A public-private partnership helps small businesses bring their innovations to market. Charles Wessner is director of technology, innovation, and entrepreneurship at the National Academies, which comprises groups of scientific experts that give advice to the federal government. This article appears in the November issue of eJournal USA, “Roots of Innovation.”

Governments around the world are committing high-level policy attention and significant resources to the challenge of knowledge-based competition and growth. Success in this endeavor depends on effectively transforming national investments in research into competitive products for the market.

Too often, national policy reflects a belief in a linear process of innovation, one that assumes that more funds for research will lead automatically to the development and commercialization of new products for the market. Yet real-world innovation processes are normally incremental, with technological breakthroughs often preceding, as well as stemming from, basic research.

Initial capital to encourage cooperation between universities and businesses is key to this transformation. To convert research into products, the United States does not rely on free markets alone.

The Small Business Innovation Research (SBIR) program offers competitively awarded U.S. government grants to small companies and university researchers and, in so doing, signals new information about innovative products to capital markets. A proven program, SBIR is increasingly being adopted and adapted around the world as a means to accelerate innovation and augment the return on national investments in education and research.

Complexity, Collaboration

Innovation is a complex process, often involving cooperation among multiple participants across an economy. Successful efforts to bring new ideas to the market are most often the result of highly collaborative processes that blur the lines between basic and applied research and the development and commercialization of new technologies. This means that to encourage innovation, we need to identify and remove obstacles to cooperation among scientists, research administrators, entrepreneurs, financiers, and other participants in the knowledge economy. And to encourage such cooperation, it is important to provide appropriate incentives.

It is useful to link cooperating participants together in an innovation ecosystem, a concept that highlights the connections among the many efforts involved in bringing innovation to market. These efforts include those organized within, as well as collaboratively across, large and small businesses, universities, and research institutes and laboratories. They also include business investment “angels,” state government funds, venture capital firms, and financial markets. Innovation ecosystems themselves can vary in size, in composition, and in their impact on other ecosystems.

This need for collaboration calls for intermediating institutions that successfully align individual self-interest with the broader objective of bringing a new technology to market. In some cases, hidden or missing information can preclude successful coordination. For example, potential sponsors may not understand an entrepreneur’s vision of a new commercial concept. In other situations, some individuals may be motivated to free-ride on the contributions of others or fail to share resources equitably with others, leading to a breakdown in cooperation. Where knowledge is “slippery,” potential investors may not be able to recoup their capital in developing a new idea. In such cases, rules concerning the protection of intellectual property can encourage the collaboration needed for innovation.

Institutions are the rules that shape human behavior. These include, most generally, rules that protect property and the regulations and incentives that structure capital, labor, and financial and consumer markets. Rules governing competition also condition the operation of markets. Antitrust rules, for example, prevent participants with significant market power from restricting the entry of newcomers with innovative ideas.

Innovation ecosystems are also shaped by shared social norms and value systems, especially those concerning attitudes toward business failure, social mobility, and entrepreneurship.

Within an innovation ecosystem, specifically designed programs that shape incentives for entrepreneurs to seize opportunities, take risks, and collaborate with others in turning new research ideas into products for the market are critical.

NASA’s Glenn Research Center in Ohio awarded an SBIR grant to a small company that specializes in metalworking and heat simulation.

From Promise to Product

Although small, innovative businesses increasingly are recognized as major drivers of high-technology innovation and economic growth, they often face challenges in bringing their ideas to market. One major challenge concerns the availability of capital, especially at the early stages of a technology’s development.

Because new ideas are by definition unproven, the knowledge that an entrepreneur has about his or her innovation and its commercial potential may not be appreciated fully by prospective investors. The term “valley of death” has come to describe the period of transition from when a developing technology is deemed promising but too new to validate its commercial potential, until the time that it can attract the capital necessary for its continued development.

The presence of such information asymmetries means that inherent technological value does not lead inevitably to commercialization; many good ideas perish on the way to the market. Even capital markets in the United States, widely believed to be broad and deep, often fail to identify promising entrepreneurial ideas and finance their transition to market.

In 2008, venture capitalists in the United States invested $28 billion over the course of 3,808 endeavors. However, more than two-thirds of venture capital in the United States was directed to firms in the later stages of development that year, and only 5 percent of venture funding was directed to the earliest, or “seed,” stage of funding. Market cycles can exacerbate the challenges of obtaining early-stage capital. The financial crisis of 2009 has led venture capital investors to retrench, favoring even more strongly ventures closer to market over those in the early stages of development.

SBIR Program

To help new firms cross the valley of death, the U.S. Small Business Administration initiated in 1982 its Small Business Innovation Research program. This public-private partnership provides competitively awarded innovation grants and contracts to small businesses with technologies that show promise and commercial potential, thus helping them grow and develop new products that help government agencies address a variety of national missions.

SBIR is funded by a set-aside, or “tax,” of 2.5 percent on the external research and development budgets of 11 U.S. government agencies. Each year these agencies identify various research and development topics -- representing scientific and technical problems related to their missions that require innovative solutions -- for pursuit by small businesses under the SBIR program. These topics are bundled together into individual agency solicitations -- publicly announced requests for SBIR proposals from interested small businesses -- that are placed on a Web site.

Any small business can identify a topic that it is capable of pursuing from these solicitations and propose a project for an SBIR grant. Each of the 11 agencies then selects, through a two-phase competitive process, the proposals that most closely meet its selection criteria, and it awards contracts or grants to the proposing small businesses. Typically, about 20 percent of the proposals submitted are accepted each year. This tough competition weeds out weak ideas; proposals have to show technical feasibility and commercial potential.

The high standard of this selection mechanism means that being awarded an SBIR grant acts as a certificate of quality -- a positive signal to private investors of the technical and commercial promise of the technology. In this way, the SBIR program helps overcome the information gaps between the small-business entrepreneur and a potential financier, thus bridging the valley of death and encouraging cooperation across the innovation ecosystem.

Foreign Adoption

The U.S. innovation system is market oriented, but its operation is strengthened by policies and programs that provide the initial capital necessary to encourage more entrepreneurial participation, which creates and signals more information for prospective investors or public procurement agencies. The Small Business Innovation Research program is a positive example of a competitive program that creates new companies, provides new low-cost solutions for government missions, and generates novel applications for government research.

Recognizing the advantages of the SBIR concept, governments around the world are undertaking similar programs to encourage entrepreneurship and innovation. Finland, Sweden, and Russia have adopted SBIR-type programs. The United Kingdom has a program similar in concept. Following a successful pilot, the Netherlands has expanded such a program across its government ministries. Japan, South Korea, and Taiwan have also adopted the SBIR concept, with varying degrees of success, as a part of their national innovation strategies. And India has recently adopted an SBIR-type program to advance its biotechnology sector. This level of emulation across national innovation systems is striking and speaks to the common challenges addressed by SBIR awards and contracts.

While national innovation systems differ in scale and flexibility, policy makers around the world face similar challenges in stimulating innovation. They have to address the challenge of expanded global competition by becoming more innovative and productive, while justifying research and development expenditures by creating new jobs and new wealth. Innovation programs such as SBIR can help transform these national investments in research more effectively into competitive products for the market. The SBIR concept has proven to be highly adaptable to a variety of national innovation systems and is an example of global best practice in innovation policy.