The Cycle Of Green Innovation

Big Green

A new Center for American Progress (CAP) report by Sean Pool presents the “network lifecycle” approach to clean energy innovation. The paper shows how the innovation lifecycle of clean energy technology can be divided into five phases, each involving a different an evolving network of participants with its own challenges and policy needs.

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Freeing our economy from its dangerous addiction to fossil fuels and averting the calamitous risks of climate change will require a major technological transformation in the way we produce, transmit, and consume energy. Inventing, developing, building, and deploying these new technologies will require a new era of American technological innovation. The result will be new industries and jobs, along with more clean energy and less pollution.

The good news is that we know that innovation is a fundamental driver of economic growth, and America has led the world in innovation for the past two centuries—from the mechanization of textile manufacturing in the late 18th century to the invention of the Internet in the late 20th century. Innovation is America’s first and greatest competitive advantage—or, as President Obama said “it’s in our DNA.” Twenty-first century clean energy technologies are already being designed, built, marketed, and installed to replace more than a century’s worth of entrenched fossil fuel infrastructure, and a recent report by the Department of Commerce indicates that there are nearly 2 million clean energy jobs in our economy today, with more on the way.

The bad news, however, is this: the United States lags behind many other countries in these emerging technology sectors because our public policy does not fully recognize the central role that innovation plays in sustaining quality economic growth and job creation. Part of the problem is a lack of understanding about exactly what innovation is, how it works, and more importantly who is involved. Policymakers in particular need to understand how different public and private sector players interact to form innovation networks, and how these networks change over time, which is why we’ve put together this primer on the energy innovation lifecycle.

We’ll first define the different stages of the innovation lifecycle, then describe the network of players engaged at each stage of the process. This “network lifecycle” approach can help us better understand who does innovation, the processes that drive it, and the opportunities for public policy to aid it at various points in the process. As you’ll see, our innovation economy in the energy arena needs some key reforms to perform at its peak again.

Defining Innovation: New Ideas that Create Value

“Innovation” is a broad and often vague term, and its meaning varies in different policy circles. But no matter what the context, innovation is fundamentally the process of inventing, introducing, and adopting a new product, practice, system, or behavior.

An innovation can be a new product, machine, policy, business model, administrative structure, managerial system, or even a new cultural or social norm that benefits society. But regardless of whether an innovation affects social processes, economic process, or physical and technological processes, what distinguishes an innovation from an idea or a principle is that it creates value and improves society.

This paper focuses on clean energy technology innovation—the invention and propagation of new machines that generate, save, or transmit energy. But as we will show, producing these new devices also requires the use of new modes of manufacturing, which can be thought of as technologies themselves, as well as new business models that can finance, produce, market, and sell these new machines.

Creating a clean energy economy is just as much about “process innovation”—incremental improvements to the materials and manufacturing process of technologies we already know about—as it is about finding new or undiscovered “breakthrough technologies.” Understanding the five phases of energy “innovation lifecycles” and the five kinds of participants in “innovation networks” will help show how these seemingly separate goals are actually related.
Five phases of the energy “innovation lifecycle”

Energy innovation is not just the process of inventing new technologies and doing research and development in government or university labs. Innovation is actually a set of interrelated processes that can be broken down into five basic phases:

  • Discovery
  • Development
  • Demonstration
  • Commercialization
  • Maturation

Each phase is undertaken by a different and evolving network of participants, and each has its own distinct policy needs.

The five-phase summary below is a synthesis of numerous academic innovation lifecycle models dating back to Joseph Schumpeter, an Austrian economist born in the late 19th century. It is important to note that rather than discrete or entirely separate categories, the different phases in this generalized model take place along a continuum and sometimes may overlap.

Discovery

Discovery is the process of researching a basic idea or scientific principle that may one day lead to a useful technology, and is done mostly by researchers in universities. This process also goes by the names “basic science,” “blue skies research,” or “pure research,” and the first goal of the process is to expand the store of scientific knowledge. Technologies at this stage in life are not fully formed, and most will never graduate to the next stage of development due to technical or cost-related constraints. Nevertheless, the goal of public policy at this stage is to empower smart researchers to cast as wide a net as possible in the hopes that one idea in a hundred could one day revolutionize industry. Government grants for university research and funding of federal labs are the primary sources of funding for this early phase of innovation, since there is not yet a functional technology that can produce profits for private investors. The Energy Frontier Research Centers are an excellent example of recent Department of Energy policy that is supporting discovery by putting money in the hands of able researchers with promising ideas on a competitive basis. The discovery phase creates science research and administrative jobs.

Development

Development is the process of linking the basic science of a discovery with functional technology, also sometimes known as “applied research.” Universities and government labs often continue to play a lead role during development, although promising technologies may begin to attract the attention of potential entrepreneurs, who seek out “seed funding” to help create startup companies to work on
developing the technology or even building functional prototypes.

Because the risks are too great for typical investors, this early jolt of private capital most often comes from angel investors—wealthy individuals who support entrepreneurs with personal funding—or venture capital firms, which do the same with larger pools of funding. Because funding for development is often very scarce, inventors and entrepreneurs themselves sometimes must tap into their personal savings—this is known as “boot-strapping.” This phase is also sometimes referred to as the “seed stage,” as the potential business generally has not developed a full grown and profitable business plan.

The Advanced Research Projects Agency-Energy, or ARPA-E, was designed on the same model as its older brother, the Defense Advanced Research Projects Agency, or DARPA. ARPA-E is an initiative of the DOE initially funded by the American Recovery and Reinvestment Act, and is an excellent example of support for development- phase technology innovation. Job creation during development includes both public and private research and administrative jobs, as well as the possibility for business, management, finance, and perhaps small-scale fabrication jobs.

Demonstration

Demonstration is the process of finalizing prototypes and testing them under real-world conditions to assess operability, technical performance, profitability, and in some cases even regulatory issues. This may also be referred to as “proof of concept” or “technology transfer” because this is the phase when technology must begin to move from labs and research institutions to assembly lines and
businesses. Both demonstration and early commercialization are sometimes also referred to as “deployment.”

Examples might include the construction and operation of a first-of-its-kind advanced nuclear reactor, a demonstration scale cellulosic ethanol biorefinery, or a coal-fired power plant with carbon capture-and-storage technology. All of these are scientifically understood technologies that are undergoing small-sale demonstration as a precursor to wider commercialization. Manufacturers who build, contractors who install, and utilities that operate and monitor the technology become essential parts of the innovation network at this stage, and their interactions with researchers and financiers promote an important kind of real-world knowledge creation called “learning by doing.”

Although demonstration projects are rarely profitable in isolation, the primary goal of demonstration is to indicate to the public, potential investors, and the business community that production processes now exist and that the technology is nearing market. As this takes place, the burden of financing begins to shift from basic government research grants to much smaller “proof of concept” development grants and on toward private financing from angel investors and venture capital firms, though the risks are still very high. For capital-intensive, industrial scale technologies, such as a commercial-scale carbon capture-and-storage coal plant, financing for demonstration may flow directly from established industry players or other large companies.

But private investors need to see a clear path to profitability before investing, and demonstration projects on their own can rarely provide this without public support. In the highly regulated and capital intensive energy industry, the path to profitability often depends on significant government incentives and assurances. This is especially problematic for capital-intensive clean energy technologies that require a lot of upfront investment to develop land, build power lines, and construct and install equipment. The scarcity of private finance is why many in the business and policy community refer to the process of carrying a promising technology from proof of concept through commercialization as crossing the “valley of death.”

Commercialization

The commercialization phase is when new technologies must meet the market test. Entrepreneurs must prove that they can produce and sell the new products profitably to early adopters and niche markets. This generally involves finalizing production processes, building a factory, obtaining manufacturing equipment, developing relationships with component suppliers, and finding enough potential buyers to make it all a worthwhile investment.

The “valley of death” private financing problem is acute at this stage, too, as new funding is critical to this cash-intensive and often capital-intensive phase of the innovation cycle. Follow-on rounds of venture capital, private equity, and/or debt financing (that is, borrowing from a bank or selling bonds) become increasingly prominent sources of money, as small- to medium- scale manufacturing and services operations are established. Startup companies at this phase are expected to generate some cash flow from sales of the technology, although profitability for the first few years may still depend on government incentives such as tax credits or cash grants for investment and electricity production, loan guarantees, or the sale of Renewable Energy Certificates to utilities who need them to meet state renewable electricity standards.

Commercialization is a critical bottleneck in current U.S. innovation policy because entrepreneurs have a growing backlog of technically proven technologies for which they cannot find affordable financing to grow their operations and achieve the economies of scale necessary to compete with conventional incumbent technologies. A Clean Energy Deployment Administration or “Green Bank” that can provide loan guarantees and other credit enhancements is one potential policy response to this market pitfall. The creation of a public-private equity investment partnership could be another way to break this financing bottleneck.

Commercialization creates more permanent manufacturing and construction jobs, as companies increase profitability and invest in and operate new manufacturing facilities, and as clean energy technologies are deployed, installed, and operated.

Maturation

Maturation occurs when new technologies graduate from niche to mainstream markets by scaling up manufacturing, gaining market share, increasing efficiency, and showing that they can compete on cost with incumbent sources of energy. In the case of renewable energy, this often occurs once technologies reach “grid parity”—the point at which the renewable energy is equal to or cheaper in price than existing power sources.

As new technologies become commercially competitive, they gain market share and gradually begin to displace incumbent technologies. This process is sometimes also called “diffusion.” Mature innovation networks should ideally become profitable for all participants independent of government incentive programs, although in the case of the incumbent fossil fuel industry, many wasteful subsidies continue to persist due to political pressure. As profitability becomes positive, seed-stage investors, angel investors, and venture capitalists are able to “exit” their investments and make a profit, either by selling their shares at an initial public offering or by selling the entire company to another larger corporation.

The innovation cycle begins anew at this stage as increasingly self-sufficient clean energy manufacturers begin to reinvest their own profits in new research toward incremental improvements to their technology and production process, or seek to acquire smaller companies with promising ideas for how to continue to improve quality or reduce costs. Continuing process innovation remains critical, even for mature technologies, but policymakers all too often ignore this aspect of innovation policy. The bailout of the U.S. auto industry, for example, can be seen as a failure of a mature industry to continue to innovate.

A major goal of public policy at this stage is to ensure that cutting-edge researchers and manufacturers continue to collaborate effectively to organically develop and commercialize the next generation of clean energy manufacturing technologies. But direct government incentives for investment and production of the original technology should begin to sunset on a reliable path.

Finally, finding a price for carbon that finally holds polluters accountable for the damages they cause would be the largest and most important long-term driver of private sector finance for clean energy activities. It would signal to the investment community that the clean energy sector is ripe for long-term growth, and unleash billions of dollars of in private, profitable investment in new businesses, new infrastructure, and new jobs.

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