Innovation in Israel - A Special Case · 2019-2826-AJMS-MDT 1 1 Innovation in Israel - A Special Case 2 3 The understanding of innovation processes is quite complex. Innovation is

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Innovation in Israel - A Special Case 1

2 The understanding of innovation processes is quite complex. Innovation is not only a 3 product of a firm or a startup. It is a product of an entire ecosystem in which many 4 actors are involved. The main tool used in order to explain innovation is the triple 5 helix considering the relationships between government, academia and industry, has 6 been developed quite intensively by Etzkowitz (see for example Ezkowitz, 2008) and 7 empirically tested in a few cases (Jackson et.al, 2018). The triple helix is good as a 8 concept, but hardly practically applicable: the input variables that directly influence 9 innovation embody combinations of government, academy and business various 10 aspects (R&D, linkages, ICTs, and so on). We believe that the triple helix functions 11 differently at different given conditions in each country. 12 This article is constituted by three main parts. First we consider the “birth of 13 innovation” in Israel by presenting a major policy measure established by the 14 government back in the 90s, the YOZMA program, which is considered as a major 15 breakthrough of the process of innovation. Second, we show the actual situation in the 16 last few years, through the perspective of startups. Third, we try to evaluate to which 17 extent the innovation process in Israel differs from that of the other countries of the 18 world and what are the unique forces that may explain this unique case. 19 20 Keywords: Israel, innovation, Ecosystem. 21 22

23

The “Birth of Innovation” in Israel- the Role οf the YOZMA Program 24 25

For several decades after its founding in 1948, Israel’s economy was 26

heavily dominated by the public sector and trade was greatly restricted. Since 27

the late 1980s, the government has actively created policies to unleash the 28

potential of the private sector and increase the business interaction with global 29

markets. This policy was accelerated when the mass of immigrants came from 30

the former Soviet Union, many of them with technological background. 31

Although the country enjoyed a relatively high level of R&D activities at 32

the time with both civilian, military and government R&D support programs 33

that were in place, the overall conditions were not ripe for venture investments. 34

One of the perceived missing components was the availability of venture 35

capital. 36

As a public response to this perceived supply-side market failure, the 37

Israeli government has set up a special program named Yozma (which means 38

“initiative” in Hebrew) - an equity co-investment program to channel equity 39

finance to capital constrained but high potential, young enterprises. The 40

program was led by the Office of the Chief Scientist (today the Israel 41

Innovation Authority), a central government agency responsible for fostering 42

innovation in various industries. This led to the successful creation of the 43

Venture Capital (VC) industry, which took place during the years of 1993 to 44

2000. 45

The Innovation Authority allocated for that purpose $100 million. Under 46

the Yozma program, 10 VC funds were formed. Each of these funds was a 47

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private-government partnership of which the government's share was a 1

maximum of 40% and the private investors' share 60%. The private sector, 2

according to Yozma program, should be composed of partnership of leading 3

Israeli financial institutions with leading foreign venture investors that have 4

experience with startups (Schwartz, 2009). 5

A major attraction of the Yozma program was the private investors' option 6

to buy out the government's share at a pre-determined price over a period of 7

five years. 8

Thus the Yozma program did not simply supply risk sharing to investors, it 9

also provided an upside incentive – that private investors could leverage their 10

profits through acquisition of the government shares. In addition, Yozma was 11

allowed to invest a certain portion of its capital directly in start-ups. 12

This program added the missing component to the ecosystem: risk capital 13

as well as experienced private sector entities with local and global experience. 14

These experienced investors provide “smart money” - beyond just funding: 15

guidance on how to manage the startup, how to grow it, and how to market 16

products to the world. While Israel had a long history of developing new 17

technologies, the Israeli entrepreneurs lacked this kind of mentorship and the 18

VC assisted in this area (Peres, 2017). 19

The Yozma program immediately proved to be extremely successful and 20

by 1999, Israel ranked second only to the United States in invested private-21

equity capital as a share of GDP (Wikipedia). 22

It was, as described by the 2010 OECD report “the most successful and 23

original program in Israel’s relatively long history of innovation 24

policy.” (Yin,2017). The share of the venture capital of GDP in Israel is like in 25

the United States, is representing more than 0.35% of GDP. While in the other 26

OECD countries the venture capital constitutes, a very small percentage of 27

GDP, often less than 0.05% (OECD, 2017, p. 124) 28

Under the Yozma program ten VC funds were formed and 15 direct 29

investments were made by Yozma itself, and major international venture 30

investors were attracted from all around the world: the USA, Germany, Japan, 31

Netherlands, and Singapore – see Table 1. 32

Nine of the 10 funds exercised their option and bought out the 33

government's share. Nine out of the 15 investments (made by Yozma directly) 34

enjoyed successful exits, either through IPOs or through acquisition. 35

The Yozma program was the catalyst for the development of the VC 36

industry in Israel and for the development of the start-up sector as shown in the 37

following charts. Prior to 1993, there was only one venture capital fund 38

operating in Israel (IVA, 2009). In 2009 (IVA, 2009), there were about 80 39

venture capital funds (www.ivaivc.co.il). 40

The capital raised by the VC funds grew from $40M in 1991 to 200 mil$ 41

in 1993, and reached a peak of 2.7 billion dollars in year 2000. In the last two 42

decades, the average amount of capital raised by Israeli VC funds fluctuated 43

around an average of 750 million dollars a year, including years of world 44

financial crisis, as can be seen in chart 1 (IVC online). 45

46

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Table 1. The Yozma Funds 1 Fund International Investors Country Origin

Eurofund Daimler-Benz, DEG (Germany) Germany

Gemini Advent (USA) USA

Inventech Van Leer Group (NL) Netherlands

JPV Oxton (US/Far East) USA

Medica MVP (USA) USA

Nitzanim-

Concord

AVX, Kyocera (Japan) Japan

Polaris

(Pitango)

CMS (USA) USA

Star TVM (Germany) & Singapore Tech Germany

Vertex Vertex International Funds

(Singapore)

USA, Singapore

Walden Walden (US) USA

Yozma –

direct

investments

None Israel Government

2

Chart 1. Capital Raised by Israeli VC Funds by Year - Bil. $ 3

4 5

The creation of the VC industry supported the establishment and the 6

development of start-ups in Israel (Avnimelech & Schwartz, 2008). From 51 7

before the Yozma program, in grew constantly until reaching a peak of about 8

600 at the end of the century, as shown in the Chart 2. The creation of new 9

start-ups stabilized around an average of about 500 every year in the following 10

years and until present. 11

12

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Chart 2. Number of Start-Ups Created in the Years after the Yozma Program 1

was Established 2

3 4

Parallelly, the capital that was raised by the high-tech companies, most of 5

them start-ups, from the VC investors rose dramatically, from less than $50M 6

in 19911 to an annual average of $1.6 bil. during the period 1999-2007 – see 7

Chart 3. After the global financial crisis, this amount has been constantly 8

growing, reaching an average of about 5 billion dollars a year. 9

10

Chart 3. Capital Raised by Israeli High Tech Companies by Year - $Bil. 11

12 Source: IVC Online database 13 14

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Innovation in Israel: A Global Current Picture 1

2 We use the Global Innovation Index (GII) in order to evaluate the relative 3

ranking of Israel in the world, from various aspects (Dutta, Lanvin and 4

Wunsch-Vincent, 2018). The GII ranks in 2018 126 countries, on the basis of 5

81 indicators. Those are divided in two parts: inputs and outputs. The ranking 6

of Israel since 2009 until 2018 is presented in the following table 2. 7

8

Table 2. Israel Ranking in Innovation, 2009-2018 9 year GII Input 0utput

2009 23 17 30

2010 23 22 23

2011 14 20 8

2012 17 17 13

2013 14 19 9

2014 15 17 13

2016 21 21 16

2017 17 20 14

2018 11 19 11 Source: GII reports from 2009 to 2018. 10 11

Israel’s rank for the year of 2018 is 11, out of 126 countries, after a 12

significant improvement from 2009. The relation between the ranking of output 13

and the ranking of input is considered as an indicator of efficiency of the 14

innovation process. Along all the years, the output index is better ranked than 15

the input index, indication a quite significantly high indicator of efficiency. 16

In terms of start-ups, the latest data show for 2016 that there were 4,362 17

start-up companies active in Israel, with 27,500 employee jobs. It should be 18

emphasized that Israel is a small country with 8.5 mil inhabitants. The start-up 19

companies are classified into sixteen fields of activity: Agro Technology, 20

Clean-Tech, Defense, Enterprise & Business Applications, Healthcare IT, 21

Industrial Technologies, Internet, Medical Technologies, Mobile Applications, 22

Pharmaceutical Products, Security, Semiconductors, Telecom Applications, 23

Telecom Technologies, E-Commerce and Online Advertising. (Table 3) 24

Even though the venture capital industry in Israel is very active’ the role 25

of the Innovation authority is still important. From 2014-2016, approximately 26

14% of start-up companies received a grant for R&D activity from the 27

Innovation Authority. 1115 projects of 650 companies were supported by the 28

Authority in 2016. A total of NIS 492, 925(thousands) was granted. (Israel 29

Innovation 2017). 30

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Table 3. Start-Ups by Fields of Actiity 1

Grant %

approved per

field of

activity

Grant amount

approved-($

thousands)

Grant

amount

approved-

(NIS

thousands)

Total

Start Up

companies

Field of Activity

100% 131,447 492,925 4,362 Total

3% 3,852 14,444 122 Agro Technology

6% 8,113 30,424 250 Clean-Tech

2% 2,746 10,296 61 Defense

15% 19,670 73,763 695

Enterprise &

Business

Applications

5% 7,203 27,011 115 Healthcare IT

6% 7,450 27,939 203 Industrial

Technologies

4% 5,068 19,004 696 Internet

21% 27,269 102,257 576 Medical

Technologies

2% 1,998 7,492 520 Mobile

Applications

10% 12,607 47,275 165 Pharmaceutical

Products

7% 9,571 35,893 262 Security

6% 8,525 31,968 85 Semiconductors

1% 1,535 5,756 91 Telecom

Applications

9% 11,288 42,330 90 Telecom

Technologies

1% 1,945 7,295 340

E-commerce and

Online

Advertising

2% 2,607 9,778 91 Miscellaneous

Technologies Source: Kirschberg, E., Enselman, T., Business-Economic Statistics Department, , Media 2 Release, 21 May 2018. 3 4

Below is a snapshot of the fluctuations during recent years (Kirshbreg, 5

Enselman, 2018): 6

7

In the years 2011-2016, 4,029 start-up companies were opened in Israel. 8

1,509 of them (37%) were closed or delayed until 2016. 9

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In the years 2014-2016 there was an average annual decrease of 29% in 1

the balance of openness and closing of start-up companies. This follows an 2

average annual increase of 12% in the years 2011-2013. 3

Total revenue of start-up companies in 2016 amounted to NIS 6 billion 4

($1.7 billion), an increase of 2% compared with 2015. 5

In 2016 the amount of employees were approximately 27,500 employee 6

jobs in start-up companies, up 7% compared to 2015. 7

64% of employee jobs are concentrated in software-based companies 8

(applications for industries and businesses, medical information, Internet, 9

mobile phone applications, security, e-commerce, and advertising). 10

11

Monthly wages per employee job (Kirshbreg, Enselman, 2018): 12

13

The average monthly wage per employee post in start-up companies in the 14

year 2016 was NIS 13,800 (about $3,680), an increase of 6% compared to 15

2015, and 1.5 times the average monthly wage for a wage job in the entire 16

economy -NIS 9,200($2,453). 17

18

In companies with a maximum of ten employee jobs, the average monthly 19

wage per employee post in 2016 was NIS 12,300($3,280), and in 20

companies with 21-21 employee jobs, the average monthly wage per 21

employee post was NIS 20,500($5,467). In companies with more than 50 22

employee jobs, the average monthly wage is NIS 21,100 ($5,627), 2.3 23

times the average monthly wage in the economy. 24

25

Geographic distribution: 26

27

In 2016, there were 1,836 companies in the Tel Aviv District, 268 28

companies opened and 159 closed. 29

30

Most of the activity of start-up companies in Israel is concentrated in the 31

Tel Aviv and Central Districts. 72% of start-up companies and 78% of 32

employee jobs are concentrated in these districts. 33

34

In the Tel Aviv District, the average monthly wage per employee post was 35

the highest (NIS 14.6 thousand), and in the Jerusalem District and the 36

South, the average monthly wage per employee post was lower (NIS 37

11,700 and NIS 11.2 thousand, respectively). 38

39

Funding: 40

41

In the group of start-up companies, there was a continuation of the positive 42

and consistent trend that began with the end of the global financial crisis. 43

The large scope of funds raised by high-tech companies had a significant 44

influence on this result. According to the IVC Research Center, 45

(Geektime, January 2017 Annual Report 2016: Start-ups and Venture 46

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Capital in Israel) approximately USD 4.8 billion flowed into the 1

companies' cash reserves during 2016-2017, a figure that constitutes a new 2

Israeli yearly record. This is while in the United States, venture capital 3

investment actually declined for the first time after five consecutive years 4

of growth. 5

6

Furthermore, the financing rounds themselves were larger than normal: the 7

average round stood at approximately USD 7.2 million, some 20 percent 8

more than the average between 2011-2016. 9

10

Quoting the director of the Authority of Innovation Aharon Aharon: 11

“Israel is a Technological Innovation Power, especially in the Field of 12

ICT. Technological Innovation is the key to economic prosperity, however 13

the financial potential of Israeli innovation has yet to be fully realized… 14

15

The Innovation Authority has formulated a strategy for preserving 16

international competitive positioning and for increasing the economic-17

social yield from Israel's prospering technological innovation.” 18

19

20

Innovation in Israel: How does It differ from Other Countries 21

22 The specific characteristics of the innovation process in Israel can be 23

explained by two main groups of factors. The first is the features of the local 24

innovation ecosystem. The second is the specific exogenous characteristics of 25

the country. 26

27

The Ecosystem Factors 28 29

A study by Turbiner, Schwartz and Bar-El (2016) tried to identify the 30

specific the relative importance of five major factors that currently influence 31

innovation in Israel, as compared with the widely acceptance of their influence 32

through literature: government and public institutions, universities and research 33

institutes, technological infrastructure in terms of information and 34

communication technologies (ICTs), access to funding, and culture. The study 35

was based on in-depth interviews with 25 leaders of innovation in Israel, 36

coming from the three sectors of the triple-helix: government, academia and 37

industry. The responses were quantified in terms of the relative importance of 38

the five major factors as mentioned above. We present the results by order of 39

importance, as ranked by the leaders. 40

41

Culture- Rank 1: 42

43

The factor which was ranked at the highest level by far in Israel is culture, 44

much before all other important factors. Culture is certainly recognized in 45

world literature as an important contributor to innovation (Saxenian, 1996; 46

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Frenkel, Meital, Leck, Getz, & Segal, 2011; Wadhwa, 2013; Dashti, Schwartz, 1

& Pines, 2008; Feldman, 2014). Cultural values such as tolerance of risk and 2

failure, individualism, low power distance and lack of formality were found to 3

have a positive impact on the emergence of innovation and also to explain the 4

difference in the level of innovation between countries. Similarly, a tendency 5

towards networking, pluralism, cultural openness, spirit of authenticity, 6

engagement and common purpose were also found to be elements that explain 7

the power of certain innovation ecologies and firms over others. 8

Still the specific characteristics of the Israeli have probably most heavily 9

contributed to innovation. In their book, Start-up Nation, Senor & Singer 10

(2009) describe Israeli culture as being devoid of hierarchies and formality, a 11

culture that includes a willingness to work hard, dedication, mutual 12

responsibility, willingness to take risks and a unique approach to failure. 13

According to the unique attitude towards failure found in Israel, it was found 14

that Israeli culture is not averse to situations marked by uncertainty. In this 15

context, a large number of the interviewees noted the contribution of military 16

service in Israel as a factor that shapes and influences the perception of risk and 17

ability to maneuver in conditions of uncertainty. It combines original thought 18

with initiative and strong performance that later translate into a culture that 19

supports innovation in the business arena. Other cultural aspects noted in the 20

interviews as supporting innovation include the tendency to challenge 21

conventions, thinking outside the box, strong improvisational skills and a 22

strong tendency to network. 23

24

Information and Communication Technologies (ICTs)- rank 2: 25

26

It is described in the literature as having a substantial impact on increasing 27

efficiency and productivity of innovation activities. In general, a strong 28

correlation was found between the degree of development of ICT infrastructure 29

and the country's level of innovation (Trigger Foresight, 2013). As a result, 30

many countries attribute a great deal of value to the development of 31

technological infrastructure that supports innovation and to increasing its use. 32

A developed ICT infrastructure significantly reduces the impact of geographic 33

distance on the emergence of innovation and serves as a catalyst for its 34

formation by reducing the costs associated with innovation activities and 35

raising capital, making global platforms of knowledge and information 36

accessible, and enhancing the ability to share, process, discuss and distribute 37

information (Rogers, 2003; World Economic Forum, 2013; Insead, 2011; 38

Chemmanur & Fulghieri, 2014). 39

The findings of the interviews of the main Israeli leaders are in line with 40

those of literature. 41

42

Academia- Rank 3: 43

44

Research literature shows that Academia and Research Institutes have a 45

marked impact on the emergence of innovation, which can be seen in the 46

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creation of two critical components of innovation - human capital and 1

knowledge. These inputs form the foundation of applied research, product and 2

process innovation in industry (Bercovitz & Feldmann, 2006; Etzkowitz & 3

Leydesdorff, 2000). 4

The field study in Israel shows that Academia has a quite moderate 5

influence on the advance of innovation. However, it should be noted that a low 6

influence was attributed to Academia by leaders of the public and the private 7

sector, while academic leaders evaluated a quite higher influence. 8

9

Venture Funding- Rank 4: 10

11

The importance of the financing bodies in the emergence of innovation can 12

be seen, firstly and foremostly, through their being suppliers of capital and 13

virtually the only source of financing for entrepreneurial and innovation 14

activity which entails great risk. A lack of venture financing entities has been 15

found to be a barrier to innovation activity and economic growth (King & 16

Levine, 1993; World Economic Forum, 2013). Furthermore, the contribution of 17

these entities to the emergence of innovation is also manifest in other aspects 18

that improve the odds of success for innovative ventures such as monitoring of 19

venture development, assistance in building quality management teams, 20

mentoring based on know-how and professional experience, connections to 21

local and global networks, providing a strong reputation to the funded 22

companies, and more (Chemmanur, Krishnan, & Nandy, 2011). 23

In Israel, as shown previously, the establishment of the YOZMA program 24

was a key factor in the ignition of the innovation process. However, the 25

importance of the access to venture capital was indicated by the leaders in the 26

field study only as moderate, differently from the extremely high importance 27

attributed to this factor in the world. This can be explained by the fact that the 28

success of the YOZMA project has led to a continuous privatization of the 29

venture capital funds, making them more accessible on a free market basis, and 30

therefore regarded as less critical to the advance of innovation. 31

32

Government- Rank 5: 33

34

The research literature shows that Government and Public Agencies play a 35

central role in leading innovation and that they are actually key and highly 36

influential innovation agents in the innovation ecosystem. The contribution of 37

these factors to the emergence of national innovation is described as being 38

broader and more comprehensive than addressing market failures and includes 39

a variety of interventions in different contexts and time intervals (Mazzucato, 40

2011). The means for promoting innovation that are available to the 41

Government and Public Agencies include both direct support of industrial 42

R&D, deployment of physical infrastructures, financing of basic research, 43

education and development of human resources as well as means that can 44

stimulate innovation processes, which are not based on conventional 45

expansionary fiscal policy such as tax incentives, enacting laws, regulations 46

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and agreements (for example, tax policy, copyright protection, international 1

cooperation agreements, immigration policy, etc.). 2

The Israeli government has generally received international recognition for 3

its economic policy, which relates to growth and innovation challenges. 4

Furthermore, a positive correlation was found between government programs 5

and actions in the field of innovation and various aspects of innovation, as seen 6

in the Israeli economy. Two salient examples in this regard are the 7

Technological Incubators Program and the Yozma Program, which were 8

successfully implemented by the government at the beginning of the 1990s 9

(Frenkel, Meital , Leck, Getz, & Segal , 2011; Schwartz & Bar-El, 2007; 10

Avnimelech, Schwartz, & Teubal, 2008). 11

Despite the evidence in the research literature regarding the importance of 12

the contribution of Government and Public Agencies to the emergence of 13

national innovation, the findings of the interviews show that on average, the 14

interviewees in this study did not perceive their contribution in the current 15

period as significant and ranked it as the less important factor for innovation 16

advance. This finding is especially interesting given the fact that half of the 17

interviewees who belong to the industrial sector received support from the 18

government to finance their innovative activity. Again, we may conclude that 19

Government was an extremely important player in the ignition of the 20

innovation process in Israel, but the progress and the continuous privatization 21

of the innovation process made the contribution of government as less critical. 22

23

Specific Exogenous Factors 24

25

The functioning of the national innovation ecosystem may be influenced 26

by various exogenous factors, which are specific to each country or region. In 27

the Israeli case, we identify three major factors that generally constitute an 28

impediment to economic growth: the scarcity of land and water, the lack of 29

energy sources and the heavy defense needs. Surprisingly, those three elements 30

played a major role in the advance of innovation in Israel. 31

The scarcity of land and of water was a major constraint to the Jewish 32

aspiration after the Holocaust for the establishment of a state and to the need of 33

a quite massive migration. However, such scarcity led to the need for an 34

extremely efficient use of land and water. Consequently many efforts were 35

done in the development of agricultural technology, of advanced production 36

processes, of new agricultural products. The scarcity of water was a major 37

stimulator in the research and development of water desalination and of the 38

treatment of used water. It was also a major stimulator in the invention of new 39

irrigation methods, mostly including the invention of drip irrigation. 40

The lack of energy resources in a country surrounded by countries with 41

high reserves of oil led to the continuous search of energy resources (rewarded 42

by the discovery of gas in the last few years), and to the major efforts in the use 43

of solar energy. 44

The defense needs as a result of military tensions with a multitude of 45

surrounding enemy countries, together with unstable political relations with 46

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other countries led to the investments of heavy efforts in the development of 1

local military instruments, first focused on automatic arms and ammunitions, 2

but later shifting to the development of heavy defense devices, usually with no 3

economic viability in a small country. This includes the development of a tank 4

that responds to specific Israeli needs, the Arrow project, and more. The 5

creation of a special military airplane (“Lavi”) was even initiated but failed 6

after a few years. 7

8

9

Conclusion 10

11 Israel would not be expected to be a leading country in the process of 12

innovation, following the quite accepted theories that explain the advance of 13

innovation. It is quite a small country with no local significant market, it is 14

geographically isolated, its infrastructures and its human capital are good but 15

not at the level of many developed countries. Still it is ranked today as one of 16

the leading countries of the world in innovation. Innovative activity covers 17

many sectors, the numbers of new start-ups are high, external investments are 18

impressive. 19

A few main factors probably are at the root of such results. 20

First, an important factor in the creation of innovation was rapidly 21

identified by Israeli policy: the critical contribution of venture capital. The 22

establishment of the Yozma program, with a quite high allocation of venture 23

capital funds and the collaboration with the experienced local and global 24

private sectors, was a major element in the ignition of the innovation process. 25

Second, the special cultural or human characteristics of the Israeli 26

population played an important role: the extreme diversity of the population 27

(reinforced by the mass immigration coming from the ex-Soviet Union), the 28

non-conformist behavior, the rejection of authority, all those characteristics 29

that are generally considered as negative to economic success, played a 30

positive role in the advance of innovation. 31

Third, surprisingly enough, exogenous factors that mostly impose heavy 32

constraints on macro-economic development, made a major contribution to the 33

stimulation of new fields of innovation in Israel: the lack of natural resources, 34

the problematic political and defense situation made the need for innovative 35

responses critical and led to innovation in fields generally dominated by big 36

economies. 37

Fourth, innovation ecosystems are dynamic and should be adapted along 38

the process of innovation. The role of the government in the provision of 39

infrastructures and venture capital is vital at the first phases, leading to a fading 40

out to private venture capital, and to the increasing relevance of cultural 41

aspects of the local population. 42

43

44

References 45

46

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