Make public procurement drive innovation

“In nearly one-quarter of a century of existence the Small Business Innovation Research (SIBR) programme has played a pivotal role in exploiting the US science base and supporting growth of its small scientific and technical companies,” says the report’s author, David Connell.

Despite the popular perception that high tech start-ups are funded mainly by equity investments from venture capitalists, the reality is that R&D contracts from customers play the key role in early stage funding argues Connell. In the US it is the federal government that places most such R&D contracts.

“In essence it is the world’s largest seed capital fund,” says Connell.

Connell’s position resonates with the ambitions of the current Finnish EU Presidency to move innovation policy in Europe towards a similar demand driven model.

In particular, the Finns want to pick up on proposals outlined in “Creating an innovative Europe”, a report written by former Finnish president Esko Aho, published in January this year. This report said the vast billions of euros that are poured into public procurement each year should be used to drive demand for advanced high tech products.

Access to markets

The public sector across Europe accounts for a huge amount of production, especially in services. Lack of access to these markets has slowed development of the private sector. At the same time, the public sector is sheltered from competitive forces, weakening the incentive to innovate. Growth in productivity is therefore lower in the public than the private sector.

In many member states, the public sector both finances and produces services that account for a large share of the domestic market. Typical areas include health, social work, education, public transport and infrastructure. A good part of these services could be outsourced to the market without abandoning the social responsibilities and objectives associated with them – by leaving their financing to the public sector, argue the Finns.

Similarly, in the UK the main Conservative opposition party put procurement at the heart of its new policy to promote innovation, launched last week. The Conservatives argue that “innovation must be more demand driven, instead of relying on bureaucratic schemes and assessment processes to ‘stimulate’ ideas through grants”.

Instead, the emphasis should be shifted to buying products and services from SMEs. “For small companies, revenue is the best form of investment capital,” says the policy statement.

Connell’s study demonstrates the US experience provides ample evidence that the requirement to focus technical development on real, well-defined customers needs provides the best market research a company can have. This is particularly important in the exploratory phase of commercialising platform technologies that have a huge range of potential applications.

Long timescales

While platform technologies may represent some of the most significant spin off opportunities from the academic science base, the long timescales involved in finding the most appropriate applications and getting them to market, can make it very hard for venture capitalists or private investors to get involved.

Connell contrasts ‘soft’ companies that survive on customer contracts, with ‘hard’ companies that are developing specific products and need a broader range of strategic, marketing and financial skills. As such the ‘soft’ phase can be seen as a stepping stone on the way to the more demanding ‘hard’ company model.

The ‘soft’ phase is particularly important in letting founders who are moving out of an academic environment to set up a company get to grips with a more commercial environment without immediately exposing them to its full rigours.

While the US government’s role in nurturing high tech companies is well-recognised, government procurement is self-evidently not used to the same effect elsewhere, says Connell.

For example, in the UK the public sector purchases more that half of all IT goods and services. But the perception that innovation is the responsibility of the private sector and the predominance given to value for money and risk minimisation means this spending power fails top fuel innovation.

Profit margins

In the US, the SIBR programme make 4,000 awards annually worth $2 billion. These are not in the form of equity, loans or grants, but contracts to develop specific technologies. The money is intended to fund 100 per cent of the work and allows for a profit margin.

The aim is that this will then lead on to mainstream commercialisation. “As a source of early stage finance, the SIBR programme is probably at least as important in value terms as venture capital,” says Connell.

However, unlike most VC investments, SIBR awards are available at the start of a company’s life. SIBR also works in concert with other legislation that requires government agencies to spend at least 23 percent of their overall procurement budgets with SMEs.

Over 300 SBIR award winners are now publicly quoted. These include companies such as Qualcomm, Genentech and Amgen.