Entrepreneur Corner

America’s innovation engine is out of gas. Much has been written about the problem, but no one has addressed the major missing piece: the role of the corporation.

American corporations have been slashing internal long-term research and development spending for decades, and, more recently, investments in venture capital-backed startups. To turn this situation around, they must re-invest aggressively in venture capital and rely far more on leading-edge startups for outside R&D.

Consider, for example, the fall of General Motors. Once the biggest industrial company in the world, it is now the beleaguered ward of the U.S. government. If it had removed its blinders and realized it could no longer pursue a business model based on the now-defunct concept of cheap energy, it might have invested in, say, Tesla Motors, the prominent San Carlos-based maker of all-electric vehicles. Perhaps its fate could have been averted.

There has been a significant and sustained reduction in the role of major U.S. corporations in American innovation for three decades. There was a time when AT&T’s Bell Labs, IBM’s Watson Labs and XEROX PARC were engines of invention and the envy of the developed world.

In 1981, U.S corporations with more than 25,000 employees represented approximately 70 percent of the investment in industrial innovation in the United States, according to the National Science Foundation. By 2006, that figure plummeted to 37 percent.

Fortunately, a new model of U.S. innovation has emerged to pick up the slack. Backed by venture capitalists, and in partnership with major university research centers, the world’s best and brightest engineers and scientists demonstrated that they could out-innovate the legendary corporate labs of the past. These startups proved that risk-oriented entrepreneurs, rewarded commensurately for success, could redefine an economy.

As corporate R&D took a dive, small companies increased their investment in this area from 10 percent of U.S. R&D to almost 40 percent. In fact, public companies that were originally venture capital-backed today represent 17.5 percent of the U.S. GDP and have created more than 12 million high-paying jobs in the last 30 years.

But the majority of corporate investments in venture capital have since declined sharply. Corporations have shied away from VC investing because it’s a long-term commitment and does not mix well with shorter-term corporate planning, nor with Wall Street’s insistence on predictable quarterly earnings.

To be fair, not all corporations have cut back on their venture investing. The most notable exception is Intel — long the corporate icon of corporate venture capital. When Intel fell on hard times late last year, the chip giant responded appropriately by closing older factories and cutting thousands of jobs. Intel Capital, however, made 169 investments totaling $1.6 billion last year, and firm president Arvind Sodhani sees no signs of an impending investment slowdown.

“We continue to do what we’ve always done, which is fostering innovation and entrepreneurship throughout the world,” Sodhani said in a recent interview in Venture Capital Dispatch. “We’re still very active in China, India, parts of Latin America and in Central Europe. We are a persistent and consistent investor.”

This is how market leadership is developed and sustained in a global economy driven by innovation. The problem is that Intel is the exception. Boeing, for example, had investments in 25 venture capital firms worldwide, but then sold its portfolio. AT&T announced a $1 billion fund during the dot-com boom, but later reduced the fund substantially. General Electric’s GE Capital also created a fund during the bubble but eventually bailed.

After a lag, GE announced the creation of another venture fund, but it appears to be in jeopardy once again because GE Capital, the home of the fund, provided nearly half of all of GE’s profits. Today, it’s the source of GE’s greatest losses, and CEO Jeff Immelt recently said his company needed “to get back to basics” and focus more on manufacturing and infrastructure and less on financial services and related areas.

Such capricious investment behavior is highly unfortunate because corporations have customers with expectations of continual, reliable and predictable innovation — expectations that must be met. Corporations simply don’t have the luxury of not being in the business of innovation, and that requires steady and consistent investment.

Unfortunately, corporate interest in venture capital investing has largely followed the ups and downs of the stock market, precisely the opposite of a sage investment approach. Corporate investment in venture capital, for example, skyrocketed during the 1999 and 2000 dot-com bubble. It then plummeted until 2006, largely because of the dot-com bust. Corporate interest bounced back a bit in 2007 when the market saw its best performance in years, but trailed off again in tandem with the market.

This misguided corporate herd mentality is dangerous. Notwithstanding individual circumstances, the fact is that corporations simply must return to the venture game, and the time is now. For all the strength of their brands, distribution networks and extensive customer relationships, their future viability will increasingly rely on the startups of Silicon Valley and their cousins elsewhere. Amid a deep recession and fierce global competition, U.S. corporations are in no position to return to the halcyon era of internal R&D spending. They must rely on partnerships with startups.

Of course, heightened corporate investment in venture capital funds and venture-backed startups will not solve all of America’s technology investment problems. Among other things, there must also be a proactive government effort to attract and retain the world’s best technology talent to work at leading-edge domestic startups.

Yet leveraging the top-flight innovation that is ubiquitous in venture capital circles is the most overlooked opportunity to address the deterioration in American R&D. U.S. corporations must rise to the occasion and help restore the luster of venture capital and America’s technological moxie.

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