WHERE ARE THE BIG GORILLAS?
HIGH TECHNOLOGY ENTREPRENEURSHIP IN THE UK
AND THE ROLE OF PUBLIC POLICY
2 THE US EXAMPLE: WHAT DID GOVERNMENT CONTRIBUTE?
The virtues of the small businessman – self-reliance, energy, sturdy independence – have always ranked high in America’s business ideology; the preservation of a strong small business sector has been seen as an essential counterweight to the power of large corporations. The first antitrust act, the Sherman Act of 1890, reflected the widespread belief that big firms were becoming too dominant and that some restraint on their expansion was necessary. However, the Act did not prevent a wave of mergers at the turn of the century, and, although the antitrust authorities were more aggressive in the years leading up to the First World War, there was a continuing trend in most industries towards greater concentration. Some defensive steps were taken during the Depression years, notably the Robinson-Patman Act, which imposed restrictions on the pricing power of large corporations; this measure was particularly directed at the retailing sector, where small shopkeepers were being squeezed out of business by Sears Roebuck and other large groups.
Political anxiety about small business continued after the Second World War. The rising importance of institutional investors, brought about by changes in the tax system, had increased the advantage which older and larger firms had always had over new and small ones in access to capital.[6] Another consequence of the tax structure, combining high income tax rates with relatively low taxes on capital gains, was to encourage owners of medium-sized firms to sell out to larger groups.
In 1953 the government established the Small Business Administration, with a mandate to “aid, counsel, assist and protect, insofar as is possible, the interests of small business concerns”. The definition of small business covered manufacturing firms with less than 500 employees, although slightly larger firms in non-manufacturing sectors were also eligible for support. The agency was authorised to make loans, to provide technical and managerial assistance, and to ensure that the interests of small business were given due weight by the military procurement agencies. In its first four years the SBA made loans of $236m to some 5,000 businesses.
The SBA’s remit was extended in 1958 with the introduction of Small Business Investment Company scheme, whereby the agency licensed and helped fund privately-owned venture capital firms, which would provide long-term debt and equity finance for small businesses. At that time the provision of venture capital in the US was patchy and poorly organised. One of the pioneers in what was to become an important part of the US financial sector was American Research and Development (ARD), a Boston-based firm founded in 1946, which set out to provide management expertise as well as finance to promising high-technology firms. ARD’s most successful investment was in Digital Equipment Corporation, the mini-computer maker which was one of the high-technology stars of the 1960s. On the West Coast there was some informal venture capital activity during the 1950s; successful stock market flotations by two firms based in what later became known as Silicon Valley, Varian and Hewlett-Packard, whetted investor interest in fast-growing, technology-based enterprises.
The SBIC programme provided an additional incentive for wealthy individuals and financial institutions to put money into high-risk ventures. The sponsors of the new investment companies had to learn how to evaluate risk and to assess the business plans of fledgling entrepreneurs; it was “an important first step in the institutionalisation of venture investing”.[7] Several SBICs were formed in California, and it was an attractive vehicle for early-stage investing in one of the great American entrepreneurial success stories, the semiconductor industry. One of the remarkable features of this industry (discussed in Section 4) was the role played by new firms in driving the technology forward. The cost of entry was relatively low, and the scientist-entrepreneurs who were coming into the market had little difficulty in raising the funds they needed.[8]
Towards the end of the 1960s the SBICs began to be replaced by private limited partnerships, an organisational form which avoided the public disclosure requirements imposed on SBICs and offered tax advantages for institutional investors.[9] Arthur Rock, a New York investment banker who had helped to set up Fairchild Semiconductor, formed his limited capital partnership on the West Coast in 1961; he participated in several of the Valley’s most famous new ventures, including Intel. Between 1969 and 1975, 29 limited partnerships were formed.[10]
A crucial requirement for the venture capitalists – and for the founder-entrepreneurs and their colleagues, most of whom held shares in their companies, either directly or through stock options - was the availability of an exit route, through initial public offerings (IPOs) on the stock market. The high-technology companies that had gone public in the 1950s, such as Hewlett-Packard, had listed their shares on the New York Stock Exchange, but the ‘Big Board’ imposed listing requirements which were difficult for young firms to meet. In 1971 the National Association of Securities Dealers set up the NASDAQ stock exchange, largely in response to pressure from the Securities and Exchange Commission to bring order into the unregulated over-the-counter market.[11] Over the subsequent decade the new exchange became the preferred market for new, high-technology firms; companies such as Intel and Apple chose to list on NASDAQ, and remained there even when they had reached a size that would have permitted a transfer to the New York Stock Exchange.
The growth of the venture capital industry came to a temporary halt in the difficult economic conditions of the mid-1970s. There were only 4 initial public offerings in 1975, raising a meagre $16m, compared to 548 in 1969 raising $1.5bn. The situation was made worse by an increase in capital gains tax and by a change in the treatment of stock options, obliging recipients to pay tax when options were exercised rather than when the stock was sold. At the same time the Employee Retirement Income Security Act of 1974 imposed new rules on pension funds, obliging them to invest with the care of a ‘prudent man’ and thus to avoid high-risk ventures; this was interpreted as a virtual ban on venture capital investments.
Concern about the dearth of capital for new ventures promoted several changes at the end of the decade. Capital gains tax was reduced from 49 1/2 per cent to 28 per cent in 1979, and to 20 per cent in 1981. The Incentive Stock Option Law re-established the earlier practice of deferring the tax liability on holders of stock options to when the shares were sold rather than when the options were exercised. Finally, the Department of Labour ruled that the ‘prudent man’ principle for pension funds was compatible with a greater degree of portfolio diversification, including venture capital. These changes helped to bring about an enlargement of the venture capital industry, with an increasing proportion of its funds coming from pension funds and other institutional investors.[12]
The formal venture capital industry was complemented by business angels, wealthy individuals who provided the initial funding to get new firms off the ground. “Angels are predominantly affluent, self-made men in their forties or older, with graduate degrees, who tend to invest in the industry where they made their money”.[13] They generally expect to be actively involved in the firms they back, either as consultants or board members, and they tended to invest close to home. A well-known example was Mike Markkula, who had worked at Fairchild and Intel and had amassed a considerable fortune when Intel went public in 1971; he provided advice and seed funding to the founders of another Silicon Valley start-up, Apple.[14]
Whether the combination of venture capitalists and business angels provide an adequate flow of capital for start-up firms has been the subject of much debate in the US.[15] Anxieties on this score were particularly acute in the early 1980s, when US industry appeared to be losing ground to German and Japanese competitors, prompting suggestions that government intervention – perhaps even a European-style industrial policy – was needed to promote a faster rate of innovation. One response was the Small Business Innovation Research programme, started in 1982, whereby any Federal agency that had an extramural R & D programme of more than $100m was obliged to allocate a certain percentage of its budget to small businesses; the average SBIR grant fell between $400,000 and $1m.[16]
The SBIR programme, which mainly affected the big Federal spenders on R & D such as the Defence Department, the Department of Health, and the National Science Foundation, was criticised by some observers on the ground that government intervention would distort the capital allocation process; others feared that the SBIR programme would divert funds from what should have been a higher priority, Federal support for basic science in universities. A study carried out in the mid-1990s concluded that the programme (which provided over $6bn to small high-technology firms between 1983 and 1995) did make a difference to firms which received SBIR grants, not least in providing a seal of approval which made it easier to tap other sources of finance.[17] However, the main benefit of the programme had gone to firms operating in those parts of the country – principally California and Massachusetts – which were already well served by private-sector venture capital funds. Public initiatives to provide capital for new firms appeared to have had only a limited economic impact; they complemented private-sector venture capital firms and other agencies that assisted new firms, but could not do much for regions where those mechanisms did not exist.
Another public-private partnership with a similar objective was the Advanced Technology Programme, set up in 1990 under the Trade and Competitiveness Act of 1988. Administered by the Department of Commerce, the ATP provides cost-shared funding to industry “to accelerate the development and broad dissemination of challenging, high-risk technologies that promise broad-based economic benefits for the nation”.[18] Like the SBIR programme, the ATP appears to have supported R & D projects which might otherwise not have gone ahead. An ATP award has a ‘halo’ effect which makes it easier for firms to attract other sources of funding.”[19]
Meanwhile the Small Business Administration has continued to monitor the availability of finance for start-up firms, paying particular attention to business angels. In the mid-1990s there were about 250,000 active angels investing in about 30,000 small firms each year, but this was thought to be well short of the number of firms that needed risk capital to get started. Angel financing suffered from inefficiencies arising from its lack of organisation and high transaction costs. “Deals depended on informal networks, different states had different regulations, and monitoring was expensive”.[20] To deal with these problems the SBA set up an electronic network known as ACE-Net, whereby small corporate offerings could be viewed over the Internet by accredited high net worth investors.
It is clear, then, that throughout the post-war period the US government has taken a close interest in the provision of finance for small business, and for high-technology ventures in particular. This has included direct government contributions through programmes such as SBIR and ATP, and the use of tax and regulatory policies to encourage investors to commit funds to small business. But finance is not the only area where public policy has influenced the environment for high-technology entrepreneurs. Four other areas are also relevant: government procurement; the promotion of competition; support for basic science; and the encouragement of technology transfer between universities and business.
In many of the high-technology industries that have flourished in the US since 1945 government procurement has provided a useful stimulus. The early computer systems were supported by Federal research funds, and the military was the principal customer. Although the main beneficiaries were established office machinery manufacturers such as IBM and Remington Rand, the effect was to widen the market and create opportunities for new entrants. The Federal government was also the biggest customer for traded software; the large domestic market gave American software firms a first-mover advantage which they never lost.[21]
In semiconductors, the surge in innovation that followed the invention of the transistor in 1948 coincided with a growing demand from the Federal government for miniaturised electronic devices. “The market for semiconductors began with the US military, and it was the Cold War that nurtured this industry in its infancy”.[22] The guidance and control systems of the Minute Man missile, and of Project Apollo, were based on integrated circuits, and these programmes were supported by R & D funding from the Department of Defense.[23]
Dependence on the military had some disadvantages. Some historians attribute the decline of American consumer electronics firms in the face of Japanese competition to the industry’s preoccupation with military electronics, causing companies to focus more on performance than on meeting the needs of the consumer market.[24] The invention of the microprocessor, and the consequent growth of the personal computer industry, owed nothing to government procurement. Nevertheless, in other areas defence-related research continued to be important. Thus the Arpanet, the precursor to the commercial internet, was developed in the Defence Department during the 1960s and 1970s. Following partial privatisation in the early 1980s the locus of innovation shifted to the private sector, but the success of American firms in internet-based activities owed a great deal to defence-related programmes in the networking field.[25]
These government programmes were driven by considerations of national security - there was no industrial policy for computers and semiconductors, and no attempt to foster national champions. (Equally, the Defence Department did not ‘pick winners’ but was keen to back a wide range of suppliers, including untried ones.) On the contrary – and this is the second area where public policy was important - the government has sought to curb the power of dominant companies. The antitrust authorities forced American Telephone and Telegraph to license the transistor widely and not to compete as a supplier of semiconductors in the open market (although it could make them for its internal use). Many of the licensees were new entrants to the electronics sector. Another example was the long antitrust suit against IBM, which led to the ‘unbundling’ of its software from the hardware side of the business, thus enlarging the market for independent software providers.
Antitrust policy has been reinforced by deregulation in industries such as telecommunications which had previously been regarded as natural monopolies. The break-up of A T & T in 1984, followed by the Telecommunications Act of 1996, increased competition in voice and data communications, the consequent reduction in local telephone charges facilitated the growth of internet services.[26] Although many of the new entrants in telecommunications did not survive the stock market collapse in 2000, their presence in the market forced incumbents to make themselves more efficient, and contributed to what has been described as the most creative period in the history of telecommunications.[27]
A third contribution from government to the success of high-technology enterprise has been its support for scientific research. Again, this policy was not specifically designed to help entrepreneurial firms, but rather to strengthen the nation’s security or to improve social welfare. Health is the biggest element in Federal research outside defence; in recent years federal spending on health-related research has been roughly equivalent to the entire research budget of the US pharmaceutical industry. Most of this spending is administered by the National Institutes of Health, and carried out either in NIH laboratories or in universities.
In the early post-war decades the principal beneficiaries of government-funded health research were the established pharmaceutical companies, but the revolution in molecular biology which began in the 1970s altered the capabilities that were needed in pharmaceutical innovation, allowing scientist-entrepreneurs to set up specialised biotechnology firms. Because the link between academic science and commercial exploitation is closer in biotechnology than in electronics, the role of government-funded research has been even more important in this sector. “What Bell Labs was to semiconductors in the early 1960s, the National Institutes of Health are to bioscience today”.[28]
American excellence in basic science was a post-1945 phenomenon, stemming in part from the prestige which science and scientists had acquired during the war. But Federal spending on scientific research has reinforced what is probably the single most important source of American success in high-technology industries – a well-funded university system highly responsive to the needs of business.
The starting-point was the expansion of higher education that followed the Morrill Act of 1862. The Act provided each state with federally owned lands as the financial basis for operating state universities, but the states themselves, not the Federal government, were made responsible for the financing and management of these institutions. What emerged over the next few decades was a competitive, decentralised higher education system consisting of state and private universities, which had to demonstrate to their sponsors – state governments in one case, private donors on the other – that they were providing a good service to local industry.[29]
The links with business took a variety of forms, including the introduction of course material that was relevant to the needs of new industries - electrical engineering at the end of the nineteenth century, chemical engineering in the 1920s, and computer science after the second world war. During this later period, as the government stepped up its support for research, the universities generated more patentable inventions, some of which were licensed to industrial firms. Patenting and licensing activity increased during the 1960s and 1970s in response to the growing importance of biomedical research.
Where the research was funded by government, the funding agency retained ownership of the intellectual property; if universities wanted to patent and licence inventions resulting from the research, they had to negotiate with the relevant agency for patent rights. To simplify these arrangements, the Bayh-Dole Act of 1980 transferred the ownership of intellectual property resulting from government-funded research to the universities themselves.[30] The result was to encourage universities to devote more resources to technology transfer, partly as a means of raising revenue; there was a shift from non-exclusive to exclusive licences, and a greater willingness by universities to take equity stakes in spin-out firms. While the Act did not greatly affect the licensing activities of universities which were already active, such as Stanford and the University of California, it brought other universities into the field.
Whether the Bayh-Dole Act has significantly increased innovative activity in the US remains an open question; some observers believe that it may even have had a negative effect, causing universities to put too much stress on exclusive licences and thus impeding the free flow of scientific knowledge.[31] That judgement is controversial, but it does underline the need for caution in developing policies to promote technology transfer between academia and business – and in assessing what such policies are likely to achieve.
There is no automatic link between government spending on research, financial incentives for universities to commercialise their intellectual property, and the emergence of fast-growing, science-based companies. The role of Stanford in Silicon Valley is often cited in this connection, but the birth of the semiconductor industry, on which the prosperity of the Valley was based, was not the result of academic research conducted within the university. The story began with the largely fortuitous decision by William Shockley, co-inventor of the transistor at Bell Laboratories, to move from the east to the West Coast and locate his new semiconductor firm in Palo Alto in 1955.[32] Three years later eight of Shockley’s senior engineers, led by Gordon Moore and Robert Noyce, broke away to form Fairchild Semiconductor. Fairchild was the most innovative of the new semiconductor firms, and, by showing how a group of talented engineers could start a new business and make themselves rich, it served as a model for other entrepreneurs. By 1971, 21 out of 23 semiconductor firms based in Silicon Valley were offshoots from Fairchild. Stanford was not directly involved in this process.
According to Gordon Moore, co-founder of Fairchild and Intel, the defining characteristics of Silicon Valley – its business models and its sustained, technology-based growth – “were neither started nor made fundamentally possible” by the presence of the university. Stanford did play an important supporting role in the subsequent growth of the industry, by providing a stream of well-trained scientists and engineers, some of whom were hired by Silicon Valley companies, and by promoting research co-operation with local firms. Moore describes the role of the university in regional high-technology economies “as an economic institution responsive to the manpower and intellectual needs of the marketplace”.[33]
Given the special circumstances which gave rise to the semiconductor industry, it is not surprising that attempts to replicate Silicon Valley in other regions have had only mixed success. Several state governments have sought to foster the creation of high-technology clusters which draw on the special strengths of local universities. In a few cases, such as Research Triangle in North Carolina, which specialises in pharmaceuticals and biotechnology, this approach has worked well.[34] But the experience of other regions has been disappointing. Even if a large number of university-linked start-ups are created, this does not necessarily not do much for the local economy.[35] The biggest contribution to job creation comes from a small number of exceptional firms, such as Fairchild in California or Digital Equipment Corporation in Massachusetts.
Whether such firms emerge in a particular region seems to be partly a matter of luck. Two other necessary conditions are the existence of a technological and market opportunity and the presence of individuals with the managerial and firm-building skills to convert start-up firms into big businesses. As is clear from the histories of the electronics and biotechnology industries which are discussed later in this paper, the US has been well endowed with such individuals, and they have created some very successful companies. Whether this reflects some distinctively American cultural trait, or perhaps greater investment in the training and education of managers, is a matter for speculation. It is possible that, for cultural reasons, more talent is attracted into entrepreneurial activity in the US than in other countries, but culture is not something that lends itself easily to government intervention. The main focus, for countries which want to emulate the US, has to be on institutions and policies. The UK’s efforts in these areas are discussed in the next section.
NOTES
[6] Carl Kaysen and Donald F. Turner Antitrust policy Harvard 1959.
[7] Martin Kenney and Richard Florida Venture capital in Silicon Valley in Martin Kenney (ed) Understanding Silicon Valley Stanford University Press 2000. See also Thomas F. Hellman Venture capitalists, the coaches of Silicon Valley in Chong-Moon Lee, William F. Miller, Marguerite Gong Hancock and Henry S. Rowen (eds) The Silicon Valley Edge Stanford University Press, 2000.
[8] John E. Tilton International diffusion of technology: the case of semiconductors Brookings 1971, p.89
[9] Paul A. Gompers and Josh Lerner What drives venture capital fund raising? National Bureau of Economic Research, Working paper 6906, January 1999.
[10] George W. Fenn, Nellie Liang and Stephen Prowse The economics of the private equity market Federal Reserve System, December 1995.
[11] Mark Ingebretsen NASDAQ, a history of the market that changed the world Forum 2002.
[12] Gompers and Lerner What drives venture capital fundraising?
[13] John Freear, Jeffrey E. Sohl, and William Wetzel Angles on angels: financing technology-based ventures – a historical perspective Venture Capital, Vol 4, No 4, 2002.
[14] Jim Carlton Apple, the inside story of intrigue, egomania, and business blunders Random House, 1997
[15] Joshua Lerner ‘Angel’ financing and public policy: an overview Journal of Banking and Finance, Vol 22, 1998, pp.773-783.
[16] Charles W. Wessner (ed) The Small Business Innovation Research Programme, challenges and opportunities National Academy Press, 1999.
[17] Josh Lerner The government as venture capitalist: the long-run impact of the SBIR program National Bureau of Economic Research, Working Paper 5753, September 1996.
[18] Charles W. Wessner The Advanced Technology Programme: assessing outcomes National Academy Press, 2001.
[19] Maryann P. Feldman and Maryellen R. Kelley Leveraging research and development: assessing the impact of the US Advanced Technology Programme Small Business Economics, Vol 20, pp.153-165, 2003.
[20] Zoltan J. Acs and Fred A.Tarpley The angel capital electronic network (ACE-Net) Journal of Banking and Finance, Vol 22, 1998, pp.793-797.
[21] David C. Mowery The computer software industry in David C. Mowery and Richard R. Nelson (eds) Sources of industrial leadership Cambridge 1999.
[22] R. N. Langlois and W. E. Steinmueller (eds) The evolution of competitive advantage in the worldwide semiconductor industry in Mowery and Nelson (eds) Sources of industrial leadership.
[23] Richard N. Langlois et al Microelectronics: an industry in transition Unwin Hyman 1988, p.152.
[24] David A. Hounshell The evolution of industrial research in the United States in Richard S. Rosenbloom and William J. Spencer (eds) Engines of innovation Harvard 1996.
[25] David C. Mowery and Timothy Simcoe Is the Internet a US invention? An economic and technological history of computer networking Research Policy, Vol 31, 2002, pp.1369-1387.
[26] Mowery and Simcoe Is the Internet a US invention?
[27] Eli M. Noam Entrepreneurship and government in telecommunications in Hart (ed) The emergence of entrepreneurship policy.
[28] Gordon E. Moore Some personal perspectives on research in the semiconductor industry in Rosenbloom and Spencer (eds) Engines of innovation.
[29] Nathan Rosenberg America’s entrepreneurial universities in Hart (ed) The emergence of entrepreneurship policy.
[30] For a critical account of the Bayh-Dole Act and its consequences, see David C. Mowery, Richard R. Nelson, Bhaven N. Sampat and Arvids A. Ziedonis Ivory tower and industrial innovation: university-industry technology transfer before and after the Bayh-Dole Act in the United States Stanford 2004.
[31] Mowery et al Ivory tower and industrial innovation.
[32] Timothy J. Sturgeon How Silicon Valley came to be in Kenney (ed) Understanding Silicon Valley.
[33] Gordon Moore and Kevin Davis Learning the Silicon Valley way in Timothy Bresnahan and Alfonso Gambardella (eds) Building high-tech clusters: Silicon Valley and beyond Cambridge 2004.
[34] For an account of the growth and creation of Research Triangle, see Albert N. Link and John T. Scott The growth of Research Triangle Park Small Business Economics, Vol 20, 2003, pp.167-175
[35] Anne S. Miner, Dale T. Eesley, Michael Devaughn and Thekla Rura-Polley The magic beanstalk vision: commercialising university inventions and research in Claudia Bird Schoonhoven and Elaine Romanelli (eds) The entrepreneurship dynamic Stanford 2001.
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