(FORTUNE Magazine) – Kennedy Space Center, Sept. 25, 1997: Standing outside the Launch Control Center, Shelley Harrison peers into the Florida evening sky. Four miles away the space shuttle Atlantis is bathed in a blaze of spotlights that would put Mann's Chinese Theatre in Hollywood to shame. Although Harrison is neither a NASA engineer nor an astronaut's uncle, this launch has his stomach in knots.

The 4.5-million-pound shuttle begins to heave away from gravity's clutches as the rockets' flare lights the horizon like a miniature rising sun. A wave of sound presses Harrison against the building's wall. He stares intently, even after the shuttle is out of sight and all that remains is a plume of smoke that snakes and settles back to earth.

What's brought him here is not concern about problems aboard the Russian space station Mir or advancing science's reach. No, it's money--$15 million, to be precise. That is how much this flight is worth to him. Harrison, you see, is a businessman, the CEO of an upstart company called Spacehab, whose most valuable assets ride aboard the shuttle. Several years back Spacehab figured that it could build pressurized containers for the shuttle more cheaply than the government's procurement experts could themselves. So without a contract from NASA, Spacehab put its own capital to work--and today it is the shuttle's premier supplier of such containers, ringing up profits others missed out on.

Harrison is not alone. As it turns out, there is a nascent revolution in the space business today, fueled not by starry-eyed exploration but by the simple quest for commerce. The traditional basis for space-related business--low-risk cost-plus contracts with the government--is being gently nudged aside by a new breed of entrepreneurs who think of space less as a scientific frontier than as a place to make money.

Plenty of people already profit from space-related businesses, of course--the commercial-satellite and launch-services industries, and traditional NASA suppliers such as Lockheed Martin and Boeing. According to a study sponsored by venture-capital firm SpaceVest and KPMG Peat Marwick, revenues from space are running at $85 billion annually and are projected to grow to $121 billion by 2000. What's surprising, though, is that this capital-intensive area, which has long seemed out of reach for smaller entrepreneurs, has recently become fertile ground for innovative upstarts. In part that's because NASA has begun penalizing suppliers for cost overruns. But it is also because demand for space-related products has reached the point where potential profits are motivating newcomers to fund their own projects, even in the face of competing NASA-subsidized efforts.

"The space market used to be driven by the government," says John McLuckey, head of Boeing's space group. "Now we are seeing a dramatic shift because it is being driven by commercial forces." In fact, in 1996 total industry revenues from the commercial sector exceeded those from the government for the first time ever.

The key factor is huge demand for satellite launches: Motorola plans to include 66 satellites in its Iridium system for mobile phones; Loral Space & Communications' Globalstar project includes 48 birds; and Craig McCaw's Teledesic project aims to create an Internet-in-the-sky with 288 satellites. These projects not only are generating earnings for commercial launchers, but as the bloated expenses of the cost-plus era begin to recede, people's eyes are opening to the potential of space commerce. Many other types of ventures will become economically feasible if the cost of launching satellites and other payloads can be reduced from current levels.

Even Boeing and Lockheed Martin are gradually embracing the new economics of space. But it is the young and scrappy companies--often filled with former NASA officials itching to cash in on their expertise--that are really sparking the change. Companies like Spacehab have no choice but to slash costs because that is the only way they can afford to do business. It is their competitive advantage.

BREAKING THE MOLD

Spacehab actually started as a half-baked idea to fly tourists into space. Founder Bob Citron, who'd had a history in both the travel business and building satellite-tracking stations, soon shifted his focus to more practical alternatives. By the time Harrison took over as chairman in 1993, the company had targeted a clear business opportunity.

It all started with the suspension of space shuttle flights in the wake of the Challenger explosion on Jan. 28, 1986. Without the shuttle flying, a backlog of some 400 experiments stacked up. Spacehab decided it would construct research modules that could expand the effective pressurized space on the shuttle and thus house more experiments. It sounds simple enough: Spacehab saw a need and moved to fill it. But it would be the first company successfully to risk its own capital to build something NASA did not specifically ask for.

Harrison had been on the cutting edge of business once before: In the 1970s he helped found Symbol Technologies, which introduced to the world the hand-held bar-code scanner. At Spacehab he surrounded himself with NASA veterans--two former astronauts and Spacehab President Chet Lee, who was formerly in charge of filling the shuttle's manifest. Still, Spacehab's novel business plan was hardly embraced by the industry. When Harrison visited his cost-plus buddies at large aerospace companies in the early 1990s seeking investment partners and advice, they were skeptical. "We don't take the risk and then look for customers," he recalls being told. "We respond to government requests."

Spacehab saw it differently. In the cost-plus world, suppliers of space hardware typically charge the government whatever it costs to produce their custom-built equipment, plus an 8% to 12% profit. So the more it costs, the more a supplier gets paid. (Though most contracts have evolved to include performance-based penalties or rewards, the cost-plus system remains essentially intact.) In the process, the government requires teams of people who do not add to productivity--civil servants who double- and triple-check every line-item specification, and a contractor's own roving bands of auditors.

Spacehab eliminated those people. In 1990, dangling a price tag of $184 million for modules that could house 200 experiment lockers over the course of six shuttle flights, Spacehab persuaded NASA to become a paying customer. A NASA study calculated that developing the same containers on a cost-plus basis would have run about $1 billion.

Today Spacehab's module is used not only for experiments but also to carry supplies, up to the Russian space station Mir, for instance. (Spacehab is also popular with shuttle crew members: While in orbit, some astronauts prefer to snooze in the module, upright in floating sleeping bags, because it is quieter and less crowded than the crew cabin.) The only competing module, called Spacelab, will be retired next year.

Harrison is pleased for now but doesn't want to rely on a government agency as his sole customer. Last February he had Spacehab buy from Northrop Grumman an outfit called Astrotech that does the final preparation of all commercial satellites in the U.S. for Boeing, Lockheed Martin, and Motorola. In the fiscal year ended last June, Spacehab generated $14 million in profits on revenues of $57 million. Its stock has doubled since January.

THE MAN WHO PUT MEN ON THE MOON

The business of Kistler Aerospace is even more ambitious than Spacehab's: building a cut-rate, reusable launch vehicle that would take satellites into space at a fraction of the current $10,000-per-pound cost. The demand for such a service would be huge--over 2,000 new satellites are tentatively planned for the next decade, says consulting firm Futron; many of them will need to be replaced about every five years. The challenge: Kistler is going head-to-head against the likes of Lockheed Martin and Boeing, with no technological or financial help from NASA. On the other hand, if the company can succeed, it would prove that unsubsidized space entrepreneurs can compete on any level.

Kistler's founders are both Spacehab alumni: Walter Kistler, one of Spacehab's first investors, and Bob Citron himself. They jump-started their new company almost by accident when, in the course of recruiting a board of directors, they visited 76-year-old George Mueller at his home in Santa Barbara. Mueller is the man who put men on the moon: He ran NASA's Apollo program, not to mention Gemini and Saturn and Skylab. He is also considered largely responsible for putting together the space shuttle concept.

When Kistler and Citron approached him in late 1994, Mueller was running a 900-acre jojoba farm. He surprised them by proposing that he become the new company's CEO. He would design the vehicle as long as the two entrepreneurs could guarantee financing. Citron looked at Kistler and said, "If George wants to be CEO, we've got it made."

Considering that the company needed $500 million to get started (to construct two vehicles), it still seemed a long shot. But Citron was right: Landing Mueller persuaded international financier Robert Wang to join as chairman. Before long he raised most of the money. And both Mueller and Wang helped the company attract board members like John McCaw (brother of Craig), T.A. Wilson (CEO of Boeing from 1969 to 1986), and Tony Coelho (former Majority Whip in Congress).

Mueller's senior design team includes the former chief engineers for the Apollo spacecraft, the B-2 bomber, the space shuttle, and the space station. Their plan is to develop a two-stage reusable vehicle that employs existing technologies in new ways. Using Russian workhorse engines that were mothballed for 25 years, their so-called K-1 launch vehicle is supposed to carry 10,000 pounds to orbit at about half the cost of current expendable rockets. Both stages land with parachutes and ungainly airbags. Yet, Loral has already signed a $100 million contract to launch some of its satellites before ever seeing the hardware. The first test flights are expected next year, and Kistler hopes to start offering commercial services in 1999.

Following Spacehab's lead, Kistler is risking its own capital to build space assets for much less than established players think possible. Citron remembers meeting with a Rockwell employee who had been sent to evaluate Kistler's proposed costs and schedule. After making a cursory estimate, the Rockwell man told Citron that the vehicle could not be developed for less than $2 billion. "Sharpen your pencil," Citron told him. "You are off by a factor of four."

THE SLEEPING GIANTS STIR

While Kistler and others approach space business as a do-or-die proposition, Lockheed Martin and Boeing are taking a phased approach. Half pushed by the military and NASA, and half pulled by the same market forces that compel the Kistler crowd, the aerospace giants are slowly but surely coming along. This year space is expected to account for about $7 billion of Lockheed Martin's revenues and $4 billion of Boeing's. Both have at times risked their own investment capital, particularly in developing the current versions of their Atlas and Delta rockets, respectively, for commercial satellite launches. Boeing also invested $100 million in Teledesic, and is helping finance Sea Launch, a project to hurl satellites from a converted oil-rig platform.

Still, neither giant is above taking government handouts. The Air Force, for instance, is footing the bill for the companies to develop prototypes for improved expendable rockets with common elements and fewer moving parts, which should cut launch costs in half. Similarly, NASA is funding almost all of Lockheed's $1 billion development cost for a prototype reusable launch vehicle called the X-33. If it proves successful, the X-33 will be the basis for a slightly more advanced vehicle dubbed VentureStar that could someday replace the shuttle.

That said, the big boys are being coaxed into a new way of doing business. Look at VentureStar, for instance: Despite that $1 billion infusion of development capital, NASA will pay not one penny to build the VentureStar fleet. Instead, Lockheed Martin will have to raise the necessary $5 billion itself--and will operate the fleet privately.

That NASA is willing to give up control of its next spaceship fleet--and has already taken steps toward privatizing the shuttle--is perhaps the greatest indication that a commercial space era is upon us. NASA faces severe budget constraints and does not want to spend any of its $14 billion annual budget running an airline (which the shuttle has effectively become). Last June NASA chief administrator Daniel Goldin told a group of investors in Landsdown, Va.: "Our goal is to get out of the low-orbit business." Today most shuttle operations are already privately managed, by United Space Alliance (USA), a Boeing-Lockheed Martin joint venture.

NASA's other major project is the $60 billion international space station slated to be assembled in orbit between 1998 and 2003. It, too, may become a candidate for privatization. In that same June speech, Goldin stated: "After we get the space station built, we want to hand it over to industry." He hopes that business will defray the costs of the shuttle and station so that NASA can get on with its basic charter of research and exploration, to pursue projects such as sending an armada of unmanned, thinking spacecraft throughout the solar system and beyond.

To free up resources, Goldin is cutting expenses with the zeal of a newly named CEO. USA's contract, for instance, is heavily performance-oriented: The company will split with NASA any savings over a six-year period greater than $400 million. USA says it is already well on the way to surpassing that goal, mostly by consolidating suppliers. With help from Spacehab, USA is also looking for ways to add commercial content to shuttle flights. In order to do that, it needs to find customers other than NASA.

One big stumbling block is that commercial use of the shuttle would require congressional approval. Another problem may be that USA's parents, Lockheed and Boeing, are already in the commercial-launch business and would not relish competition from a subsidiary that neither controls fully.

Those issues won't hamper VentureStar, which is scheduled to start flying around 2005. Says Mel Brashears, who heads Lockheed Martin's space business: "We have no problem with putting more capital at risk and letting market forces decide what happens." That's because VentureStar is a potential replacement not only for the shuttle but also for Lockheed Martin's expendable rockets. It is expected to reduce launch costs to one-tenth of today's rockets, or to about $1,000 per pound.

One of the main reasons launch costs remain in the stratosphere is that, somehow, a new rocket engine has not been developed commercially in the past 25 years. VentureStar's elegant aerospike engine supplied by Boeing's Rocketdyne division solves the problem of needing multiple stages to achieve orbit. The craft will be piloted remotely, and if people ride on it, they will do so only as cargo. As the Lockheed executive overseeing the project--the appropriately named Jerry Rising--says: "VentureStar is simply a truck to low-Earth orbit." Spoken like a true businessman.

NEW BUSINESS FRONTIERS

As it becomes more economical to lift cargo and people into space, new ventures and applications are popping up. Already, Global Positioning Satellite navigators for cars are becoming popular. And Hughes Electronics' DirecTV is the fastest-growing consumer-electronics product in history. Orbital Sciences (which offers commercial launch services) is building and launching its own constellation of 28 satellites that will allow industrial customers to track trucking fleets or monitor flow rates and leaks in long-distance pipelines. Caterpillar, for one, says it plans to use the system to help its dealer network figure out where leased tractors are at any time and when preventive maintenance is necessary.

Remote sensing satellites are another growth area. Space Imaging EOSAT, for example, a spinoff of Lockheed Martin and Raytheon that's devoted to this technology, next year will launch the world's first commercially available satellite that can take pictures with so-called one-meter resolution. Each image will cost 40% less than aerial photos now command. Foreign governments could be large users, and even the U.S. might contract to fill in gaps in its own national security systems.

Remote sensing can also be used to detect changing phytoplankton concentrations on the world's oceans--valuable information for fishing fleets, as well as scientists monitoring global warming--or for precision farming. "If you could fly over a cornfield and put various filters in front of your eye," explains Orbital CEO Dave Thompson, "you could detect certain types of crop stress before it became evident to a person standing right there in the field." In the end, the technology offers new, valuable information: "I think the long-term market is a digital-information market," says Space Imaging CEO John Copple, "something you can deal with on the Internet or CD-ROM."

DRUGS IN SPACE

The biggest single opportunity for new commercial activities in space may lie with the single biggest project under way: the international space station. Once again, the old cost-plus system comes into play here. Boeing, which is putting together the U.S. portion of the station, is already estimating that there will be a $600 million cost overrun. While that will cause the fee Boeing receives to be docked by $40 million, NASA is still obligated to cover the overrun itself. As a result, some components initially planned for the station are falling off the budget.

That's where an enterprising company can come in--to build components on its own. Not surprisingly, Spacehab is already queuing up. A piece of furniture for the space station that originally was a budgeted item is an X-ray crystallography laboratory. Drug companies are desperate to unlock the structure of protein crystals to help them design better drugs, and the near-zero-gravity environment of space lends itself particularly well to such testing. As Spacehab's science director and former astronaut Bernard Harris Jr. explains: "It is easier to get floppy, spaghetti-like molecules to line up in space."

While such experiments are conducted on shuttle flights today, there have been no major breakthroughs because shuttle flights do not last long enough and are too sporadic. Also, existing space-based test labs don't include critical X-ray equipment. Spacehab wants to build X-ray labs for the space station and charge drug companies for their use.

Harrison sees other opportunities in the space station as well. Spacehab's investors and partners include the major corporations building parts of the station for other countries: Mitsubishi in Japan, Daimler-Benz Aerospace in Germany, Rocket Space Corp. Energia in Russia, and Alenia in Italy. These alliances position Spacehab to participate in any future commercially developed add-ons such as, say, extra storage facilities or even a sick bay. "Some day," dreams Harrison, "people will look up at that space station and see blocks that say Spacehab." If so, it will be like a beckoning neon sign flashing: OPEN FOR BUSINESS.