Israel’s technology economy exists as a bubble within the wider Israeli economy. 
Maturing investor expectations provides Israel with the opportunity to evolve the tech sector for the benefit 
of the wider domestic economy


Photo credit - Paul Tennant

Scale-up Nation

The story of Israel’s transition to Start-up Nation is impressive. However, the dynamics that powered the rise of the Start-up Nation from the 1990s are evolving. The beginnings of this new era can be seen from 2006 onwards.

Since 2006 the number of new start-ups created each year has been around 1,000. Some reports, for example, one published by Start-Up Nation Central (SNC), a nonprofit organisation that tracks Israel’s tech industry has placed the figure for 2017 to be as low as 700 with 408 closing down, resulting in a net growth of 292.  This is not necessarily a bad sign, rather an indication that the industry is maturing. The question is, “Is Israel ready for the maturing technology industry?”

Technology funds

Fundraising peaked in the period 2014-2015, primarily fuelled by significant growth in late-stage deals in more mature companies. Investment in seed and early-stage start-ups as a percentage of total investment has been on the decline since 2006.

Access to venture capital funds has become more difficult as there are fewer domestic funds which were traditionally more willing to invest in seed-stage start-ups. There is also a more significant presence of foreign venture funds. This lack of growth in funding is not specific to Israel. Since the tech bubble of the early 2000s, the US has seen little growth in VC investment, apart from a surge in 2014-2015 that normalised again by 2016.

While the growth of the number of companies has accelerated, employment in the technology sector has not been rising. The average early stage start-up consists of 3-4 people who
are primarily technology focused with little in the way of management skills.

As the US does not suffer from the same talent pool constraints as Israel , economist David Rosenberg in his book “Israels Technology Economy”, suggests that “the start-up phenomenon globally may be reaching its natural limit relative to the rest of the economy.”

Early exits

The trend up until 2017 has been for early exits, arguably resulting in a lower impact on the broader Israeli economy due to the smaller number of employees and shunning the Tel Aviv stock exchange in favour of the NASDAQ.

The Israeli culture has been perfect in providing the necessary skills for the Start-up Nation. Now the skills must be found to take them to Scale -up Nation.

As a result, very few Israeli technology companies have a sustainable, evolving business model or a workforce that covers the whole of the traditional corporate activity.

Those that do exist were formed in the 1990s before the evolution of the technology sector in its current form and include Amdocs, Check Point Software Technologies, Nice Systems, Orbotech, Stratasys a US-Israeli company, TowerJazz and Mellanox.


Photo credit - Paul Tennant

The beginnings of Scale-up Nation

According to the Times of Israel, Israel has seen a 3-year decline in the number of new start-ups. In the first half of this year (2018),  the number of funding rounds in which start-ups raised $10 to $20 million, so-called “scale-up rounds,” more than doubled in the first half of 2018 compared to the first half of 2015. This combined with the smaller number of start-ups being set up indicates that investors are looking for more substantial returns on more mature companies and that entrepreneurs are beginning to move away from early exits.

This is good news for the Israeli economy as this indicates a maturing technology sector which will have a more significant impact on the domestic economy. Traditionally Israeli tech start-ups have focused on foreign markets as customers for their technology as the demand from the domestic market is low. This is due to both a lack of large high tech companies being based our of Israel and also the lack of innovation being demanded by other sectors, such as manufacturing. If the Israeli technology companies can scale-up domestically, this will fuel employment in the sector not just for technology skills but management and business skills in general. If followed through, in time the domestic market will mature to being a customer of innovation, a role that they currently do not play.

To build sustainable businesses, they must evolve their technology leadership.

To monopolise on this new opportunity, the skills to run larger high-tech businesses must be forthcoming. This is an area that the majority of Israeli entrepreneurs have avoided, preferring to focus instead on technology and engineering. To build sustainable businesses, they must evolve their technology leadership.  Technology in isolation provides a two to four-year market advantage, in which time an exit was usually executed. To grow beyond this requires a broader skill set including market intelligence  and strategic management. The Israeli culture has been perfect in providing the necessary skills for the Start-up Nation. Now the skills must be found to take them to Scale-up Nation.

Inclusive society

Part of the answer is unlocking untapped potential by building an inclusive society. Although the IDF and universities provide excellent training and education, primary and secondary education has benefited poorly from public expenditure, very often failing those students who aren’t top performers with a penchant for technology and few Arabs join the IDF. More recently there has also been a decline in university enrolment. Additionally, none of the Israeli universities were featured in the 2019 top 250 Times Higher Education Supplement world university rankings.

Inclusiveness of the Arab community into the high tech sector is an initiative that is gaining momentum. Currently, 5,600 Arabs are working in the Israeli high-tech sector out of 120,000, somewhat short of the 20% share of the general population. Programmes such as Tech2Peace are promoting cross Israeli and Palestinian working along with reach-out events such as “Arab women in tech” run by the UK Israel Tech Hub in conjunction with the British Embassy in Tel Aviv.

We are watching with keen interest as Israel takes on the next chapter in her history and the transition is made from Start-up Nation to Scale-up Nation.

 

Researched and written by Jon Ellard