Addressing the Innovation “Valley of Death:” It’s the Products, Stupid!

Opinion

Several articles published in the press this past year have emphasized the importance of technology innovation in creating high-paying jobs and fueling our nation’s economy. Janet Rae-Dupree’s aptly titled New York Times piece, “Innovation Should Mean More Jobs, Not Less,” makes the case that investing in innovative technologies is critical to the future of the United States economy. In their New York Times op-ed columns, Thomas Friedman (“Start Up the Risk-Takers“) and David Brooks (“The Protocol Society“) describe the importance of investing in innovation to stimulate entrepreneurship and job creation. These articles (and many others) reiterate that our country’s leadership position in the global innovation economy is dependent on our sustained investment in research and its translation into innovative products.

Historically, the majority of innovative products (many of which stem from federally funded research) were entirely developed by large, fully integrated corporations. This model was highly successful until the 1970s, when certain business practices were introduced that eventually stifled innovation.

[Editor’s note: This post was adapted from The Distributed Partnering Model, an article co-authored by Pedro Cuatrecasas, an adjunct professor at UC San Diego, published yesterday by the Ewing Marion Kauffman Foundation]

Fortunately in 1980, adoption of the landmark Bayh-Dole Act allowed universities and non-profits to gain ownership of intellectual property (IP) derived from research funded by federal grants. This led to the formation of many start-up companies, which were built around a license for the research-based discoveries and primarily financed by venture capital (VC). During the 1990’s and the early 2000s, this VC start-up model transformed our economy through the creation of major high-tech and life sciences clusters around the US. But over time, the VC model has been increasingly challenging to maintain. It has proven difficult to fund start-up companies and achieve a sustainable and acceptable return on investment based solely on an early stage discovery. As a result, many of these research discoveries reside in the so-called “Valley of Death” because they lack the necessary financial support and skilled management team to progress into the “proof of relevancy” phase. To address this gap, foundations and advocacy groups have stepped in to try to provide funding. However, these investments are generally insufficient to carry these startups to follow-on VC funding.

If this investment gap is not addressed, the US could lose its comparative advantage in commercializing innovative discoveries, which has been the base of our strong economy over the past several decades. Due to increasing global competition, it is imperative that we create a more sustainable investment model that will offer acceptable investor risks and rewards to finance the translation of early research discoveries into commercial products.

A New Approach?

To address this funding challenge, I worked with retired Warner-Lambert pharmaceutical R&D executive Pedro Cuatrecasas to propose a new funding model for innovation, which we call the Distributed Partnering Model. While we explain in our paper how to apply this model to advance life sciences innovation, it can also be applied to high-tech, cleantech, and other technology sectors.

This model emphasizes the importance of advancing the innovative technologies and products— instead of a model that emphasizes building individual companies around each new discovery or invention. In our model, we have identified four independent entities that work collectively to advance innovation—based on the unique assets, skill sets, cultures, and risk tolerance to be applied. Each would have a rational investment risk and reward as a specific innovation gets relayed from one business entity to the next. They are:

Discovery: A research institute that focuses on new discoveries.

Definition: A company that invests in defining the initial product(s) from the research-based discoveries in a given field of expertise.

Development: A company with responsibility for funding and advancing product development.

Delivery: A company with a significant marketing and distribution channel.

Our model is fundamentally different than previous models in that it focuses on these independent groups to collectively contribute to advancing products from research discovery to commercialization. As senior fellow Frank Douglas says in a statement issued by the Kauffman Foundation, “The model focuses on advancing products as opposed to companies. We need thousands of new products, not thousands of new companies.”

There are two key enabling elements of the proposed model: the formation of a new type of company to address the “Valley of Death” bottleneck, called a product definition company (PDC), and a more efficient use of infrastructure and product development expertise provided by professional service providers (PSP). PDCs would focus on translating a portfolio of research discoveries into an early, development stage product. These would be managed by an experienced entrepreneurial team with significant operating experience in a given field. The PDC business model would call for SELLING the product or technology assets to VCs or distribution companies after the initial product definition phase for further product development and, eventually, delivery to the market by distribution companies. Potential PDC investors would include angels, large corporations, VCs, foundations, etc., and investor focus would be on their field of interest and the expertise of the operating team.

Instead of investing in infrastructure, as was the norm for the VC start-up company model, the translational experiments to reach “proof of relevancy” would be contracted to PSPs to perform the key development activities. In this model the PSPs would become a significant force for providing expertise in a given area. Furthermore, by transferring the product development (and technology) to the PSPs, acquirers will not be dependent on the PDC management team for expertise (with perhaps the exception of the project manger). Following acquisition, the product development company could operate in a virtual mode with a small group of key managers by simply continuing to fund the PSPs. Hence the vast majority of investment in this model is focused solely on advancing the product (or technology) rather than on inefficient infrastructure and the associated operating and maintenance costs.

To increase the level of investment in this critical space of product development, we have called on the federal government to consider investing as a limited partner (LP), matching the PDC’s private sector investment with federal dollars. Termed the American Innovation Investment Fund (AIIF), the government would share the fund’s profits as any other LP (typically in the VC model, the LPs receive 80 percent of the profits and the management receives 20 percent). This would allow the federal government an opportunity to earn a significant return and recycle its investments in the next wave of innovations. Government investment criteria could require that a high percentage (~80 percent) of the investments be tied to federal or state funded research and that all investments are pre-VC.

As the PDCs would not require legions of experienced entrepreneurs, this model could work equally well in existing innovation hubs as well as Michigan, Florida, Iowa, or any other region that has high quality research centers funded by the federal or state government. The AIIF could be an economic development activity that truly benefits the entire country.

Why should Government favor investment in early stage science and technology innovation?

The federal government, through its many science and technology related agencies, is already the largest single investor in basic research in the United States. From this research, discoveries are made that lead to better health, increased security and defense, more nutritious food, a cleaner environment, and better communications.

The world’s biggest challenges require technological breakthroughs in these sectors. As a result, these are the areas that should attract the largest investments. By focusing on early stage technology investing we will see major global benefits and economic impact in addition to significant investor returns and significant new job creation. Furthermore, the US is currently the world leader in innovation and our future leadership will increasingly depend on our ability to more efficiently transfer discoveries from research through commercialization.

While modifications of the previous innovation models (fully integrated and VC start-ups) will certainly continue, we believe that the Distributed Partnering Model offers a rational framework for a new approach to risk-adjusted financing of innovation. There are many potential modifications and hybrids of the proposed new model and we have faith that entrepreneurs will certainly add creative dimensions over time.

Our concept of a distributed partnership model is further supported by two very recent articles: In Sunday’s New York Times, op-ed columnist Friedman calls on President Obama to make 2010 the year of “Start-Up America;” and last week, Morgan Stanley analyst Simon Varcoe called on large Pharma to downsize internal research programs in favor of in-licensing.

Duane J. Roth was Chief Executive Officer and board member of CONNECT, the San Diego nonprofit organization that fosters entrepreneurship by catalyzing, accelerating, and supporting technology and life sciences innovation. He founded Alliance Pharmaceutical, and was a longtime life sciences industry executive. Follow @

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