Are a few dozen SBIR mills sucking the air out of small business innovation?

Wrote a SBIR blog. Then the DOD and members of Congress reached out, asked questions, and were all supportive. So let’s dig deeper and focus on the elephant in the room - SBIR mills.

Note: Without rehashing the prior post, I covered some issues with the DOD SBIR process from the vantage point of emerging tech companies and defense investors. I went light on the companies that are taking a large portion of DOD SBIR dollars, known as “SBIR mills.” I didn’t have all the data, and I was 100% confident that many of these companies provide some services the DOD wants or needs in some capacity. So why cast stones at them? Unfortunately, I have the data now and I can’t unsee this trainwreck.

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TL;DR:

Taxpayers, small businesses, defense investors, and military operators have reason to be annoyed, concerned, and/or furious. A small group of companies — “SBIR mills” — consume hundreds of millions of non-dilutive dollars each year and raise questions of innovation versus entitlement. To be specific, the top 20 SBIR mills and their histories of DOD of contracts, have received $7.4B in total DOD funding, with $3.4B or 46% coming from Phase I/II contracts. Someone recently said to me that SBIR mills are anecdotes for politicians, $3.4B to 20 companies is not an anecdote, it’s a problem.

To make matters worse, the success rate of these investments (Phase III and beyond) is hard to track but all indicators say it is abysmal. Money is being wasted and capabilities are not being fielded — the men and women in the field deserve better. The situation is bad enough to demand more oversight and reform on SBIR mills highly dependent on SBIR dollars and/or question the purpose of the entire SBIR process itself.

However, SBIR as a program has incredible potential to be the accelerant for new business and rapidly transitioning technological advancements for years to come. A few policy changes should be considered to drastically increase the pool of companies participating in the DOD SBIR program and strengthen the bond between the emerging tech community, defense investors, and the DOD.  

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There you go. There you go.

Follow the money

Let’s start by exploring and defining SBIR mills on a few dimensions, see where the money is going, and scope the size of the problem. A fairly conservative approach would put the estimate of SBIR dollars each year awarded to SBIR mills at $300M. To put that in perspective, that’s about 30% of all SBIR dollars each year and is over two times the annual In-Q-Tel investment/operating budget and close to four times the DIU operating budget. That’s a lot of cheese.

The table below is a pull from FDPS and the SBIR contract databases and is a snapshot of 20 SBIR mills dating back to their first contracts with the DOD. The columns show the total DOD contracts, total SBIR dollars awarded, total dollars awarded in recent years, and the percentage of total contracts from SBIR awards. This gives us a better perspective of a company’s dependency on the SBIR awards — past and present. For the purposes of this article, let’s categorize SBIR mills into three varieties: SBIR-dependents, graduated mills, and what-the-heck mills.

Note: The timeframe of first two columns is total contract history per company (some span back 20 years), the third column is ‘15-21 to show recency.

SBIR - dependents - Almost all companies on this table fall into this category, Intelligent Automation is highlighted in red. With $362M of total DOD contracts, 72% of the money comes from Phase I/II contracts. Ooof.

They are not alone, dozens of companies have received tens to hundreds of millions of dollars Phase I/II dollars from the DOD. At some point, these companies should be less dependent on the SBIR process, and yet Phase I/II SBIRs range from 36 - 72% of their overall DOD contracts. This begs the questions:

• How much is enough?

• How many years in a row should be acceptable?

• Should some of this money come from Operations & Maintenance dollars?

• What was the real success rate of these investments?

Not necessarily the best use of dollars

Graduated mills - Another interesting discussion arises when looking at companies like UES Inc (green). On a relative scale, they currently aren’t the worst offender, but they’ve also been awarded a large amount of DOD money overall. One argument is that they should be able to compete for new innovation dollars as long as they are innovating. The other argument, if part of innovation is to seed the growth of the overall DOD industrial base, this seed is now giant redwood. The question to ask here is: what defines a small business, and when should it be disqualified from receiving SBIR awards?

And last but not least, the what-the-heck mills!

What-the-heck mills: These are mills that kinda just make you gasp a bit. Why? Some of the “small businesses” being awarded large amounts of DOD SBIR dollars are — in fact — publicly traded companies. Let’s look at Luna Innovations Incorporated (NASDAQ: LUNA). From 2009-2021:

• Luna received $165M from 1200 Phase I and Phase II contracts

• 30% of Luna’s revenue comes from Phase I and Phase II contracts

• 71% of all Luna’s DOD revenue came from Phase I and Phase II contracts

• Identified Phase III contracts represent less than 1% of company revenue

Without any criticism of Luna’s product offering, it is more than fair to question the role of publicly traded companies as benefactors of so many small, exploratory contracts. One-off corporate subsidizations are called bailouts, perpetual subsidizations are corporate entitlement programs.

The community can make progress together.

What can be done?

Here are some suggestions to consider moving forward to address the mills.

1. Implement an 8/4/2 policy that would limit the annual number of Phase Is, IIs, and STRATFI/TACFIs (post-Phase II awards) that any company can receive to 8, 4, and 2, respectively. This will free up roughly $200M a year — $30M in Phase I and $170 in Phase II respectively — for hundreds of other companies, submissions, or bigger bets. Moreover, it would force SBIR mills and DOD personnel to focus on transitioning Phase I and IIs to Phase IIIs, rather than lighting additional cash on fire with hundreds of dead-end projects.

2. Add accountability. Phase III awards are not always reported well, but the median Phase III contribution from the companies listed above was less than 5% of their total dollars. Simply put, the SBIR mills are a bridge to nowhere. DIU and IQT combined budgets are less than the SBIR mills are siphoning off, and DIU/IQT have extensive accountability, actively track investments, and report conversions on programs and success. In the final post, I’ll talk a lot more about how to put all of these organizations and their results into perspective.

3. More open topics! While I’m still working through data on this, recent work suggests that Open Topics (championed by AFWERX) greatly increase the number of new companies engaging with the SBIR process. This is a good thing, but the DOD will still need to figure out paths for companies to move to Phase II/III and to track outcomes like the rest of the SBIR program.

4. Use other money to support the mills’ activities. Many of these companies are likely helping the DOD with some of their efforts. Yet it’s fair to question whether the perpetual nature of SBIRs mills should be linked to innovation funds or at some point, transition to O&M dollars. Notional example -- if an organization is geographically located near an Air Force MAJCOM, it is undoubtedly a useful and convenient partner doing work that is important to that particular organization. However, it’s unclear that SBIR projects sponsored by the MAJCOM fuel the intent of the program overall, and it’s quite possible that other O&M dollars could have been used.

5. Finally, do not cut the above funds from the overall budget! With shifting market conditions and geopolitical events unfolding, the DOD and Silicon Valley could draw closer than they have been for decades. To be more explicit, the war in Ukraine is demonstrating opportunities and weaknesses in our own military platforms; we will need to adjust accordingly. Couple that with the need for technology companies to weather market conditions and become profitable sooner — the DOD will be even more attractive to reach these goals. Both sides are aligned, let’s make it happen.

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If you’re still reading this, thank you! There’s one article left in the series; it will focus on how we got here and what an ignorant tech guy would like to see to overhaul our thinking on SBIRs and the path to overall defense acquisition reform.

Please feel free to reach out with questions, feedback, or concerns. I don’t really do the Twitter/LI takedowns, especially when talking about defense acquisition as that feels a bit too nerdy, but am happy to engage IRL to make improvements and learn more.

Thank you to Alex and Amanda Bresler for helping me pull the FDPS data and to the wonderfully talented @samlauj for the amazing illustration.