Pentagon R&D spending skyrockets

(FSB Online) -- What does the "war on terror" mean for America's small businesses? A government report, released Wednesday, said that military operations related to the war could add as much as $1.7 trillion by the year 2017 to the hundreds of billions we already spend on defense.

Much of that money would have to be borrowed, driving up the costs of credit and making it harder for new businesses to grow. And on the receiving end, much of this spending - the purchases of Humvees, boots, and weapons - tends to go to a handful of giant contractors.

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For technologically innovative small businesses, however, the outlook is brighter. The Pentagon's Small Business Innovation Research (SBIR) program, which has grown 77% since 9/11, offers seed funding for entrepreneurs who create new tools for the military.

The program gives out slightly more than a billion dollars a year, often in increments of less than $100,000. But its true economic impact is much greater. When a project succeeds, the military is first in line as a customer, often spending tens of millions to deploy a new technology quickly on a vast scale.

The Pentagon has other programs designed to steer government buyers to small business vendors of everything from potatoes to aircraft components. Those efforts often prove costly because they reduce economies of scale.

But when it comes to innovation, small players are often the perfect place to look: nimble, passionate, and able to focus on niche projects that might get lost inside the bureaucracy of a large defense contractor.

Anthony Martoccia, who runs the Pentagon's Office of Small Business Programs, which includes SBIR, acknowledges that many of his unit's programs spring from a desire to give smaller firms a place at the table. But SBIR, he announced in a July press release, is all self-interest, "focusing the talents of small business on the needs of our warfighter."

Four times a year, SBIR publishes a mammoth list of defense-related technologies that it wishes some small business would develop. Reading through the list, which is hundreds of pages long, feels like a visit to the set of a near-future action movie.

The Air Force wants an unmanned aerial vehicle whose wings can change shape in mid-flight. The Marines want technology to warn distracted soldiers about distant snipers - before the snipers shoot. The Navy wants a high-powered laser for anti-submarine warfare. And the Army wants sensors that can draw a real-time, 3D map of a building as soldiers are running through it. In each case, the requests include pointers to relevant research, a description of the imagined military use, and speculation about how the technology might be used in non-military settings.

Sometimes, the uses are obvious. Take HemCon, a Portland, Oregon-based biotech startup that FSB spotlighted last year. In March of 2002, the firm received a $300,000 SBIR grant to develop a new, stronger adhesive bandage that could quickly stop battlefield wounds from bleeding. With soldiers' lives on the line, HemCon went to work at a breakneck pace.

Eight months later, HemCon's bandage sped through FDA approval, and the Pentagon immediately began buying in bulk. In 2007 alone, HemCon is on track to sell about $30 million worth of bandages to the military.

"From the very beginning, HemCon's basic ability to survive has been the direct result of government contracts," says Mike Williams, the company's vice-president of finance. "We wouldn't be where we're at today without the Department of Defense."

Focusing on the non-military market from the start can be good business strategy. "We don't want to be an SBIR house, which is what people in our field call companies that only pursue SBIR grants. We only choose ones that are in-line with our business plan for both technology and commercial use," says Dean Wormell, director of application marketing at InterSense, a maker of motion-tracking tools in Bedford, Mass.

The company's technology can be found in precision flight simulators, but it also sells a vest that will analyze the wearer's golf swing.

The program doesn't stop participants from commercializing their work - in fact, it encourages commercialization, letting companies keep the proceeds. "It's our hope that by 2009, less than half of our revenues will come from the military," says Williams. "And if peace were to break out tomorrow, then we'd concentrate on the commercial market."

The projects aren't all home runs, but a surprising number turn out to be successful. According to a recent National Research Council study, half of the small businesses that participate succeed in creating new products for either military or civilian use.

Examples so far have included night vision goggles that offer a wider field of view, a more water-efficient washing machine, and even a modular armor system that uses velcro to attach protective ceramics to military vehicles in the field.

Velcro armor might not be on its way to your local mall. But it is notoriously difficult to foresee the future trajectory of a present-day innovation. Let's say we asked the budget analysts behind Wednesday's gloomy war cost figures to gauge the amount of wealth that Pentagon-funded research has generated over the years. Their findings would no doubt be distributed, just like this article, over a global computer network that began its life as a far-out defense research project. - With additional reporting by Ingrid Tharasook