New technology in the U.S. is largely due to individuals in academic and some few government laboratories. The over-arching scenario is a government grant is given to study some basic principle and this in turn leads to the discovery of something that seems to the inventor might be successful on the commercial market. Sure, not all technology is born this way, but the large majority of it is. There are many examples of such technologies many, many of which are now getting quite old – they aren’t “new” technologies any longer. As they age, they are usually off-shored to lower cost manufacturing sites, while new technology manufacturing has traditionally replaced it stateside. But this pipeline of new technologies to our “factories” in the U.S. is beginning to fail pretty badly.
Of course there are also loads of examples of “feed – in” technology that enables the products that companies create – just look at the list of IP used in an iphone. Much of this came from academic labs here in the U.S. But what we are talking about here is the really new ideas, that new widget that no one else thought of. Where are they?
Once an idea is hatched, then what? Well in the vast majority of cases in the U.S. nothing at all! The concept gets patented and goes into a portfolio that the university puts up on a website somewhere that very few people even look at. Professors get tenure, university administrators get raises, and the whole system rolls on – with very little output. Once in a great while something really special happens; an investor comes along and says, ”I am interested.” This investor uses a load of other people’s cash – known as venture capital – to put together a company whose job it is to commercialize and bring this idea to market.
At least that is the way it happens in the U.S. In other countries such as Germany the route can be quite different with government labs and government/private institutes such as Fraunhofer set up to make the bridging of the lab-market divide a little smoother. This is done simply to insure the flow of new ideas and products into the nations manufacturing base – a base the country has every interest in maintaining. The understanding is straightforward; newer high tech will be produced at home, whereas older technologies will eventually move elsewhere. So the pipeline is a key element in being a manufacturing powerhouse. It is NOT, and never has been, to hold onto one product manufacture forever because eventually demand for this product will wane and it must be replaced. In the high tech world, manufacture must be agile and well trained, and the pipeline of ideas must be continuous.
But here in the U.S., VC is the funding behind our commercialization route to manufacture. In fact, we as a nation codify and legalize routes to enhance the investment opportunities (and yield) available to the emerging entrepreneur at every level. Through tax breaks for the uber-wealthy (capital gains), and the creation of a “business environment” that benefits such startup endeavors. So is it working? Is all this government giveaway actually creating more and more commercial opportunity for new ideas and new technology through increased investment? Does it actually lead to a stronger high tech economy? Well the answer is a little more complicated than our “investor class” would have you believe. The answer is that we have built a system of government “gamesmanship” far more reaching and ineffective than a truly free and open market can sustain.
According to the NVCA: http://www.nvca.org/... in 2010 there were approximately 462 active funds operating in the U.S. and they provided 2749 companies around $22 billion in operating capital. The average size of the funds was right at $150 Million. A 2011 Venture Impact study by IHS Global Insight says that startup companies that were formed from an original stake from a VC accounted for ~11.9 million jobs with over $3.1 trillion in revenue in the U.S. They used the 2010 data to determine this. That adds up to be right at 21% of domestic GDP and 11% of private sector jobs. About 40% of these will fail in the first 5 years whereas another 40% will yield a moderate return – only about 2 x of the original investment. Another 20% will yield BIG returns – from 10 x to 100 x or more. Some will need more investment.
Not bad right? 11% of all private sector jobs coming from companies that were originally started from a bunch of rich folks investing their money in the hopes of BIG payoffs. In fact, their odds are better than anything in Vegas. And remember, these investors are “playing the table.” They spread their risk around with multiple investments, so nearly all of these funds make a return, very few fail outright.
But as pointed out, the US system of science commercialization relies on this. The game is rigged to make it so that only the wealthiest can benefit from the intellectual property and hard work of academics, basement inventors, and they guy/girl with a great idea. Federal agencies like NSF and DOE actively seek investment from such gamers to carry ideas to the next stage of commercial success. They do this because THEY are not supposed to pick winners and losers among the scientists they support. So they allow the winners and losers to default to the moneyed elite. The catch phrases used usually involve statement like – “let industry decide” like somehow investors are really making decisions based on manufacturability and market drivers. In reality, this is a numbers game and investors are a set of roulette players generally. Yes, they do take an active role in the companies they invest in at times. But the idea that they have the domain expertise to see the commercial enterprise through is based solely on the premise that having money from any source makes you an expert. At least according to federal funders. According to Deloitte, when broken down by country, the U.S. economic growth is the most heavily dependent on this VC system of investment than any other nation on earth. In the initiation of manufacturing base, the U.S. has swallowed up more than 28% of the worldwide investment, compared to 12% in India, 7% in China, and just 5% in Germany.
I say “dependent” here because those international competitors for manufacturing are all net exporters and are sustaining a thriving and growing manufacturing base whereas the U.S. has seen a contraction. Given that the U.S. has received the largest share of private investment, the question is naturally “why?” My thesis in this diary is that it comes down to the source of money. These other countries have mechanisms that allow for sustained manufacturing without huge amounts of private capital at every turn, though admittedly there is some.
Oh well, we (the U.S.) are still number 1 right? This brings me to the really troubling news. Over the last 10 years we have come to rely on this system even more to create the next economy. It drives our default “manufacturing policy” in the U.S. But there is nothing to make sure these type of funds continue to do what we all hope they will do. In fact the 2010 - 462 funds investing in our future has fallen from a 2000 number of approximately 1,022! (taken from NVCA again). Sure, the total dollar amount has remained steady or risen some, but not nearly enough to keep pace with global growth. Moreover, many of the funds that focused on high tech now have become super funds of over $1B and have taken on a more global approach according to a 2012 study by WalkerSands Communications.
That's right. It seems as though all those tax breaks and funny small business protections are not enticing more investment in the U.S., but less of the sort we would need to see to build a thriving high tech economy. This even in the face of the fact that those same investors have become more wealthy, faster than ever before over this same time period.
There are of course many reasons for this: returns in the banking sector are out of proportion with manufacturing, confidence in the investor community has fallen in the U.S. and the ease with which we can now move money abroad are all part of the changing landscape. But not IP generation and startup formation by inventors – these have continued to growth domestically. So this adds up to mean that our system of using the “good will” of private investors to bolster what our economy will look like in the future only really worked when there was little to no real competition out there; China and India without sufficient infrastructure, Europe rebuilding after a devastating war, etc.
So what does this mean? I believe it means that the U.S. should start looking at the system of VC funded entrepreneurship in high tech as the government sponsored enterprise that it actually is. And, we should begin to form a set of policies at the federal level based on the more realistic view that none of this has to do with free market drivers. Rather, it is simply another way of determining winners and losers – and in this case we in the U.S. are the losers.
Now this might sound a little “communist manifesto” to some, but in fact it is pure market economics. Most of the technologies we are talking about here are given a chance to succeed based only on their access to a few wealthy people and the inventor’s ability to convince the vetters of a given fund to take the chance. This chance is based on many things, but almost never on the specific domain knowledge to make good business choices in the development of the technology. By contracting the sources of capital down to a few funders, winning and loosing comes down much more to chance than it does to merits or the market. A thriving open market necessitates multiple funding routes to the startup scheme. Without this it falls into the trap of capitalism – a contraction of market to only a few players and it is these few players that will determine outcomes, not true market drivers such as consumerism.
The irony here is that open and free markets are better served by market protections that allow for a multitude of ways to bring products to consumers, but NOT by rampant and unfettered capitalism. This principle seems to me, to apply even at early stage technology development.