The Israeli High-Tech Economy

Israel's technology industry has earned international accolades and a position at the forefront of global technological innovation. However, these achievements also present their own problems and challenges, chief among them the need to ensure our continued advantage in human capital. The technology sector is on the brink of crisis, driven by the shortage of skilled workers (engineers and programmers in particular) and the crisis in technology studies.

Israel's high-tech industry has made impressive strides over the past two decades, the result of a unique ecosystem built on the fruits of technological education, civilian applications of the defense industry, and government aid in raising venture capital—which generated a sophisticated private venture capital infrastructure. In the 1990's, these factors on the ground met with a significant wave of immigration from the Commonwealth of Independent States that brought a large reservoir of talented engineers to Israel at the same time that the global computer industry shifted its focus from hardware to software, giving Israeli companies a tremendous edge in the global technology market. 

While Israel (and, in fact, Zionism) has always emphasized scientific research and human development, partly in response to the country's lack of natural resources and the Arab embargo, in the three decades spanning 1984 to 2014, Israel redoubled its efforts on this front. 

Over the course of this 30 year period, Israel saw a 378% increase in the number of university and college students, an increase of 228% in national R&D expenditure as a percentage of product (from 1.3% in 1984 to 4.2% in 2014), and is currently ranked first out of 148 economies in innovation abilities, second in entrepreneurship and third in global innovation (source: IMD Competitiveness Yearbook). The annual Global Dynamism Index (GDI), which reviews 60 leading economies around the world, also puts Israel in first place (78.3) for technological and scientific abilities.

Israel's strengths in innovation and the quality of its human capital have attracted hundreds of technology companies from all over the world to set up shop in Israel. Today, more than 300 international companies including Facebook, Microsoft, IBM, Intel, Google, Apple, Cisco, Motorola, Philips, Applied Materials, Siemens, HP and EMC, have established R&D centers in Israel and have even purchased dozens of Israeli start-ups (see below). These big-name, multi-national companies employee some 280,000 workers, of whom some 52,000 work in R&D centers.

Since the 1980's, one of the most active technology communities outside Silicon Valley has come into being in Israel. The breakthrough products coming out of Israel span the gamut—everything from medical instrumentation, to security products and irrigation applications. All this is happening despite a decline in investors' enthusiasm for technology companies, burdensome security problems (three intifadas and several military campaigns), a growing anti-Israel embargo, and a hostile atmosphere towards Israel in Europe and the U.S.

The Growth Engine of the Israeli Economy

In recent years, the technology industry in Israel has been the driving force behind the country's economic growth. The technology sector makes the largest contribution to the country's export (about 50%, a leap of 3,700% since 1984), it has the greatest access to the world's capital markets, and actually is the only sector that successfully raised impressive sums of foreign capital for equity, as opposed to the government, the banks and Israel Electric Corporation (IEC), which only succeeded in raising debt.

There are currently 7,072 high-tech companies in Israel—25% of them in Internet, 20% in telecommunications, 19% in IT and organizational software, 17% in life sciences, 9% in cleantech, 2% in semiconductors and 2% in website technology.

High-tech employees are estimated to number 288,348. With the addition of indirect employees multiply that figure by four: for every person working directly in high-tech, there are four who work in related services.

Israel also has one the world's most highly developed infrastructures in all the parameters required to create a thriving technology industry. The number of engineers and scientists as a proportion of the population is among the highest in the world, as is the number of new ventures. It is also worth noting that in Israel, 90% of inventors are local, as in India, China, Japan and Korea. In other words, most of the technological innovation in Israel is the product of Israeli inventors. 

The Unique Israeli Ecosystem

The strength of the Israeli tech sector rests on four "legs": the military defense industry, which trickles down to the civilian sector; the close affinity between industry and academia; the presence of multinational companies; and the cumulative effect of all of these factors.

Israeli high-tech owes a great debt to the national defense system. The prestigious intelligence and computer units of the IDF and Unit 8200 in particular, release thousands of extraordinarily talented young people into civilian life every year. Many find their way into Israel's cyber industry which, incidentally, was the recipient of 20% of the country's R&D investments in 2015.

The complex Israeli reality—and more specifically, its security situation—are responsible for close ties between education and the military. The IDF identifies the most suitable recruits even before they leave school, invests huge sums of money in their training, and posts them immediately to the technology front line. While nobody can quantify this tremendous investment in human capital which evolves into the talent tapped by the high-tech industry (the number of Unit 8200 graduates behind Israel's start-ups is no coincidence), its influence must be taken into account.

The flow of human capital, ideas and budgets from the military to the civilian market is one of the most notable features of Israel's technology ecosystem. For visitors to the new high-tech park in Be'er Sheva—which stands on equal footing with similar high-tech centers around the world—it is immediately apparent that Israel is a priority destination for multinational companies.

The ties between Deutsche Telekom, for example, and Ben Gurion University of the Negev and between the university and the IDF—which is relocating its computer communications and intelligence units to the Negev—have created a unique amalgamation of technological cooperation, notably in the field of cyber. When all this happens in a relatively small market, such multipliers are more than strong enough\  to create waves throughout an entire industry.

The defense system and the intelligence system seek out experts to analyze enormous quantities of constantly-changing, complex, and multidimensional data. This yawning need translated into increased training in Business Intelligence (BI), Artificial Intelligence (AI), and big data. The data-analysis skills acquired in the defense system trickle down to the civilian sector where they manifest in new industries such as cyber, which enjoys a steady flow of experienced manpower from the IDF.

In the early 1990's, Israel invested in two programs that put wind in the sails of the high-tech industry, which up until that point, had been concentrated mainly in the defense industries. The Yozma program led to the establishment of 10 venture capital funds dedicated to attracting foreign investments. In parallel, the new technology incubator model began taking in 80 to 100 start-ups every year and provided extensive financing and support to early-stage startups. These two programs gave rise to the Israeli venture capital industry that went on to turn Israel into the "Startup Nation". 

By the 1990's, most of the elements that we see in today's high-tech ecosystem were already coming into place—academic institutions and research centers, service providers such as patent attorneys and auditors, global companies and more. The venture capital industry was the missing piece the puzzle, and once it too was in place, the road to success in promoting initiatives and innovation became faster and easier.

In recent years, another important factor entered the picture in the form of accelerators. The role of tech accelerators is to give early stage startups a leg up, helping entrepreneurs to clear one of the most complicated hurdles—obtaining seed money. The accelerators are characterized short rounds of activity, differentiated from each other by the type and extent of the services they offer—all contributing to a shared bottom line: the growth of more Israeli startups.   

Exits and Raising Capital: Intellectual Property as a Comparative Advantage

A deeper look at the Israeli high-tech industry enables us to better understand the intellectual property situation in Israel, owing to the fact that intellectual property and technology are two sides of the same coin. To a large extent, intellectual property—in its broadest sense—is an expression of the essence of technological development, and often seems to foresee it, for the simple reason that entrepreneurs and developers register patents on the development before products go to market.

This is forcefully illustrated in Israeli start-ups that were sold to mega corporations abroad. Last year, 2015, there were 107 exits which generated a total of 8.03 billion dollars. The real record years for Israeli exits were the three years between 2011-2014: in 2014, 117 exits grossed 7.7 billion dollars; 2013 saw 97 exits for 6.71 billion dollars; and 2012 produced 91 exits worth 9.75 billion dollars.

_{Source: IVC Research Center}

The buy-outs by giant multinationals are unprecedented. For example, Microsoft has purchased no fewer than 21 Israeli start-ups for $1.4 billion, Intel—14 companies for $2.2 billion, Cisco—11 companies for $6.5 billion, Google—eight companies for $1.2 billion, HP—six companies for $5.5 billion, Marvel—three companies for $2.9 billion, just to highlight a representative sample of similar activity.

_{Source: IVC Research Center}

Giant corporations such as Apple, EMC, Cisco, IBM, Broadcom, Johnson & Johnson, Intel, Microsoft and others are eager buyers for Israeli start-ups, hungry for their innovative technologies which comprise intangible intellectual assets (intellectual property). These acquisitions were not solely motivated by cash flow, impressive customer lists, or sales volume rather by the value of the proprietary technology on the negotiating table. There can be no doubt that intellectual property will continue to be the main attraction for multi-national corporations looking to buy into or invest in Israel's high-tech sector.

In other words, intellectual property reflects technological innovation and is the core value in the sale and acquisition of high-tech companies. 

The value of intellectual property can also be seen through the prism of venture capital investments between 2006 and 2015, when investments totaled an extraordinary $21.8 billion, demonstrating a strong, consistent upward trend.

_{Source: IVC Research Center}

In 2015, Israeli technology companies set a new record in venture capital investments, raising $4.4 billion, 30% more than in 2014. Nevertheless, the percentage of Israeli funds has sharply declined, increasing dependence on foreign investments, mainly from the U.S. Last year, 85% of venture capital investments in Israeli start-ups came from foreign funds. While there has been a rise in investments from China and others in recent years, American money continues to dominate. This is a challenge for the high-tech sector which reacts to U.S.'s economic fluctuation—notably the aftershocks of the 2008 crisis. In 2009, Israeli VC funds felt the effects in: American venture capital investments in the Israeli technology industry fell dramatically.

The amount of money raised by Israeli VC funds fluctuates wildly. These funds, once the mainstay of the thriving Israeli high-tech industry, have been gradually losing their power and influence. The decline in their status is apparent, first and foremost, in the noticeable decline in capital raised. Today, VC funds are less likely to invest in young high-tech companies, showing a decided preference for depositing their ever-decreasing investments with more mature—and less risky—companies.

Since 2000, venture capital funds in Israel have witnessed a steady decline in their ability to raise capital. Whereas in 2000 the funds raised no less than two billion dollars, in 2005 that figure fell to 1.4 billion, in 2009—200 million, and in 2010 the funds stopped raising capital altogether. There was a slight recovery in 2011 when the funds managed to raise about 800 million dollars barely scraping the bottom of the 2008 numbers. Overall, this trend remains unchanged.

2012 brought no real change—just more marching in place. The venture capital funds raised about $900 million, slightly more than in 2011. In 2013, the numbers took a nosedive and totaled a mere $600 million. Since 2014, there have been signs of improvement, with the funds raising $1.2 billion and $1.1 billion in 2014 and 2015, respectively. Projections for 2016 are in the neighborhood of one billion dollars.

_{Source: IVC Research Center}

A bird’s eye view reveals that between 1995 and 2005, the venture capital funds raised $14.8 billion with the entire period divided into six sub-periods, each of which reflects a business cycle. The graph indicates a noted rise in capital between 1995 and 2000—the year the high-tech bubble burst—and shows a steady decline from then to 2011, after which we see a reversal of the trend.

Another way of evaluating growth in the high-tech sector is by looking at the number of new companies that open every year. High-tech companies are significant producers of technological innovation and intellectual property even if they do not make an "exit" (statistically, few do). We can see that in 2015, there were 829 new start-ups compared with 1,029 in 2014 and 860 in 2013. The important number here is the four-year average—891 new companies since 2012, which is higher than the average in the four preceding years—434 new companies from 2008 to 2011.

_{Source: IVC Research Center}

Naturally, while many companies opened, other closed. In 2015, just 213 companies closed their doors, compared with 574 in 2014 and 607 in 2013.

 _{Source: IVC Research Center}

An analysis of the companies that entered the market reveals that 29% were in Internet, 27% in telecommunications, 20% in software and only 13% in the life sciences. This mix is more or less the same as in prior years.

 _{Source: IVC Research Center}

The venture capital sector in Israel behaves like an inverted pyramid: at the vertex are the Angels, the pre-seed investors, and at the broad base are the foreign funds that usually invest in the second and third rounds in companies that demonstrate growth. In the middle, we find incubators, crowd-funding and micro-funds that invest at the seed stage, and Israeli and foreign funds together with private Israeli investors that contribute to the first round of funding.

_{Source: IVC Research Center}