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Strategic Management of Technological Innovation Melissa Schilling

Chapter 7 CHOOSING INNOVATION PROJECTS

Boeing s Sonic CruiserBoeing was developing a new midsized jet, the Sonic Cruiser, which would travel 15-20% faster than existing commercial jets. It was expected to cost $10 billion to develop. However, in 2002 air ticket sales were down, several airlines faced bankruptcy, and aircraft were put into storage to reduce capacity.Despite this, Boeing forecasted that the worldwide aircraft fleet would double by 2021.

Boeing also noted that the company needs to create a new aircraft every 12 to 15 years or else the people with the skills and experience will be either leave the company or retire and the next generation of employees will not have that knowledge passed on to them.2

Boeing s Sonic CruiserThe Sonic Cruiser was scrapped but development of the 787 Dreamliner began and is scheduled to fly in 200950 percent of the primary structure, including the fuselage and wing, will be made of composite materials. This eliminates 1,500 aluminum sheets and 40,000 50,000 fasteners. health-monitoring systems will be incorporated that will allow the airplane to self-monitor and report maintenance requirements to ground-based computer systems.

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The Development BudgetMost firms face serious constraints in capital and other resources they can invest in projects. Firms thus often use capital rationing: they set a fixed R&D budget and rank order projects to support.R&D budget is often a percentage of previous year s sales. Percentage is typically determined through industry benchmarking, or historical benchmarking of firm s performance.

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The Development BudgetR&D Intensity (R&D as a percent of sales) varies considerably across and within industries.Industry Software & Internet Health Computing & Electronics Technology Aerospace & Defense Automotive Industrials Consumer Products Telecom Chemicals & Energy R&D as a Percent of Sales 12.7% 11.2 7.6 4.3 4.1 4.1 2.3 2.1 1.9 1.55

The Development Budget Top 20 Global R&D Spenders, 2004 Microsofts 21% is higher than the 12.7% of the Software 7 Internet industry GMs 3% is below the auto industrys 4.1%Company R&D Expenditures ($billions) $7.8 7.7 7.4 7.0 7.0 6.5 6.2 5.7 5.7 5.2 R&D as percent of sales 21% 15% 4% 4% 4% 3% 7% 7% 6% 11% Company R&D Expenditures ($billions) 5.2 4.8 4.7 4.7 4.6 4.4 4.3 4.2 4.1 4.0 R&D as percent of sales 14% 14% 4% 7% 13% 5% 6% 15% 17% 18%6

Microsoft Pfizer Ford DaimlerChrysler Toyota General Motors Siemens Matsushita Electric IBM Johnson & Johnson

GlaxoSmithKline Intel Volkswagen Sony Nokia Honda Samsung Electronics Novartis Roche Holding Merck

Theory In ActionFinancing New Technology VenturesLarge firms can fund innovation internally; new start-ups must often obtain external financing. In first stages of start-up and growth, entrepreneurs may have to rely on family, friends, and credit cards. Start-ups might be able to obtain some funding from government grants and loans (SBA, DOE, NASA, etc) If idea and management are especially promising, entrepreneur may secure funds from angel investors (typically seed stage and $1 million).In 2005, angel investors funded approximately 50,000 ventures valued at $23.1 billion7

Venture vs Traditional CapitalTraditionalMore fluid Bears lower return Invested based on immediate future Concerned with past performance Loaning bank is creditor and requires collateral

Venture capitalLess fluid Requires high return rate Invested based on longer-run future Concerned with product and market potential Venture capitalist and partner are co-ownersVenture capitalist brings credibility to the company and mentoring

Angel FundingThe angel investor market in the first half of 2007 has shown signs of a small retreat from the growth of the past several years, with total investments of $11.9 billion, a decrease of 6% over the first half of 2006, (Center for Venture Research at the University of New Hampshire http://wsbe.unh.edu/cvr) A total of 24,000 entrepreneurial ventures received angel funding in the first half of 2007, a 2% decline from the first half of 2006. The number of active investors in the first half of 2007 was 140,000 individuals (8% above Q1Q2 2006) though the total dollar size of the market and the number of investments exhibited a slight decline from Q1Q2 2006 Reflecting this trend is the decrease in the average deal size by 4% over the first half of 2006 and an increase (10%) in the number of investors per deal.

Angel Funding Sector Analysis Q1Q2 2007Healthcare services/medical devices/equipment and software remained the sectors of choice, with 22% and 14%, respectively, of total angel investments in the first half of 2007. This was followed closely by biotech at 10%. Electronics/computer hardware, IT services, retail and industrial/energy garnered close to 10% each. The remaining investments were approximately equally weighted across high tech sectors, with each having 3-5% of the total deals.Sector Deals Health 22% Software 14% Biotech 10% Electronics 8% IT Services 7% Retail 6% Industrial/Energy 6%

Angel Funding AnalysisAngels continue to be the largest source of seed and start-up capital in the United States, with 42% of the first half of 2007 angel investments in the seed and start-up stage. This preference for seed and start-up investing is followed closely by post-seed/start-up investments of 48%. While angels are not abandoning seed and start-up investing, it appears that market conditions, the preferences of large formal angel alliances, and a possible slight restructuring of the angel market are resulting in angels engaging in more later-stage investments. This restructuring of the angel market has in turn resulted in fewer dollars available for seed investments, thus exacerbating the capital gap for seed and start-up capital in the US. In the first half of 2007 angels exited their investments primarily through sale of the business (acquisitions by another firm), with 61% of the first half 2007 exits through trade sales. Exits by initial public offerings represented 6% of exits and bankruptcy occurred in 33% of the exits. For all these exits the average rate of return was 30-40% and roughly half (52%) were at a profit.

Venture Capital Funding AnalysisVenture capitalists invested $29.4 billion in 3,813 deals in 2007 marking the highest yearly investment total since 2001.The total invested in 2007 represents a 10.8 percent increase in dollars and a five percent increase in deal volume over 2006. Much of the increase in investments over the prior year can be attributed to record investment levels in the Clean Technology and Life Sciences sectors as well as strong investment levels in Internet-specific companies.

Investments in the fourth quarter of 2007 totaled $7.0 billion in 963 deals, marking the fourth straight quarter with investments totaling more than $7 billion a phenomenon not seen since 2001.

Source http://www.nvca.org/pdf/07Q4MTRelEmbargoFINAL.pdf

VC Sector and Industry AnalysisThe Life Sciences sector (Biotechnology and Medical Device industries together) set an all-time record for venture capital investing in 2007 with $9.1 billion in 862 deals, compared to $7.6 billion going into 786 deals in 2006.The most significant growth was seen in the Medical Device industry, which rose 40% in 2007 to $3.9 billion going into 385 deals. For the year, Life Sciences accounted for 31% of all venture capital invested, which also represents an all-time high. Life Sciences also retained its position as the number one investment sector for 2007.

Software investing remained relatively flat in 2007, consistent with levels over the last five years with $5.3 billion going into 905 deals, compared to $5.1 billion going into 920 deals in 2006.Despite the lack of growth, it still remained the largest single industry category for the year both in terms of deals and dollars, edging out Biotechnology for the top position.

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VC Sector and Industry AnalysisThe Clean Technology sector (alternative energy, pollution and recycling, power supplies and conservation) which represented two of the five biggest deals of the year, experienced significant growth in 2007 with $2.2 billion invested in 201 deals.This investment level represents a 46% growth in dollars and a 57% growth in deal volume over 2006 when $1.5 billion was

invested in 128 companies. Internet-specific companies received $4.6 billion in 748 deals in 2007, an increase of 12% and 8%, respectively, over 2006 when these companies received $4.1 billion in 691 deals.Internet-specific refers to a company whose business model is fundamentally dependent on the Internet, regardless of the company s primary industry category. These companies accounted for 16 percent of all venture capital dollars in 2007, approximately the 14 same percentage as in 2006.

VC Sector and Industry AnalysisThe Media and Entertainment industry saw more venture capital dollars in 2007, with $1.9 billion going into 340 deals compared to 2006 when $1.7 billion went into 318 deals. Other industries that saw increases in deals and dollars during the year include Business Products and Services, Financial Services, IT Services, and Retailing/Distribution. Telecom companies saw a decrease in investment in 2007 with 290 deals receiving $2.1 billion dollars, a drop from the $2.6 billion in 301 deals they captured in 2006. Other industries that experienced declines in deals and dollars in 2007 include Healthcare Services, Semiconductors, and Electronics/Instrumentation.

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Total equity investments into venture-backed companies Q1 2001 Q4 2007

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Most active venture investors 2007The most active venture firms in the