Where Are Israel's Googles, Intels and Ciscos?

The answer: They have been sold to those companies because the so-called 'start-up nation' is unconducive to big businesses

Israel was all aflutter. In July 1998 Mirabilis, a start-up less than two years old, was sold to the American Internet giant AOL at a price regarded as insane at the time, $407 million. The deal turned Mirabilis' founders, Arik Vardi, Yair Goldfinger, Sefi Vigiser and Amnon Amir, all ages 27 and 28, into celebrities.

The Israeli high-tech scene has since seen more than its fair share of exits, earning Israel the moniker "start-up nation" and has turned it into a model for other countries that have asked to learn the Israeli system of innovation and enterprise.

But from the get-go, "start-up nation" has also elicited increasingly critical voices that warned about the long-term consequences of Israel's exit culture: a generation of entrepreneurs not interested in developing a real industry but in making a quick buck. They won't be enriching the national economy but hurting it.

High-tech needs big, stable companies that will give the economy a long-term competitive advantage - not start-ups that are sold to foreign companies after a few years and disappear.

Fourteen years After the Mirabilis exit, the debate rages on. Even government officials ask what is better and more productive for the economy, but intuitively they feel that big companies sell more and pay more taxes.

Israel has a few of these companies, both in high-tech and other industries - Teva Pharmaceutical Industries, Iscar and Keter Plastic among them - but nearly everyone agrees that the economy needs more of them. Is the Israeli economy not structured to encourage large, multinational enterprises? Is the small number that we do have really a problem?

The manufacturing pyramid

Most of those who are critical of the start up and sell fast phenomenon point to the structure of Israeli industry to back up their view. Big companies account for employment and contribute more to gross domestic product, so policy-makers should be encouraging more of them instead of start-ups.

Figures obtained by TheMarker show that this claim does have a basis. On the assumption that the businesses that contribute the most to the economy are those that export, you can look at the Israeli manufacturing sector as a pyramid.

At the bottom are thousands of small businesses and hundreds of medium-sized enterprises that export an average of about $50 million annually. In the middle are about 50 medium-plus-sized companies that export between $50 million and $100 million a year. Further up are about 40 large exporters, which sell between $100 million and $250 million annually overseas.

At the top are a dozen companies whose exports exceed $250 million annually and seven mega-exporters whose foreign sales exceed $1 billion.

Big companies also provide more jobs. Figures presented at the 2009 Caesarea Conference showed that about 1% of Israel's high technology companies, each of which employ more than 450 people, account for a quarter of all high-tech employment (not counting research and development centers operated by foreign companies in Israel ). Another 9% of companies defined as medium-sized accounted for approximately 30% of high-tech employment.

The remaining 90% of high-tech firms - incubator companies, start-ups and the like - accounted for just 45% of all jobs in the sector.

Figures from the Israel Export institute provide even more evidence for the contribution of big companies. They show that large firms - those with revenues in excess of $50 million - account for $17.8 billion of GDP and employ 268,000 people. By comparison, small firms - defined as businesses whose sales don't exceed $2 million - contribute NIS 1 billion to GDP and provide jobs for 14,000 people.

The institute investigated the acquisitions of start-ups by foreign companies and found that they rarely led to further growth of the acquired business - and frequently led to its closure. Between 2005 and 2007, Israel formed 606 start-ups on average every year, with 240 of them going out of business annuaklly. During these years, some 240 merger and acquisitions deals were made, two-thirds of them by foreign companies.

"Most start-ups purchased by companies don't survive," says Shauli Katznelson, head of he economics unit at the export institute. "Of 160 start-ups bought by foreign companies, 56% ended their operations. The other 44% remained in business. Of those, 48 are now R&D centers for the foreign company that bought them and 23 operate as subsidiaries of the acquiring company."

The bottom line: Exits through mergers and acquisitions are good for investors and entrepreneurs, but not for the economy or the company that gets bought.

'Exits leave scorched earth'

One of the start-up phenomenon's biggest critics is Giora Shalgi, a former CEO of the state-owned Rafael arms development company.

"Exits leave scorched earth. The media celebrate them, but whoever is buying a start-up doesn't intend to leave anything behind," he says. "What is left is a small stratum [of people] who are enriched by their talents and the other 95% are left behind.

"In a healthy industry, there is an element of start-up companies side by side with classical industry," Shalgi continues. "Even in the United States they are starting to bring back industry. The Germans have preserved their industrial base and Germany, relative to other countries, is in a good position ....We have a large collection of small manufacturers who need to be pushed to turn them into larger ones. The barrier now is quality of management."

Shmuel Barkan, CEO of the multinational semiconductor maker Freescale, contends that Israel needs another 10 to 15 large companies more than it needs more start-ups.

He notes that Israeli high-tech is very dispersed, with some 2,500 companies each having an annual turnover of less than $20 million. There is a lot of innovation and a few big exits, but half the country's research and development engineers work for foreign companies.

"The bottom line is lots of attempts to turn intellectual property into a lot of money quickly by forming start-ups or by working for R&D centers run by foreign multinationals," says Barkan.

"We have to end the strong affinity between managers and the groups that invest in companies and want to cash out on their investment quickly," he says. "This affinity works against quality management and gives priority to investors over the companies."

On the other side of the debate, of course, are the investors and entrepreneurs of the start-up industry, among them Arik Vardi. He sees the phenomenon as an Israeli asset that all the world is jealous of and should be carefully tended to.

"Yes, we have big companies in Israel. We call them something Israel - Intel Israel, Google Israel," he says.

Experience shows that big Israeli companies do not provide stable employment, maintains Vardi. "Many of them never stood the test of time," he says. "We Israelis excel at taking an idea and sowing it. We are a greenhouse, which is a risky business and requires determination, stubbornness and dedication to your goal. We excel at this. We talk with entrepreneurs in Spain who say they want steady work, no risk. The same in Germany and Japan - they fear risk."

Haim Shani, former CEO of Nice Systems and former treasury director-general, says there is room for both in Israel's technology economy.

He points to two kinds of multinational operations here - pure R&D operations like Microsoft and Google, and those that encompass R&D and production, like Hewlett Packard and Applied Materials.

Average start-up sells for $40 million

In the first instance, the company promises steady employment to its Israeli workers but keeps the innovations they generate. The economy profits from the employment they create and the intellectual property they produce. In the second, the economy benefits from the employment as well as the wide range of jobs created including in manufacturing and business.

Big Israeli companies do the same but offer an even wider range of jobs as development, management, sales and other operations are all conducted in Israel.

"The average price for an Israeli company in the last decade was $40 million," he says. "If companies waited a few more years before selling out, the return to the founders, investors and the economy would be higher."

Shlomo Markel, vice president of the multinational company Broadcom, says big-company advocates have to take into account the risk of their strategy.

"If a start-up aspires to become a very big company, the odds are that it will eventually shut down or go bankrupt. To make yourself into a large company requires a managerial-creative and operative-creative perspective," he says. "There's nothing you can do about it - Israelis are very creative but they don't know anything about efficient manufacturing, corporate management or marketing."