Israeli startups

The Economist discusses the disproportionate impact of Israeli startups in the tech industry. Israelis are especially prominent in computer security, often due to their training in the military. One of the public companies that almost acquired my last startup (since merged/acquired by Juniper) had an extremely bright Israeli CTO who had come aboard from a previous acquisition. Like many other Israeli technologists, he was an alumnus of the IDF (Israel Defense Forces) signal corps training program, which takes in the brightest recruits for intensive IT training. Membership in that unit is sort of equivalent to having a Caltech or MIT degree. At least, the screening process is pretty tough. Of course, there might be other reasons for Israeli success in high tech 🙂

Red Herring: Talpiot is a special army training program that puts the best high school graduates through a rigorous curriculum of computer science, physics, and math, then places them in key assignments in, say, intelligence units.

…The selection process for Israel’s army-trained technology elite starts when teenagers apply to programs, usually in their last two years of high school. Only volunteers are eligible to be chosen for the army’s training programs. The most selective program, Talpiot, accepts only 30 applicants, or 1 in 10, a year. Officers say the army doesn’t look for fuzzy traits like creativity and leadership; it focuses on measurable qualities. Extremely high aptitude in math and science, along with success in rigorous exams, are the key qualifications.

REBOOT CAMP

Talpiot’s M.O. is total immersion, whether the subject is software coding or the Arabic language. The programming course is just six months long, but classes run from 8 a.m. to 10 p.m., five and a half days a week. Although many soldiers say that the program’s immersion approach is an effective way to learn, Col. Tregar says it’s simply the only way to cram a lot of information into a very short period of time. There’s little time to spend on theory and skills that won’t directly relate to the students’ army postings later on. “In an academic setting, you’ll learn about models for parallel processors and the structure of compilers — those kinds of things,” Col. Tregar says. “It’s true it gives you a much broader understanding, but on a practical level, you won’t have to deal with them in your first job. People with academic degrees that come to the IDF need to undergo considerable training before being put into practical assignments.”

Economist: In 2003, 55% of Israel’s exports were high technology, compared with the OECD average of 26%. Tech giants such as IBM, Motorola and Cisco have research centres in Israel, which is also where Intel developed its Centrino chip. Not bad for a country with a population of 6.9m.

Why is Israel—sometimes called the “second Silicon Valley”—so strong in technology? For several reasons, says Mr Mlavsky. First, the pump was primed by government grants in the 1970s, by the BIRD Foundation (a joint American-Israeli initiative that supported many start-ups before VC money was widely available), and by government schemes to encourage Russian immigrants who arrived after the collapse of the Soviet Union.

The second big factor is the army. “The army gets hold of everybody at age 18, and if they have a glimmer of potential, it catalyses their transformation into engineers or scientists,” says Mr Mlavsky. The technically minded are given projects to develop and run, and are allowed to keep any intellectual property that they develop, which results in many spin-outs. It also means that once they get to university, trainee engineers already have practical experience and a problem-solving mentality. Israel has 135 engineers per 10,000 employees, compared with 70 in America, 65 in Japan, and 28 in Britain (see chart).

The small size of Israel’s home market is also, paradoxically, an advantage. While a British start-up, say, will look to its home market to get started, Israeli firms cannot. Accordingly, they look to America for customers, so that Israeli start-ups function as “mini-multinationals” from the off—and are instantly exposed to the world’s most competitive high-tech market. Similarly, Israel’s relative lack of land and resources serves to steer entrepreneurs towards high technology instead.

Naturally, cultural factors play a part too. Around 5% of start-ups in America are headed by repeat entrepreneurs, says Mr Mlavsky, compared with around 30% in Israel. “The whole culture, we’re like junkies, and the real kick is success, not the fruits of success, so we want to do it again,” he argues. Israeli entrepreneurs are often workaholics who tend not to change their lifestyles much after becoming successful, he says. Gil Shwed, the boss of Check Point and one of Israel’s richest men, still has a regular DJ slot at a Tel Aviv restaurant on Wednesday nights, for example.

The bad news for other countries that wish to encourage the development of their technology industries is that few of these factors can be replicated. Singapore’s attempt to establish itself as a biotechnology centre faces the challenge of encouraging risk-taking and entrepreneurialism in a highly conformist society. And Britain is hardly likely to introduce conscription in order to boost the fortunes of the technology cluster around Cambridge University. In technology, as in so many other ways, Israel is a special case.

Chalabi, Hitchens tragicomedy

I don’t know whether to laugh or cry. As you may know, Chalabi is the former Iraqi exile (and Chicago math PhD) who conned the neocons with all kinds of crappy pre-war WMD “intelligence,” as well as the notion that our troops would be welcomed with flowers (who would you have believed on this, Chalabi or Army Chief of Staff Shinseki?). Rather than being the subject of an FBI/CIA investigation, he is being feted in Washington by Condi and others, and giving a lecture at AEI, apparently attended by Iraq war apologist and self-important blowhard Christopher Hitchens. The little nugget below comes via TalkingPointsMemo.com (see here for more).

Hitchens then turned the subject back to Chalabi, his good friend. I asked him if he thought Chalabi had been passing American intelligence to the Iranians. “No,” he insisted. “It’s possible that with his training, you know, at [The University of] Chicago that with his own ability he was able to crack the codes. He is a mathematical genius. His expertise is cryptology. It is possible that he broke the codes himself.” (This is a paraphrase since I was walking down M Street and crossing Connecticut Avenue all while being amazed that I was having an actual conversation with Christopher Hitchens at the time). Now, I don’t believe this for one second. Why would Chalabi be trying to break American codes in his spare time anyway? Who does that if they are friendly to us? Suspicious, I say.

Well, Chalabi’s expertise is not cryptography, and no, he didn’t single handedly break any Iranian ciphers. What he did was pass on some important intel to the Iranians (that the US had broken their ciphers) that should occasion yet another investigation into neocons leaking classified information.

What makes me most sad is that someone (Hitchens) so ignorant and un-careful in thinking and speaking about topics about which they know nothing could be a public intellectual. But then again in our culture knowledge of basic mathematics or physics is considered geek esoterica whereas an educated person is expected to have read all of Shakespeare.

Baby boom

Invaders: 2, Adults: 0.

The invaders have overwhelmed us! Communications may be interrupted for some time…

VCs, Greenspan and globalization

NYTimes on Silicon Valley VCs and China investments. Note the final paragraph.

WHEN Joe Schoendorf, a Silicon Valley venture capitalist, was in Shanghai a few years ago to hear a pitch from a Chinese start-up company, he sensed something familiar. He interrupted the meeting, walked to the window and pulled back the curtains.

“What are you looking for?” he remembers the would-be entrepreneurs asking.

“I just wanted to make sure I was in China and not back in Palo Alto,” he responded.

China’s high-technology community, with its brains and competitive spirit, is probably more like its counterpart in Silicon Valley than any other in the world.

Yet Silicon Valley’s views of investment in China have tended to swing between wild optimism and deep anxiety – with the anxiety going beyond a fear of losing money. Some worry about helping Chinese start-ups move up the technology food chain.

These days, the Valley venture capitalists are sharply divided in two camps: one rushing into China and one holding back.

…The dominant perspective is that China is a vast sea of opportunity, from its low-cost skilled labor pool to its enormous consumer market that is more than one billion strong.

In fact, it is now routine for venture investors to demand that their start-up firms place the bulk of software development and manufacturing efforts in China or India. (A supply chain problem at a manufacturing arm in China, however, can easily ruin financial results in any given quarter.)

For China skeptics, the concern is that American investment will help energize a formidable competitor, which could come to dominate both markets and technologies.

The fear is based in the Valley’s complex relationship with China as supplier, partner, customer and competitor. Most venture capitalists say this evolving relationship will define the future of the Valley and maybe even technology development in the United States.

The Ningbo Bird Company is one case in point. It went from being a contract manufacturing supplier for Motorola to being a serious rival in the Chinese handset market in a matter of a few years.

Still, last year, most of the Valley seemed to throw caution aside as venture firms invested nearly $1.3 billion in China, up nearly 30 percent from 2003, according to Zero2IPO, a venture capital research and consulting company based in Beijing.

But in the first half of this year, investment slowed drastically after several changes in Chinese securities regulations. Those new rules caused “a decline of 50 percent in the first two quarters,” said Dixon Doll, managing director of Doll Capital Management, based in Menlo Park, Calif.

The lull is ending, though, in part because of the high-profile success of the initial public offering of Baidu, a Chinese search engine company that was able to raise $86.6 million in August, and a securities rule change in October. In September, Sequoia Capital, a major backer of Google, was reported to be planning a $200 million fund and hiring several employees in China.

That announcement followed an earlier joint agreement this summer by Accel Partners, a leading Silicon Valley firm, and the International Data Group to set up a $250 million fund.

There have even been reports recently that Kleiner Perkins Caufield & Byers, the Valley’s highest-profile venture firm, was creating its own China fund, though people briefed on the firm’s plans said that was not true. While Kleiner has recently added Colin L. Powell as a partner to serve as a “rainmaker” in Asia, it remains concerned about changes in Chinese security laws that could complicate the return of investment funds to the United States.

Mr. Schoendorf, who is an Accel partner, sees benefits in helping China to become a fierce new competitor. He likens this moment of anxiety and promise to the 1970’s, when Japan began to compete successfully with the United States.

“The Chinese graduate more engineers than we do,” he said. “They’re smart, they work hard, and so the only way to compete with them is to remain more innovative.”

WSJ: Greenspan comments on globalization of labor markets. (Holding down inflation is the same as diminished returns to labor…) The bond market reacted negatively to these comments, as Greenspan said the effect would eventually go away. But I think that was a mistake: only the leading edge of those 2 billion workers have been integrated into the world economy — a distinct minority. It will take decades before that deflationary effect wanes. Not to say that there aren’t other inflationary forces at play, like oil and commodity scarcity, but the labor component is deflationary as far as the eye can see. Not only do low-skill workers have little pricing power, but even engineers and service professionals are under pressure from abroad.

The integration of China, India and the former Soviet bloc into the world trading system is helping to hold down inflation but at some point, that effect will fade, Federal Reserve Chairman Alan Greenspan said.

…Mr. Greenspan said the addition of more than 100 million educated workers from former Soviet countries, large segments of China’s 750-million strong work force, and workers from India “would approximately double the overall supply of labor once all these workers become fully engaged in competitive world markets,” a development that “has restrained the rise of unit labor costs in much of the world and hence has helped to contain inflation.”

But while these forces “may well persist for some time,” he said, the process and its contribution to inflation control will wane and that “will need to be monitored carefully by the world’s central banks.”

Black holes for financiers

No, that’s not a typo: it’s black holes, not Black Scholes 🙂 I posted the following comment on Brad Setser’s blog (mostly read by finance and econ types). He was fascinated by this Times article on a measurement of the size of the supermassive black hole at the center of our galaxy.

It’s now widely believed that many galaxies have at their centers supermassive black holes with masses larger than a million solar masses. (The existence of these supermassive holes is a plausible consequence of how galaxies are formed through non-linear growth of density perturbations in the early universe, but that is another story.) Because black holes are dense, even these supermassive black holes are not that large. The one at the center of our galaxy appears to have diameter roughly that of the earth-sun distance (= 93 million miles; the galaxy is 10^9 times larger), and a mass of 4 million solar masses.

It is easy for astronomers to find objects which are so dense that, theoretically, they must be black holes. The thing at the center of our galaxy is one example; there are many more that are remnants of stellar evolution (very large stars that run out of fuel and collapse to form black holes — these are only a few orders of magnitude more massive than our sun). To estimate the density astronomers need to measure the mass (based on the gravitational pull exerted on nearby objects such as stars) and size of the object.

The recently reported findings have to do with radio astronomers looking at the black spot caused by absorption of radio waves coming from behind the black hole. They can measure the radius of the black spot to estimate the size of the black hole.

What is most interesting about black holes is the general relativistic effects associated with their “horizon” — particles, even photons, which pass the horizon can never escape and are doomed to eventually fall into the “singularity” inside the black hole where (according to general relativity) known physics must break down. Unfortunately, based on what I just said, outside observers will never know what happens at the singularity since the object falling in cannot send a signal back out once it has passed the horizon!

To establish the properties of the horizon predicted by general relativity would require probes which signal back to us as they fall in. (They would go dark just as they hit the horizon — their signal would be “infinitely redshifted.”) Astronomical observations are not really enough (although these radio observations are a step in the right direction) since in principle a very dense object which isn’t necessarily a black hole might absorb photons (radio waves) to yield a black spot. The identification of an object as a black hole simply based on its density relies on general relativity in a domain in which the theory has not been tested experimentally.

Economist on intellectual property

The Economist has a nice survey on patents and IP. As I mentioned in an earlier post, the US patent system (esp. for software) is pretty broken right now. The Economist looks forward to a day when ideas themselves can be bought and sold like any other product. In such a world, some firms might specialize solely in innovation, leaving other tasks like manufacturing, marketing and distribution to others. Of course, this assumes a smoothly functioning IP system, which seems very far off. At the moment, the legal costs of resolving a patent dispute are sufficiently high that startups (which produce a disproportionate amount of innovation) often cannot afford any confrontation with a public company. Given that many big companies are aggressively pursuing a patent-hoarding strategy (hiring more patent attorneys, but perhaps not more scientists!), this may have a negative effect on innovation. See here for leading patent recipients in 2004.

It can take years of hard work, and millions of dollars, for VCs, inventors and entrepreneurs (all of whom have “skin in the game”) to determine the worth of an idea. (In this process, the original idea is almost always revised in important ways.) Thus, even if a liquid market for patented ideas existed, valuation would be a very difficult problem. It is true that large companies often sign bulk cross-licensing agreements (for example, Sony and Samsung have cross-licensed a huge number of patents), but I have a hard time imagining a future where I can list a clever idea on EBay and sit back to consider bids from around the world.

The new predominance of intellectual property in technology industries is fed by a number of broader industry trends. First, IT and telecoms have become so complex that there is a greater willingness to accept the innovations of others. Gone are the days when vertically integrated firms handled every step of a product, from initial design to final sale. Now, a small army of specialist firms focus on narrow portions of technology, using intellectual-property rights to protect their inventions when they are licensed out.

Second, as many new technologies quickly turn into commodities, firms increasingly rely on innovation to remain competitive. Yet the return on investment in R&D is short-lived because more people innovate at a far faster pace than before. That means margins have shrivelled, explains Ragu Gurumurthy of Adventis, an IT and telecoms consultancy. “How to recoup the cost of innovation? By licensing the technology,” he says.

Third, customers are demanding “interoperability” and common standards rather than proprietary systems, which means different firms’ technologies must work together smoothly. This often requires pooling patents or cross-licensing agreements.

Fourth, generating intellectual property is less capital-intensive than other aspects of the IT businesses because it relies mainly on people rather than bricks, mortar and machinery. That makes it attractive to many start-up firms. Venture capitalists often demand that firms patent technology, both to block rivals and to have assets to sell in case the firm flounders. This was particularly apparent during the internet boom in 2000. “In addition to the dotcom bubble, we had a patent bubble,” says Mark Webbink of Red Hat, a firm that sells Linux, an open-source operating system.

Companies cannot simply turn their back on what is happening in intellectual property. Even if they refuse to play the game, they may be unwittingly infringing someone else’s patents because there are so many more of them around. Unless firms have patents of their own to assert so they can reach a cross-licensing agreement (often with money changing hands too), they will be in trouble. Thus many companies are acquiring large numbers of patents for purely defensive reasons, for use only to keep others’ patent threats at bay.

…But when talking to executives in the technology firms themselves, the language you hear most often is that of “the arms race” and “mutually assured destruction”. Companies amass patents as much to defend themselves against attacks by their competitors as to protect their inventions. Many technology companies have recently championed reform of the patent system to deal with spuriously awarded patents, licensing extortion and massive lawsuits. “There is a broad recognition in the US that the patent system, if not reformed, will…begin to impede American competitiveness around the world,” says Bruce Sewell, general counsel of Intel, the world’s biggest chipmaker.

This survey will argue that, despite such adjustment problems, the huge changes in intellectual property currently taking place in the IT sector will in time produce more efficient markets. But what do the IT firms themselves make of it all?

See also this article in the survey on IP in China and India.

The rise of China and India has mainly been underwritten by foreign companies, not indigenous ones, though this is starting to change. Both countries have been good at persuading firms setting up operations there to invest in training locals. Today, nearly all the large IT firms have big research centres in both countries, and local companies understand the need to develop their own intellectual property. Local people who went to Silicon Valley to find fortune are now starting up their own businesses in their home countries. Foreign venture capital is pouring in.

Without home-grown technology, India and China have to depend on foreign firms, and they do not like it. China, in particular, has seen a surge in the royalties it is paying to foreign firms, and is trying to stem the flow. When Qualcomm’s boss went to China in 2001 to negotiate royalty payments for his company’s third-generation mobile-phone standard, he agreed to accept less than what he charges others. Within a year, China was working on developing its own 3G wireless standard. If it succeeds, Qualcomm will see its royalties shrink further.

China and India have more to offer than just low costs, although these are clearly important. They are also able to deploy huge numbers of people to work on a project. Being able to throw bodies at a problem is vital in IT. It allows firms to do things such as speed up development cycles or explore alternative approaches that would not be possible with a smaller labour force.

In short, China and India are not simply taking over western IT jobs, they are changing the very process of IT development. It is not about doing the same thing cheaper, but about doing things that simply could not be done before. In that endeavour, intellectual property is becoming increasingly important.

There are limits to the optimism about India and China. Both countries have a culture of keeping technology to themselves. The western concept of patents is fairly new to them, and has proved controversial for countries at their stage of development. Also, both nations have huge institutional and infrastructure obstacles to overcome. Capital markets are embryonic. Big companies are coddled by the state. India’s government bureaucracy is stifling; China’s is opaque and corrupt. The legal system is uneven in India and consistently inadequate in China. Both countries badly need more experienced managers.

American technology executives with some experience of India and China are worried that the two are about to eat the rich world’s lunch, but locals with deep knowledge of both countries think it will take at least a decade. Still, the overall trend is clear: the rise of China and India as centres of innovation will radically shake up the technology industry that is today based mainly in rich countries.

…Take Huawei Technologies, a big vendor of communications equipment, with revenues of $5.6 billion in 2004. This year, revenue from abroad is expected to surpass that from domestic customers for the first time. Around half of its 34,000 employees do R&D work, claims the company. Its patent filings almost doubled each year during the 1990s, though they have recently started to slow somewhat: the number this year will be around 2,400, and from next year it is expected to settle at around 3,000 a year. In 1995 the company created a special department to work on patents, which currently has 100 people on the payroll but will expand to twice that number next year.

“If you didn’t have patents, you would be in a very disadvantaged position relative to your competitors,” explains Liuping Song, the head of Huawei’s intellectual-property department, at the firm’s headquarters in Shenzen. “Other companies approach you and charge you for using their patents.” So is the firm chasing after patents simply because other companies are doing the same thing? Mr Song laughs and says, “That is a difficult question to answer.” Then he adds: “We have to play by the rules of the game.”