Chicago’s Potemkin Village: A case study in how, and how not, to build an innovation economy

Thomas Day, Co-Founder, Invent2026, NLC Chicago

As war neared with the Ottoman Empire, the governor of the conquered Crimean region was eager to please the Russian Empress, Catherine II. The year was 1787. Per mythology, as Catherine II visited the war-ravaged region, constructed along the banks of the Dnieper River were new and glimmering structures, temporarily assembled to present a strong, vibrant Crimea. After Catherine II returned home, the temporary villages were disassembled.

The governor of the region was Catherine II’s supposed lover, Grigory Potemkin. We now refer to similar demonstrations of false economic vitality as “Potemkin Villages.”

Potemkin’s savvy, if slightly ridiculous, tactics have endured into the current day. As the Bay Area, Boston, and New York have far outpaced competitor cities in nearly every metric of entrepreneurship and economic dynamism, the idea of building facades to conceal a city’s true condition has formed a technology industrial complex that has grown into an uncontrollable monster. Incubators and accelerators are now seen as the ends and not the means to drive regional growth. Something of a design arms race has emerged among open floor coworking spaces.

No Potemkin Village is as ornate and ultimately deceiving — more to those on the inside than the outside — as that of Chicago. Since 2012, lawmakers for the City of Chicago and the State of Illinois have joined with philanthropists and real estate developers to build what appears to be a remarkable shrine to tech entrepreneurship. Chicago is home to about 80 different incubators and accelerators, and more than a million square feet of millennial-friendly co-working spaces.[i] These efforts have led Chicago’s business and technology publications to, quite prematurely, announce Chicago as the new “tech town.”

Yet during these last five years, Chicago has not expanded its share of the national venture capital market or increased federal investment to drive technological advancement.[ii] That has not stopped leaders in Chicago’s venture community to fill the void with a defiant message that momentum in Chicago’s advanced industries is building.

It is a large void to fill. In 1980, Wisconsin Steel closed its South Side manufacturing plant and marked the beginning of the end of Chicago’s once-mighty steel manufacturing industry. Chicago’s steel plants once employed 200,000 Chicagoans. In the nearly four decades since Wisconsin Steel closed, the Chicago steel industry has withered to nothing; and in those nearly four decades, Chicago has failed to replace steel and other manufacturing industries with new industries.

I single out Chicago for criticism for two reasons: First, Chicago is my home; I care deeply about this city and want it to succeed. Second, Chicago’s Potemkin Village is reaching new heights of ridiculousness. The story of Chicago’s efforts to catalyze tech entrepreneurship should be a cautionary one. Anecdotes from friends and colleagues in other cities suggest Chicago is not alone in building a Potemkin Village.

While other cities have formed clusters in software (Seattle), medicine (Raleigh-Durham), and robotics (Pittsburgh), Chicago has floundered, seeking to build our own clusters in sectors ill-suited for our region’s assets, and failing to define where it fits in the modern economy.

This doesn’t need to be. Chicago is the most robust research hub outside of Boston; it is the only city with two national Department of Energy laboratories. Two of the top five business schools in America — the University of Chicago’s Booth School of Business and Northwestern University’s Kellogg School of Management — are in Chicago’s metropolitan area.[iii] Factors too numerous to include in this essay — reasonable cost of living, abundant natural resources, great food — make this city a boomtown in the making.

Chicago’s laboratories, universities, entrepreneurs, and industry partners should be working together to transition lab-generated inventions into new products and new companies. Right now, they’re only building their own fiefdoms of the Potemkin Village.

New industries are being created in Chicago’s laboratories in new battery designs, sensors, advanced materials, and a host of other domains, yet these new frontiers will remain unexplored without more open technology transfer from the laboratories, and a stronger commitment from entrepreneurs to assume the risk attendant to new product development in the high sciences.

Technology transfer can be the catalyzing force for growing these new industries, but first the challenges must be understood, and a lab-to-product chain must be built.

Divine

Chicago’s legion of incubators and accelerators grew out of the flotsam of Divine InterVentures, a for-profit incubator that was founded in 1999 to replicate nascent communities of technology companies in the Bay Area and Boston. Divine’s founder Andrew Filipowski, eager to catch the dot-com bus before it left the station, built Divine as a conglomerate of Chicago-based internet ventures. Divine raised $450 million in private money to buy up new dot-com companies, who would then share back office support.[iv]

Soon, Filipowski would be seen by many as the father of Chicago’s venture community — and not in a good way. Divine filed for an IPO shortly after its launch, and quickly ran into trouble. As the dot-com bubble collapsed, Divine collapsed, leaving creditors and initial investors, whose ranks included Michael Jordan, with nothing. Divine filed for Chapter 11 in 2003.[v]

Shaken and shamed, Chicago’s community of technologists would reemerge years later with dogged determination to compete with the coastal markets for talent and venture capital. 1871, a massive co-working space for technologists, opened its doors in 2012, quickly becoming the headquarters for Chicago startups.

The obvious intent of 1871 was to assert Chicago’s presence in tech-enabled industries and new ventures, but in fact Chicago’s entrepreneurial community had already begun to grow and prosper. As recounted by Harvard Business School’s Lynda Applegate, Alexander Meyer, and Talia Varley in their case study, “Rising from the Ashes: The Emergence of Chicago’s Entrepreneurial Ecosystem,” venture-backed deals increased four-fold between 2010 and 2012.

And then, Chicago flatlined. Just two percent of invested venture capital in the United States is invested in Chicago, the same as it was five years ago.[vi] The State of Illinois ranks 17th — the bottom among states with a major metropolitan market — in receiving grants under the U.S. Small Business Administration’s Small Business Innovation Research (SBIR) program.[vii] By any measure, the growth of Chicago’s innovation economy since 2012 has been marginal at best.

The reason for this, I would theorize: Around 2012, five years after the introduction of the iPhone, market opportunities closed for startups developing a new app and scaling quickly, just the kind of startups designed to grow out of coworking spaces, incubators, and accelerators. Strangely Chicago has chosen to double down on get-rich quick schemes and not the hard work of developing new industries.

It is now clear that the successful startups of the next 20 years will require much longer and more capital-intensive product development cycles.

Lab-to-product value chain

I have teamed up with a few business partners to launch something called Invent2026, an initiative to join the region’s entrepreneurs with applied researchers at our university, corporate, and federal laboratories to collaboratively build a Midwest innovation corridor rooted in a lab-to-product value chain. In ten years, ahead of America’s 250th birthday, we wanted to assert Chicago and the Midwest’s presence in new, advanced industries.

Last year we hosted leaders of applied research from Argonne National Laboratory, the University of Chicago, Northwestern University, and the University of Illinois for several roundtable discussions. These discussions centered around identifying sectors that could be clustered around Chicago, given our assets. The physical sciences, the task force agreed, presented an opportunity for Chicago. New battery designs, sensors for smart farming, water sensors to monitor toxins, and autonomous vehicles are now being designed at Chicago’s laboratories. The challenge, we agreed, was to commercialize these inventions here.

Understanding that consumers drive new business growth, we focused on ways to engage the largest consumer on earth: the U.S. government. Governments are (or should be) interested in solving national challenges, however they define them.

It has always been this way. The federal government has historically provided demand for early-stage technologies and the companies commericializing those technologies, from the telegraph to mobile phones and the semiconductor.

The history of Silicon Valley, as told by retired entrepreneur and author Steve Blank, began with the Franklin Roosevelt Administration directing massive federal subsidies into research in technologies that would support the Allies in World War II.[viii] The Harvard Radio Research Lab, led by Frederick Terman, then one of the most skilled radar engineers in the United States, oversaw all electronic warfare in World War II.

After the war Terman moved to Stanford, where he would earn the title “father of Silicon Valley.” As the temperature increased in the Cold War, the Pentagon again turned to Terman, subsidizing research to design electronics to intercept Soviet communications.[ix]

Under Terman Stanford’s engineering school received massive federal subsidies for research, integrated their basic and applied research labs, opened intellectual properties for low-cost and expedited tech transferring, and encouraged entrepreneurship among Stanford’s students. This is what laid the foundation for the startup economy in Silicon Valley.[x]

The lab-to-product value chain under Fredrick Terman at Stanford ended with the federal government, consuming the end-product. Governments still play that role today. For cities looking for an overwhelming amalgamating force to gather researchers, entrepreneurs, and financiers to drive a region’s cluster, federal grants have provided, and can continue to provide, that force.

To a remarkable degree in recent years, the federal government has demonstrated an interest and willingness to partner with startups who are commercializing new technologies. In 2015 the Department of Defense launched the Defense Innovation Unit Experimental, or DIUx, in Mountain View, California. DIUx has become the platform for the military to interact with Silicon Valley; two additional DIUx posts have been built in Boston and Austin, Texas. The Department of Homeland Security and the State Department have also built similar footholds in startup communities, seeking procurement opportunities with early-stage companies.

But the most critical sources of federal capital that continues to drive technology advancement through entrepreneurship are the Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs. These are federal grant programs that provide multi-phased funding for small businesses that are commercializing technologies of strategic need to the federal government.

Of note: California and Massachusetts received more than 33,043 and 21,590 SBIR Phase I and Phase II grants in 2015, far outpacing the third-highest recipient of SBIR grants, Virginia, which received 9,320 SBIR grants.[xi] Illinois ranks 17th in receiving SBIR funds, near the bottom of states with a major municipality.

SBIR and STTR money is directed to startups that are solving national challenges with lab-generated technologies. It would then follow that if local leaders, in government and the private sector, want to grow a robust startup economy, their planning must begin with a deep conversation on how that startup economy can leverage its region’s assets to solve national challenges. SBIR and STTR will gauge how well they’re doing.

It falls on startups to drive growth in new industries

The end acquirer of the lab-to-product chain may also be found in large corporations. We have seen record activity among corporate venture arms; 44 percent of invested venture capital in the United States now comes from corporations, according to the National Venture Capital Association.[xii]

This course is driven by several unsettling trends. Corporations are struggling to capture the full benefit of their own research, confounded by knowledge spillovers that have accrued to industry rivals, and by what Harvard Business School Professor Clayton Christensen has termed the “Innovator’s Dilemma,” or the reality that research can only deliver value over many years and cannot drive short-term quarterly growth.

Adding to the downward pressure on corporate R&D budgets: powerful shareholders who demand that corporations aggressively cut costs, including R&D, and turn over profits in the form of stock buybacks and dividend payouts.

Gone are corporate laboratories like Bell Labs and Xerox Labs that have historically driven technological advances. Corporations are frequently unwilling or unable to assume the risk attendant to developing new technologies into a product. Instead they have turned to corporate venture arms to acquire startups that can take on the risk of developing a new product and proving a market.

Startups are increasingly going to provide the outlet for new technologies to be prototyped and tested in the market, with corporations acquiring the startup once the technology has proven a commercial pathway. Instead of continuing to build Potemkin Villages, regions looking to grow their own venture communities should instead build out the systems that connect the laboratory to new startups, and support prototyping at regional maker spaces.

Recognize also that the startups of the next twenty years will require patient venture capital that supports new business through multiple rounds of funding. Chicago-rooted startup have continued to struggle to overcome the “Valley of Death,” or the dwindling pool of venture capital that entrepreneurs must compete for during the “B,” “C,” and “D” rounds of funding. These rounds can and should be supported by corporate venture arms.

“Startup studios,” a variation on the standard incubator, are where patents, teams, and capital can come together. This new model supports startups by building teams around technologies, providing seed funding, and rigorously identifying commercial pathways. As described by Hungarian entrepreneur Attila Szigeti in his 2016 book, “Startup Studio Playbook,” startup studios are rewriting conventional wisdom for driving innovation.

“While incubators and accelerators are focusing on mentoring startup teams, investing into them for equity or providing infrastructure for cash, startup studios build startup products, teams and companies — one after another,” Szigeti writes.

The great wall surrounding our research laboratories

Consider the incredible technological advances that are changing the very fabric of our society:

• Genomic sciences will advance to the point where doctors, with a simple saliva sample, will determine a patient’s risk for a range of diseases long before any identifiable symptoms;

• Biological sciences will build a human heart from a single cell;

• Americans will rely on solar-generated energy to an unprecedented degree, powering the grid with energy generated and distributed not from a sole central source, but from homes, offices, and shops, and shared in neighborhood energy cooperatives;

• Autonomous vehicles will begin to integrate into our transportation system;

• Our roads, bridges, waterways, and farms will be managed with the help of sensors that will monitor traffic, levels of toxins in our rivers, and soil fertility in real time.

These technologies were discovered in research laboratories, not the coworking spaces that dot the Potemkin Villages.

The challenge for designing and growing a regional economy based on applied research and entrepreneurship is building the connective tissue between applied researchers and entrepreneurs, and providing enough incentives for researchers to actively drive their work into the commercial market. At present, technology transfer systems have become far too slow and burdened with red tape, and researchers often figure it isn’t worth their time and energy to help find a commercial pathway for their intellectual properties. As a result, the opportunities to support regional growth through applied research and entrepreneurship is lost.

University and federal laboratories hold massive portfolios of intellectual properties that, for various reasons, sit idle. The director of Northwestern University’s Center for Genomic Sciences told us that 99 percent of their intellectual properties are not supported by their university’s tech transfer office.

Northwestern is hardly alone in failing to capitalize on their intellectual properties, and I use the term capitalize carefully. Under federal law, universities may patent federally-funded discoveries that emerge from its labs, and negotiate exclusive licensing agreements with private sector partners and startups. Stanford received more than $336 million after Google’s initial public offering, a benefit received because Google’s search algorithm was discovered at the university with the aid of a federal research grant. Yet, the wall remains.

Lab-generated intellectual properties, patents, and inventions can bring reality to the Potemkin Villages. Entrepreneurs need patents more than venture capital. There should be entrepreneurs not huddled around coworking spaces, but the front gates of our university and national laboratories. And these labs should eagerly welcome them in.

It takes a (real) village

“The New Geography of Jobs,” an incredibly insightful book by University of California-Berkeley economist Enrico Moretti, provides the new model of American competitiveness: we provide the innovation (the invention and the design), and it gets built overseas. Moretti’s model is not at all at odds with the model I’ve provided. In Chicago, we can invent something at Argonne National Laboratory or the University of Chicago, and prototype that design in our South and West Side manufacturing plants.

It is when these products move into the mass production phase of product development, with more rote manufacturing processes, that it’s likely the manufacturing would be offshored. Fine. When manufacturing moves offshore, we’ll take the new designs moving out of the laboratory and start the process all over again.

Chicago can embrace this model Moretti describes by tearing down our Potemkin Village and building a fast-moving, seamless lab-to-product value chain, rooted in the resources we have, connecting laboratories to entrepreneurs.

But there’s one missing element that I haven’t yet discussed: people. To grow a robust startup economy, it takes a community that embraces the leadership and staff of recently-failed ventures, supports and learns from one another. It may also take one person — a superstar entrepreneur or researcher — to provide the initial spark.

“Entrepreneurs follow local entrepreneurs,” a 2014 Kauffman Foundation report found, noting that entrepreneurs most frequently follow the social media accounts of “other entrepreneurs, entrepreneurial programs, and individuals affiliated with local entrepreneurship support organizations.” The Kauffman Foundation report also noted that the most influential social media accounts in local entrepreneurial economies were often those of other entrepreneurs within that local market. “Entrepreneurship is a local phenomenon,” the report said.[xiii]

It is our hope that Invent2026 will sit at the intersection of this growing community of entrepreneurs in Chicago and throughout the Midwest and Rust Belt regions, and the nearby laboratories that are providing technologies that will drive new industries.

This summer, Invent2026 will launch TNEBULA (as in Tech Nebula), an interactive platform that employs game mechanics to identify technologies emerging from client laboratories with the most commercial promise. Upon logging onto TNEBULA, users will be presented an inventory of intellectual properties, discovered at partner laboratories, that have already been approved for licensing.

TNEBULA users competitively collaborate to uncover the technologies that hold the strongest commercial potential. Users are asked to provide feedback on the uses of these technologies, and the technology’s appropriate markets. This insight is extremely valuable for laboratories and inventors looking for a commercial pathway for their inventions.

Where we go from here

I will make my final point with a bit of apprehension, but because I am convinced that it needs to be said: Chicago’s failure to lead new industries is literally killing our residents. 740 of our citizens were shot and killed last year, a product of the lack of economic opportunity in our city, which is itself a product of the failure to ensure new technologies are designed, built, and commercialized here in Chicago.

The failure to replace the industries of the past is changing the political map. Midwest and Rust Belt workers are mistakenly blaming our region’s economic struggles on Chinese imports and Mexican labor when the real threat is our inability to compete in advanced industries.

These are the true costs of Potemkin Villages, and the failure to transfer technology. Here are a few ideas on how to drive new industries at the state and local levels:

[i] Ori, Ryan. “Co-working growth expected to continue in Chicago.” Crain’s Chicago Business, July 25, 2016. Accessed May 27, 2017. http://www.chicagobusiness.com/realestate/20160725/CRED02/160719866/co-working-growth-expected-to-continue-in-chicago.

[ii] “Where does venture capital reach?” Ecosystem Dashboard. March 6, 2017. Accessed May 27, 2017. http://nvca.org/research/ecosystem-dashboard/.

[iii] “The Best MBA Programs in America, Ranked.” U.S. News & World Report. March 13, 2017. Accessed May 27, 2017. https://www.usnews.com/best-graduate-schools/top-business-schools/mba-rankings?int=9dc208.

[iv] Rose, Barbara. “Divining Divine InterVentures.” Crain’s Chicago Business. January 22, 2000. Accessed May 27, 2017. http://www.chicagobusiness.com/article/20000122/ISSUE01/100013756/divining-divine-interventures.

[v] Rose, Barbara. “Divine files for Chapter 11: Highly visible tech firm cost investors millions.” Chicago Tribune, February 26, 2003. Accessed May 27, 2017. http://articles.chicagotribune.com/2003-02-26/business/0302260244_1_platinum-technology-international-software-and-services-computer-associates-international.

[vi] “Where does venture capital reach?” Ecosystem Dashboard. March 6, 2017. Accessed May 27, 2017. http://nvca.org/research/ecosystem-dashboard/.

[vii] Awards Information: State Summary. Accessed May 27, 2017. https://www.sbir.gov/reports/state-summary.

[viii] Blank, Steve. “Secret History of Silicon Valley.” SteveBlank.com (video blog), November 20, 2008. Accessed May 27, 2017. https://steveblank.com/secret-history/.

[ix] Ibid

[x] Ibid

[xi] Awards Information: State Summary. Accessed May 27, 2017. https://www.sbir.gov/reports/state-summary.

[xii] 2017 Yearbook. National Venture Capital Association (NVCA). March 2017. Accessed May 27, 2017.

[xiii] Motoyama, Yasuyuki, Jared Konczal, Jordan Bell-Masterson, and Arnobio Morelix. Think Locally, Act Locally: Building a Robust Entrepreneurial Ecosystem. Report. Kansas City, Kansas: Ewing Marion Kauffman Foundation, 2014.

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