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Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
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INTRODUCTION

Simon Glynn

The U.S. economy has been particularly successful at developing and using new, innovative technologies. Increasingly, this success is identified with small, technology-intensive companies. Indeed, according to the National Science Foundation’s 1993 Science and Engineering Indicators, nearly half of all U.S. high-tech companies operating and 60 percent of companies in computer-related and bio-technology fields in 1993 were formed since 1980 (See Table 1).

The six papers in this volume address the role of these new, high-tech companies in the development of six technology-intensive sectors of the U.S. economy. These papers, as well as staff research, served as inputs for a series of workshops held by the National Academy of Engineering (NAE) from mid-1993 to late 1994-one workshop for each of the sectors examined in the papers. The results of these workshops are addressed in a 1995 NAE report, Risk and Innovation: The Role and Importance of Small High-Tech Companies in the U.S. Economy (1995).

It is important to be clear at the outset on what these papers are and are not. The intent of these papers is to focus on the importance of small, technology-intensive companies and the circumstances and management practices that affect their success. These papers are not intended as comprehensive, industry-specific studies. As well, in certain instances, the sectors are evolving so rapidly that data used for these papers are no longer current. Nonetheless, the six papers in this volume, read as a set, provide an introduction to the range and nature of critical issues facing smaller, high-technology companies. Also, beyond their function in the workshop, these papers provide a useful perspective for thinking about small, high-technology company success and, by implication, for conducting policy analyses.

Simon Glynn is a research associate in the National Academy of Engineering’s Program Office.

Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
×

TABLE 1 High-Tech Companies Formed in the United States: 1980–93

 

All HighTech Fields

Automation

Biotechnology

Computer Hardware

Advanced Materials

Photonics & Optics

Software

Electronic Components

Telecommunications

Other Fields1

Number of Companies

 

Total

22,728

1,534

558

2,176

869

823

5,644

2,611

1,267

7,246

Companies formed 1980–93

10,957

490

358

1,253

243

296

3,395

807

593

3,522

1980–84

5,659

315

178

683

137

171

2,026

453

324

1,372

1985–89

4,660

150

150

489

88

100

1,131

299

239

2,014

1990–93

638

25

30

81

18

25

238

55

30

136

Percentage of All High-Tech Companies

 

Total

100.0

6.7

2.5

9.6

3.8

3.6

24.8

11.5

5.6

31.9

Companies formed 1980–93

100.0

4.5

3.3

11.4

2.2

2.7

31.0

7.4

5.4

32.1

1980–84

100.0

5.6

3.1

12.1

2.4

3.0

35.8

8.0

5.7

24.2

1985–89

100.0

3.2

3.2

10.5

1.9

2.1

24.3

6.4

5.1

43.2

1990–93

100.0

3.9

4.7

12.7

2.8

3.9

37.3

8.6

4.7

21.3

Percentage of All High-Tech Companies, by Field

 

Total

100.0

100.0

100.0

100.0

100.0

100.0

100.0

100.0

100.0

100.0

Companies formed 1980–93

48.2

31.9

64.2

57.6

28.0

36.0

60.2

30.9

46.8

48.6

1980–84

24.9

20.5

31.9

31.4

15.8

20.8

35.9

17.3

25.6

18.9

1985–89

20.5

9.8

26.9

22.5

10.1

12.2

20.0

11.5

18.9

27.8

1990–93

2.8

1.6

5.4

3.7

2.1

3.0

4.2

2.1

2.4

1.9

NOTE: Data reflect information collected on new high-tech companies formed through June 1993.

1 Other fields are chemicals, defense-related, energy, environment, manufacturing equipment, medical, pharmaceuticals, subassemblies and components, test and measurement, and transportation.

Source: CorpTech database Rev. 8.2 (Wellesley Hills, MA: Corporate Technology Information Services, Inc.), special tabulations.

Reprinted from Science & Engineering Indicators—1993 (National Science Board, 1994).

Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
×

SECTORS ADDRESSED BY THE PAPERS

Of course, there are obvious limitations to this approach to understanding small, high-tech companies. By definition, case studies are selective rather than comprehensive, and any inferences create the danger of extrapolating from specific sectors of the economy that may not be representative in some important sense. In an effort to minimize this danger, the sectors addressed in this project are deliberately narrow and quite different, reflecting a variety of different influences. The six sectors are:

ADVANCED DISPLAYS AND VISUAL SYSTEMS. Advanced displays include several competing flat-panel display technologies and projection systems and video presentation equipment used in advanced electronics systems, for example full-color notebook computers or aircraft display systems. The current commercial display market is about $4 billion and is dominated by Japanese companies. A few small U.S. companies, however, are perceived to be leaders in next-generation technologies, including active matrix LCD, electroluminescent, and plasma displays that may eclipse current liquid crystal display technology.

IMPLANTABLE AND SURGICAL MEDICAL DEVICES. Currently, U.S. production of all types of medical devices—for U.S. and foreign markets—is estimated at around $40 billion, and between 10,000 and 11,000 device firms operate in the United States. The markets for individual types of devices range from relatively modest to hundreds of millions of dollars, and participating companies include a large number of start-ups and small, specialized suppliers. The phrase “implantable and surgical” refers to medical devices designed for implantation in the human body such as shoulder prostheses and left ventricular assist devices, or for manipulating human organs and tissues, especially devices used to perform minimally invasive therapy. These devices include angioplasty catheters, endoscopes, and a variety of accessory device technologies including miniaturized forceps and lasers.

SOFTWARE. Global spending for software is divided between prepackaged software, for example database or word processing applications, and customized “enterprise” software and services, including systems integration to help clients to address specific requirements. The division between these classes of software is increasingly blurred but combined global spending for prepackaged software and customized software and services is estimated to be in excess of $115 billion annually. The very large market opportunities in software are often exploited by relatively small, entrepreneurial companies—more than half of all U.S. software companies have fewer than 5 employees and 97 percent have fewer than 100 employees.

Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
×

ENVIRONMENTAL TESTING LABORATORIES. Environmental testing laboratories perform assessments for industry and government agencies regarding the nature and extent of environmental contamination. The current market for these services in the United States is about $1.5 billion and is highly fragmented. There are perhaps 1,400 to 1,600 environmental testing labs in the United States, and of these only 20 or 30 have revenues greater than $10 million. On the other hand, the top 25 manufacturers of analytical instrumentation used by the environmental testing labs account for about 75 percent of the market for instruments.

NETWORK SERVICES AND ACCESS DEVICES. The emergence of competitors in the nation’s telecommunications networks and the plummeting cost of computational power and the refinement of input devices (readers, sensors, etc) have combined to create a huge, technically dynamic, and fragmented “networks” industry in which there are few organizational or technical certainties. Opportunities are being pursued by companies of all sizes that are capable of creating and/or combining software and physical assets to create networks and deliver services over those networks. This industry’s fuzzy boundaries, its overlapping and competing technologies, and its many participants make meaningful estimates of total size impossible, but it is very large. Indeed, even “small” equipment markets—such as the market for video conferencing equipment—are conservatively projected to grow at 20 to 30 percent in each of the next several years.

OUTDOOR SPORTING GOODS. The $4 billion to $6 billion U.S. outdoor sporting goods industry is nested within the larger industry of general sporting goods. Outdoor sporting goods, as defined for this study, include products related to the use of national parks and wilderness areas such as backpacks, climbing ropes, kayaks, and tents, and also sports such as in-line skating and mountain biking. General sporting goods markets are dominated by small, privately held companies. Perhaps 5 percent are public companies, and only six of these have a market capitalization of over $1 billion.

THE EFFECT OF TECHNOLOGICAL RISK ON OPPORTUNITIES

The six papers are presented in original form written independently, but it may nonetheless be useful to highlight several themes that characterize the observations in these papers. First, a useful distinction can be made in these papers between the impact of new technologies, and the consequences of policies that shape opportunities. These two areas of inquiry represent an important distinction in the environment for small companies. Obviously, technological uncertainty—and therefore technological risk—shapes the opportunity for start-ups and smaller, technologically oriented companies. Indeed, the papers in this volume demonstrate that small companies accept a level and type

Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
×

of risk not often tolerated by larger companies and that substantial benefits from this risk-taking accrue to users and larger companies, as well as entrepreneurs. Biotechnology is an example of this (although not addressed in these papers). The rate of formation of new firms dedicated to the exploitation of one or another aspect of recent advances in biotechnology has been phenomenal: 800 new enterprises were founded in the 1980s, and the industry currently numbers more than 1,200 firms. A few of these firms have become large, successful operating companies (e.g., Amgen), but the vast majority are small, investor-funded R&D ventures.

Advanced displays also illustrate the importance of new companies in exploiting new technology. As is clear in Saccocio’s paper in this volume, the reason that small companies continue to exist in advanced displays is that, with few exceptions, there is little agreement regarding which technologies are likely to dominate which applications. The market pull on competing display technologies is undeveloped in many applications or potential applications. Therefore, there continues to be a proliferation of small, technology-intensive companies and product and process innovation.

UNINTENDED CONSEQUENCES OF POLICIES

Obviously, then, technology and inherent technological uncertainty shape the opportunity set for start-ups and smaller, technologically oriented companies. But a second type of risk that derives from policies and regulations also shapes these opportunities for new companies. This second type of risk is different, as well, because the intended and unintended consequences of regulations and policies are surprisingly arbitrary.

The negative effects of regulation are clear. Regulations may increase the costs (and risk) of pursing a potential opportunity or establish requirements, such as the Clean Air requirements for automobiles in California, that effectively monopolize research and development. They may also destroy opportunities. The basic rational for these government actions is not disputed—regulation of health and safety, and of the environment, are widely accepted objectives for government policy. Nonetheless, it is important to recognize that these government actions may have negative (and typically unforeseen) consequences for small companies.

Government regulation, for example, plays an enormous role in changing opportunities for small companies in implantable and surgical medical devices. More stringent regulations that require increased numbers of trials and evaluation increase the expected time to market of new devices and boost the cost of demonstrating new devices. As Gelijns et al. observe in their paper in this volume, this translates directly into a more difficult financial environment for device start-ups. Health care reform efforts also play an important role by increasing the uncertainty with regard to device markets. Health care corporations rather than individual physicians increasingly form the base for these firms, and third-party payers are becoming more restrictive in terms of what expenditures they will allow.

Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
×

The impact of policy on opportunities in networks is also clear. As Hunziker and Glynn note in their paper, what the convergence and competition between computers and communications will look like, and how quickly they happen, will be shaped to a very large degree by regulation. Network devices and services are embedded in the telecommunications industry, which has historically been heavily regulated with regard to technology, antitrust, and pricing. More recently, increasingly intense competition has seen regulations relaxed in almost all sectors of telecommunications. This deregulation and the immediate absence of standards (including proprietary standards) create opportunities for small companies willing to accept a high level of risk. This uncertainty simultaneously discourages larger competitors.

But these papers also indicate that the direct consequences of government actions on opportunities for new companies are nonetheless quite variable from sector to sector. The effects of regulation on opportunities for new companies can be positive as well as negative. For example, as Bangert and Lynch observe in their paper, the market for environmental testing services is created primarily by regulation and driven by enforcement. Laboratories are constrained by process regulations and by conflicting and overlapping state regulations and certification. In environmental testing labs, in contrast to displays, proprietary technologies are largely irrelevant, because the regulations that create the opportunity also preclude most product and service innovations.

The distinction between these two aspects of the environment for small companies—the effects of new technology on opportunities, and the consequences of policies that impact these opportunities— may be stated as a proposition: The degree of risk small companies must bear depends on the degree of uncertainty or complexity inherent in their technology and policy environments.

These factors are crucial to understanding why start-ups and entrepreneurs dominate these technology-intensive sectors of the economy. Typical early barriers (barriers to entry or “start-up”) derive less from the need to command massive resources than from the ability to bear risk, be creative technologically, and make forward-looking decisions. This also explains why larger competitors are usually not first to exploit these opportunities.

IMPORTANCE OF SCIENTIFIC AND TECHNOLOGICAL RESEARCH

Most new companies do not perform leading-edge research (with the notable exception of biotech companies), and for this reason access to the advanced thinking and new technologies in universities and larger, technology-based companies is critical. As Saccocio observes in his paper, larger companies have been very important for early innovation in advanced display technologies as well as for spinning off new companies. Similarly, large-scale corporate research programs have been extremely important in developing new computer and software technologies that enable these technology-intensive sectors of the economy, even though the larger companies themselves may not have exploited these technologies.

Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
×

Equally, although innovation in different sectors may not require close collaboration with universities, as for example in biotechnology or recent efforts in superconducting ceramics, universities are nonetheless extremely important for smaller, technology-intensive companies. Universities are a source of advanced thinking and technology in these sectors and, in the instance of medical devices, crucial to innovation. For example, in electronics, academic research is often the source of radical new designs and concepts that enable the development of “breakthrough” technologies. As participants at the NAE workshop on advanced displays and visual systems stressed, in the absence of continuing large corporate research programs, the intellectual capital and technology in universities is imperative for small companies in advanced displays.

Indeed, even in sectors of the economy where there is considerable “distance” between startups and universities as a source of talent or technology, innovation nonetheless depends on academic research in basic sciences, such as physics, materials sciences, and mathematics, that impact enabling technologies, for example the microprocessor. In medical devices, for instance, Gelijns et al. cite current developments of the endoscope using CMOS chips for imaging, as well as fiber optic technologies. The papers also note a trend at universities to formal mechanisms for technology transfer, although these mechanisms seem less important in these sectors than do the indirect contributions of academic research.

In medical devices and to a lesser extent in networks, the interactions between universities and new, technology-based companies extend beyond academic research to include development. For example, medical devices are usually designed and developed (at least initially) by individuals in academic and/or clinical settings to address a specific need. Consequently, the imperative for new companies involved in medical devices is to create close interactions with academic clinicians. An example of this is consultant arrangements, including clinicians or surgeons on industry R&D teams. Equally, in networks, the concepts of distributed computer and communication links now used by the Internet were developed initially for networks used to connect academic and military supercomputer sites and other centers for computing research. Current research and development on “gigabit testbeds” to develop networking technology that will enable computer networks of 1 billion bits per second (one gigabit) is also expected to be developed, at least initially, on academic networks.

ACCESS TO CAPITAL

A critical requirement for smaller, technologically oriented companies is access to capital. Access to equity financing depends on a variety of tax and regulatory policies that on balance appear to favor small companies. Access to equity financing does vary, though, according to the anticipated liquidity or expected potential opportunity of equity investments in the different sectors. In software and network devices, for example, the very large number of start-ups reflects the high liquidity of these sectors. Venture capital is available to new companies because the perceived opportunities to exploit

Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
×

new technologies and markets creates liquidity in public markets (as IPOs), even though the companies may not be long-term survivors. Indeed, software attracted more venture capital financing than any other sector of the economy in 1992, including biotechnology. As the viability of these new technologies or markets is demonstrated, these opportunities then also become valuable to larger companies (because the risk is lessened), creating liquidity by acquisition.

In contrast, poor liquidity creates barriers to exit for entrepreneurs in environmental testing labs and outdoor sporting goods. The very low degree of concentration in these sectors reflects the fact that investors are stuck—that is, liquidity is in many instances extremely low. In environmental testing, for example, the economics appear to preclude consolidation (by acquisition or expansion). There is effectively no market-clearing function, so competitors will stay in the industry simply because they cannot leave it. Limited (or no) near-term opportunity precludes venture capital financing. As a consequence, equity financing for start-ups or expansion in environmental testing labs is most likely to come primarily from the entrepreneur, not external sources. Similarly, although branding in sporting goods can create liquidity for small companies, the overwhelming majority of opportunities for investors in this sector is nonetheless relatively illiquid.

Indeed, even if liquidity is high, the potential market needed to justify an investment increases as the requirements for resources and capital increase. For example, Gelijns et al. observe that venture financing of implantable and surgical medical devices, historically quite active, has changed dramatically as the time (and cost) of moving from start-up to successful company have increased substantially. This may shift the burden of financing innovative investments to larger companies that may be able to reduce the risk (through their experience with the regulatory system) and that can justify a slower or lower device-specific return because the investment is part of an overall corporate growth and development plan. Equally, the number of small, technologically-innovative companies in advanced displays reflects less the technological and strategic questions than the fact that companies do not have access to capital needed to make the required investments in prototyping and manufacturing.

IMPLICATIONS FOR POLICY

Finally, several points also emerge from these papers that are perhaps obvious but nonetheless important. First, it does not make sense to speak of the importance of small technology-intensive companies and the opportunities they exploit without embedding that discussion in the context of a specific sector, technology, and the character and actions of large companies in the industry. Equally, it is critical to recognize the synergy that these papers identify between different sectors of the technology-based economy.

Second, these papers clearly demonstrate that small companies accept a level and type of risk not usually tolerated by larger companies. Substantial benefits from this risk accrue to successful entrepreneurs, users, and even larger competitors. The inherent risks of small-company innovation also

Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
×

means that majority of new companies will fail, and these failures are inherent in small company innovation.

Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
×

REFERENCES

National Academy of Engineering. 1995. Risk and Innovation—The Role and Importance of Small High-Tech Companies in the U.S. Economy. Washington, D.C.: National Academy Press.

Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
×
Page 1
Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
×
Page 2
Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
×
Page 3
Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
×
Page 4
Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
×
Page 5
Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
×
Page 6
Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
×
Page 7
Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
×
Page 8
Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
×
Page 9
Suggested Citation:"1 Introduction." National Research Council. 1996. Risk & Innovation: Small Companies in Six Industries: Background Papers Prepared for the NAE Risk and Innovation Study. Washington, DC: The National Academies Press. doi: 10.17226/9191.
×
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