Israel’s Startup Nation
By: Noam Weinblatt
December 18th, 2012
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Abstract:
This paper explores the viability of startup companies in Israel and the impact on its
economy, as well as the measures the Israeli government should take to ensure continued
success. A number of factors suggest that the startup industry within Israel will become weaker
in upcoming years. After analyzing the situation, I have concluded that Israel’s startup industry
will continue to be a force within the world for some time to come provided that Israel’s
government will take steps to ensure that its economy will remain strong. It will need to focus
its energy on creating motivated, innovative citizens, rather than narrow its focus to build just the
startup industry.
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I.
Introduction
A country the size of New Jersey is 64 years young with a population of fewer than 8
million citizens and is constantly in the news because of war and terror. Surrounded on all sides
by enemies bent on eradicating it, one would assume the country has little hope of focusing on
anything other than survival. However, in 2005, Bill Gates, the second richest person in the
world1 referring to that same country said, “It's no exaggeration to say that the kind of innovation
going on in Israel is critical to the future of the technology business”.2 A year later, the third
richest man in the world1, Warren Buffett said that he believes “in the Israeli market and the
Israeli economy and I think that this is a good time to invest in it.”3
By all measures, Israel’s economy is very successful. According to the World Bank, at
the end of 2011, Israel’s GDP per capita was $31,282 ranking it 32nd in the world, with inflation
at a healthy 3.46%.4
While those numbers may seem moderate, during the recent global
financial downturn, at a time when most western countries are having their credit rankings
lowered,5 S&P upgraded Israel’s credit rating to an A+. Israel is third after Canada and China in
terms of number of stocks on NASDAQ. Since 1981, on average, two new Israeli firms register
on NASDAQ per year, and registration has increased every year since then.6 The biggest vote of
confidence comes from Warren Buffet, whose first foreign investment was in Israel in 2006,
when he bought 80% of ISCAR Metalworking Companies for $4 Billion.4
Part of the reason for the success of Israel’s economy is that it is heavily based on
startups, which account for 32% of Israel’s economy.7 A startup company is a company that is
in its early stages of development. The focus of a startup is on product development and
1
http://www.forbes.com/2011/03/09/billionaires-20-richest_slide_2.html
http://israel21c.org/technology/bill-gates-israel-is-a-high-tech-superpower/
3
http://www.mfa.gov.il/MFA/Israel+beyond+politics/Buffett+acquisition+of+Iscar+puts+Israel+on+the+investment+map+7-May-2006.htm
4
http://data.worldbank.org/country/israel
5
http://www.israelbonds.ca/news.php#SPUpgradeSept2012
6
http://www.scirp.org/Journal/PaperInformation.aspx?paperID=3211
7
http://www.home.roadrunner.com/~nickgier/IsraelEcon.pdf
2
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receiving capital.
Individuals who create a startup company usually have the qualities of
ingenuity, focus, and drive.
Israel is one of the most successful countries in the world when it comes to startups. As a
country, Israel has the highest density of Hi-Tech startups in the world and has the most Hi-Tech
companies outside of Silicon Valley. Israeli startups raise more venture capital dollars per
person than any other country. Israel raises over twice as much in venture capital funds per
capita as the US, 30 times more than Europe, 80 times the amount in India and 300 times the
amount in China.8 A recent example is Facebook’s purchase of Face.com for $100 million in
June.9 Other companies are taking notice of Israel’s success by opening up R&D facilities in
Israel. Microsoft and Cisco developed their first foreign R&D facilities in Israel. 10 As a result,
there are numerous startups and ideas that have come out of Israel, such as the cell phone, instant
messaging, Paypal, and Google’s predicative text. So prevalent are these companies that a
region in Israel is affectionately referred to as, “Silicon Wadi,” a play on the famous startup town
Silicon Valley. This area runs along the coastal plain where a large number of startups have
been hatched.
Israel has been recognized for its exceptional performance in startups by the World
Economic Forum and the International Institute for Management Development. The World
Economic Forum and the International Institute for Management Development came out with
rankings relating to entrepreneurship, business efficiency, infrastructure, economic performance,
and government efficiency.
Israel ranked first among entrepreneurship, and performed
exceptionally well in the other rankings, finishing number one in public and private sector
ventures, second in public expenditure on education, innovative capacity, and scientific research,
8
http://www.freakonomics.com/2009/12/04/how-did-israel-become-startup-nation/
http://bits.blogs.nytimes.com/2012/06/18/facebook-acquires-israeli-facial-recognition-company/
10
http://www.slideshare.net/trade-gov-il/foreign-rd-centers-in-israel-august-2011
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sixth in flexibility and adaptability and seventh in creation of firms.11 Additionally, The World
Economic Forum has Israel listed first in quality of scientific research institutions, fourth in PCT
patents, fifth in strength of investor protection, sixth in capacity for innovation and company
spending on R&D.
II.
Factors contributing to the success of Israeli startups
Israel owes its success in the startup industry to a number of factors. The first aspect to
consider is the role of the military in Israeli society. Israel requires military service for citizens
aged 18. Military service teaches and trains Israelis the importance of teamwork and leadership.
Being in the military requires completing and mastering life threatening tasks that require
immediate and quick thinking. Being in the armed forces also provides many Israelis training
with sophisticated hi-tech equipment. Additionally, the high stakes and intense pressure forces
Israelis to communicate and improvise effectively in stressful environments which improve
critical thinking skills.
Furthermore the connections forged during the army have created
business partnerships.
Finally, Dan Senor and Saul Singer suggest in their seminal book,
“Startup Nation”, that analyzes Israel’s success, that the structure of the Israeli military is a
significant factor that contributes to an attitude and atmosphere that fosters innovative thinking.
Soldiers are encouraged to take initiative in an army which is not as hierarchically structured as
most armies.
Israel also has a very high rate of immigration, another factor that has helped to spurn the
startup sector. During the 1990s, Israel absorbed a million immigrants from the Soviet Union.
Although Israel had to support and find housing for the immigrants, many of those Russian
immigrants, or at least by the next generation, were highly skilled and educated workers, which
11
http://www.financeisrael.mof.gov.il/FinanceIsrael/Pages/en/EconomicData/EconomicHighlights.aspx
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provided a boost to the startup industry. A report done by the National Foundation for American
Policy found that 46% of American top venture-companies had at least one immigrant founder.12
Israel’s immigration policy encourages engineers, scientists, and business professionals to come,
start businesses and stay in the country.13
Israel spends successfully on research and development which translates into the success
of its citizens. In the ranking shown earlier, Israel is ranked first in business expenditure and
total expenditure on R&D by percentages. According to the Innovation and Investment article,
Israel spends the same on R&D as the entire Middle East & North Africa region.6 The graph
below show’s Israel’s expenditure as a percent of GDP in relation to the world, US, UK,
Germany, France and Canada. By leading the way in R&D, Israel is able to develop and learn
about technologies very early on. Israel has twice the number of engineers per capita than the
US or Japan.14 Israel also has the highest number of Nobel Prize winners this past decade.13
Finally, Israel has the most scientists and technicians in the world per capita and highest number
of university degrees per capita.15
According to Mustafa Akin’s article, “Innovation and
Investment: Nasdaq-Listed Companies of Israel”, Israel is ranked third in the world in quality of
scientific research institutions.16 The relationship between the Technion, known as Israel’s MIT,
and other universities and the private sector is structured to encourage cooperation. The WEF
ranked Israel #8 in University-industry collaboration in R&D.
As a result, Israel’s high
investment in R&D has greatly benefited its citizens.
12
http://www.inc.com/eric-markowitz/immigrant-entrepreneurs-are-key-job-creators.html
http://ncf.uschamber.com/library/2012/08/innovation-nation-worlds-toughest-neighborhood
14
http://www.forbes.com/sites/ricardogeromel/2012/05/16/procter-and-gamble-israel-startup/
15
http://www.mfa.gov.il/NR/rdonlyres/D20FEF83-FB02-4775-9298-0AB129C4CD82/0/Innovations2010En.pdf
16
http://www.scirp.org/Journal/PaperInformation.aspx?paperID=3211
13
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17
“Chutzpah” is a term that describes someone who has a bit of arrogance, is not afraid to
question authority, and who oversteps the boundaries of accepted behavior. In general, Israelis
have a lot of chutzpah which is an asset when creating a startup. Chutzpah, which as Senor and
Singer point out, is fostered in the Israeli army experience, allows and encourages people to
challenge and question norms which are important when trying to create solutions to problems.
It means not being intimidated by overwhelming odds. “Innovation and Entrepreneurship in
Cities”, written by Dr. Darrene Hackler suggests that Governments need to create and incentivize
a culture of risk taking in order to create a successful city which innovates.18 The Israeli
government does not need to create the culture of risk taking, because that mindset already exists
in its society.
Jonathan Avidor concludes in his paper, “Building an Innovation Economy: Public Policy
Lessons from Israel”, that the startup boom can also be attributed to the successful calculated
moves by the Israeli government. Avidor studies avenues for creating an innovative economy
and concludes that four factors account for the proper atmosphere. Those four are economic
incentives, access to financial capital, human capital and access to information. Israel was able
17
18
http://databank.worldbank.org/ddp/processGraph.do?REQUEST_TYPE=CHART&NEW=Y&COMMA_SEP=fales&REPORT_ID=
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2015055
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to create economic incentives by reducing the cost of capital through financial reforms,
strengthening local intellectual property protections, and provide resources for new
entrepreneurs. By providing R&D grants and creating a venture capital industry, access to
financial capital was adequate. Human capital was sufficient because of the large network of
academic institutions, encouragement of skilled engineers and scientists, and facilitation of an
efficient transfer of skills from military to civilian life. Finally, access to information was made
possible by sponsoring conferences, creating consortiums between the industry and academia, as
well as others.19 According to Jonathan Avidor, the Israeli government has been instrumental in
creating the startup boom because it has done all four of these sectors in a way which creates the
necessary incentives for startups to thrive.
III.
Is the startup industry declining?
While it is important to recognize past achievements, will startups continue to be
successful within Israel’s economy? Startups are 32% of Israel’s economy today, but if that
number goes down, Israel will need to find other ways to make up for that lost part of the
economy. There are many serious question marks and negative trends within Israel that do
threaten the vitality of its startup industry.
Growth rates in the business sector have steadily declined since Q3 in 2011, dropping
from 4.5% to 3.4% to 2.6% in Q1 of 2012.20 Those numbers can be attributed to Europe’s fiscal
condition and high levels of economic uncertainty. Another issue is that startups accounted for
30% of the money raised in Israel in 2011.21 However, Israeli venture capital firms are spending
24% less during the first six months of 2012 compared to the previous year. Additionally, in the
19
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1856603
http://ozar.mof.gov.il/debt/gen/docs/AnnualReport2011.pdf
21
http://www.adweek.com/news/technology/israels-silicon-wadi-143282#1
20
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past couple of years, United States venture capital firms are having a tougher time.22 Israeli
startups require funding from venture capital firms. The problem is that venture capital firms are
spending less money when startups raise a big portion of the money in Israel.
The potential of the future population in Israel is not promising for the startup economy.
The two fastest growing population groups in Israel are those who do not integrate into the hitech startup industry, Israeli Arabs and ultra-orthodox Jews. These groups lag in subjects such as
math, science and English. In 1960, these groups were less than 15% of school children.
However, today, they account for 50% of first graders.23 If the trend continues, by 2040, that
group will account for 78% of first graders.24 The president of Israel’s oldest university, the
Technion, is worried about the future, concerned that only 10% of high school graduates have
studied the five units of math required at the Technion University.25 The population groups that
are becoming more dominant in schools today lag in the specific subjects the president of the
Technician declared important. Additionally, the original startup boom could be attributed to the
influx of high skilled Russian immigrants. It is unrealistic to expect the same amount of highly
educated immigrants to come to Israel in the near future.
According to the Federal Reserve Bank of Cleveland, recessions do not help improve
entrepreneurship. After looking at statistics from the Great Recession, the number of selfemployed people fell and the amount of firms being formed were worse than before the Great
Recession.26 Today, we are in a global economic downturn and more than 3,000 people are
expected to lose their jobs in the high-tech industry in Israel,27 which according to the study by
the Federal Reserve Bank of Cleveland, will most likely not lead to an influx of entrepreneurs,
22
23
http://blogs.timesofisrael.com/israeli-startup-funding-is-down-should-we-worry/
http://blogs.timesofisrael.com/elections-and-the-next-startup-challenge/
25
http://www.theaustralian.com.au/higher-education/threat-to-israels-startup-nation-status/story-e6frgcjx-1226445750529
http://www.clevelandfed.org/research/commentary/2011/2011-04.cfm
27
http://blogs.timesofisrael.com/elections-and-the-next-startup-challenge/
26
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and may even cause some of these highly valued employees to look for employment outside of
Israel.
One of the last issues of concern is the sustainability of a business model in which
businesses are created in order to be sold. In Europe, manufacturing companies with more than
250 workers are 30-40% more productive than companies with fewer than ten employees.28
Bigger companies allow for employment and contribute more to GDP. Smaller companies
merging or being bought out are good for the investors and entrepreneurs, but might not be good
for the economy.29
IV.
Signs of strength
While there are a lot of issues that call for concern, Israel is a country that has been very
successful at weathering the storm of the global economic downturn, which brings about
optimism for the future of the startup industry’s role in the Israeli economy.
“Innovation and Entrepreneurship in Cities”, written by Dr. Darrene Hackler, explores
the importance of small and medium sized entities (SMEs) within cities. Dr Hackler observes a
different statistic than the paragraph above suggesting that gazelles, companies aged three to five
years, are more important to an economy. In 2007, gazelles accounted for 66% of new jobs and
the top one percent of fastest growing companies generated 40% of new jobs in the US. Dr.
Hackler uses Austin, Texas as an example. Austin, Texas experienced very high rates of small
business growth at 1.5%, which was almost three times higher than the next market at 0.6%. As
a result, Austin experienced a 9.3% job growth rate when the rest of America was experiencing
higher than normal unemployment rates.18 While bigger companies are more productive, smaller
28
29
http://www.timesofisrael.com/whats-next-for-the-startup-nation-by-uri-goldberg/
http://www.haaretz.com/business/david-com-vs-goliath-inc/to-exit-or-not-to-exit-1.467398
10
companies generate more new jobs.
This could explain why Israel has had such a low
unemployment rate compared to other countries, which is shown in the second graph below. I
believe that it is more important to keep the workforce employed because it keeps them active.
By being in a work atmosphere, people develop skills while working with products they will
eventually understand and find ways to improve. Ideas are shared and expanded upon when
working with others and the best tool for learning is experience. Since faster growing companies
generate more jobs and create an active workforce, I believe it is more important than having
mega-companies.
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The graphs shown above are from the IMF depicting Israel’s economy (blue shade)
compared to the US’, UK’s, Germany’s, France’s, and Canada’s economies’ over the past couple
of years. The first graph shows Israel’s real GDP growth and since 2004, Israel has had the
highest growth rate. The second graph shows unemployment rate and since Q3 of 2010, Israel
has had the lowest unemployment rate. These encouraging signs about Israel’s economy are
very important since this is happening during times of global economic uncertainty and
downturn. In April, the IMF praised Israel’s economy, speaking highly of their fundamental
economy, sound institutional framework, and robustness of the financial systems.30
War ravished countries generally do not have high levels of economic growth. However,
Israel is an exception to this pattern. During the 2009 Gaza operation and second Lebanon war,
the Tel Aviv Stock exchange was higher on the last day than on the first day.13 When Israel was
being shelled by rockets launched from Lebanon by Hezbollah a few years ago, Eitan
Wertheimer, chairman of Iscar, the company purchased by Warren Buffet, insisted that
production continue full force, and not a day of productivity be lost, despite the fighting. 31 As
recently as a couple of months ago, there was fighting between Israel and Hamas. The quick war
should not negatively affect Israel’s economy in the long run. According to a post written by
Yoram Ettinger, Israel’s economy two months after its other most recent wars finished higher on
the Tel Aviv Stock Exchange than during the start. The fact that Israel factories continue to
produce even during wartime has bolstered confidence in the Israeli economy in general.
There are other encouraging signs of the Israeli economy.
The Central Bureau of
Statistics growth forecast suggests Israel’s GDP in 2012 is to increase by 3.5% which is higher
30
31
http://www.theettingerreport.com/Overseas-Investments/The-International-Monetary-Fund-%28IMF%29-Praising-Isr.aspx
Start up Nation
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than the OECD average of 1.6% and -0.1% in Eurozone.32
In Q1 2012, venture capital
investments in Israel were higher than in Q1 2011.33 In addition, Israel high-tech companies
raised 8% more in Q3 of 2012 than in Q2 2012.34 Finally, according to a global confidence
survey, Israel ranks third in highest confidence level in a home country’s economy and
governments policies.35
V.
A fork in the road
Israel is at a critical stage, in that it could go down two different economic paths. There
is the chance Israel could start to lose its competitive edge and therefore no longer be a leading
startup economy. Many businesses fail because they become complacent and do not embrace
change. Israel must make sure that its policies continue to adapt to the evolving economy it has
created. The Israeli government must enact some new policies in order to change the trajectory
of some potential threats in the future.
The Israeli government has helped make its own country’s startup industry what it is
today. Through policies such as investment in R&D, the creation of Yozma, a venture capital
firm that was the government’s initiative and other actions taken suggested by Jonathan Avidor,
Israel’s government has been instrumental in the startup boom. The Knesset should continue to
act in ways that help the sector. There should be a major worldwide conference held in Israel
that would showcase successful and new Israeli startups which would boost awareness of Israeli
created startups. Not to mention, this would also help Israel’s economy by boosting tourism,
which is another important sector of its economy.
32
http://www.globes.co.il/serveen/globes/docview.asp?did=1000784251&fid=1725
http://www.vccafe.com/2012/04/23/144-israeli-startups-raised-483-million-in-q1-2012/
34
http://www.globes.co.il/serveen/globes/docview.asp?did=1000792299&fid=1725
35
http://www.deloitte.com/view/en_US/us/Industries/technology/1590daa3ba088310VgnVCM3000001c56f00aRCRD.htm
33
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Israel needs to focus its efforts on what contributes to making the startup sector so
successful, and that is innovation. Innovation is what breeds a culture and a nation of thinkers
and doers. By investing in R&D that translates into an educated innovative society, Israel can be
ahead of the curve in whatever the future holds. While startups now may be very successful, in
20 years, they may not be the future of the economy. However, by investing in R&D, Israelis
will be educated and figure out different ways to succeed.
Disproportional growth within the population creates a bleak future for the workforce.
The ultra-orthodox and Arab communities are much weaker in innovative subjects such as math
and science and do not attend the army, yet they are the populations with the biggest growth. As
reported earlier, only 10% of students graduating have studied the units of math required at the
Technion University. Therefore, the Israeli government must require all schools, regardless of
whether they are public or private, to require the five maths needed at the Technion. If these
students are not educated in innovative subjects Israel will lag behind other countries. The
orthodox community must also be required to serve in the army.
Albeit this is a very
controversial issue, Israel could create an entirely new program for the ultra-orthodox
community, where they serve in a separate division and have time to study the bible. That way,
they could serve their country and receive important experiences that most other Israelis receive,
and indeed such programs are slowly being introduced today.
An influx of another group of highly skilled Russian immigrants does not seem likely
today. Therefore, the Israeli government should continue to increase their incentives for
immigrants, but focus primarily on highly skilled immigrants that could be brought into the
workforce successfully. This would be considered more of an investment in its own future.
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By focusing on the future and key sources of long term growth, Israel has positioned
itself successfully for the long run. Dr. Darrene Hackler concludes in her paper that knowledge,
technology, innovation and entrepreneurship are the key sources for growth in the 21st century.
Israel has been at the forefront on those issues. Mustafa Akin created a regression analysis on the
valuation of stock on NASDAQ with coefficients in total revenue, gross profit and R&D.
Revenue and gross profit accounted for a healthy 0.31 and 0.61 positive correlation with market
value, while R&D’s coefficient translates into an increase at 5.42. That means that a one million
dollar increase of investment in R&D results in a five million dollar increase in a company’s
market value. Those initiatives have been some of the main reasons for Israel’s success and if
they continue pursuing those avenues, it will continue to lead to Israel’s success in the future.
VI.
Conclusion
With the changes I suggest the Israeli government implement, some of which are already
being put in place, as well as continuing to mold and change its policies with the changing
economy, Israel has the capacity to have a successful economic future: an economy focused on
developing its citizens to become innovators which will lead to sustained growth and
development.
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