Commentaries from founder Kenan Sahin

May 5, 2017

Alarming Failure Rate of Innovation-Seeded Startups. Why? And Why the TIAX / CAMX Power Technology / Business Model Helps

I want to highlight why in 2002 I positioned TIAX and later CAMX Power to be a way station to take early-stage technologies and mature them to be IP-protected, derisked, and scaled-up or scale-up ready, for established companies to acquire/license to produce and sell.

Innovation Backlog Growing
In 2004, I published an article in the MIT Technology Review asserting a contrarian view that in the US the glaring issue was not lack of innovation, but lack of implementation. Indeed, the innovation engines in the US such as universities, research hospitals, startups and national labs were churning out innovations and inventions at an ever-accelerating pace. Yet the pathways to conversion into sustainable products and services seemed clogged then, and are even more clogged now, with first the bust and then the Great Recession shrinking conversion channels.  Worse, the “conversion capacity” of the system arguably was and continues to be too small a fraction of the “inflow” from the engines of innovation and invention.

The result is a surplus of innovations, with vast numbers of potentially important advances being warehoused or shelved. This situation is alarming enough in itself, but even more worrisome is the fact that innovations don’t have an unlimited shelf life: they are perishable and risk becoming unusable when the people associated with them move on to other endeavors. Another reason for concern is that warehoused innovations remain untested and deprived of the iterative improvements so critical to their journey from inception to implementation.
In the decades following WWII, big companies took on massive research and development (R&D) and the Federal government sponsored extensive R&D through its national labs and through universities. A plethora of amazing products emerged that continue to shape our lives today including the computer, the Internet, and GPS. Since the late 70’s however, in the era of so-called “rightsizing” (i.e., downsizing), corporate R&D has been hit hard. Instead, small companies took up the task of R&D, with the rapid emergence of venture capital as well as innovative government programs like the Small Business Innovation Research (SBIR) grants that funded R&D and left the IP with the small company to commercialize. Many small companies so sponsored grew into giants.  When the Telecommunications Act of 1995 was passed breaking the hold of big companies, suddenly a huge number of small companies found markets, which ultimately led to the boom.  Despite the subsequent bust, many technologies that emerged in the 90’s carried on to this century, leading to such giants as Google, Facebook, Uber, etc.

Has the blooming of the 90’s come back? There might be the impression that it is, given the huge successes and “unicorns” in the IT domain. Innovation and entrepreneurship are still in great vogue especially with research universities really pushing both aggressively.

Unfortunately, the numbers tell a different and a disconcerting story. Let’s first examine the assertion that the innovation engines are churning out more than ever. One proxy of that is the number of patent applications -- which is a better measure of innovations/inventions activity than the actual patents granted. According to the US Patent and Trademark Office, in 1996 there were 106,000 applications of US origin, in 2000 the count was 165,000, and by 2015 it had increased to 288,000.  That is very good.  By rough modeling, it appears that about half the applications are from small businesses and research universities—supportive of our assertions.

Small companies are viewed as the carriers of innovations into markets, and rightly so. What is happening to them? What is their success rate?

There are many assertions or myths. One is that 1 out of 10 succeeds. While good numbers are a little hard to find, one can glean some trends from macro data. According to Kaiser Foundation reports, in 2012 there were about 5 million firms with 50 or fewer employees and 1.7 million firms with 50 or more employees.  According to Kaufman Foundation reports, about 500,000 companies with employees are founded each year. If the success rate were 10%, one would expect the under-50-employee company count to grow, and then about 10% of the base of 5 million companies to “graduate” to the next bracket. But then the next bracket (50 employees and above) should grow substantially.
According to the Kaiser Foundation report, however, in 2015 the below-50 and above-50 counts were about the same as they were in 2012, meaning almost no change over that time period. The implications are disconcerting, namely that as many small companies fail as there are new companies founded. Small Business Administration data support this. One conclusion is that the success rate might be far, far less than 10%, maybe 1% and maybe even 0.1%.  

Is there another way of assessing the picture? Let’s look at a key metric of presumed success of innovative companies, which presumably attract venture or outside capital. An important aspiration and path to success is an IPO. Let’s make a rough estimate that only 10% of start-ups get outside capital.  Given the Kaufman Foundation findings that there are about 500,000 start-ups each year, then every year 50,000 companies would be funded. Over the period 1990 to 2000, there was an average of 300 IPOs a year in all fields (not just technology), according to Kaufman Foundation reports. That is less than 0.1% for a presumed base of 50,000. Unfortunately, small as that number is, in the period 2001 to 2011 the average IPO count dropped to 90 per year.  

Even with this small number of IPOs, over a 20 year period from 1990 to 2010 one would expect the number of listed companies to grow. If one assumes a blended average of 200 per year, there should have been around 4,000 additions to listed companies over two decades. Not so. In fact, according to National Bureau of Economic Research, the number of listed companies (NASDAQ plus NYSE) declined from 8,000 in 1996 to about 4,000 in 2012—a net loss of 4,000 instead of a net gain of 4,000. Some of this decrease would be explainable by mergers and acquisitions, but there were not 8,000 of them.

Another path to success is the acquisition of small companies by big companies. My rough examination of that path is not very encouraging either.  My overall conclusion is that the success rate of startups best described as joining the ranks of mid-sized companies in 5 to 10 years, and with their founders being financially rewarded, is probably less than 0.1% or less than 1 out of 1000.

An important question is: what happens to the companies that don’t make it?  In another blog, I will address that, but here I want to move to my key points.

The Innovation to Implementation Pipeline
The above suggests that the innovation backlog is growing, leading many innovations to be “warehoused” and doomed to slowly perish.  What a huge waste.

More alarmingly, of those inventions/innovations that do receive funding and enter the pipeline, vast numbers perish along the way. In fact, it is not a pipeline of the ordinary kind.  It is a huge funnel that is very leaky. As the innovations pulled in move along, a lot of them are just leaked or pushed out with only a small fraction making it to the other end – an even a greater waste of innovations but now also a waste of vast sums of capital as well as vast amount of human capital.  Unlike the myth in Silicon Valley, failures do scar people and some never recover.

Valley of Death and Green Valleys
There is much talk of the “valley of death” where many start-ups perish.  There is much truth to that.  Taking a raw innovation all the way to implementation is worse than crossing a vast desert with no water.

Unfortunately, even when the crossing is achieved, success can still be very elusive. I call that “death in the Green Valley.” Let me highlight two big dangers. First is the way potential buyers of innovations at the end of the journey talk: with mixed messages.  They praise innovative products but they really want implemented products that are substantially derisked, e.g. with clearly visible revenue potential such as paying customers.  That is a tough order.  

There is even a bigger danger lurking in the Green Valley: the natives.  Those who have reached success early on, often do not welcome the newcomers. For instance, the once-small technology companies who made it (Facebook, Apple, Google, etc.) do not necessarily tolerate small innovative companies and sometimes just extinguish them if there is any threat. Those who were once the challengers now become fierce defenders of their ever-growing turf.

The situation is vastly exacerbated since 2000 because almost in every industry segment there is consolidation – or the market leaders never let competition in in the first place.  In many sectors, two to four companies account for maybe 80% of revenues.

The shrinkage of listed companies from 8,000 to 4,000 is a stark indicator of this concentration. Even more telling is the oligopolistic increase in corporate profits. In 2000 they totaled $400 billion. In 2007, just before the Great Recession, the number reached $1.3 trillion.  In 2009, during the Great Recession, they dropped to $700 billion but quickly recovered.  Now corporate profits are at an all-time high of $1.8 trillion, or almost five times the level in 2000.  That is 500% growth in total profit in just 15 years – with half as many companies.

So the natives, using their vast financial resources have now erected huge barriers to entry. Crossing the Valley of Death is dangerous.  But the Green Valley yonder might be even more so.

The TIAX/CAMX Power Technology/Business Model
Based on several decades of business experience in technology and my prior academic experience, I had pretty much reached the conclusions above in 2002. When I started TIAX and had the good fortune of rapidly hiring extraordinarily talented staff with deep technological knowledge, I wanted to do my share in helping to deal with the innovation backlog and death in the green valleys. Hence the model to take early-stage technologies, maturing them to be production ready and, taking advantage of my extensive network of executives, introducing these almost production ready implementations to them. The work is still going with partial success.  Much more lies ahead. My expanding mission is to encourage the formation of more companies like TIAX, but with different financing models.

In a subsequent blog, I will discuss why I focused on electric vehicles and in particular lithium ion batteries, and hence CAMX Power.