Innovation center? How Israel became a 'Start-Up Nation.'

The recent New York Times bestseller Start-Up Nation drew much attention to Israel as a global innovation center. Israel has more Nasdaq-listed companies than all Europe, but is this success sustainable? Venture capital funding fell sharply in 2009.

In a world where investors seek stability, how has a country that’s been embroiled in three wars in the past decade alone become a high-tech hub sought out by global giants such as Warren Buffett and Intel?

Saul Singer and Dan Senor, a former spokesman for the Coalition Provisional Authority in Iraq, have drawn much attention for their explanation of that question and others in their New York Times bestseller Start-Up Nation: The Story of Israel’s Economic Miracle. But critics say that the story behind how a country of 7 million has more Nasdaq-listed companies than Europe is more complex than Singer and Senor paint it to be. They also question how sustainable Israel’s success as an innovation center will be.

Data released today added a sobering dose of news, revealing just how hard the global credit crunch hit one of the world's hottest centers of innovation. Israel’s IVC Research Center reported that Israeli venture capital funds were able to raise only $229 million in 2009, a 72 percent decline from the previous year, though fundraising is expected to rebound to $500 million for 2010.

And while not all Israeli start-ups are funded by Israeli companies, the country still saw a 61 percent drop in start-up financing last year – one of the most dramatic drops worldwide, according to a recent Dow Jones VentureSource report.

But such rain clouds aside, Start-Up Nation offers a vibrant look at what Israel got right in moving from a socialist economy to a high-tech tiger – despite hostile neighbors. Singer, a writer and conservative columnist for The Jerusalem Post, and Senor, an adjunct fellow at the Council on Foreign Relations, also offer what lessons could be applicable elsewhere.

The role of Israel's military

Several key themes emerge in Start-up Nation, foremost among them the role of Israel’s military in preparing young people for innovative thinking – and the society’s embrace of their skills when they leave the service.

"What typifies the Israeli military is improvisation and informality. Except in basic training, you hardly ever salute a more senior officer, and ranks here get all mixed up. It reinforces the non-hierarchical nature of the culture,” says Singer, who moved here in 1994 from the US, where he grew up. “The Israeli military is smaller at the top than most, and it forces more authority down. The sense of improvisation comes from being stressed and short on resources.”

Singer also contrasts the high respect the Israeli business world has for its best soldiers (most Israelis are called for two to three years of mandatory service at age 18, and many volunteer to stay on longer to become officers) with the lack of a welcome mat in the US for soldiers coming back from the battlefields of Iraq or Afghanistan.

“They’re coming home and having a hard time getting jobs, and that shouldn’t be. Our message is: take advantage of this talent,” says Singer. “We’re not saying that every society has to militarize. If you don’t have that, you can find ways to get it – such as by creating a civilian service program – where young people learn things that you don’t get in a university.”

How Israeli business wriggled free of state influence

Government played a role as well, both by helping and then by getting out of the way. That’s no small feat for Israel, which was originally founded as a socialist country, and until about 20 years ago, was dominated by state-owned companies. In the 1990s, the government began to privatize state enterprises, encouraging competition and making leaps in fields like telecommunications. It funded a program called Yozma, which invested in technology companies and new venture capital funds.

The program offered a matching program that came close to a company’s own contributions. “If the Israeli partners could raise $12 million to invest in new Israeli technologies, the government would give the fund $8 million,” the book says.

But after the government injected funds, the private entities were able to buy out the government, says Singer.

Niron Hashai, head of strategy and entrepreneurship at Hebrew University’s School of Business, agrees that the government here was instrumental in the high-tech success story. But he says that recent steep budget cuts for higher education threaten that trend.

“One cannot really rely on past achievements and assume the future will be the same. All the academic budgets have been cut to such an extent that top-tier education could be harmed: government support for that crucial level in the process is not what it was,” he says. Competition, he says, is also getting stiffer. “In India and China every year, the number of engineers graduating is equal to the total number of engineers in all of Israel.”

That and other factors, he says, raises questions of whether the “miracle” is sustainable.

Innovation? Check. Management? Still working on it.

If Israel is such a high-tech wonder, why doesn’t it have a Nokia, Samsung, or IBM to show for it? The authors try to address that frequent question. Hot Israeli companies often get bought out by larger ones before they get much bigger. They then become R&D hubs for the bigger companies. Part of the reason, Hashai suggests, is that Israel’s track record on good management isn’t as good as it is on innovation.

“We have problems managing large corporations on many fronts, for example, in how to report in an accurate way to Nasdaq,” says Hashai, pointing to the example of Converse Technologies, which was one of Israel’s big success stories until it violated Nasdaq’s accounting rules, prompting a major overhaul and mass firings. “Good, organized, by- the-book-management is not easy to do, and we’re not there yet, I’m sorry to say.”

Ruth Schuster, senior business and finance editor for The Marker, a financial paper distributed with the Israel daily Haaretz, says while there are great lessons to be gleaned from Israel’s high-tech success, Start-up Nation engages in too much cheerleading for its own good.

“The book is filled with a gasping sense of wonder, which weakened the authors’ arguments,” says Ms. Schuster, who reviewed the book for Haaretz. “I think there’s a lot of to learn about how this high-tech success happened. But imagine you’re an Egyptian reading this, and you have a jaundiced view of Israel. It could have been interesting, but instead I think they’ll throw it aside after a few pages because they’d see it as biased.”

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