between Phases I and II for SBIR projects. The Phase II Enhancement program is designed to encourage the transition of SBIR research into DoD acquisition programs and/or into the private sector after Phase II. This report, therefore, does not seek to determine if the Fast Track program is better than the Phase II Enhancement program or vice-versa. The report recognizes that these two initiatives are designed to address different needs and determines whether each of them provides measurable benefits to the DoD SBIR program.
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Revisiting the Department of Defense SBIR Fast Track Initiative KEY CONCLUSIONS The current National Research Council’s (NRC) evaluation of two Department of Defense (DoD) Small Business Innovation Research (SBIR) Program initiatives—Fast Track and Phase II Enhancement—indicates that, from the perspective of the participants, both programs are effective.8 Firms that have participated in either Fast Track or Phase II Enhancement are glad they did. Ninety percent of Fast Track and 95 percent of Phase II Enhancement reported satisfaction with their decision.9 Fast Track Attracts New Firms Firms that apply for Fast Track tend to be new to the program and younger than average SBIR firms.10 They have had far fewer Phase II awards than the overall population. Sixty-four percent of surveyed firms are first time Phase II award winners.11 The average annual firm revenue for Fast Track applicants is less than average SBIR firms. Fast Track is successful in involving firms with no prior SBIR experience. The number of Fast Track awards is small, however, lessening the significance of this effect. This is a very good outcome of the Fast Track initiative. It means that the program effectively reaches out to new companies and new investors. This influx of new firms sustains the competitive nature of DoD innovation, encouraging commercially focused, high-quality entrepreneurs to participate in defense procurement. Fast Track Drawbacks for Firms Fast Track presents two significant drawbacks for firms. The first drawback is that it requires firms to obtain funding commitments prior to completing Phase I, which in turn means attempting to find such funding before or very early in Phase I—i.e., before the demonstration of feasibility is completed. The second related drawback, which applies whenever the third-party investor is not a federal program, is that many small innovative firms are reluctant to part with equity that is often demanded by private sector investors. In the first year of Fast Track, 80 percent of the third party investors were from the private sector. In the most recent four years of the program, only one third of the third party investors were from the private sector. 8 It is important to note that this report does not seek to compare Fast Track with the Phase II Enhancement program, as these are different programs with different objectives. 9 See Figure 2-20. Source: NRC Project Survey 2006, Questions 28 and 30, Appendix C. 10 Only 2.5 percent of Phase II awards are Fast Track. The survey indicates 64 percent of Fast Track participants are first time Phase II awardees. However, for the other 97.5 percent of the DoD Phase II program, 37 percent are first time Phase II. Thus, only 4 percent of all first time Phase II awards are on Fast Track proposals. 11 See Figure 2-4. Source: NRC Project Survey 2006, Question 19, Appendix C.
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Revisiting the Department of Defense SBIR Fast Track Initiative Fast Track Drawbacks for the Agency There are also drawbacks to Fast Track from the agency viewpoint. For SBIR program managers, the Fast Track program requires additional administrative effort because Fast Track operates outside the normal SBIR selection process. Recognizing the positive value of gap funding under Fast Track, however, program managers initiated procedures for additional funding after Phase I to firms that submitted a Phase II proposal, reducing the attraction of Fast Track.12 Analysis of DoD SBIR awards presented in this volume indicates that as more firms pursue Phase II Enhancement, participation in Fast Track, never large, has declined. Since the origination of Fast Track, participation has declined from 7 percent of all Phase II awards in DoD to 2.5 percent, driven by choices made by individual firms.13 However, there is no direct relationship between the percentage of firms applying for Fast Track and the realization of overall SBIR goals. Early Acquisition: A Source of Survey Bias The most successful Fast Track firms may, in fact, be absent from the survey. In some cases, the infusion of private-sector third-party funding for early Fast Track firms appears to have led to their acquisition and thus limited the number responding to the survey.14 Some of these firms were known to have been highly successful in sales, yet these sales are not reported in the survey.15 Some of the least successful firms may have been unwilling to respond or may have gone out of business. There are therefore sources for bias for the most successful firms and the least successful firms.16 Funding Gaps Remain Fast Track continues to be successful in nearly eliminating the funding gap between Phases I and II; however, the percent of Fast Track awards 12 The Air Force issues a nine-month Phase I, but accepts Phase II proposals after six months. Other components have procedures for three or four months of bridge funding after Phase I at the rate of Phase I funding. 13 DoD Submissions Database. 14 Early acquisition encourages entrepreneurship through infusing innovation to the established channels within the services and agencies in the Department of Defense (e.g. Prime Contractors). It is also a proven tool to help bring new products to broader commercial markets. 15 See Figures 2-10 and 2-11. One firm, Digital Systems Resources, Inc., which received 16 of the 248 Fast Track awards made during the surveyed period, was acquired by General Dynamics in September of 2003. At the time of acquisition, DSR had received 40 Phase II SBIR awards and had reported $368 million in resultant sales and investment. 16 For a discussion of multiple sources of bias in survey responses, see Box 2-1 in Chapter 2 of this volume.
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Revisiting the Department of Defense SBIR Fast Track Initiative reporting no gap has decreased and the average gap has increased in recent years.17 The Phase II Enhancement Program The Phase II Enhancement program has grown each year since its inception. Of projects receiving their Phase II award in 2002, almost 20 percent received a subsequent Phase II Enhancement.18 This growth appears to reflect the advantages of this program. Advantages of the Phase II Enhancement are, first, that it does not require evaluation of the Phase II proposal outside of the DoD component’s normal evaluation process. Second, the Phase II Enhancement also employs criteria established by the DoD component to meet their priorities, making the Phase II Enhancement program responsive to the needs of the units making the awards. Third, the Enhancement program provides firms additional time to locate third party investors and places less of a burden on firm management. Proposals are not due until late in Phase II and, thus, provide time (normally one additional year) to obtain additional SBIR funding to the firm. Finally, based on a project’s technical achievement, Phase II Enhancement also provides the opportunity to leverage acquisition program funding to increase the level of funding available; i.e., an acquisition program has its R&D investment in Phase II Enhancement matched by SBIR funding, thereby achieving more with its programmed funding.19 These innovations in SBIR program operations at DoD reflect well on its management. Both programs were designed to provide additional support to promising firms able to attract additional private or public sector interest and investment. The growth of the Phase II Enhancement suggests that additional measures may be warranted to transition the most promising technologies to the warfighter. 17 See Figures 2-24 and 2-15. 18 DoD Submissions Database. 19 See Chapter 1, section on “DoD Initiatives to Improve Commercialization: The Phase II Enhancement,” in this volume.