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How to Revitalize Our Innovation Engine

As the former CEO of Danger, a wireless company that was sold to Microsoft for $500 million, and Tessera, a $300 million company that makes semiconductor casings for companies like Intel, Henry (Hank) Nothhaft knows a thing or two about innovation. Nothhaft sees a direct correlation between innovation and creation of jobs, but also sees that US regulations are stifling the job creation we so desperately need.

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Before he stepped down as CEO of Tessera, a San Jose, Calif.-based NASDAQ technology miniaturization firm, Henry (Hank) Nothhaft, 67, set forth his concerns about revitalizing America’s entrepreneurial leadership in a book, Great Again, where he documents the link between innovation (chiefly via small and mid-size technology-based companies like his), and prosperity that is diffused throughout society. He worries that there are numerous forces that are severing this link.

Beginning in the 1980s, the U.S. began to divorce innovation from production. For example, China now dominates the $30 billion solar power industry even though the first device to convert solar energy to electricity was patented by AT&T’s Bell Labs in 1957. South Korea’s LG Chemical is making the rechargeable lithium-ion batteries that GM uses in its Chevy Volt. Nothhaft points to an Information Technology & Innovation Foundation study that reports that of the 40 most advanced nations the U.S. ranks dead last in the innovation progress it has made over the last 10 years.

The son of German immigrants, his father was trained as a lithographer for a U.S. Steel plant near his hometown of Sharon, Penn. Nothhaft attended the U.S. Naval Academy, became an engineer and served in the Marines. He pursued a series of entrepreneurial endeavors, which culminated with his becoming chairman and CEO of Danger, a wireless software company later sold to Microsoft for $500 million. From 2008 to mid-2011 he was chairman, president and CEO of Tessera, a $300 million company that also makes semiconductor casings for companies such as Intel.

The key to restoring the link between innovation and wealth and job creation is through start-ups.

While Nothhaft claims he has nothing against the Web-based firms personified by Google, Facebook, Twitter and LinkedIn, he sees something missing from the burgeoning social media industry compared with earlier tech-based industries: jobs. Facebook may have 500 million users and a market cap approaching $50 billion, but it employs 1,400 people. By contrast, Sony employs 170,000, Disney 144,000 and Boeing 157,000. Even Google at a comparable stage employed just under 11,000 people when it was seven years old.

Since the key to restoring the link between innovation and wealth and job creation is through start-ups and sustainable new businesses, Nothhaft advocates:

Liberating entrepreneurs from start-up killing tax and regulations. One solar power entrepreneur in Silicon Valley observes that the taxes and regulations are “stifling.” “We had to pay almost $1 million dollars in tax on $10 million worth of manufacturing equipment that we bought from Germany. That’s not a tax on income; it’s a tax on our business.” A 2008 World Bank study found that a 10 percent increase in the effective tax rate reduces the investment-to-GDP ratio by 2.2 percent and foreign direct investment by 2.3 percent.

Fix the VC engine. In the 1990s venture firms were trying to build companies for the long-term. Most VC firms were staffed with executives with operating experience, in contrast to today where many are led by financial types with no horizon beyond flipping companies as private equity firms do. Not exactly a strategy for building companies to last.

End the indifference to domestic manufacturing. Other countries understand (even if the U.S. doesn’t) that manufacturing strengthens an economy and sustains a middle class like no other form of activity. Decades of outsourcing have left the U.S. without the means to invent the next generation of high-tech products. China, for example, offers a five-year tax holiday to semiconductor manufacturers. Many other high-tech firms are entitled to a permanent 15 percent tax rate. Also, there’s a flaw in the “R&D and services only” economy. R&D depends upon close contact with manufacturing for its success and will follow if it relocates. Once the most R&D intensive economy in the world, the U.S. now ranks eighth.

But the most pressing concern, Nothhaft feels, is fixing our busted patent system. Chief Executive spoke to him about this when he came to New York.

Hank Nothhaft 

Hank Nothhaft

Why is patent reform necessary and why should other CEOs care?

Most of the CEOs who read your magazine have seen a shift in the last 20 years where maybe 20 percent of their balance sheets were represented by intangibles like intellectual property (IP). Now it’s many times higher. IP is the new currency of competitiveness. To us it’s critical. We’re an innovator. We spend a lot of money on R&D, and we license our technology. We have 2,300 patents. We’re sort of like the Edison Labs of the 21st century. Once it took 12 months for a patent to be reviewed. Now it takes anywhere from three to seven years. Any delay in securing clear title to a patent allows competitors a chance to look at your patent application, because the patent office publishes your patent application 18 months after you file it.

How long has this been a problem?

Since 2002, more and more patents are being filed. The backlog has grown. So, today, there are 700,000 patent applications that have never been looked at. There are 500,000 patent applications that have been looked at, but have not resulted in either a rejection or a patent being
issued. So, as we sit here today, the patent backlog is 1.2 billion.

What’s the solution?

Owing to the fees it charges, the Patent Office is one of the only self-funding agencies
in the federal government, but both democrats and republicans have treated it as a petty cash drawer. In the first six months of this year they’ve taken away $150 million alone. Along with other business leaders I would like to see the agency use more of its income to open field offices in locations other than just Alexandria, Va., upgrade their systems and be able to hire more people to sort through the patent backlog.

Twenty-five percent of all the patents filed for in the U.S. come out of California. Yet, there’s no representation out there. If you’re a small business and you need to talk to a patent examiner about your patent and you don’t have money, you can’t talk to them. It’s so arcane. It’s really hard to believe that most people in the country are unaware of how we’re running the system.

And what will be the fallout if this doesn’t happen?

We’re aiding and abetting our economic competitors. If you file for a patent in Korea, which is emerging as a very severe competitor, you can actually get a patent in way less than a year.

And let’s not forget the strong correlation between job creation and patent issuances. Four to 10 jobs are correlated directly with a patent. So, depending on what math you want to use, it’s certainly more than two million jobs as a cost to the economy. So, we’re all saying, “Hey, Congress, stay out of the candy jar. Let the Patent Office use its own funds, modernize its office, hire the staff, pay the overtime. Let them even raise fees a little for large enterprises and lower them for small businesses. Right now, it’s a cost-based model. They calculate that a given application costs $3,000 to issue a patent. Then, they’re only allowed to charge $3,000. Let them use market pricing. You need a patent faster? Pay more for fast track. Unleash the innovation.

You also argue that our venture capital system for launching start-ups has broken, and say Apple couldn’t be started in today’s environment. What needs to be changed?

What has happened is the IPO cycle has broken down. This type of exit that replenishes the equity capital pool has dried up. As a result, venture capital has become much more risk averse and much more late-stage investment.

Sarbanes-Oxley more than any single event has dried up IPOs. In the case of my last company, Danger, a software-as-a-service company, we got up to $100 million a year in revenue and were profitable. We had roughly 400 employees on a worldwide basis. We were in a hot market. When we went public it cost us $3 million to be SOX compliant, and the ongoing costs per year were more than $1 million to $2 million a year. If you’re running a $100 million company and you’re making $8 to $10 million, you’re taking $2 million of your $8 million in profit away. It reduces the valuation of the company by 25 percent, not to mention all the distractions to management.

So, why is this important? Why should we care about IPOs? Two reasons: 92 percent of all the job creation in venture-backed companies occurs after an IPO. So, we’re only getting 8 percent of the job growth. Numerous studies show that large companies are not as innovative per employee or per dollar spent compared to small companies.

A company like Danger, now that it is subsumed into Microsoft, is being used to maintain the status quo rather than, if it were independent, to create new industries or create huge new opportunities in the marketplace. That’s why you should care.

About JP Donlon

JP Donlon is the Editor-in-Chief of Chief Executive magazine.