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OCR for page 56
5
How Governments Can Nurture
Small Companies and
Technological Innovators
Numerous federal, state, and local policy mechanisms, includ-
ing federal R&D fundirlg, technical assistance programs, business
incubators, loan guarantee programs, and university-~ndustry col-
laborative ventures promote small company formation and growth.
These initiatives are motivated by a variety of objectives, including
the desire to assist specific segments of the economy such as small
businesses or high-tech companies.
As discussed earlier, this study did not specifically evaluate
government programs to support small high-tech businesses.
Rather, the committee has asked, How well do government poli-
cies (a) help technological innovation in small companies, or (b)
inadvertently affect small high-tech companies (e.g., regulation or
tax policy)? This section provides an overview of three types of
federal policy mechanisms:
1The material in this section is derived from several sources, including the Eco-
nomic Report of the President 1994 (U.S. Government Printing Office); Guide to NIST
(U.S. Department of Commerce, Technology Administration, October 1993~; The
State of Small Business: A Report of the President 1993 (U.S. Government Printing
Office); Small Business Innovation Development Act Tenth Annual Report 1993 (U.S.
Small Business Administration Office of Innovation, Research, and Technology);
and conversations with staff at the National Institute of Standards and Technol-
ogy, the Small Business Administration, the Advanced Research Projects Agency,
and the House Committee on Small Business.
56
OCR for page 57
NURTURING Same COMPANIES AND TECHNOLOGICAL INNOVATORS 57
· Those aimed at helping small business.
· Those aimed at fostering technology clevelopment.
· Those that assist companies that are both small and technol-
ogy-intensive.
This chapter also provides an overview and examples of state
and regional efforts.2 The closing sections describe some of the
unintentional effects of government policy on entrepreneurial,
high-tech companies and proposes some basic principles for poli-
cies intended to encourage small high-tech company formation and
operation in the United States.
Many of the policy mechanisms described in this chapter-
either directly or indirectly play an enormous role in creating and
destroying opportunities in many sectors of the economy that de-
pend for their development on small high-tech companies. Gov-
ernment programs that directly support R&D in advanced displays
can reduce technological risk, for example. But the indirect conse-
quences of government actions are often poorly understood by
policymakers-compliance with health and safety regulations, for
example, in many instances is especially difficult for small compa-
nies and start-ups. These indirect consequences of government
policies on innovation, and the extreme diversity of external condi-
tions for small technology-intensive companies, need to be care-
fully considered.
r
FEDERAL POLICIES: SMALL BUSINESS ASSISTANCE
The Small Business Administration (SBA) is the federal gov-
ernment's economic development agency for small business. The
SBA's primary task is to guarantee loans, but it also provides pro-
curement assistance and other business development programs
and conducts research into the operations of small business. The
SBA's second-largest program after loan guarantees is the Small
Business Development Centers (SBDC) program. The program
issues matching grants to participating academic, private, and pub
2An excellent reference work on state technology activities is Partnerships: A
Compendium of State and Federal Cooperative Technology Programs. Published by the
Battelle Memorial Institute in 1995, the Compendium profiles the cooperative tech-
nology programs of the 50 states and 10 federal agencies.
OCR for page 58
58
RISK AND INNOVATION
kc institutions, of which there are more than 750 across the coun-
try, to provide training and counseling to sharpen management
skills for owners of small businesses. The program also offers
specialized services designed to meet local needs in the areas of
international trade, procurement, rural development, and techni-
cal assistance. The SBA currently also has a cooperative agreement
with the National Institute of Standards and Technology (NIST) to
help the SBDCs access on-line technical and business information.
The SBA licenses Small Business Investment Companies
(SBICs) to provide government-guaranteed loans and other types
of financing to small companies that cannot obtain financing else-
where. SBICs have invested more than $10 billion in nearly 70,000
small businesses. During the savings and loan crisis of the late
1980s, more than 160 of the SBICs were liquidated, in many cases
because their assets were less than they had led the SBA to believe.
The Small Business Innovation Research (SBIR) program,
which will be discussed below, provides competitive opportunities
for small companies to win federal R&D contracts.
NtST administers the Manufacturing Extension Partnership
(MEP) program, which promotes the commercialization of tech-
nologies and the diffusion of technological information. This pro-
gram consists of four major elements: Manufacturing Technology
Centers (MTCs), Manufacturing Outreach Centers (MOCs), the
State Technology Extension Program (STEP), and LINKS.
The Manufacturing Technology Centers program was estab-
lished in 1988 to help small- and medium-sized manufacturers
upgrade their technological practices and performance. MTCs, of
which there are currently seven across the country, are selected
from competing proposals submitted by prospective sponsoring
organizations. They provide a variety of services, ~nclucting indi-
vidual project engineering, training courses, demonstrations, and
assistance in selecting and using software and equipment.
Awards for Manufacturing Outreach Centers started in
FYI994. These centers, like the MTCs, help manufacturers adopt
appropriate, modern technologies, but they offer more limited ser-
vices. They will be affiliated with existing technical or training
institutions, such as vocational institutes, technical colleges, state
or university technical assistance centers, in areas not servect by
MTCs and with lower concentrations of industry. The State Tech-
nology Extension Program provides support to state and local tech
OCR for page 59
NURTURING Same COMPANIES AND TECHNOLOGICAL INNOVATORS 59
nology-outreach organizations to enhance coordination among ex-
isting technology-assistance programs and help to improve deliv-
ery of those services. STEP grants, which are generally in the range
of $50,000 to $200,000, are awarded to nonprofit institutions or
organizations that must provide matching funds for the project.
The purpose of LINKS is to identify and "network" sources of
assistance, information, and technology. A key feature is the elec-
tronic linkage of MTCs, MOCs, and other organizations such as
federal laboratories and universities. Rapid communication and
access to databases and information on manufacturing practices
and technical experts in intended to be enabled by LINKS.
in addition, small businesses are the beneficiaries of contract
set-asides from the federal government that totaled $12.9 billion in
1994 alone. The aim of such set-asides is to ensure that small busi-
nesses get a fair share of federal business. Among federal "quota"
programs, the one for small businesses is by far the largest the
$12.9 billion in federal contract set-asides for small business in 1994
was double that for minority-owned businesses.
FEDERAL POLICIES: TECHNOLOGY INITIATIVES
Technology initiatives strive to promote the development and
diffusion of growth- and productivity-enhancing technologies as
well as correct market failures that would otherwise generate too
little investment in R&D. in general these programs work by at-
tempting (a) to share risks during start-up phases by providing
partial funding for a technology development or refinement that is
selected and also supported by the private sector; and (b) to stimu-
late the diffusion of new technologies among small firms by pro-
viding small amounts of resources and information. There are a
number of programs in place to accomplish these purposes.
The Advanced Technology Program (ATP), which is adminis-
tered by the NIST, provides grants to industry consortia and start-
up firms involved in precommercial R&D. The program helps
firms develop breakthrough technologies that will have substan-
tial long-term economic benefit but may be considered too risky by
venture capitalists.
Projects are selected based on technical and business merit by
independent panels of experts. The competition is rigorous. Single-
company awards are limited to $2 million to be spent over no more
OCR for page 60
60
RISK AND INNOVATION
than three years and must be used only for direct R&D costs. Joint
ventures may receive up to $5 million, but they must also provide
matching funds. The ATP supports development of laboratory
prototypes and proof of technical feasibility but not commercial
prototypes or proof of commercial feasibility. Award recipients
are allowed to patent inventions or copyright software that is de-
veloped using ATP awards, but the government retains a
nonexclusive license.
Begun in the 199Os, ATP has made 89 awards to 66 companies
and 23 joint ventures since its inception. Including the private-
sector funds, the awards have totaled $500 million. In 1994 it was
announced that $745 million over the next five years would be
dedicated to 11 strategic areas of technology: tools for DNA diag-
nostics, catalysis and biocatalysis technologies, materials process-
ing for heavy manufacturing, motor vehicle manufacturing. ad-
vanced vapor-compression refrigeration, ~ ~
software, digital video information networks, digital data storage,
information infrastructure for health care, manufacturing compos-
ite structures, and computer-integrated manufacturing for electron-
ics. Government investment in these strategic areas is expected to
leverage an equal investment by industry. This support is in addi-
tion to ATP's general competition for all areas of technology. In
1995 Congress rescinded about $90 million in FYI995 funds from
the ATP budget. As a result, NIST delayed the announcement and
implementation of new focused programs and decreased the num-
ber FYI995 awarders.
Launched on March Il. 1993, the Technology Reinvestment
Project's (TRP) mission is to promote the development of dual-use
(commercial and military) technologies and to help small defense
firms make the transition to commercial production. A six-agency
council representing the Departments of Commerce, Energy, Trans-
portation, and Defense, NASA, and the National Science Founda-
tion implements the program. The TRP funds three types of
projects: technology development, technology deployment to small
businesses, and manufacturing education and training. As of De-
cember 1993, 162 projects had been selected for TRP support total-
ing $! billion in public and private funds.
a,
comDonent-based
~,
The intent of Cooperative Research and Development Agree-
ments (CRADAs) is to leverage the technical expertise resident in
the country's 726 federal laboratories to enhance U.S. competitive
OCR for page 61
NURTURING Sail COMPANIES AND TECHNOLOGICAL INNOVATORS 61
ness through jointly financed collaborations with companies and
industry consortia. The agreements cover joint research efforts in
which both the federal lab and the cooperating company provide
staff, equipment, facilities, or funds in any number of possible com-
binations. In the Department of Energy's 31 laboratories alone,
there are 650 agreements totaling $~.4 billion in combined public
and private funds.
The Advanced Research Projects Agency (ARPA) manages
selected basic anc] applied research and development projects for
the Department of Defense and pursues R&D in areas where there
is high risk and payoff as well as significant potential for both
military and commercial applications. ARPA does not carry out
research in its own facilities but acts as a technology broker and
venture capitalist by contracting work to industry, academia, and
branches of the armed services. The FYI995 budget for ARPA was
$2.6 billion.
FEDERAL PROGRAMS THAT SUPPORT
SMALL HIGH-TECH COMPANIES
The Small Business Innovation Research program, adminis-
tered by the Small Business Administration, was established in
1982 and requires each federal agency with an external R&D bud-
get of at least $100 million to set aside 2 percent of these research
funds for SBTR in fiscal years 1995 and 1996 and 2.5 percent there-
after. Currently 11 federal agencies participate. According to the
Tenth Annual Report on the Small Business Innovation Develop-
ment Act, since the program's inception, 25,000 awards have been
made to small high-tech companies worth more than $3.2 billion.
Each agency participating in the SBTR program issues a solicita-
tion at least once a year indicating its R&D needs and inviting R&D
proposals from small companies. In Phase I, small companies may
apply for agency funding up to $100,000 for feasibility testing of an
innovative idea or technology. In Phase Il. award winners whose
ideas show promise may receive up to $750,000 and two years to
develop the concept. Following completion of Phase 11[, small com-
panies are expected to obtain Phase [~l funding from private
sources or non-SBTR federal sources to develop the concept into a
commercial product. The SBA classifies SBIR awards into various
technology areas. Roughly 36 percent of all SBIR awards made
OCR for page 62
62
RISK AND INNOVATION
during the 1983-1992 period involved electronics, while another 36
percent were computer related.
A secondary but distinct program created by the 1992 Small
Business Research and Development Enhancement Act is the Re-
search and Research & Development (R&R&D) Goaling Pro-
gram. Federal agencies with a fiscal year budget for research or
research and development in excess of $20 million are required to
establish small business goals for awarding R&R&D funding agree-
ments to small companies. Seven other agencies, in addition to the
11 SBIR agencies, participate in the goaling program.
As part of the Small Business Research and Development En-
hancement Act of 1992, the Small Business Technology Transfer
Program (STTR) was established. This is a three-year pilot pro-
gram at five federal agencies- Department of Defense, Department
of Energy, Department of Health and Human Services, National
Aeronautics and Space Administration, and the National Science
Foundation- with extramural R&D budgets over $! billion. The
program was started in FY1994, with steadily increasing set-asides:
0.05 percent in FYI994, 0.10 percent in FYi995, and 0.15 percent in
FYl996. It will peak in 1996 at $75 million. Under this plan, the
federal government allocates the above percentages of its external
R&D budget to fund cooperative R&D projects involving a small
company and a researcher at a university, federal laboratory, or
nonprofit research institution. Not less than 40 percent of the work
must be performed by the small business and not less than 30
percent by the research institution; however, the small company is
the primary contractor with overall management and performance
responsibilities. The intent is to combine the entrepreneurial talent
of small business and the innovative ideas of engineers and scien-
tists in research institutions.
Like the SBIR, the STTR is a competitive, three-phased pro-
gram. Phase ~ awards of $100,000 are to determine the scientific
and technical merit and feasibility of an idea. The most promising
Phase T efforts will be able to continue the research through a Phase
~ award, averaging $500,000. In Phase Ill, the awardees are ex-
pected to use private capital or non-SBTT funds to pursue commer-
cial applications of the R&D.
The Advanced Technology Program is not explicitly targeted
to smaller companies, but such companies are often the beneficia-
ries of the program. In the first three competitions, over half the
OCR for page 63
NURTURING SMALL COMPANIES AND TECHNOLOGICAL INNOVATORS 63
ATP awards were led by small companies with many more acting
as subcontractors to larger company awarders.
A substantial number of participants in CRADAs are small
firms, although this program as well is not specifically targeted to
small companies. For example, approximately 44 percent of NTST's
250 CRADAs are with small businesses.
ARPA is a source of support for small business through its
participation in the STIR and TRP programs and through the grant-
ing of other R&D contracts.
STATE AND REGIONAL ASSISTANCE PROGRAMS
From a national perspective, the value of state and local eco-
nomic development efforts are uneven. On the one hand, competi-
tion among states for plant location using tax breaks and economic
development bonds may do little for the national economy. On the
other hanct, state and local manufacturing extension the provi-
sion of management and technical assistance to small and mecTium-
sized manufacturers can be of considerable value, depending on
how the programs are designed and managed. Also, state and
local efforts to develop regional, technology-intensive, entrepre-
neurial economies do have the potential to strengthen the national
economy and, perhaps, help drive technical innovation of value to
consumers and citizens.
Each region's approach needs to be different and will depend
on the region's current assets and weaknesses. A region with a
high density of technical facilities of larger companies will need to
develop different assets than one that has few such facilities but
one or more first-rank technical universities. A region that has a
strong tradition of skilled manufacturing (and therefore a regional
density of skilled technical manufacturing personnel) will need to
develop different assets than a region with little manufacturing
history but with a substantial biological research institute.
State technology assistance programs, also referred to as tech-
nology or industrial extension programs, encompass a variety of
initiatives offering assistance to small firms. Although not explic-
itly mandated to serve small companies, most of the firms using
these services are small- or meclium-sizedL companies. The funding
is mixed, with state governments, universities, industry, and user
fees providing most of the funding and federal government contri
~. , ~.
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64
RISK AND INNOVATION
buttons making up the balance. The types of services provided
include review of current or proposed manufacturing methods and
processes, productivity and quality assessments, assistance with
plant layout and operations, advice on the acquisition and imple-
mentation of equipment, assistance with total quality management
programs, access to databases, and business networking.
A 1991 National Governors' Association study of 42 programs
in 28 states founct that half of the programs are administered by
universities or community colleges and the remainder are admin-
istered by state agencies, quasi-public organizations, or private
nonprofit organizations. The programs often target for assistance
industries with a large concentration in the state. Although the
majority of the programs serve existing manufacturing operations,
they sometimes aid small start-up companies.3
Most states also have a package of assistance programs de-
signed to nurture start-ups, particularly in high-tech industries.
Such programs include small business incubators and a variety of
financial assistance instruments such as low-cost loans and loan
guarantees, grants, venture capital trust funcls, and pooled bond
programs. It is difficult to determine exactly how much is being
spent by states on programs of this sort since state technology
efforts are broad and encompass a range of company sizes. By
virtue of the fact that many of these programs nurture start-ups,
however, they are nurturing small companies.
The most visible and studied examples of regional concentra-
tions of high-tech companies are Silicon Valley in California and
Route 128 in Massachusetts with areas like Austin, Texas, and Re-
search Triangle In North Carolina also receiving considerable at-
tention. The Capital Region of New York State (Albany, Troy and
the surrounding communities) is a less developed high-tech region
and, therefore, provides a less cluttered example of the range of
assets a region can bring to bear and the type of issues an emerging
center of technical entrepreneurship faces. Among that region's
sources of entrepreneurs and innovations are the following:
3M. Clarke, and E. Dobson, Increasing the Competitiveness of America's Manufac-
turers. A Review of State Industrial Extension Programs (Washington, D.C.: National
Governors' Association, 1991~.
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NURTURING Same COMPANIES AND TECHNOLOGICAL INNOVATORS 65
· Rensselaer Polytechnic Institute (RPT), a 170-year-old re-
search university that has graduated 3,120 B.S. engineers, 1,470
M.S. engineers, and 550 Ph.D.'s in science and engineering over the
last five years. Further, RensselaerJs School of Management spe-
cializes in Technology and Management and offers five-year
double degrees in management and science or engineering.
· General Electric Corporate Research Laboratories, a facility
employing 1,110 research personnel.
· The State University of New York, Albany, a public univer-
sity that graduated 1,610 B.S, 455 M.S., and 157 Ph.D.-leve! scien-
tists during the last five years.
· The Wadsworth Center, a basic research facility of the New
York State Department of Public Health, that has spawned a ven-
ture firm in the last decade.
· There are over 70,000 college-level students in the region
attending more than a half dozen colleges and universities in addi-
tion to RET and SUNY-Albany.
· The region has more than 800 high-tech or manufacturing
firms, ranging from a division of General Electric to small entrepre-
neurial ventures.
Over the course of the last 15 years, the region's community
leaders have focused on creating a set of assets to support the start-
up and growth of technology-based firms. in 1980 RPT formally
established an on-campus incubator facility that provides low-rent
space, shared services, and some business assistance to qualified
start-up companies. Since its inception, the incubator has spawned
more than 90 start-ups, with a high record (greater than 80°/O) of
survival, that currently employ almost 900 people and generate
almost $100 million in revenue. The incubator itself is currently
being expanded. in 1982 RPI established a technology park, a I,200-
acre real estate development aimed at attracting young technol-
ogy-based companies, and the technologically intensive operations
of larger companies and state agencies. This park now hosts 45
establishments employing more than i,600 people. While neither
the incubator nor the technology park requires a business to have a
formal connection to the university, there is a strong predisposi-
tion in the' behavior of the two enterprises to favor and encourage
those businesses that build on, or contribute to, RPT's strengths. A
significant attractor for many companies to locate in either the in
OCR for page 66
66
RISK AND INNOVATION
cubator or the technology park is the location of companies in simi-
lar stages of development or with similar technical orientations.
in actdition to RPI's efforts, both the state of New York, through
its Science and Technology Foundation, and the Capital Region's
Center for Economic Growth, through its Technology Develop-
ment Council, offer considerable assistance to technology-based
start-ups. For example, the New York State Science and Technol-
ogy Foundation supports joint university-inclustry centers for ad-
vanced technology at New York universities. These centers are
explicitly designed to support the development of industrially rel-
evant technologies with high potential for commercialization. Two
such centers are located in the Capital Region, the Center for Ad-
vancect Thin Films and Coatings at SUNY-Albany and the Center
for Advanced Technology in Automation and Robotics at
Rensselaer. The Foundation also operates a Manufacturing Tech-
nology Center, supported by federal, state, and private funds, that
assists small- and medium-sized companies in adapting new manu-
facturing technology to their needs. Additionally, the Foundation
operates a small venture seed capital func! to invest in New York-
basecl start-ups and a venture/financing referral service to put
start-ups in touch with potential investors.
The Capital Region Technology Development Council's is a
regional (~-county) economic development agency funded prima-
rily by the state of New York and private funds. While the Tech-
nology Development Council offers a range of networking and
business services, the flagship service is a business advisory pro-
gram that enlists experienced technical and business people as vol-
unteers to serve as senior level management consultants (about 300
volunteers) to provide services such as legal, risk assessment, com-
mercialization, and business planning for client companies. Some
of these people also invest in the small firms. The aid supplied
these firms is often in the form of workshops and networks, as well
as individual consultation. The Technology Council also plays an
important role in providing information about, and a connection
to, resources outside the region. One of the most visibly successful
efforts they have undertaken in recent years is to assist companies
in the region in applying for federal Small Business Innovative
Research grants, more than $5 million in such grants having been
won by small, local ventures in 1994.
In short, the Capital Region seems to have much of the basic
OCR for page 67
NURTURING Same COMPANIES AND TECHNOLOGICAL INNOVATORS 67
infrastructure in place to develop as a regional, high-tech entrepre-
neurial center. The region is succeeding in starting companies, but
it now faces new issues in learning to help these firms grow to
significant size. Several of these firms have begun to make that
transition and must now find skillect business managers willing to
take a risk to join a new company; banks familiar with the prob-
lems of high-tech, rapid-growth companies and able to evaluate
their prospects; and larger equity investors with knowledge of anct
experience in the region.
The activities in the Capital Region are representative of activi-
ties in many regions of the United States that have marshalled their
resources to create and develop new businesses and industries.
While regional approaches vary and are necessarily tailored to
specific regional assets such as universities and large company re-
search facilities it is clear that geography matters a great deal.
The policies and programs of local, state, and regional govern-
ments are important aspects of the local and regional business en-
vironment for high-tech companies. The best are responsive to
local conditions and reinforce the strengths of the region by pro-
moting technologies and industries of national economic impor-
tance.
v
THE NATIONAL BUSINESS ENVIRONMENT
The opportunity set for small high-tech businesses and start-
ups is heavily dependent on industry-specific issues and regional
characteristics. There is also, however, an important set of na-
tional-scale, and even international, concerns affecting small U.S.-
based, technology-driven companies. In many cases, these issues
are identical to those affecting the opportunities and performance
of larger companies. For example, the first-order impacts of trade
barriers, employment laws, government policy on interest rates,
international standards, and intellectual property rights fall in simi-
lar ways on both larger and small companies, on both technologi-
cally sophisticated companies and those with little technical capa-
bility or orientation. A number of national policy matters that have
been widely recognized as having significant effects on the pros-
perity and performance of industry generally can have especially
profound influences on the viability of small high-tech businesses.
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68
RISK AND INNOVATION
· Maintenance of open and accessible public equity markets.
These are key to liquidity for small companies and an important
source of capital for growth.
· The tax structure, especially capital gains taxes, which affect
the relative attractiveness of longer-term investments such as those
necessary to develop new technologies or markets for new prod-
ucts. Lower capital gains taxes (especially for technically risky
investments held for longer periods of time) could provide a stimu-
{us for investment in small high-tech companies.
· Regulatory burden on small companies and especially start-
ups. It is too easy for well-intentionecT regulation from different
levels and parts of government to accumulate to the point of crush-
ing a small business or, especially, a start-up.
· Maintenance of a vigorous national portfolio of government-
supported and university-based research. Research and related
advanced technical education done in a largely nonproprietary set-
ting, in an environment that is favorable for entrepreneurship, are
an important national resource for high-tech start-ups.
· The legal environment, especially product liability laws and,
for high-tech and high-growth companies, securities fraud liability
laws.
The national business environment was not a major focus of
this study, but certain aspects of the findings about the role of
small business have important implications. For example, a focus
on the role of small high-tech companies in pioneering markets
and new applications can free them from the burden of expectation
that they be the nation's primary job creators; it is much easier to
show that important new directions for commercial products and
services originated in garages in the Silicon Valley/StanforcT nexus
than to argue that Intel and Hewlett-Packarct are important em-
ployers on a national scale. The benefits to consumers of techno-
Togical advances brought to market by those two companies are
large, and would be whether they employ 100,000 people or 50
people.
It is the committee's judgment that the federal government
can help maintain the vigor and contribution of small high-tech
businesses in the following ways:
· Working to ensure that financial market regulation, bank
OCR for page 69
NURTURING SMALL COMPANIES AND TECHNOLOGICAL INNOVATORS 69
ing laws, and securities regulatory agencies are sensitive to the
particular demands of small high-tech companies.
· Monitoring, and when possible reducing, the total federal,
state, and local regulatory burden on small high-tech companies.
· Maintaining, especially in light of prospective cut-backs in
research and development spending, a rich portfolio of univer-
sity research as a source of potential new commercial opportuni-
ties for start-up companies.
UNINTENDED EFFECTS OF
GOVERNMENT POLICYMAKING
A wide variety of government actions aimed at and justified by
other missions public safety, environmental quality, and national
defense, for example also have an enormous impact on small tech-
nology-intensive companies by affecting the cost of innovation or
the risk of failure. For example, in sporting goods and medical
devices, suppliers of materials critical for the manufacture of these
products have restricted or ceased sales to these sectors to elimi-
nate their exposure to product liability lawsuits. Legislative re-
forms, in this context, could markedly affect a company's product
strategies and posture toward innovation.4
Government regulatory actions affect all businesses but they
often have a disproportionate effect on small or new companies.
These companies may find it more difficult to sustain their busi-
nesses under new conditions, financial and otherwise, imposed by
regulatory changes. indeed, part of the risk that small high-tech
businesses often shoulder is the risk created by the possibility of
unintended consequences of government actions. For this reason,
actions that affect the opportunities for such companies directly
or indirectly should be informed by knowledge of the likely con-
sequences, and those consequences shouIcl be weighed against the
other, intended consequences of policies and regulations.
It is important to recognize, as well, that the effect of regulation
on innovation is not always negative. Government actions regu-
larly create as well as destroy opportunities for small companies.
4See National Academy of Engineering, Product Liability and Innovation. J.
Hunziker and T. Jones, eds. (Washington, D.C.: National Academy Press, 1994~.
OCR for page 70
70
RISK AND INNOVATION
in environmental testing, for example, regulation is responsible for
the creation and sustenance of an entirely new set of opportunities
for technically oriented new companies. Nonetheless, it is useful
to ask whether it may be possible to lessen the negative effects of
government actions (and therefore risk) without taking away from
the clear benefits of government actions, for example, in health and
safety. Several examples may help to make this clear.
Medical Devices: Innovation as an Investment Decision
Technological innovation depends critically on risk taking by
entrepreneurial individuals and small companies. This risk-in
various forms links market size and expected growth, and the
impact of size and expected growth on innovation, to external
sources of financing. This is especially important in the medical
device industry, where the economics of innovation high techno-
logical risk and fragmented markets tend to be unattractive to
larger companies.
Recently, radical changes in the regulatory and policy environ-
ment for medical devices appear to be increasing this risk. Food
and Drug Administration regulation of medical devices requiring
increased numbers of trials and evaluation is increasing the ex-
pected time to market for new devices as well as the cost of demon-
strating these new devices. The basic rationale for these govern-
ment actions, of course, is not disputed-regulation of the health
and safety of medical devices is an objective of government policy.
But it is important to recognize that even as regulation of medi-
cal devices is not directly concernec! with economic factors, it may
have unforeseen (and expensive) consequences for innovation in
medical devices, especially by small and new companies. For ex-
ample, delays weaken incentives to undertake new product intro-
ductions for small firms that need to recoup their investments more
quickly than large firms. By increasing the risk and therefore the
difficulty of attracting external financing these regulatory
changes draw into question the viability of innovation by small
companies for specialized, low-volume mectical devices.
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NURTURING Salt COMPANIES AND TECHNOLOGICAL INNOVATORS 71
Environmental Testing Labs:
Created and Constrained by Environmental Regulation
In contrast to medical devices, the comprehensive set of envi-
ronmental laws directed at air and water pollution has created
enormous opportunities for small and new, technically oriented
companies. Demand for environmental testing services in the
United States, now between $1.5 billion and $1.6 billion annually,
is almost entirely in response to environmental legislation and
regulations. Equally, the opportunities for 1,400 to 1,600 compa-
nies virtually all of these small-that provide these services are
in large measure determined by the degree to which future legisla-
tion and regulations create new markets and a demand for innova-
tions in testing technology and methodology.
Paradoxically, however, a more subtle effect of regulation in
this area has been, in many cases, to remove incentives to explore
innovative approaches to improving monitoring capabilities for
pollutants. The sources of pollution that the government requires
be measured or monitored vary enormously. But the imperative to
provide legally defensible data precludes experimentation with
new techniques or pollution-reclucing technological advances. In-
stead, approved analytical methods are followed so closely that
new innovative techniques, which may be developed by innova-
tive firms and are demonstrably superior to current techniques, are
not explored.
The objectives of environmental regulation, of course, are not
primarily to encourage innovation, but it is possible that innova-
tion in this area would advance these objectives. There is no ques-
tion that environmental legislation has created enormous demand
for pollution control technologies, for example. In addition, the
Environmental Protection Agency has been active in recent years-
through initiatives such as Superfund Innovative Technology
Evaluation, called the SITE program in attempting to promote a
more flexible approach to the use of new technologies and the use
of problem-based methods to replace at least some of the rigid,
highly prescriptive testing methods now in use. It is not clear that
cTirect regulation is the best approach to encourage the develop-
ment of new technologies and reduced levels of pollution.
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RISK AND INNOVATION
Networks: Evolution of Regulatory Schemes
The astonishing new complexity of communications and infor-
mation networks, and the speed of their transformation, is driven
to a large extent by new technologies. Chief among these new
technologies are advances in computers, which enable the digital
encoding (and compression) of information, and in photonics,
which enable massive increases in network bandwidth using fiber
optics. These technological advances create enormous opportunity
for network companies to create proprietary network technologies
and to realize the opportunities video-on-demand, games, and
data services are examples-that will drive demand in these new
networks.
The question is whether regulation will enable small compa-
nies to exploit this new competitive environment. In contrast to
medical devices or environmental testing services, which are domi-
nated by large numbers of small competitors, regulation in tele-
communications has historically focused on economic regulation
of a "natural" monopoly, AT&T. Now, new technologies have
enabled companies of all sizes to compete for new opportunities in
telecommunications by creating software or the physical assets to
create services over these new networks.
Consequently, what these opportunities and technologies will
look like, and the speed at which this happens, depends to a large
extent on changing regulatory structures. The consent clecree that
broke up the Bell system in 1982 deregulated long-distance ser-
vices and regulations have relaxed for almost all sectors of commu-
nications. Delays in making regulatory decisions may impede op-
portunities in networks. For example, pressure on their monopolies
in the local loop has left the Bell operating companies anxious to
compete with cable television providers by sending video over the
telephone network. The current regulatory structure in telecom-
munications is under a great deal of scrutiny. What items should
be providect as universal service and at what cost? With respect to
content, to what extent will regulations control the content avail-
able to consumers?
Given the risk that government policies will have inadvertent
negative consequences for small high-tech businesses, it is impor-
tant that policymakers concerned with economic growth under-
stand the specific roles that entrepreneurial, high-tech companies
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NURTURING Sail COMPANIES AND TECHNOLOGICAL INNOVATORS 73
play in the development of industrial sectors and of the economy.
Policies should be based on the premise that maintaining a na-
tional portfolio of high-tech entrepreneurial companies is impor-
tant.
IMPLICATIONS FOR POLICY
The contribution of this study to policy debates is to ask the
question, Given the contributions of small technology-oriented
companies to the economy, what principles distinguish good policy
and programs from bad? The central findings of this study are that
small technically oriented companies assume risks that other com-
panies-large and small will not and that such risk takers play a
particularly important role in technically new and small markets.
The relevant question for policymakers, therefore, is, What types
of policies substantially encourage (reduce the risk of, or increase
the likely return on) commercial technical experimentation by small
companies and start-ups?
As the industries studied in this project show, the fecleral gov-
ernment is either purposefully or inadvertently an important
force in many industries that depend for their development on
small high-tech companies. With regard to purposeful support,
government programs that share technological risk by supporting
R&D can alleviate some new and small market risks. Also, actions
that ensure financing alternatives or facilitate linkages with indi-
viduals or institutions that can provide assistance and advice to
nascent companies are also important. Government programs like
TRP, ATE, and STIR, are created with the best of intentions and
bridge gaps not addressed by private-sector financing for higher-
risk ventures. But much ambivalence about these programs re-
mains, as eviclenced by talk of cutbacks in funding for the ATE and
TRP. The SBIR program was both widely praised and widely criti-
cized during the industry workshops held as part of this study.
Praise centered on the fact that funds are available from a number
of agencies for exploratory technological work and on the examples
of companies successfully founded with SBIR funds. Criticism
focused on the way the program has created "SBIR houses" (i.e.,
companies whose only revenues are from SBl[Rs and never from
products) and is too rigidly oriented on the mission of the agency
providing funding. The comments in the workshops mirror the
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74
RISK AND INNOVATION
results of a recent General Accounting Office report that reviewed
the SBTR program.5 That report concluded that the quality of sub-
mitted and funded proposals remains high but that duplicate fund-
ing companies receiving funding for the same proposals twice,
three times, ant! even five times has become a problem.
Participants in several of the industry-specific workshops, soft-
ware and meclical devices in particular, noted that programs such
as TRP, ATE, and SBTR that could provicle financing for small high-
tech companies were less useful because of the long review cycles
and time delays inherent in highly bureaucratic programs.
With regard to the inadvertent impact of government actions, it
is clear that government itself is a substantial source of risk for
some small companies; part of the risk that small high-tech busi-
nesses often shoulder is the risk created by the unintended conse-
quences of government actions. In the committee's judgment, the
consequences of government actions for technically oriented start-
ups and small companies and by implication for their ability to
bear technological risk and drive innovation are often poorly un-
derstoocl both by the public and bypolicymakers. State and fed-
eral actions aimed at, and justified by, other missions public
safety, environmental quality, antitrust, commercial standard set-
ting, and national defense, for example often have the most pro-
found impact on the opportunities for small high-tech companies.
Federal and state actions such as these regularly both create and
destroy opportunities for small high-tech businesses.
Given the extreme budget consciousness that appears to per-
vade Congress, the committee suggests that federal activism on
behalf of small business and technology initiatives focus first on
establishing mechanisms within government many of them off-
budget that can improve the general environment for innovative
enterprises. Because the structure and implementation of regula-
tions affect the character and speed of innovation (through the
risks they can create or remove for companies), regulatory ap-
proaches across a wide variety of government functions need to be
carefully considered with regard to their impact on small high-tech
companies.
5General Accounting Office, Federal Research: Interim Report on the Small Business
Innovation Research Program, March 1995.
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NURTURING SMALL COMPANIES AND TECHNOLOGICAL INNOVATORS 75
With regard to programs for active support of small technically
orientec! businesses, the committee suggests that the central issue
is whether federal support will make a difference in the economy's
technological development. Private investment is likely to be much
greater than any imaginable level of public investment in frag-
mented, technically dynamic industries with low barriers to entry
and a history of (or widely perceived prospect of) successful entre-
preneurship. in such industries the important question is, How
can government research, development, and demonstration
complement the huge private investment (risk taking) to the ben-
efit of the national economy? The challenge in program design and
implementation is to articulate and adhere to an industry-specific
rationale for government support in light of substantial private-
sector activity:
· What is the evidence that market capital is not available to
this industry? What leads policymakers to believe that public funds
are necessary to drive commercially important technical advance
in this industry?
· is development in this industry amenable to the kind of dy-
namic, iterative, failure-ridden process that characterizes the most
rapidly developing technologies and industries?
· if so, how can a government program constructively seed or
accelerate such a process?
Finally, in the committee's judgment, many government policy
mechanisms to promote economic growth some types of federal
R&D funding, technical assistance programs, local incubators, uni-
versity-industry collaborative ventures need to be designed and
managed regionally or locally. Local and regional programs may
have an advantage in that they are closer to the resources that
small companies need and are potentially more able to adapt to the
needs of small high-tech companies.
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Representative terms from entire chapter:
government actions
