Innovation through "venture capital" in DoD's Working Capital Fund organizations: generating new ideas and turning ideas into revenue - WOF - Entrepreneurs, Innovators

Program Manager, May-June, 2002 by Mark Lewis

"...The last bastion of Soviet-style central planning can be found In Fortune 500 companies--it's called resource allocation."

Gary Hamel

Bringing Silicon Valley Inside

Of the largest 100 firms in the United States a century ago, only a handful exist today in y form. Various fates awaited em on the road to oblivion--mostly bankruptcies and takeovers. Given enough time, successful firms will usually fail because they become irrelevant, their products and services surpassed by far better offerings. They move too slowly to keep up with the market.

The Need Innovation

Peter Drucker, in his article "The Discipline of Innovation," published by Harvard Business Review in 1998, defines innovation as "the effort to create purposeful, focused change in an enterprise's economic or social potential." The history of American business makes it clear that sustained innovation is a prerequisite for an organization's long-term success and its continued existence.

Within the private sector, the language of business is peppered with terminology such as merger, acquisition, and bankruptcy. Within the Federal Government, the counterparts to those terms are reorganization, RIP [Reduction in Force], and BRAC [Base Realignment and Closure]. As in industry, government organizations close shop when there is no demand for their output; it happens at a slower and less dramatic pace than in the private sector, but it happens nonetheless.

Generating new ideas and turning the ideas into revenue is a primary characteristic of firms that stay healthy over decades. The quick pace of technology continues to shorten product life cycles, so faster innovation cycles become increasingly important. A good product pipeline is essential, and companies like Kodak, Digital Equipment, and General Instruments that fall to sustain innovation show the way to insolvency But do government Working Capital Fund (WCF) monopolies (for example, the Naval Undersea Warfare Center, the Defense Logistics Agency and the Air Force Transportation Command) face similar risks of irrelevance? Certainly!

In some of our organizations, more than half of the 1990 workforce is now gone. The trend is outsourcing, where industry designs and develops almost all military platforms and systems, industry funds and conducts a higher percentage of research, and full-service contracting will dramatically reduce the need for government logistics and maintenance personnel. Contractors, not government technical experts, will accompany the warfighters into harm's way. The handwriting is on the wall for many WCF business units, largely because of our inability to innovate and keep up with the private sector.

(The DoD's WCF organizations operate much like private firms, except that turning a profit is not allowed. Through marketing and sales of services, we generate revenues, which in turn pay salaries and other expenses. If revenues drop, expenses must drop by the same amount. This is in contrast to headquarters, program offices, etc., that are "mission funded" directly in the defense budget.)

The illustration on p.__(published in Leading Product Development by Wheelwright and Clark, 1995) depicts the innovation funnel that all organizations must manage to stay competitive over the years. Firms can fall down at any of the stages of innovation, but this article focuses only on "idea generation"--the stage at the mouth of the funnel. Regrettably, It is also a stage at which many large organizations within the Federal Government fall short.

In recognition that our innovation in computing and information technology lags behind the private sector, for example, the Pentagons Director of Force Transformation is floating "venture capital" projects to provide start-up money for technology firms with good ideas. In the parts of the DoD financed by the Working Capital Fund, "venture capital" programs hold much potential to spur ideas internally.

What is Venture Capital?

To be successful, innovation requires not only ideas but also money (i.e., capital) and talent to develop the ideas. Most entrepreneurs cannot finance the business themselves, so they seek capital from a variety of sources. Banks (i.e., commercial lenders) are an important source of start-up financing for new businesses. However, businesses are unlikely to receive bank loans if they lack hard assets (land, buildings, and equipment) for collateral: have large degrees of uncertainty about their future: or will suffer several years of losses prior to earning money.

Venture capitalists accept the high risk of start-ups, but they demand ownership of a large portion of the firms and strict control rights in return for contributing their expertise and a relatively modest amount of money Entrepreneurs often resist these controls, striving to retain ownership at all costs. They often have little choice, however, if their idea is to be incubated and brought to life. Unfortunately great Ideas often make slow progress without outside capital infusions.

Banks tend to approve one-third or one-fourth of loans requested by established companies, but venture capitalists approve only one out a hundred of the proposals presented to them. Of 10 investments made by a venture capitalist, five may be total write-offs, three may be modest successes, one will double the initial investment, and one will return the investment 50- to 100-fold. Making sure you have a big winner is the goal--not making sure there are no losers. This philosophy runs contrary to the DoD's risk-averse culture.