Israel's high-tech culture must rejigger, VC says

TEL AVIV, Israel--For one of the most important venture capitalists in Israel, the nation's recent burst of entrepreneurial success isn't going to be good enough to guarantee a productive future.

Chemi Peres, founder of the Pitango Venture Capital partnership, doesn't mince words when he talks about a high-tech landscape that he had a big part in shaping. The way he sees it, Israel's start-up culture will likely take one of two directions.

"Some people think we are only meant to innovate, and that once we build something, the best strategy going forward is to sell that company," he said. "The other school of thought is that you have to focus on building significant companies. Otherwise, it will endanger the idea of Israel as a state of science and technology."

For much of the last decade, Israeli high-tech companies have excelled in innovations but then sold technologies to larger multinationals that took those products to customers. Although Israel has prospered by adopting a more technology-oriented focus, Peres believes the build-and-sell model won't suffice in a fast-changing global market where competition is likely to come from anywhere on the globe.

"We're living in a world which doesn't have a original market," he said, "so we have to think on a global basis from Day 1."

I spoke in more detail about the local high-tech scene with Peres, who was on hand for an investment summit here sponsored by Silicom Ventures.

Right now, what's the hottest tech sector for VC investment in Israel?
Peres: Some are the more traditional ones, like software or semiconductors. But we see lots of activities and a great interest in life sciences.

What about clean tech?
Peres: Yes, there is more interest in clean technologies, though right now, the subsector within it that's emerging quickly is energy. The big issue of energy is very visible in the world, and we're starting to see some interesting companies out there.

Are the themes that VCs are looking at in Israel these days much different from a year ago or is a continuation?
Peres: I would say that it is a continuation from previous years. The Internet continues to attract a lot of interest, along with life sciences and energy--though energy is the No. 1, new growing area.

Can energy and clean tech turn into areas where Israeli tech start-ups hold a qualitative edge over the rest of the world, even the U.S.?
Peres: I think that potentially those are new sectors where Israel can stand in the forefront of technology. The issue is whether our market can become aware of changes in the world at the same time that others are. This is one of the critical factors related to the long-term perspective of the Israeli technology sector. We need to be aware of changes--if not ahead of everybody--then definitely no later than anybody else. Because we are far away from markets, the result is that sometimes we start things with a delay, which is not so good.

In the past, the criticism was that Israeli start-ups do a great job coming up with new technology ideas. But when it comes to marketing, they don't do quite so good a job. Do you think that's still true?
Peres: Clearly, you'll find deficiencies that result from the fact that we come from different cultures. We speak different languages. And our scale of measurement is adjusted to different levels. Israel is a very small country, while the U.S. is a very big country. You behave, think, react, and initiate differently when you live in a small country because you are used to things that catch up very quickly. Everybody is in the same time zone. Things look simpler. But I think that over time...Israelis may catch up still.

In the early '90s there was a big influx of immigrants from Soviet Union and so you had quite a massive supply of relatively inexpensive engineering talent to pick from. That was a once-in-a-generation event. And your universities can only turn out so many computing engineers each year. Since everything comes down to supply and demand, has all that affected cost-per-employee at your average Israeli tech company?
Peres: When you absorb over 1 million immigrants, there is a period of time you can enjoy that cost reduction. But it doesn't last as the immigrants get absorbed. Meanwhile, our currency has become stronger compared with the dollar. So while the dollar is weakening, what happens is that many Israeli companies are generating substantial portions of their revenues in dollars and euros. Because our expenses are in Israeli shekels, we suffer from the devaluation of those foreign currencies and therefore, our cost structure has become less advantageous when you compare it to the Silicon Valley.

The cost of an engineer in Israel has become higher than the cost of the engineer in the U.S. for the first time in history. We usually were more efficient or less costly than Silicon Valley and now we are in line--or in some cases--may be even more expensive, because of the shekel's strength.

I think your high-tech sector employs around 8 percent of the civilian workforce. If there is a shortage of engineers and technical people, what are the implications for Israel's high-tech prowess?
Peres: The most important thing is not the amount of people that you can recruit; it's the number of people that can innovate, that can invent and can develop. The rest can be complemented by different sources.

When a prospective Israeli tech entrepreneur comes knocking on your door and asks you for funding, what qualities are you looking for?
Peres: We like to see entrepreneurs who can carry the company from A to Z. People who can address problems, people who can build management teams, lead, and have a great vision.

What about biotech? Israel has a track record in coming up with new technology, but I don't hear anywhere the same amount of news concerning biotech start-ups in Israel. Why is that?
Peres: It takes time for companies to mature in life sciences. For instance, one of our portfolio companies, TransPharma, just announced a deal with Eli Lilly, which is a significant deal. This is a company that it took a long time to build. I think that you'll hear more interesting news about start-up biotech companies in Israel, but it's just that the maturity time horizon is longer than in the IT and the communication sectors. Still, you see the level of excitement.

A few weeks ago, we had the Israeli Biotech and Israeli Lab Sciences Industry conference, and 7,000 people registered for the conference--1,000 of them came from abroad. And remember that we're a small country and people were nonetheless very interested in what's going on here.

Is there much VC investment from Israel going into the Palestinian territories?
Peres: No, not yet; we have one interesting example, which is Ghost. It's visible because of the fact that the R&D center is in Ramallah.

But, you know, the deal flow is close to zero for us at least. We don't see opportunities to invest. And clearly, the situation is not in favor of doing business. But we have an interest to explore ways to cooperate, and actually there is a conference at the end of the first week of July, which is organized by the Israeli Chamber of Commerce, the Israeli-America Chamber of Commerce with PITA, which is the Palestinian IT Association.

Part of the discussions will be around how do we better operate on the IT side.

We'll have some business people talking about ventures. I think Ghost is going to present theirs and Yadin Kaufmann is putting a fund on the Israeli Palestinian front. So, you know, it is something that should be, should have happened before, a long time ago.

I think it's something that we look forward to see, and I think that once that will (be) a success story, I think that there will be an explosion of opportunities as opposed to explosion of other things. You need to ignite the market, initiate the imagination. And the way to do it is really to find something that will be successful.