Start-up Nation in Danger of Seizing Up

Israel's high-tech industry has an oversized head and a shriveled body that contributes nothing much to the economy.

Another Israeli start-up bit the dust last week.

Of course, that’s not how it was portrayed by the company or by the media. Long pursued by social-networking behemoth Facebook for its technology, Face.com was finally acquired for a price variously estimated at between $50 million and $100 million.

The price was probably closer to the lower end of the range, but even so it was still a good investment of time (three years of labor by fewer than 20 people) and money ($5.3 million of capital) that its founders, investors and employees put into it.

Face.com was in the cutting-edge business of technology to recognize faces from photos uploaded via web or mobile phone. What could the deal be except further evidence of Israeli genius, the bounty that start-up nation Israel has bestowed on the economy and an inspiration for young people?

 Deals like this smack of the Klondike gold rush or wildcatting for oil in Texas. You conceive of an idea, raise some capital, hire some programmers to put it to work and hope that after a couple of years someone will recognize the results -- which these days in inevitably some kind of mobile application --  as a big enough thing to buy you out for multiple tens of millions of dollars or better.

In Face.com’s case it was the fortune of Facebook’s relentless pursuit of new come-ons for its social networking site, its move into mobile and its strategic decision that images was a segment it wanted to pursue.

The downside, of course, is that you will be beaten to the punch or pursue an idea that has no traction and end up with the digital equivalent of a dry well. But as a business it isn’t bad. Venture capital basically works on this proposition – invest in a portfolio of start-ups and count on a couple of big hits to compensate for the rest of the misses.

That isn't "progress"

It wasn’t supposed to be like that. When start-up nation was born here some 20 years ago, the assumption was that at least a few of the tiny companies that were sprouting up would turn into industry leaders.  There has certainly been plenty of time for that to happen. In 1992, Google didn’t exist, neither did Facebook or Amazon. In 1992, Apple was a struggling maker of PCs. But two decades later, Israel basically remains a nation of start-ups.

This digital wildcatting is profitable for those engaged in it.  But does the Israeli economy -- that is, the rest of us -- get anything out of it?  The answer is, not really, when you look at what goes into making a start-up and what comes out of it.

Let’s start with the capital, most of which comes from overseas. Last year, Israeli venture funds accounted for just a quarter of all new investment in high tech, with the rest coming from overseas.

That was the lowest percentage in a decade. But the fact is that generally, foreign venture capital funds have accounted for most venture investment in Israel over the past decade. Even Israeli venture capital funds raise most of their money overseas, not from the locals.

The economy benefits from the infusion of capital, but when the start-up is acquired the profits go back from whence they came.

What about employment? Start-ups usually have a payroll that can fit into a single photograph without benefit of a wide-angle lens. They pay their employees well and create huge amount of wealth, but there is a limit to how many office supplies and midnight pizza deliveries they can order to spread the benefits around to the rest of the economy. Because these companies get sold very quickly they never need to take on the kind of personnel bigger enterprises typically do, which would mean more jobs and more demands for goods and services.

Delusions of grandeur

If you look at the skills break down for the high-tech sector you will find that it employs almost 53,000 software and hardware engineers, compared with fewer than 4,200 people in sales and 3,700 in marketing.

The industry employs more physicists (4,400) than finance professionals (3,700); more experts in algorithms (nearly 3,300) than in business development (2,400).

In other words, high-tech in Israel is an industry with an oversized head full of new ideas and innovations and a shriveled body that does little to develop them commercially, build sustainable businesses and create employment.

Realistically not everyone can be or should be a brilliant software developer. Technology is our flagship industry, but it needs to be an industry that crates work for a wider range of skills and abilities, thereby spreading the wealth farther and wider than it does right now.

Indeed, we may have little choice because there are signs that start-up machinery is slowing. The supply of engineers, which ballooned with the massive Russian aliyah in the early 1980s, is aging and isn’t being replaced, a worrying phenomenon that can be laid to a lousy educational system and a growing portion of the population that has never wanted (Haredim) or been invited (Israeli Arabs) into the high tech world.  

Right now, we are in many ways a nation of a few well-paid engineers and (to use the local equivalent of burger flippers) many more struggling shwarma slicers. If we’re not careful, the balance may grow worse.

Ilya Melnikov
Ilya Melnikov
Tess Scheflan