Knowledge Creation and Transfer:
The emergence of Israel as a High-Tech powerhouse

Israel D. Nebenzahl
Bar-Ilan University

 

Israel D. Nebenzahl
Graduate School of Business Administration
Bar-Ilan University
Ramat-Gan 52900
Israel

Telephone: +972-3-5318907
Fax: +972-3-5353182

Email: nebenzal@mail.biu.ac.il

 

abstract

The 1990s decade has seen Israel being transformed to a high-tech center that challenges Silicon Valley with its high-tech industries that are growing at an exponential rate. The large number of technology-based start-up companies and their relatively high rate of success have attracted venture capital that help fuel the development process. Israeli technology has been transferred to the world market either via mostly through transfer of knowledge to Western multinationals, but more recently, also via local production. Factors which brought about this transformation are outlined and their implications for the future are discussed.

 

Knowledge Creation and Transfer:
The emergence of Israel as a High-tech powerhouse

In recent years, Israel has captured attention for its role as a major player in the creation and transfer of High-tech knowledge in a number of fields, the commercialization of knowledge-bases products and the relatively high rate of success of its technology-bases start-up companies (Maor, 1998). Those familiar with either High-tech, venture capital or international finance has known these facts. The purchase, last year, by America On Line (AOL) of Mirabilis, a small Israeli software company that developed the ICQ (in short for "I seek you") program, for $407M in cash served to draw attention to the Israeli High-tech industries by the general public (Domberg, 1998). The October 99 purchase of DSPC, an Israeli company specializing in cellular technology with headquarters in California, by Intel for $1.6 Billion in cash (DSPC, 1999) indicates that the purchase of Israeli firms by multinationals is becoming a trend rather than an exception. Considering these trends, it seems that Israel is rapidly becoming a High-tech powerhouse where technology is developed and transferred to the world markets via multinationals. The purpose of this paper is to outline these recent developments, to provide their main causes and to discuss their future implications.

Recent Highlights

Some fact and figures should help appreciating the present state of the Israeli High-tech industry.

  1. Israeli scientists are highly productive. In recent years Israel has had the highest annual number of new patents issued per capita. More scientific articles are published, per person, by Israeli scientists, than by those of any other country.
  2. Israel has the highest percentage of engineers and scientists in its labor force. It has 135 engineers per 10,000 people. In comparison, the US has 85.
  3. "A new study finds only Canada and Israel even within shouting distance of America." Israel is third to the U.S. and Canada in the proportion of individuals starting their own businesses. The number of such individuals is 8.4 per 100 in the U.S., 6.9 in Canada and 5.2 in Israel. (Skiles, 1999)
  4. The Israeli knowledge-based companies are concentrated in a few industries. The main ones are electronics, telecommunications, software and biotechnology.
  5. Many multinational technology-bases companies have research facilities, usually in the form of fully owned subsidiaries, in Israel. These include IBM, Digital (now Compaq), Intel, and Motorola, to name just a few.
  6. Recently, such companies have also opened production facilities. For example, Intel has just began production of its most advanced chips at a new $1.6 Billion plant in Kiryat-Gat (a development town) that augments its prior production facilities in Jerusalem (Intel, 1999).
  7. Presently, Israel is second only to the United States in annual investment in High-tech start-up companies and venture capital investments. In no other country such investments come even close to those in the two leading countries.
  8. Venture capital, from both internal and external sources, is fueling the Israeli high-tech industries. By December 1997, the total number of Israeli funds reached 81, and they had raised altogether $2,086 million, of which $1,189 million, or 57%, was invested. In 1997 alone, the funds invested $429 million in 150 companies.
  9. With the exception of the U.S. and Canada, more Israeli companies are traded in New York stock exchanges, mostly High-tech companies on NASDAQ, than from any other country. The latest summary data provided by the footnoted source states that the 1998 (month is not provided) market value of the 80 Israeli companies listed in these stock exchanges was approximately $23 billion. By October 27th 1999, 108 actively traded stocks in these exchanges approached the $50 Billion valuation (globes, 1999b).
  10. The impact of these trends on the Israeli economy can already be observed. In 1997, High-tech products accounted for 33% of Israel's total exports, and 80% of its industrial exports. Total High-tech exports in 1997 were $5.7 billion.

The above facts and figures clearly document the strength and viability of the Israeli high-tech industry. To summarize, from an exporter of oranges and processed diamonds Israel has become an exporter of knowledge-bases products in electronics, software and biotechnology. Leading players in Internet, telecommunications, electronics and software are not only doing research in Israel but are also actively seeking potentials for acquisitions of and joint ventures with Israeli start-ups. While ten years ago, there were no local venture funds and venture capital was not flowing from abroad, Israel is becoming the second world venture capital (Globes, 1999a). While ten years ago one could find just a few Israeli listings on New York stock exchanges and no listings in other foreign exchanges, presently Israeli shares begin to play a key role on the NASDAQ exchange, some are traded on the New York stock exchange, seven companies had their initial public offering (IPO) in London and other European exchanges are seeking ways to lure Israeli start-ups. Given these trends no wonder that some say that the Silicon Valley's most serious global competitor is to be found in Israel ("The Hot New Tech Cities", "Newsweek", November 3, 1998). It is, therefore of interest to try and understand the key forces that propel these trends.

Key Factors in the Development of the Israeli High-Tech Industries

It is beyond the scope of this paper to provide detailed information about all factors that influenced the development of the Israeli high-tech industries. What we provide below is an outline of those factors about which there is a general consensus. We begin with environmental factors.

Jewish attitude towards learning

Historically, Jewish culture has cherished learning for the sake of learning. That is, learning is viewed not only as a mean for achieving economic welfare and social status but also as an end for itself. As a result, the level of education of Jews is among the highest in the world. This may explain, in part, the large number of Jews among winners of Nobel and other prestigious prizes. This holds true both in the Diaspora and in Israel. Furthermore, immigrants who came to Israel from less developed countries have been highly motivated to advance. As a result, the level of education of the young generation far exceeds that of its parents. In my opinion, this factor is the most influential on the quality of the Israeli labor force.

Another aspect of Jewish culture is its high spirit of enterprise. Environmental causes in the Diaspora forced Jews to strive for economic independence. This entrepreneurial spirit remains a clear characteristic of the Israeli Jewish population. At the beginning of the decade, Israeli entrepreneurs began taking advantage of the convergence of special factors that made investment in High-tech industry in Israel potentially highly profitable. The results are observed today.

Defense Needs

When Israel declared its independence in 1948, it was attacked by seven of its neighboring Arab countries. The state of war continues to date with some of the Arab countries, notably, Syria, Lebanon and Iraq. Other countries still pose a more distant threat, including Iran, Libya, and others. Both wars and political embargo on arm shipments to Israel have forced the country to develop a strong defense industry. At its infancy, this industry comprised of small metal shops producing primitive submachine guns (the Sten), small mortars (the Davidka) and ammunition. The industry grew slowly until the 1967 war. Prior to this war, France was the main arms supplier of Israel and the Israeli airforce was equipped with French airplanes. The French embargo that followed the war was the catalyst for the development and growth of the Israeli Aviation Industry that grew from a maintenance and repair shop to Israel's largest industrial complex with numerous subsidiaries. Investing heavily in R&D, this conglomerate became a world leader in avionics, including radar, telecommunications, and man-machine interface. Its attempt to produce its own fighter, the Lavi, was a technological success that was cancelled due to economic (and American political) pressures. We may note in passing that the Lavi project was initiated at about the same time that the U.S. curtailed spending on its space program, releasing thousands of highly skilled engineers and technicians, some of which immigrated to Israel to join the Lavi project. The end of the Lavi project, in turn, released to the Israeli labor market thousands of capable engineers and scientist that eventually served as the core of entrepreneurs and qualified manpower for the Israeli high-tech industry.

The military imperative has not disappeared. In general, the search for better systems in the areas of weapons, intelligence gathering, and command and control, goes on apace. In parallel with R&D conducted by the defense industry, the Israeli is army is conducting its in-house research in cutting edge technologies. Engineers who had the knowledge developed by these efforts transformed the technologies for civilian use and established some of the most successful high-tech companies, such as Check Point.

The Arab Economic Boycott

Israel is a small country, with almost no natural resources and relatively small internal market. These conditions imply that the only avenue for economic growth is via international trade. The war of independence was followed by the Arab boycott that, in part, continues to date. While most analysts view this boycott as being detrimental, and while the Israeli government has been fighting it by all its means, in my opinion it has been highly beneficial for the long run development of the Israeli economy in general and its high-tech industries in particular. The Arab world surrounding Israel is economically less developed and needs rather basic products. By blocking this market, Israeli companies had to seek other outlets. Instead of trading with its less developed Arab neighbors, it was forced to trade with the highly developed European and North American markets. In these markets, Israeli companies could not compete with the low production costs of the Far East nor with the mass production capabilities of its European and American partners. The solution that eventually evolved was catering to high-tech niche markets, where Israelis can compete by providing the knowledge, if not the production.

The Influx of Russian Immigrants

During the first half of the 1990s decade a large number of Russian Jewish immigrants, including a relatively large number of highly trained and experienced engineers and scientists entered Israel. They posed a severe absorption challenge, which as described below, was turned into an opportunity. These highly skilled immigrants raised the overall level of the Israeli labor force.

We now turn to governmental policies and actions that have played a role in promoting the Israeli high-tech industries.

Free Trade Agreements (FTA) and Liberalization of International Trade

To guarantee access to its major markets, Israel negotiated free trade agreements with its key trading partners. The first agreement was reached with the European Union. Between 1975 and 1977, the European markets were opened to tax-free Israeli exports. To protect its local industry, the Israeli market was gradually opened to the EC, a process that ended in 1989 with full exposure to tax-free imports. The FTA with the United States followed with gradual lowering of trade barriers for Israeli exporters beginning in 1975 and culminating in the complete opening of the Israeli market to American exporters in 1995. By mid 1990s, Israel had full or partial additional FTAs with EFTA, East European countries and East Asia countries. The latest FTA agreement was signed with Canada in 1997. Israel was the first and only country with FTAs with both American, European and Asian countries. These agreements forced liberalization of the Israeli industry. Traditional industries, such as textile could not compete with inexpensive imports from the Far East and the Israeli industry is being restructured, with high-tech replacing the more traditional manufacturing industries.

Privatization

During the early years of its statehood, Israel tripled its population by absorbing refugees from Europe and the Middle East. Most came with no resources forcing the government and the Histadrut (labor union) to actively participate in all aspects of the Israeli economy, including the creation of employment opportunities. These governmental and Histadrut involvement were not viewed unfavorably by the socialist parties that ruled the country until 1977. However, with the opening of Israel to free open trade, government economic enterprises, bureaucratic and inefficient, had to be privatized or closed. During the 1990s privatization took momentum, leaving room to entrepreneurs to play a stronger role.

Investment and R&D incentives

Israel has traditionally offered large incentives to attract both foreign and local capital. Investment projects granted Approved Enterprise status entitle companies to substantial financial support from the government in the form of reduced taxation, investment grants or guaranteed loans. The Office of the Chief Scientist has provided matching funds for R&D expenditures. State financing for R&D amounted to $250 million in 1997 (Globes, 1999a). These incentives have been instrumental in motivating numerous international companies, such as IBM and Intel, to make direct investments in R&D and more recently in production facilities in Israel. Until the 1990s, the research facilities of these companies only provided employment to Israeli scientist, while the developed knowledge served the parent companies to the exclusion of Israeli ones. Yet, over time they served to raise the productivity of Israeli scientists by putting greater emphasis of the development part of R&D. Just as the defense and military research released highly qualified entrepreneurs, so did the R&D facilities of companies in the league of IBM, Intel, Digital and Motorola.

The Technology Incubator Program

The opening of Israeli markets to imports on one hand and the influx of Russian immigrants on the other, required government intervention. However, such intervention ran counter to liberalization and privatization. The solution was found in the form of the technology incubator program. Founded in 1991, the incubator program was designed for the dual purpose of helping entrepreneurs develop highly risky, but potentially marketable technologies as well as provide employment opportunities for the influx of technically educated Russian immigrants. Under this program funds have been provided for the establishment of technological incubators within academic, regional and business organizations. Each incubator can ran 10-20 projects in parallel, providing all projects with management, finance, accounting, administrative and legal services. Each project can stay in the incubator for a two-year term, with a budget of up to $344,000, 85 percent of which financed by the government. During the incubation period, the project entrepreneurs are supposed to develop prototypes of their technological ideas and prove the existence of a market. By the end of the incubation period, projects should be in a position to raise seed money, leave the incubator and become independent high-tech businesses. The selection of projects was left in the hands of the incubators, with the approval and supervision of the Chief Scientist office. Thus, while the government provides most of the finance for the incubators and their projects, their management and operation have been private. From 1991 through 1998, 676 projects, managed by 15 incubators, received a total of $267M. Of the 476 projects that graduated the incubation period, 51 percent continued as independent companies and attracted an average of $1.1M initial seed investment. This rate of success favorably compares with the 10 percent success rate in the U.S. for similar programs (Shalit, 1998).

Initiation of Venture Capital Funds

As noted earlier, at the beginning of the decade venture capital was not available in Israel. It took a government initiative to propel this sector. In 1992 the Israeli government Founded Yozma, the first Israeli venture capital fund. Yozma brought local investors together with prominent international investment names, and it served as a catalyst in the creation of the Israeli venture capital market (Globes, 1999a).

Conclusions

A number of environmental and strategic factors propelled the Israeli high-tech industries into an exponential rate of growth. The combination of favorable, or challenging, environmental factors with strong entrepreneurial drive and higher rate of success than is experienced elsewhere, have attracted world attention to the Israeli technology-bases start-ups. The resulted technological and business successes attract additional venture capital, with Billions of Dollars presently seeking investment opportunities in Israel. These trends started to attract skilled immigrants not only from East European countries but also from the West. The availability of investment money coupled with the publicity given to the subject in the local press, further motivate Israeli engineers and scientists to become entrepreneurs and initiate new projects. Thus, the Israeli high-tech industries have reached the stage whereby the growth process feeds itself and is expected to continue in the near future.

Some technology-bases Israeli companies have reached a significant share of the world market by achieving technological leadership and became multinational. Companies like Scitex in the print industry, Elcint in medical instrumentation, DSPC in telecommunication technology, Check Point in computer communication protection and the less prominent Magic in data base management are notable examples. In addition, Israeli technology is being transferred to the world markets via Western, mostly American multinationals. These companies either have research facilities in Israel or they buy out young Israeli companies that have the technologies they seek. Recently, Intel has shown that, contrary to common belief, Israel can serve not only as a think tank but also an appropriate production site. Indeed, the country's skilled labor is capable of producing highly complex products, providing a comparative advantage. It can be concluded that either via Israeli made products or through technology transfer, most technology-based products sold in the world markets have today or will have in the very near future "Israel Inside".

references

Domberg, N. (1998), Commentary: How Much are ICQ Users Worth for IOL? Israel's Business Arena, June 10, http://www.globes.co.il/cgi-bin/Serve_Arena/pages/English/1.2.2.24.2

DSPC (1999), Intel to Acquire DSP Communications, Inc., for Approximately $1.6 Billion in Cash DSPC press release, October 14, http://www.dspc.com/pr/101499.htm

Globes, (1999a) Globes-Arena Web site: http://WWW.globes.co.il of 28.10.99.

Globes, (1999b) Israeli Shares Traded in the New York Exchanges - 27.10.99, (Hebrew) October 28-29, p. 78.

Intel (1999), Intel's Lachish Kiryat-Gat Plant Starts Production of Processors using 0.18 Microns Technology, Legal Information, (Hebrew), http://www.intel.com/il/content/intel_il/pr/pr_0081.htm

Maor, Rafi, (1998) High Tech Managers: Israel as a Technology Incubator, Globes, January 15, (Hebrew).

Office of the Chief Scientist, Ministry of Industry and Trade (1999), The Incubators Program, http://WWW.incubators.org.il

Shalit, D., (1998), Waiting for Gadot (or Next Mirabilis), Globes, June 23, p. 10, (Hebrew).

Skiles, H., (1999), In the U.S., Startups Bloom Like Nowhere Else, BusinessWeek On Line, http://WWW.BusinessWeek.com, July 30.