INNOVATION AND PROCUREMENT POLICY

Convened by Terry Cutler and Mark Dodgson

Canberra, October 2007

In a past era, government procurement was a major lever for industry development and innovation--one thinks back to offset programmes, and commitments required under industry licensing schemes. The world has moved on. What might be the role of government procurement in industry development today? And what might we learn from the experience of schemes in other countries?

The Canberra roundtable began with a presentation by David Connell. David was the Chief Executive of TTP Ventures, a Cambridge based venture capital fund specialising in early stage science and technology based ventures. He is also associated with the Centre for Business Research at the University of Cambridge. In the UK David has been campaigning for the introduction of a US style Small Business Innovation Research (SBIR) programme and his recent report on this subject has had a major influence on UK policy thinking. The authoritative report on Innovation in the UK by Lord Sainsbury (1), which was released just weeks after this Canberra forum, strongly recommended the adoption of such a scheme.

David Connell's presentation was followed by panel discussion around a variety of Australian perspectives on procurement policy.

USING GOVERNMENT PROCUREMENT TO HELP GROW NEW SCIENCE AND TECHNOLOGY COMPANIES: LESSONS FROM THE US SMALL BUSINESS INNOVATION RESEARCH (SBIR) PROGRAMME

David's presentation fell into two parts. In the first part of his presentation he explained the development challenges facing the growth of new science and technology companies, and the disadvantages UK firms suffered compared to their US counterparts. In particular, and this expanded upon some of the myth-busting about commercialisation which featured at our 2006 Summit, David argued that we have been too narrow in our thinking about the origins of technology innovation and tend to ignore what he terms 'soft companies' built around customer contracts and solving real world customer problems. David then outlined the operation of the US Small Business Innovation Research (SBIR) programme, and the competitive advantage it, and related procurement policies, give to US firms.

'SOFT' AND 'HARD' COMPANIES

First of all I want to talk about the idea of soft and hard companies. This is a particular way of looking at the business models that technology companies can adopt when they start out. When an entrepreneur or a group of entrepreneurs start a technology business there are a whole range of strategies open to them, with different levels of risk and return. Risk in this context has three components. First there is all the uncertainty: can you make the technology work? Is there a market? Will competitors get there first? Secondly, how much is the technology going to cost, and what's the investment going to be? Thirdly, how difficult is it going to be to manage the business as it progresses? (See Figure 1--Risk and return).

At the bottom of this exhibit, there are consulting businesses. Lots of technologists and scientists find they can start start some kind of consulting business; a business card and a telephone number and you are away. A bit more difficult but more expensive to start is contract research and development. This is where you develop technology for individual customers. It is very easy to start a business of that kind in areas like software but you can also do it in other areas as well, often with relatively little capital investment. A bit further up the spectrum is where you are actually developing and supplying volumes of product. Right at the top you've got speculative product development. This last option is your classic business school model. You have your bright idea, you write your business plan, you raise your money, you develop your product and eventually you sell it to a grateful group of customers.

[FIGURE 1 OMITTED]

Down at the bottom are the soft companies; up at the top are the hard companies. The reason the word soft and hard are used is because, at the bottom end of the spectrum, your strategy is very malleable. Essentially your business is skills based. You are probably selling off a PowerPoint presentation, a little technical demonstrator or something of that kind. If the customer doesn't like this you can sell him that. So soft companies are very flexible in their approach to customers. In the world of the hard company, once you have defined your product and focussed on developing it, then if you get it wrong there is probably not going to be a second chance.

The dividing line basically depends on who pays for the R&D. At the bottom it's the customer; at the top it's the company or to be more precise, the investor.

Hard start-ups typically require significant amounts of venture capital to get going but they can, if successful, bring very large returns to investors because such businesses tend to be scaleable. Soft start-ups rely much more on customer contracts to fund development and they are actually not terribly attractive to venture capitalists because the rate at which you can grow such a business is typically the speed with which you can recruit people, which is probably at a rate of 30% or 35% per year at best. The soft model actually turns out to be very important in the exploratory stages of exploiting new technologies, particularly platform technologies.

[FIGURE 2 OMITTED]

ROLE OF CONTRACTS IN THE COMMERCIALISATION OF NEW SCIENCE AND TECHNOLOGY

Innovation is about problem solving; customers have problems and they have 'wish lists'. A development contract from a customer is the best market research a technology company can have. So let me now turn to the role of contracts in the commercialisation process of new starts and technology commercialisation. The way I like to look at this is using this little diagram here (see Figure 2--Gap).

There's a series of research activities which typically go on in universities or maybe very large corporate labs which are genuine research. And there's the activity which businesses are good at doing, particularly if you like venture capital backed businesses, businesses that are very well managed and so on and a hard start up business where you have a scaleable business model. There is, however, a lot of stuff in the middle which is much more exploratory and this is particularly the case where you have a technology emerging from an academic laboratory which is probably going to be a platform technology. It is made from a particular kind of software algorism with different applications, maybe a bit of material processing technology. There may be multiple applications but you really do not know at that time whether any of them are going to be commercially viable compared with the competition. So this is an exploratory process, but one which has to be undertaken in a business environment. Universities can't do this. One academic with quite a few spin offs to his name was saying to me just the other day that the trouble is that in universities you cannot do anything. What he meant is once you start engaging with customers, they are interested in deadlines, you need a team of engineers to start providing demonstrators and your colleagues want to do something different. But if universities cannot provide a helpful setting, on the other hand you have not got a proposition which will be attractive enough to investors. All you can say is we have got some interesting technology, and we think it will be worth something some where. No investor is going to buy that, by and large. But in this part of the process it is really this soft company exploratory process which, to my mind, is the key way forward. Put simply, I think innovation is very simple, it's all about problems--problem solving. Actually the best innovators are generally your academics because they invent their own problems, but for most of us it is about speaking to the customers, finding out what their problems are, finding out what their wish lists are and trying to apply our skills and our technology to those challenges. The best market research you can have is a contract from a customer who says 'I like that idea and I'm prepared to pay you to develop it for me'. So money changing hands is an important part of the commercialisation process.

If you look at technology success stories, certainly in the UK and elsewhere, actually many, probably most, owe a large part of their success to this soft company model. In the US both Intel and QualComm are good examples. Intel's family of processor chips which is the main bit of the business was initially first won and then carried out as a paid contract for a Japanese calculator company. It was another ten years before Intel realised that this would be the bulk of their business. QualComm dominates the technology for mobile phones and, again, contracts, especially government contracts, were an important part of its early history

So certainly in the UK, and I believe worldwide, this soft model is really important. I think the reason it is not understood is because the hard company model, the model of Silicon Valley venture capitalism, is much more glamorous. People like to talk about it much more. But actually the more you dig the more you find that this soft model is important. Within Cambridge, which I can talk about best, soft companies are actually more important than the University as a direct source of spin out companies. There are not that many really successful spin out companies from Cambridge University; if you get a couple a year you're doing really well. Soft companies have provided a really important initial training ground for entrepreneurs and venture capitalists, many of which have started through this route and gone on to do other things. I would argue they provide a really useful stepping stone for academic scientists as they take that step into the commercial world. They learn project management skills, little bit of marketing and so on.

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