So the conclusion I would draw is that if government wants to support technology exploitation and have a vibrant innovation policy it's very important that it supports these soft companies and, in particular, it can do so by placing R&D contracts with those companies to solve its own, that is to say, government problems and government issues. Government is roughly half the economy in the UK and there is an important role that it can play if it chooses to do so.

KEY ISSUES FOR SMALLER ADVANCED ECONOMIES

Now I think there are some special issues for smaller economies and I would include the UK and Australia within that group. I start by looking at venture capital returns in the UK. We have a strong VC industry in the UK, the strongest outside the States. If you look at the returns you will see that early stage technology is the worst place you can possibly be in terms of delivering return for your investments. This is a consistent story over many, many years. Now, this isn't to say that there isn't a big dispersion around the aggregate returns nor that there are not well performing funds. This, nevertheless, does not matter because the institutions that invest in venture capital, the so-called funds of funds, are now very internationalised businesses. They can decide whether to invest in a VC fund in the UK or a buy-out fund in the US or a resources fund in China. It is a global business and the result of this is that there are very, very few investors that are interested in investing in venture capital funds in the UK, or in Europe. This is because they look at the average returns, and that is a completely sensible and rational decision

I draw a second conclusion from this and that is that if we want to build a viable UK technology venture capital industry then we have to redraw the dividing line between public and private finance.

Capital and money in today's world is pretty mobile, and there is evidence to show that UK entrepreneurs build very big companies in the US. US entrepreneurs coming to the UK have exactly the same problems as local companies. The reality is that we have not built any gorillas in the UK. So we haven't had the home runs which is what VC returns depend on. The question is, why?

And then I turn to this model.

[ILLUSTRATION OMITTED]

When you are creating a hard company, a company with standard product and potentially big volumes, what you find is that the source of competitive advantage changes very rapidly as that market grows. Right at the start it's all about innovation, it's about being clever, but it rapidly becomes being about scale and ultimately about cost. If you take a UK and a US company starting at roughly the same time, after five years the US company will typically be five times the size of the UK company and would have five times as much to spend on marketing, on R&D and on acquisitions. This is because the US market is so much more scaleable, so much more homogenous. There is almost an inevitability that UK companies will get out-competed and gobbled up.

Thus critical success factors for companies are:

* time to first customer feasibility study,

* time to first customer trial, and

* time to first customer deployment.

It is always easier to be a follower if you are trying to sell overseas. When our companies are trying to sell in the States the first question they are asked is 'can you show me a reference site'. So government has an absolutely crucial role to play in being prepared to be a first customer, and so should be encouraged to do that through customer trials and through early research and development contracts.

SBIR AND US GOVERNMENT PROCUREMENT POLICIES

It turns out that the US does this rather really well, and has done so for a long, long time. The key role of the US Federal Government in the national R&D system is generally well understood. It has been pivotal in the development of the semi-conductor sector, the computer sector and lots of other areas. Expenditure is very large, and a substantial part of it is with industrial companies. Within the blood stream of government is the understanding that small companies have a pivotal role to play in innovation. The US Small Business Administration tells us that they generate thirteen to fourteen times as many patents as large companies, and that they generate 60 to 80% of the new jobs.

A lead programme in the US is the Small Business Innovation Research Program (SBIR). It was initially established in 1982 by Ronald Reagan. The law defines the amount of money that has to be set aside for this program, which is 2.5% of all larger agencies' external R&D budgets. It used to be much less; the percentage has gradually increased over the years. The key features of the SBIR scheme are as follows:

* Aimed at meeting Agency's requirements for new technologies as customers: usually specified in some detail, typically in terms of functional wish lists.

* Available to US businesses owned 51% or more by US citizens.

* R&D contracts (plus some 'grants' for directed research). 100% funding is the norm. No collaboration is required. Companies retain and own IP.

* Competitive process run by each agency 2 to 4 times a year. Agencies required to ensure 'simplified, standardised and timely solicitations'.

* Complete transparency of topics, award winners and amounts.

The scheme provides 100% funding, with a 6% allowance for profits.

The important thing which people often are not aware of is that essentially this is a seed fund. It's not a 'set aside' target, it's a seed fund. It takes a pot of money, 2.5% of the larger budget, and runs it through this competitive seed funding process.

Different agencies operate slightly differently, but there is a standard model which is based on a phased funding approach. A successful company will first of all get a Phase 1 project contract. That's typically $100,000 to do a feasibility study, maybe funding six months work. Roughly around one in seven companies that apply are successful. Phase 2 is for a two year development program, typically $750,000 dollars per contract.

There is a third phase that is not actually funded from this total $2 billion dollar budget. The third phase is funded from normal budgets, arising from public sector deployment. If you get Phase 3 status essentially there is an expectation that for any technology based on this SBIR funding, for any technology that you supply to any government department in the future, you will be sole supplier. In fact, if you're not sole supplier the agency has to notify the SBA. So these are really valuable benefits.

The scheme delivers about 4,000 contracts a year to about 1500 firms. Lots of companies win multiple contracts. Most of them go to the smaller end of the scale: 70% to companies employing less than 25 people, and 50% to companies employing less than 10. In the Defence area there are also a lot of companies in any one year that are new to DOD contracting. The DOD regards this as being a way for companies to get on the first step of the procurement ladder. Because firms can receive multiple contracts in parallel there has been some criticism of what are called SBIR mills. These are firms, mainly in the Defence arena, that have made a living out of doing research. I should add that when agencies are assessing firms bidding for these contracts explicit attention is paid to the prospect of dual use, for example commercial uses as well as military uses, and this figures quite significantly in the decision making.

What about the economic impact? Whole series of different analyses have been done of the impact of the SBIR. I think, to be honest, like so many of these kinds of things you have to question whether some of the authors are completely impartial but actually they are all pretty positive. There have been lots of very good reviews by US government bodies. One issue is the case of SBIR mills mentioned earlier and the 11% of SBIR funding going to a very small number of firms. The conclusion analysts have drawn is that this is either not a bad thing or possibly a good thing because they are doing good research for the government. If it is a bad thing then it's not so bad as really to jeopardise the value of the overall programme. In 1999 Joshua Learner at Harvard Business School compared 500 companies that have got SBIR contracts with 900 matched companies which hadn't. He concluded that the SBIR firms had created 5 times as many jobs over a 10 year period. In regions with high levels of entrepreneurial activities, such as Silicon Valley and Boston, the difference was 17 times. This really highlights the value of the programme in fuelling economic growth. An analysis of companies receiving National Science Foundation contracts tells a similar story.

The SBIR program is just one part of the procurement picture in the US. As well as the SBIR, which is worth about $2 billion dollars a year, there is a very similar program called the Small Business Technology Transfer Research Programme. This is virtually identical except you are required to have a University partner, and between 30 and 70% of the funding can go to that partner.

There are significant R&D procurements from non-SBIR budgets. I mentioned SBIR Phase 3, which is funded outside the $2 billion, and is probably worth about another $2 billion dollars. Beyond that there's also participation in what I call 'broad area announcements' to solicit proposals from industry. This is open to large businesses as well as small. Small businesses can compete but they're more likely to win in most cases if they're part of a consortium. So there's probably significant money going to small business through this mechanism as well.

So the total going into small firms is probably about $8 billion dollars, a very rough estimate. There are published statistics showing that 13% of all Federal R&D contracts by value in 2003 went to small firms. In addition about another 20% of the total Federal Government procurement goes to small businesses via other mechanisms, so essentially 45% of US Federal Government procurement is earmarked for small businesses. These beneficiaries are small US businesses, so this is obviously a key barrier to the rest of us.

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