The Small Business Innovation Research Program: An Assessment of the Department of Defense Fast Track Initiative (2000)

The Small Business Innovation Research (SBIR) program is one of the largest government-industry partnerships in terms of its annual budget. It is also one of the most dispersed in terms of the agencies responsible for its implementation, the diversity of program goals, and the variety of award recipients. Ten agencies and departments grant SBIR awards totaling $1.2 billion annually to support a wide variety of federal missions.¹ Despite the size of the program, its 18-year existence, and anecdotal evidence of its success, relatively little independent research and analysis of the program has been conducted.² The papers presented here and the accompanying recommendations represent an important step toward a better understanding of this innovative program and, in particular, the recent Fast Track initiative at the Department of Defense (DoD).

SBIR was established in 1982 as a way to channel federal research and development funds to small businesses, while meeting agency mission needs through the use of research and development (R&D) expertise that is often unique to small businesses. Initially, the SBIR program required agencies with R&D budgets in excess of $100 million to set aside 0.2 percent of their funds for SBIR. This totaled $45 million in 1983, the program’s first year of operation. Over the next six years, the set-aside percentage grew to 1.25 percent and, in 1992, Congress renewed the program and doubled the set-aside rate to 2.5 percent.³ For fiscal year 1998 this resulted in a program budget of approximately $1.2 billion across all federal agencies, with the Department of Defense having the largest SBIR program at $540 million, followed by the National Institutes of Health (NIH) at $266 million.⁴ Since its inception, the SBIR program has made over 45,000 awards totaling $8.4 billion in 1998 dollars.⁵

From the start, the SBIR grant-making process has had three phases. Phase I is essentially a feasibility study in which award winners undertake a limited amount of research aimed at establishing an idea ’s scientific and commercial promise. Today, Phase I grants can be as high as $100,000. Phase II grants are larger—normally $750,000 —and fund more extensive R&D to further develop the scientific and technical merit and the feasibility of research ideas. Phase III normally does not involve SBIR funds, but is the stage at which grant recipients should be obtaining additional funds either from an interested agency, private investors, or the capital markets to move the technology to the prototype stage and into the marketplace.

Over the SBIR program’s 18-year lifespan, the American economy has undergone substantial structural change, yet the relevance of the program has if anything increased. There are several reasons for this. First, policymakers and economists have shown growing appreciation of the role of the small firm in economic development. Starting in the late 1970s and accelerating in the 1980s, a growing body of empirical evidence began to indicate an increasing role for small businesses in job creation and innovation.⁶

Second, the program grew and matured at a time of increasing concern over the ability of U.S. companies to commercialize R&D results. The early 1980s witnessed a severe recession and the entire decade experienced economic performance below post-World War II norms. The trade deficit rose sharply amidst widespread worry that this was driven by a Japanese economy that was outperforming American manufacturing in important industries, such as steel, autos, and semiconductors.

At the program’s inception, a prominent element in the diagnosis of America’s economic ills involved the country’s failure to successfully commercialize new technologies developed by researchers. A recent report by the STEP Board recalls how the “gloomy picture of U.S. industrial competitiveness” in the 1980s was frequently cast in terms of American industry’s failure “to translate its research prowess into commercial advantage.”⁷ One of the strategies adopted by the United States in response to its loss in competitiveness (at least in some sectors) was to encourage greater cooperation among industry and between industry and government.

Such collaboration was by no means novel in the U.S. economy. As noted above, government funds had supported the demonstration and development of the telegraph in the last century, and after World War I the federal government fostered an independent radio industry. ⁸ Later, the federal government also provided active support through a variety of mechanisms for military and civil avia-

tion and the electronics industry.⁹ Yet the 1980s and early 1990s saw a conscious effort to expand cooperation, in part by using federal R&D funding more effectively, to meet what were seen as unprecedented competitive challenges.

A series of public and private initiatives in the 1980s demonstrate the renewed emphasis on cooperation. The change in public policy is illustrated by the number of major legislative initiatives passed by Congress. These included: the Stevenson-Wydler Technology Innovation Act (1980), the Bayh-Dole University and Small Business Patent Act (1980), the Small Business Innovation Development Act (1982), the Federal Technology Transfer Act (1986), the Omnibus Trade and Competitiveness Act (1988), the National Competitiveness Technology Transfer Act (1989), and the Defense Conversion, Reinvestment, and Transition Assistance Act (1992). These individual acts are summarized in the below.

Even with these policy innovations, the persistent perception that the U.S. continued to lag in its economic competitiveness fostered cooperative efforts to more fully capture the benefits of its research programs.¹¹ A National Academy of Sciences study released in 1992 found that “U.S. technological performance is challenged less in the creation of new technologies than in their commercialization and adoption. ”¹² While noting the difficulty in determining whether the United States ’s ability to commercialize technology was deteriorating relative to foreign competitors, the Academy found that “the United States can strengthen technology commercialization, at a stage prior to that at which private firms invest in commercialization activities, through federal activities to facilitate precommercial R&D.”¹³

The SBIR program approached reauthorization in 1992 in the context of continued worries about the U.S. economy’s capacity to commercialize inventions. As noted above, the 1992 SBIR reauthorization resulted in the set-aside being raised from 1.25 percent to 2.5 percent. This increase was consistent with a recommendation from the National Academy of Sciences to increase SBIR funding as a means to improve the U.S. economy’s ability to adopt and commercialize new technologies.¹⁴ By 1992, the SBIR program had also become politically popular with increasingly influential small business advocates. In conjunction with the emergence of innovative small start-ups in computing, biotechnology, and advanced materials, there was ample support for program expansion in 1992.¹⁵

The increase in the percentage of R&D funds allocated to the program was accompanied by a stronger emphasis on encouraging the commercialization of SBIR-funded technologies. As Robert Archibald and David Finifter describe in detail in this volume, legislative language added to the SBIR program’s charge in 1992 explicitly highlighted commercial potential as a criterion for awarding SBIR grants.¹⁶ For Phase I awards Congress directed program administrators to assess whether projects have “commercial potential” in addition to scientific and techni-

cal merit when evaluating SBIR applications. With respect to Phase II, evaluation of a project’s commercial potential would consider the existence of secondphase funding commitments from the private sector or from non-SBIR sources and the existence of third-phase, follow-on commitments, along with other indicators of commercial potential.

Moreover, the reauthorization directed that a small business’s record of commercialization be taken into account when considering the Phase II application. To further reinforce the emphasis on commercialization, the 1992 reauthorization moved the goal “to increase private sector commercialization” from fourth to second in the list of SBIR program goals. The reauthorization did not provide specific guidelines as to how much weight should be given to commercialization as compared with the program’s other goals, such as technological innovation or importance to the agency mission.¹⁷

As noted, the SBIR program applies to the ten federal agencies with annual extramural R&D above $100 million. While the Small Business Administration is tasked with the coordination of the SBIR program, the dispersal of the program across departments and agencies with very different missions and modes of operation results in considerable variation across the participating organizations. And, in the case of DoD and NIH, the missions the program supports also vary substantially. This has resulted in a very diverse response to the 1992 mandate to increase the focus on commercialization.¹⁸ One of the most important responses has come from the Department of Defense, which has the largest SBIR program.

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.¹⁹

In October 1995, Defense launched a broader Fast Track initiative to attract new firms and encourage commercialization of SBIR funded technologies throughout the Department.²⁰ The principal ways in which Fast Track seeks to improve commercialization is through preferential evaluation and efforts to close the funding gap that can develop between Phase I and Phase II grants. 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 pilot addresses 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.²¹ In this context, third-party financing means that another company or government agency has agreed to invest in or purchase the SBIR firm’s technology; it can also mean that a venture capitalist has committed to invest in the firm or that other private capital is available. The expedited decision-making process for the Phase II award is justified from the agency’s perspective because outside funding validates the commercial promise of the technology. More broadly, the Fast Track program addresses the need to shorten government decision cycles in order to interact more effectively with small firms focused on rapidly evolving technologies.

Two years into the Fast Track initiative the Under Secretary of Defense asked the National Research Council’s Board on Science, Technology, and Economic Policy (STEP) to assess Fast Track and related SBIR policy matters. The Under Secretary’s request focused on three issues:

1. Whether Fast Track projects are achieving, or appear likely to achieve, greater success in SBIR than comparable non-Fast Track projects;

2. Whether Fast Track projects progress at different rates than non-Fast Track projects;

3. What companies perceive as advantages and disadvantages of Fast Track participation.

The request also permitted the Board to review other issues relevant to the operation and performance of the SBIR program. The STEP Board accepted the Under Secretary’s request, taking up the task under the auspices of its project on Government-Industry Partnerships for the Development of New Technologies, led by Gordon Moore, Chairman Emeritus, Intel, and Chairman of the distinguished Steering Committee listed in the front matter.

While the Department of Defense is to be commended for seeking an outside assessment of a major initiative for its SBIR program, the assessment of an initiative that has been in place for a relatively short period posed a special challenge. To meet that challenge, the Steering Committee decided to undertake a multifaceted approach to the research. The first phase was to bring together university researchers, award recipients, and DoD program managers to discuss the operational goals and practices of the program, the experiences of the awardees, and how the program might by evaluated.

Based on these initial meetings and the virtual absence of academic research on the SBIR program, the Committee decided to commission field research on the program with a special emphasis on the Fast Track initiative. To this end, a research team—whose members had not previously studied the SBIR program—was assembled.²² The team examined the SBIR program awards and the Fast Track initiative from three different perspectives:

1. Survey Research: As a first step, the STEP research team developed a survey instrument and then commissioned an outside consulting firm experienced with the program to carry out a large-scale survey of DoD SBIR awardees, using a sample of firms that have participated in Fast Track and a control group. The roughly 300 firms²³ (294 firms doing 379 projects) queried constitute the largest survey to have focused on the Fast Track

pilot. Reflecting the diligence with which the survey was pursued, the survey response rate was high, with approximately 72 percent of the firms responding.

1. Case Studies: In parallel, members of the research team conducted a series of case studies of SBIR companies including, wherever possible, both Fast Track and non-Fast Track participants. The case studies looked at firms in New England, California, North Carolina, Indiana, Texas, New Mexico, Colorado, and the Washington, D.C., metropolitan area. A total of 55 case studies were conducted.

2. Empirical Analysis: Using survey results and case studies, STEP-commissioned researchers also examined whether SBIR-funded technologies would have been pursued without the SBIR award and what the social returns to SBIR-funded technologies were.

The recommendations and findings approved by the Committee appear in of this volume. They are based on the commissioned research, described above, and on a series of fact-finding and review meetings. The largest of these review meetings was a symposium held on May 5, 1999, at the National Academies, where the papers on which the findings and recommendations are based were presented. Symposium attendees (listed in Annex B) included Department of Defense officials, academics, and staff members from Capitol Hill and the Executive Branch. The symposium permitted researchers to obtain feedback on their work, and researchers were able to subsequently revise their papers based on comments from discussants and symposium participants. The supporting analyses and papers are reproduced in Chapter IV. Additional references and background information are available in the annexes and the bibliography.

While it is important to keep in mind the limits of the research effort and the short history of the Fast Track initiative,²⁴ the findings of the researchers do reflect well on the program. Put simply, the case studies, surveys, and empirical research suggest that the Fast Track initiative is meeting its goals of encouraging commercialization and attracting new firms to the program. Consequently, the Committee recommends that Fast Track be continued and expanded where appropriate. The Committee does not recommend that Fast Track be applied to the entire SBIR program at DoD. To do so might put at risk other goals, such as research and concept development. It is also important to keep in mind the need for additional research to validate these results over time.

To further the reader’s understanding of the program, this volume includes the individual research papers on which the recommendations and findings are largely based, as well as an overview of existing economic assessment. The Harvard Business School’s Josh Lerner and Colin Kegler note in their review that despite the proliferation of public efforts, both in the U.S. and abroad, to finance small, high-technology firms, there has been relatively little assessment of the economic impacts of these programs. Their paper provides valuable background to the case studies in that it explores the challenges posed by the financing of new firms, the ways specialized financial intermediaries address them, and the rationales for and problems faced by programs designed to assist small firms. Lerner and Kegler also provide a valuable summary of previous evaluation efforts of such programs and their limitations. The dearth of research on these programs, noted above, and particularly the SBIR program, led the Committee to commission original field research in the form of case studies and a survey in order to better understand the operation of the SBIR at the Department of Defense, and in particular, its Fast Track initiative.

The case studies prepared by the research team are also included to provide additional texture and detail to the analysis. While the case studies were all based on a common template (included in Annex C), the researchers undertook their research independently and were encouraged to pursue fruitful lines of inquiry even if these diverged from the template. Consequently, while all the case studies address the issues requested by the Under Secretary of Defense, each paper reflects the individual perspective of the researchers and the differences in the questions posed. All the companies interviewed for the case studies also responded to the survey. In addition, several researchers pursued independent lines of inquiry. For example, the paper by David Audretsch, Jurgen Weigand, and Claudia Weigand (Indiana University) on SBIR recipients in Indiana looks closely at whether the program influences the behavior of individual researchers, especially those in university environments. Reid Cramer, with Robert H. Wilson (University of Texas, Austin), develops a classification of SBIR firm types from case studies of firms in the southwestern and mountain states. In looking at a small sample of SBIR firms in the southeastern states, Albert N. Link (University of North Carolina, Greensboro) discovers distinct differences between Fast Track and non-Fast Track firms in the area of funding gaps between Phase I and Phase II, commercial potential, cost of commercialization, and social returns. John T. Scott (Dartmouth College) conducted the largest set of case studies, focused on New England. He examined fourteen SBIR award recipients and found clear differences between Fast Track and non-Fast Track firms in the area of commercial potential and social rates of return.

The paper by Robert Archibald and David Finifter (College of William and Mary) and the paper by Maryann Feldman (Johns Hopkins University) also took

different approaches to assessing SBIR and Fast Track. In addition to providing a detailed legislative history of SBIR, Archibald and Finifter explored whether a tradeoff exists between the program’ s goals to encourage scientific and technical excellence as well as commercial success. To explore this question, they developed an innovative, e-mail based survey of DoD technical monitors of SBIR awards. Contrary to their initial hypothesis, they found that the technical monitors rated the quality of SBIR-funded research as virtually equal to that of other research funded by the Defense Department. Maryann Feldman examined DoD SBIR funding of a particular technology area, namely the biosciences. Her work highlights the contributions of DoD funding of R&D in the biosciences, and how Defense SBIR awards have proven to be important catalysts to the commercial success of several growing biotechnology firms.

With respect to the empirical analysis of the survey of SBIR awardees, Peter Cahill (BRTRC, Inc.) reports that half had participated in the Fast Track or BMDO co-investment programs and half had not. The survey results provide indispensable baseline data for determining the differences (e.g., age of firm, the firm’s past experience with SBIR, length of funding gap between Phase I and Phase II, and commercial potential of the technology) between Fast Track and non-Fast Track firms. Finally, using information gathered in case study research on firms in the Southeastern and New England states, Link and Scott develop a measure of the social returns to SBIR-funded technologies in excess of private returns. They find that social rates of return substantially exceed expected private returns, which they see as the “fundamental rationale” for the program. Link and Scott also find that the funded companies would not have undertaken the R&D without public support.²⁵

In order to provide a basis for more systematic conclusions about differences in Fast Track and non-Fast Track projects, the Committee commissioned a statistical analysis of the influence of the Fast Track program. This analysis was a collaborative effort among Audretsch, Link, and Scott. The major conclusions of this analysis of the survey data were that Fast Track projects have greater expected sales, a shorter funding gap, and greater employment growth than non-Fast Track projects. These findings complemented the case-based analyses described above and were designed to correct for potential bias. The use of multiple research techniques—carried out by a heterogeneous team of researchers with inputs from both DoD managers and awardees —represents a cohesive effort to measure the program’s impact. The fact that several overarching findings emerge from a variety of different approaches, applied by researchers working independently, suggests that the findings are reasonably robust.

The findings and recommendations are grouped under general findings, specific research topics, and two sets of recommendations for the Fast Track program and for future research. This section on general findings addresses issues of relevance to the program as a whole and outlines the results of the survey and case studies specifically relevant to the Fast Track initiative. A second general grouping reviews the specific findings by research topic. These topics include the impact of SBIR awards on university researchers, the role of DoD awards in developing innovations in biotechnology, the regionally-based findings, and a series of findings and recommendations with regard to multiple award winners. There is also a section with specific findings and recommendations made by the Steering Committee for the DoD Fast Track program itself. Lastly, there is a series of recommendations for future research. The findings and recommendations appear in Chapter III.

Small business will continue to play a prominent role in the U.S. economy and innovation system. With the growth of the Internet and electronic commerce in the 1990s, along with the unfolding biotechnology revolution, entrepreneurs and small businesses will be a vibrant source of innovation and job growth. Programs such as SBIR can serve as a catalyst for encouraging innovation in this entrepreneurial climate. To remain responsive to small firms in rapidly changing markets, programs such as SBIR must engage in policy experiments. The Fast Track initiative represents an innovative way of matching program objectives to an economy in which the rewards to rapid innovation are growing. The analysis and recommendations in this volume underscore the positive contributions of the SBIR program to the Defense mission. Based on its evaluation of Fast Track, the Committee recommends that the program be continued and expanded where appropriate.²⁶ The recommendations also identify areas which would benefit from further research and analysis in order to ensure the Fast Track initiative and the SBIR program at the Department of Defense continue to improve.

Charles W. Wessner