Firm Level Innovation Upgrading

Experience of India S. Korea and World Bank

Melvin Goldman

Seminar on Enhancing Latvian Competitiveness, Riga

June 8-9, 2004

Firm Innovation Requirements

Solve problem in existing product line Raise quality level or adjust to standard Improve existing product or plant Develop new product or process Staff training to absorb or develop new

technology

Sources of Technology

Supplier or Customer--domestic or overseas

In-house Consultants Firm with capability Technology Institution

Learning, Doing, Competing

Elements ofInnovation

Doing Yourself

Bringing in Incentives

People Training Outside advice Education,Tax

Machinery Reverse Engineering

Import Tax, loans

New Knowledge

R&D License, joint or contract R&D

Tax, risk loans….

Problem Solving

Solve in company

Get help Open to competition

Ideas Brainstorming, R&D, Seminars,Tinkering, solving

Cust,supplier,literature, network

Institutions, education

How can TIs work with companies?

It all depends Big or small or new? What sector? How technologically advanced is the

company? Local circumstances?

Eight Economy Research Study

Japan, S. Korea, India, China, Hungary, Canada, Mexico

2049 firms responding, 564 firms interviewed, 157 TIs interviewed

Objective: To determine how firms innovate where they get their tech support and role of TIs and when and how they perform best

Use of Public TIs by Firm-size and in-house lab/department

0

10

20

30

40

50

60

70

80

90

Small (1-50)

Medium(51-350)

Large(531+)

Without in house-labWith in house-lab

* National, regional or local technology institutes, industry association

% o

f re

sp

on

din

g f

irm

s w

hic

h h

ad

us

ed

TI

at

lea

st

on

ce

Use of TI Services by Firm Size( Data excludes Taiwan (China))

0102030405060708090

100

Small (1-50)

Medium(51-350)

Large(351+)

InformationTrainingProblem SolvingContract R&DStandards

% o

f fi

rms

usi

ng

a T

I at

lea

st o

nce

Importance of TI Services by Sector

3.2

3.4

3.6

3.8

4

4.2

4.4

Polymers Autoparts Software Total

InformationEducation &TrainigProblem SolvingContract R&DStandards

Impo

rtan

ce (

1 to

5)

of S

ervi

ces

Successful TIs

Identify their markets and clients.

Are culturally service oriented. Have various ways, formal and informal, for interacting with current and potential clients to serve and determine their need.

Manage and provide incentives, that take account of clients needs, both today’s and tomorrow’s.

Ensure that the quality of people and service match market demand.

Successful TIs(continued) Build feedback mechanisms with clients (e.g. revenue generation

criteria) and technical community (for example, advisory panels for long-term involvement) which ensure that goals are being met.

Give due importance to the confidentiality of clients.

Have various approaches to building new capabilities and learning from others.

TECHNOLOGY INSTITUTIONSBenchmarks: Contracts with clients(Percent of Total Revenues)

0% 10% 50% 75% 90% 100%

Technology-- science base, advance sector most sectors or technologies engineering well-

developedindustry

industrial -- no industry in the country soon well developed manydevelopment (concerned sectors in technology) medium size firms

principal -- R&D and Human Resources multiple, information testing/ services Development to R&D standards/ information

Government Role

Motivate the formation of TIs. Ensure that the structure avoids bureaucratic

management of them--TIs need autonomy and flexibility.

Stimulate industry’s demand for using TIs. Provide limited support to TIs for carrying out more

strategic work. Develop specialized institution for SMEs. Encourage SMEs to demand service.

Tech Support for Small-Scale Enterprises

Results of study: Generally, traditional R&D Institutes work better with sophisticated large firms.

Institutions specializing in support to SSE generally support them best.

How Best to Provide Technological Support for SSE?

Mechanisms of Support for Small Scale Industry:

Questions to be Addressed

Institutional quality in country Level of trust by industry in gov’t and other firms Can institutions attract and keep good people Extent of corruption How to ensure that funding achieves its purpose--eg

consultants will not raise fees.

Question-2 SSI How to pay for operating costs of intermediary?

Overhead charge like Steinbeis Industry Association--India for quality program for members Government

How to motivate SSI to use services--won’t unless dynamic or forced by market

Must find way of attracting good consultants

Institutions must be free of Government interference

MODEL VSystem to provide range of specific and generic expertise

Small Extension in educational

Companies Organization institutions SSI 1

SSI 2

SSI 3

SSI 4

Tech. Center 1

Tech. Center 2

Tech. Center 3

Tech. Center 4

MODEL VIFacilitating particularTechnology Transfer Training

Companies Training Small Industrial Provider

Program Ass. Program

T1

T2

T3

T4

TQM Consulting

ISO 9000Training provider

MODEL VIIJapanese Business Association

Company 1

Company 2

Company 3

Company 4

TemporaryInstitutionBusiness

Association

ForeignTechnology

Provider

Tech.

Transfer

transfer

transfer

transfer

transfer

1. Technology diffusion, extension

Technology diffusion, extension or whatever it may be called should be a more important component of technology activity and support in almost every country

firms need and want it it is cheaper - more efficient - to

provide than developing new technology

2. Government support

Government must support Technology in SSI by stimulating institutional and program development and partially financing it.

3. Type of programs

A range of programs built on the needs of the industrial sector usually provides better coverage and choice for firms.

The variety include:a) generic technology/productivity supportb) industry specific expertisec) institutional sourcesd) private consultant sources

The particular mix will depend on the institutional culture and industrial structure of the country.

4. Cost sharing

Firm should pay a significant share of the cost, but a subsidy is also required.

5. Linkages and competition

Clients should have choices but multiple linkages.

Similarly among institutions and programs.

6. Funding Technology Providers

They require (whether private or public) a portion roughly 1/3 to build expertise, develop new technology access.

Implementation is the Key Outside support can be helpful--institutions to

countries are like technologies to firms: No country has a monopoly of ideas for structuring institutional (and program) arrangements. Outside support can be very useful.

The WB helped India, Korea and Israel in very different ways. In Taiwan, example of reform with returned, experienced expatriates.

Timing of interventions/ reforms is also crucial

Korea’s Innovation System Tax incentive for R&D--since 1973 Technology institutions developed as needed Programs for joint industry-institution R&D KTDC --a WB contribution for financing R&D in

industry VC for start-ups

Korea Technology Development Corp

Institution cleverly built to fit Korean institutional culture

Sensible approach to encourage R&D in industry and growth of small firms

Clever Financial incentives, fund raising Excellent track record for 7/8 years Gradual success led to hubris

weak supervision and financially driven As you well know, must be careful with privatization Too risk averse until privatization

Korea’s not Perfect Tax incentives clever--tax credit this year for

investment in R&D over the next three years-- but didn’t have an impact for nearly 15 years.

More than half of VC for start-ups failed. Underemphasized the difficulty of nurturing start-ups.

KTDC made excellent impact on technology development and had superb track. Then it went from 80% private to 100% private and it lost orientation.

Israel In the early 1970s the World Bank funded the first

financing program to stimulate industrial R&D by the chief Scientist’s office.

This was followed soon thereafter by the creative and hugely successful Bird program to support joint programs of R&D between companies in the US and Israel

Together with the influx of highly trained Soviet scientists and the military culture (like in the US) that spurred technology development, these programs set the base for the rapid growth that facilitated the success of VC during the nineties.

Lesson

It’s always difficult to find the right balance between private and public participation and control or between profit and development motivation.

Project to help Indian firms innovate How to get them to modernize, do more R&D,

and use the available infrastructure? Liberalize technology import; make firm access

easier Promote increased competition Provide appropriate incentives to use technology

infrastructure Build up the capability of the infrastructure to be able

to and desire to work with industry Build up a new form of financing and help to grow

new and young technology intensive companies

Encourage Technology Infrastructure to work with Industry

Strategic business plans Limit automatic budget transfers Incentives--monetary and substantive to

institutions, researchers/staff, and research for contracted work with industry

The SPREAD Program Encourage “sponsored R&D” by firms with any

non-captive outfit Provide “conditional loan” for half the cost Market new instrument Appraise carefully to ensure reasonable

probability of success. Supervise closely Managed by excellent development bank > than 85% success rate

Growing technology companies-- Start-ups and young companies

Equity finance and seed finance Venture Capital Lots of advice--eg. strategy, business

model Lots of hand-holding--eg. Introduce to

banks, recruitment, accounting, problem solving

Ideal Conditions for Venture Capital to Succeed People

Entrepreneurs Technical talent Financial capability Some trained/

experienced private equity investors

Stable Macro and Political Environment

Business environment History of good

business practice Appropriate regulatory

framework--IPR, contract law, courts…

Stock market(s) that works fairly

Exit routes for smaller companies

How does VC Get Going?

It seems to always need a kick-start Need a positive environment for

entrepreneurial endeavor Need an environment favorable to capital

investment Is there a public sector role?

Government Role for building an environment for VC?

Regulatory Framework Effective capital markets Contracts and intellectual property Financial Sector

Encouragement of Venture CapitalPromoting technology developmentGood quality education and training

particularly technical

India--Prognosis for VC in 1988The Advantages Entrepreneurial Lots of good engineers Resources available within big groups Financing available from development and

commercial banks for industrial growth projects Existence of contract law, legal system and 100

year old stock market

India--Prognosis for VC in 1988Issues

Government industry licensing rules stifling Inadequate trading volume of most stocks IPO price determined by MOF Legal system slow, difficult to enforce contracts Entrepreneurs wanted to pass on company to

children--exit difficult Not clear that there were enough good ideas Even software/pharma success stories were not

state-of-the-art; no likely Microsoft

Getting VC Going

ICICI Experimentation World Bank help

6 VC Schemes, 9 funds, total of $180 million for 350 investments

Approved first 5 investments in each fund Regular supervision Internship of 18 vc executives at vcs in US/UK

Regulatory guidelines change to facilitate VC

Creation of new stock markets, training

Initial Experience

Separate Management Companies Experience, risk taking, exit planning Bankers are not good venture capitalists Tax pass through important Average returns must exceed interest rates Threshhold IRRs must be substantially higher

Problems Encountered

Start-ups (and most companies) require: lots of nurturing and hand holding Much more time than anticipated

VC staffing --business skill, industry know-how with resourcefulness, commitment and brains

Staff mobility--Incentives and work environment Due diligence-- must also be done on foreign

partner or provider Exit must be planned

Examples--Early Learning Photovoltaics--Success followed by failure Water filter--Success less than potential Hotel Software--Need strategic partner Shrimp and Flowers--fads, risky, know-how Dosa King--Part of Risk Blast freeze drying for vegetable/fruit export--

advanced process tech--VC role

Changes in VC Climate1990 2000

managementcompanies

public financialinst

foreign JVs

instruments conditionalloans

equity

exit difficult, gov’tcontrol

IPO, buyout

entrepreneur family, longterm

Techno; temporary

industries Every sector,autoparts,consumer…

Software, IT pharma

returns < 10% in $, 20-30% in Rs

Very high some >100%

Results of VC Experience Returns--can be highly profitable Examples and professionalism Growth in demand Range of VC Operations--different cultures IT originally under-invested, then fad, now out of

fashion Huge inflow of foreign VC Becoming an entrepreneur is now the pinnacle of

success Fund availability slowed since late 2000

Key Important lesson New technology companies

take a long time to build into successful companies require constant nurturing need a range of financial support from the VCC in

addition to equity-- low interest loans (with perhaps a royalty kicker), bridge and convertible loans, buy-back provisions

require creative assistance from VCC regarding finances, strategy, marketing, exit, and general support

Stages in India VC Development Herd?

Technology emphasis Quick buck pre-IPO General industry Invest in Silicon Valley Software, Internet, dotcom Beginning to mature

VC’s Key Questions for Investment Decision Does the business proposition make

sense? Can we work with the management? Is the management totally ethical? Does the company have the drive to

grow? Do we have the capability to add value? How and when will we exit?

Sector-wise Distribution of VC and Private Equity Investments 1998 (Rs. [mil])

2956.67

2508.87

1381.49817.48

735.41

718.56

471.89

448.77

426.06229.56

1865.09

Industrial products (24%)

Computer software (20%)

Consumer related (11%)

Medical (7%)

Computer hardware (6%)

Food and Food Processing (6%)

Tel/Communications (4%)

Biotech (4%)

Other Electronics (3%)

Energy related (2%)

Other (15%)

ICICI Software Fund--A success $ 7 million invested in 1996/97 worth about $50

million early 2001. Nine investments Summary of performance-->100% IRR in $

Success Stories

SQL Star: 2 businesses • a) authorized (certified) training centers including Oracle and IBM• b) software services with strong capability in the insurance sector. IPO

after two years. TDICI realized more than double the entire fund for less than ten percent of the fund investment.

Kale Consultants: specializes in work for the airline industry. Has core technology in revenue

sharing among airlines. Sought after by midsize airlines. Flagship account is with Air New Zealand. Second area is banking/financial sector. Successful IPO. Expected to grow rapidly based strong IPR position.

Planet Asia: web services and high end website design. Offshoot of web services of

successful software services company Microland. One half the shares sold back to the company after a little over one year at 2.7 times initial price.

Ruksun: Specializes in internet software development. Contracts with software

product companies, eg Microsoft for email, imap protocol. Second round financing obtained after 18 months at valuation of 23 times the first round investment. Company had strong IPR.

Where Improvement is Needed Screening quickly Management--turnover, incentives, hierarchy Due diligence--international markets and

partner, risk assessment (banking mentality) documentation

Investment phase--Knowing to cut losses, taking control, dealing with troubling cases

Markets--some liquidity for small companies in good times. OTCEI

Basic elements for successful VC--mini-checklist Entrepreneurs with Drive and Know-how Business environment fostering growth Exit Mechanisms that Function Venture capitalists with business/industry

experience who understand start-up prob. Patient and risk taking investors Technical education and R&D

infrastructure

Lessons for Building a VC Industry

For Early Stage Technology VC It should be driven by local institutions and money, though

foreigners and foreign money should be encouraged Government should stimulate VC, not run it

Ensure level playing field for local and foreign money

Financial institutions should initiate and be involved but not be the sole body or run it by themselves

VC should be run by entrepreneurs, risk takers and business developers

Develop Exit Mechanisms• Stock exchange needs to be friendly to SMEs

• encourage buy-backs and buy-outs

Thoughts for Building a Successful VCC

Build overseas links• with VCCs• with expertise in markets and technologies

Gather team with business and domain expertise

Build focused investment strategy based on market needs and your own capabilities

Do not follow herd

Beyond VC There is a need to build new models of equity

and quasi equity hands-on finance for the vast majority of potentially successful companies that will achieve modest IRRs and for which exit is tough: 3Is model with income/dividend earnings Start-up funds with clever buy-back provisions Mix of equity, low-interest loan and royalty--ala Tom

Gibson and GVFL experience

Conclusion

Tailor intervention to environment Find the right leadership and people Continuous, intensive supervision Flexibility together with tenacity

Examples of Success India VC and TI Reform KTDC Establishment and 1980s ITRI Restructuring--Taiwan BIRD and PACT Programs 7 SSI extension/tech diffusion program--including

Indonesia and Philippines Turkey R&D in industry

Some Key Messages Technology improvement occurs in a variety of ways

through many channels Requires the right people Requires continuity and intensive hand-holding and

nurturing Find the right channels and champions Build in flexibility, so you can change course to achieve

objectives when an unexpected event occurs Build in adequate training and TA resources--cheap if

possible, but don’t sacrifice quality