Innovation and the State/Chapter 2
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[edit] Chapter 2: The Development of the IT Industry in Israel: Maximization of R&D as an Industrial Policy
Like old Soldiers, old R&D Projects never die.
There is always the sequel.
—Brig. Gen. (Ret.) Professor Itzhak Yaakov, Israel’s Chief Scientist, 1974–1978
Israel’s IT industry is an impressive success story. In less than twenty years, the country has emerged as a key player in global IT technology, with Israeli companies pioneering many hardware and software market niches, such as voice over Internet protocol (VoIP), encryption, printed circuit board inspection, antiviral protection, digital printing, and firewalls. This small country of only six million has, after the United States and Canada, the highest number of IT companies listed on NASDAQ. In 2000 Israeli IT industrial export revenues exceeded $13 billion and accounted for more than 71 percent of all industrial exports; the IT industry accounted for 70 percent of GDP growth, by far the highest percentage in the world. By 2004 the industry had shaken off the NASDAQ’s dot-com crush, and revenues exceeded $15 billion (CBS 2000b, 2001, 2004a, IAEI 2006).
Looking at Israel today, with its strong science-and-research infrastructure, one can easily claim that its success in the IT industry was predictable. However, nothing could be farther from the truth. Israel’s industrial policy in its first two decades of existence resembled the model prescribed by the “old” developmental-state theorists. The state employed long-term planning and directly intervened in the creation of specific sectors and industries, especially textiles and defense, without any thought given to the creation of hightechnology industries (Levi-Faur 1998, 2001). In 1968, Israel’s science-andtechnology (S&T) industrial policies were based in public research institutions. R&D activities in the private civilian industries were almost unheard of. Israel’s total R&D expenditures as percentage of GDP—less than 1 percent in 1965—were lower than any of the Organization for Economic Co-operation and Development (OECD) countries except Italy. The number of scientists and engineers was not low—10 per 10,000 employees—but it was still less than half the ratio of the United States (25) and Sweden (22) (Katchalski 1968, p. C-7). The absolute number of R&D personnel in the industry was minuscule, and most R&D activities and personnel were concentrated in the defense and academic research sector.[1]
What accounts for this enormous transformation and the success of Israel’s IT industry? First, Israel’s main competitive advantage has been its R&D capabilities— its competitive edge originated in an existing defense sector and academic research system. The state’s almost exclusive focus on the enhancement of technological cutting-edge R&D capabilities has enabled firms to develop novel products based on the latest technologies, the new technologies themselves, or new applications of these technologies. In turn this has led Israel’s IT industry into its position as a supplier of new technologies to the global IT industry’s production network. This development path brought the IT industry to success first in hardware and then in software; thus the software industry developed within an industrial system that was already centered around advanced product R&D activities.
Second, from the beginning of the 1970s S&T industrial policies focused almost solely on developing capabilities to create new R&D-based products. In addition, the state’s R&D policies viewed private firms as the main agents of R&D; the state saw its own role as the grantor of capital for R&D activities. It encouraged the development of R&D capabilities in the private market, diffused R&D know-how from the university and defense sectors to the civilian industrial sectors, and coordinated and provided public space in which private and public R&D agents could meet in order to enhance the flow of information and ideas (Breznitz 2005a, 2006). Thus in Israel the state’s actions nurtured an institutional environment that stimulated private firms to develop advanced R&D capabilities and gave them the resources to do so.
Third, in the case of Israel the state forcefully advanced a specific division of labor between local firms and MNCs. The state advanced both a specific and prominent model of organizational development in the IT industry, and a specific model of embeddedness into the global IT industry’s production networks. This division of labor allowed Israeli firms to specialize in product R&D and to utilize American (and later European or Japanese) MNCs as marketing channels.
However, the state’s almost exclusive focus on promoting R&D activities and business models that are based on new innovations is also the source of the industry’s most severe weaknesses. With management and businessdevelopment skills on the back burner many Israeli companies have difficulties in sustaining their initial success for the long term. Many market niches that were pioneered and controlled by Israeli firms no longer have any Israeli firms operating in them. More worrisome is that this is especially true in market niches that have grown in their importance and overall revenues. Indeed, for an industry with more than thirty years of global success, it is extremely rare to see market niches in which the Israeli industry has had long-term leadership.[2] Furthermore, the institutional setting of the industry, its strong imitation of the American start-up model and VC financing—and with it the need to focus on securing financial exits—exacerbates this problem. Meanwhile, it becomes increasingly apparent that Israelis no longer control a growing percentage of the Israeli IT industry. Therefore it is not at all clear whether it is Israel and its society that fully enjoy the fruits of the industry’s success. In addition, the continuing decline of the rest of Israel’s economy and its industrial productivity suggests that the IT-R&D sector is now disconnected from the rest of Israel’s economy.[3]
In this chapter, I present a full view of the co-evolution of Israel’s S&T industrial policies, the particular growth pattern of the industry, and the state’s role in this growth. I first give an overview of Israel’s early economic history as a background. It is important to show how the development of industry was profoundly influenced by the nature of the Israeli bureaucracy, national security concerns, and an ideology that privileged scientific research. In the next section I analyze the early years of the OCS, as well as the decisions that led to its creation. Following this account, I examine the growth of Israel’s IT industry, first hardware and then software, by evaluating the intricate co-evolution process between state policies and industry development, the changing roles of the OCS, and the particular division of labor that evolved between the local and the global industry, and between public research institutions and private firms. In the last sections I investigate the industry’s development in the 1990s, the influence of a new set of OCS policies, the ways in which these policies, in turn, were influenced by the industry’s evolution, and the industry’s current strengths and weaknesses.
[edit] Historical Background and the Beginning of the IT Industry
In the first two decades of Israel’s existence, industrial R&D in general, and in private industry in particular, was almost unheard of. Nevertheless, a few factors that proved crucial for Israel’s IT industrial growth were already in place. The three most important were the continuous growth of an educated workforce and a highly capable university research sector, a small but expanding defense R&D sector, and a national ideology that gave very high status to science and technology (with scientists having easy access to political leaders). Furthermore, the flexible structure of the Israeli bureaucracy made it possible for leaders within the civil service, who came to see the development of IT industry as a national interest, to devise and implement policies with relative ease.
The transformation of Israel’s industrial policies, especially the beginning and evolution of S&T industrial policies, had little to do with the ability of the bureaucracy to conduct long-term planning and monitoring, or with its internal cohesiveness. It had more to do with the specific constellation of political leaders in positions of power in the development agencies and government, as well as their views on the proper goals for S&T industrial policy. The structure of Israel’s civil service, with its porous borders and revolving doors between state, academia, and industry, eventually made Israel’s IT industrial and financial elites not only look as one but act as one.
This structure reflects a conscious political decision to give political leaders power in shaping and implementing policies—in effect, designing the Israeli bureaucracy more in the American view of civil service than in light of Weberian ideals (Deri 1993, Heclo 1977, Sharkansky 1989).[4]
[edit] From Independence to the 1967 Crisis
From its 1948 independence to 1966, the Israeli state followed a protectionist economic policy coupled with an interventionist industrial policy. There were three goals: security and regional policy, industrial development, and the building of a private ownership–based economy. While waves of immigrants from less-developed countries lowered the average level of education, the institutional underpinning of Israel’s education system and its research-oriented third-level education system was already well established and enabled Israel to quickly upgrade its workforce. New immigrants were channeled to new cities, located according to a security-based logic, not on a purely economic basis. The state anchored these new cities around privately owned, governmentsubsidized, large-scale plants. (The textile industry was the focus of this state industrial planning, but parts of the defense industry complex and various other industries were also enlisted in these aims.) The result was a quasiprivate, large-scale, plant-based industrial sector, deeply dependent on, and actively lobbying for, government subsidies and aid.
The growing friendship and alliance during this period between two leaders of industrial and economic policy, Pinchas Sapir and Levi Eshkol, was to have an important long-term influence on Israel’s industrial and economic development and the setting of S&T industrial policy until the mid-1970s. Each served as minister of the three main economic ministries: the Ministry of Development, the Ministry of Trade and Industry, and the Ministry of Finance. Eshkol was also the prime minister at a critical period of Israel’s development between 1963 until his death in 1969, with Sapir serving as his minister of finance.[5]
This long-term alliance and friendship was critical for several reasons: first, the fact that these two strong political leaders remained in positions of influence for such a long period of time, gaining extensive and intimate knowledge of their domain, institutionalized specific patterns of state-industry relationship and gave the two an unusually high level of influence over Israel’s economic development, even beyond the relatively high level of power that Israel’s bureaucratic structure grants political leaders. Second, this long-term stability and influence over the key industrial-development ministries, especially the Ministry of Finance and the Ministry of Trade and Industry, enabled Sapir and Eshkol to follow a plan of professionalization, populating them with handpicked personnel. Many of the graduates of the Hebrew University Department of Economics (at the time the only one in the country) were recruited straight into the bureaucracy, sometimes even before they finished their studies (Levi-Faur 1998). Third, Eshkol and Sapir nurtured longterm personal relationships with some of Israel’s key scientists and early IT entrepreneurs. These relationships were crucial for the start of Israel’s S&T industrial policies.[6]
Ideology has also played a significant role in Israel’s development, with social-democratic principles given cultural prominence, evident in the idealization of the kibbutz (Tsuk 2004). Nevertheless, the state, led by the Socialist Party until 1977, had also (surprisingly to some) used its considerable power to ensure that private ownership of the forces of production became the predominant form. The Labor Party’s political leaders firmly believed that the future of the Israeli economy crucially depended on a strong capitalist industry led by private entrepreneurs. This tension came to a head in 1956 when the industrial conglomerate of the Federation of Labor Unions (Histadrut), Solel Boneh, was deemed too powerful for private industry to compete against, and the Labor Party’s national political leaders moved briskly to break it up and force the resignation of its manager, Dan Hillel. The Labor-led government did so at a time when the party was controlling the Histadrut, with Hillel as a longtime party member. In a meeting of the Labor Party’s members of Parliament during the Solel Boneh crisis, Minister of Finance Sapir’s remark illuminated the economic belief behind these actions:
When I spoke with Dan Hillel yesterday I realized that he has an interesting ideology. I think it is utterly destructive for the national economy, and I told him so. He says that there is no hope or future for private industry in Israel. Myself, I think that if there will be no private industry in Israel there will be no public industry in Israel. . . . The conclusion of the things I just said is that Solel Boneh is impeding the growth of Israel. I am utterly sorry for it, but it does not prevent me from seeing the reality. (protocol of the parliamentary Labor Party meeting of December 11, 1956, as it appears in Levi-Faur 2001, p. 179; my translation)
In 1965–1967, Israel suffered its first recession, which ended with the 1967
war. The war became a critical point in the development of Israel’s scienceand-
technology industrial policy, thanks to the unexpected hero of the Israeli
IT industry: French President Charles de Gaulle. Today, after three decades
of close Israeli alliance with the United States, few remember that in the first
two decades of Israel’s independence, its main ally was France.[7] Israel bought
almost all of its military equipment, including such critical systems as fighter
jets and ships, from France, and Israeli engineers were working closely with
French teams on the modification and specific systems R&D for various
weapon platforms.[8] In 1967, on the eve of the June war, with Israel under a severe
security threat, de Gaulle declared an immediate military embargo on Israel,
due to France’s decision to ally itself with the Arab world. That decision
resulted in Israel’s inability to buy critical weapon systems off the shelf anywhere
in the world, while at the same time its enemies had access to the latest
Soviet weapon systems and military aid.
The immediate reaction of the Israeli state was to shift large amounts of resources and R&D power to ensure the rapid growth of Israel’s hightechnology defense industry. A decision was reached that Israel should never again be completely dependent on a foreign power for military platforms. Starting in 1967 Israel’s military R&D targets changed from developing niche weapon systems, the most sophisticated of which were radar-guided rockets, to developing its own weapon platforms, such as tanks, fighter jets, and ships. At least as important as the skills and product R&D capabilities these projects helped to develop in Israel was the rising demand for scientists and engineers. As we shall see, this demand and the accompanying higher wages and higherstatus prospects for scientists and engineers in Israel created strong incentives in the Israeli labor and education markets to acquire these skills (Halperin and Berman 1990, Halperin and Tsiddon 1992).
[edit] The Seeds of the IT industry
While the official history of computing in Israel began in 1947 at the Weizmann Institute of Science (then known as the Sieff Research Institute), before the creation of the state of Israel, the 1948 War of Independence and continuing security threats propelled Israel’s development of computing onto a different track. While academia, mainly the Weizmann Institute, continued to develop three generations of scientific computers called the Golems, the defense apparatus and the state bureaucracy quickly became the torchbearers of computerization development in Israel.[9]
Probably the first unit in the Israeli defense complex to develop and use computers was RAFAEL (the Hebrew acronym for armament development authority).[10] RAFAEL, the first, and for many years almost the only, body in Israel to conduct high-tech R&D, had already started to use computers in the 1950s. In 1956 RAFAEL built an analog computer, one of the first analog computers ever made and designed in Israel. In 1959 RAFAEL created a more sophisticated analog computer, Itzik, to enable larger-scale simulation. Later RAFAEL developed a few early digital computers.[11]
The way RAFAEL was organized is an example of the high esteem in which science was held in Israel and the way it was used in building a national identity. RAFAEL was organized until the early 1990s more as an applied academic institution than as a company. Its researchers were considered academics and were granted all the educational benefits of full-time academic staff, including a sabbatical every seven years, which most of them spent outside Israel at leading academic universities or IT companies. RAFAEL sponsored graduate academic education for its employees both in Israel and abroad, contributing to more than a few thousand graduate degrees in Israel and a few hundred in top U.S. engineering schools such as MIT and Stanford, to which these graduates returned regularly as visiting scholars. Thus, from the point of view of a national contribution and international scientific connections, RAFAEL acted as a small-scaled elite engineering university.[12]
RAFAEL played two other important roles, aside from being an important source of information diffusion in the areas of science and technology and R&D management, and generating spin-offs.[13] First, some of the scientists who founded RAFAEL, such as the Katchalski brothers Efraim and Aharon, formulated Israel’s science-based industrial policy at the end of the 1960s. Second, RAFAEL was used by the state as an incubation center to “infect” other defense and civilian companies and organizations with IT R&D capabilities.[14] The most important of these were:
- the creation of the Israeli military computer unit (MAMRAM) in 1960 (Breznitz 2005a, 2006);
- the first attempt in 1962 to upgrade the Israeli Aircraft Industries (then known as Aircraft Maintenance Corporation) into a high-technology company with the relocation from RAFAEL of the entire project team that developed the Gabriel, the first Israeli sea-to-sea radar guided rocket; and
- the creation in a joint venture with the Elron group of a high-tech start-up called Elbit in 1966, the R&D basis for which was created by the relocation of the entire digital computer development team of RAFAEL to Elbit.[15]
A second major computerization and software programming effort was conducted in the Ministry of Finance.[16] In 1960 the Deputy Income Tax Commissioner Emmanuel Sharon decided to computerize tax assessments. Due to the absence of software programmers in Israel, a special course was arranged, similar in organization to the military’s MAMRAM core programming course, on a one-time basis.[17] Graduates of these two centers later became the early leaders of the Israeli software industry.
While the state apparatus was generating future IT industry leaders, interesting parallel developments in the private sector occurred. Their importance is not just that they culminated in the first globally successful Israeli IT companies but also that they clearly show the differences between the co-evolution of state-industry relationships in Israel and that of Ireland and Taiwan. In Israel private entrepreneurs gave the impetus to critical policy decisions, including the idea of financing industrial R&D ventures. This was possible because of the porous and flexible structure of the bureaucracy and its early embeddedness within the industry. These early efforts of private industry were also critical for laying the foundation for the intimate relationship between the Israeli IT industry and the United States, fashioning not only their basis but also the specific form that they would take in the future.
While most of the banks and investment companies in Israel, like their Irish and Taiwanese counterparts, found investing in the IT industry too risky, there was one critical exception: Discount Investment. At the time, the group was called the Israeli Company for Investment and Finance and was headed by Dr. Augusto Levi. Italian born and educated, Dr. Levi decided to follow the export-oriented industrial investment model of Italian banks. At the beginning of the 1960s, Dan Tolkowsky, who left the military after commanding the Israeli Air Force, joined Discount Investment. Tolkowsky became instrumental in moving the discount group into high-technology investment. In 1961 he first met Uzia Galil, the founder of the Elron group. Elron was the first, and for many years the main, hub of IT NTBFs in Israel. Throughout the 1960s and 1970s, the Elron group and Discount became the two main sources of NTBFs in Israel. Elron, Elbit, and Elscient, all of which later had IPOs on NASDAQ, were created by Galil, with Tolkowsky, as the manager of Discount Investment, becoming their chairman.[18]
In 1965, without realizing it, Tolkowsky and Galil started the process that would culminate in Israel’s first S&T industrial policy and development agency. Concluding that without state support there would be little hope for the industry’s future, they came up with the idea of organizing a small industrial R&D grants program and presented it to the Ministry of Trade and Industry, arguing that the creation of “science-based” industry was important for Israel’s economic future. At the time Aharon Dovrat, then a protégé of Sapir, was the manager of the industry department in the ministry.[19] In another example of the power Israel’s bureaucratic structure confers on its politically backed midmanagers, Dovrat accepted the idea and was able to create a part-time position for a chief scientist to evaluate industry R&D-based newproduct proposals for support from a very small fund. Thus the efforts of entrepreneurs secured the creation of the forbearer of OCS.[20]
Tolkowsky was also crucial at another decisive juncture for the Israeli IT industry, its development of relationships with the U.S. industry, financial markets, and stock exchanges. In 1971 he flew to the United States to interest the still young U.S. VC industry in investing in Israel. Knowing that on merit alone he would have limited chances, he approached Arthur Rock, who not only was one of Silicon Valley’s most famous VCs (crucial in securing the financing for Fairchild Semiconductor and Intel, and later involved in Apple), but, even more important for Tolkowsky, was Jewish. Rock turned him down but introduced Tolkowsky to the other famous Jewish VC of the time, Fred Adler of New York. (Adler was involved in Applied Materials and Data Systems at the time.) Adler still remembers Rock’s phone call:
I got a phone call from Arthur about Dan Tolkowsky. He told me that Dan is seeking someone to invest in Israel. He then told me about Dan and his background: a fighter for the British RAF in World War II who became the commander of the Israeli Air Force. You must remember it was only three years after the 1967 war, and I must admit that it got me so interested in the man himself that I wanted to meet him just because of that. (interview, September 28, 2000)
Tolkowsky had better luck with Adler, who later visited Israel and became
involved with Elscient. Realizing that he could not raise VC for the company,
Adler decided to bypass the VC stage altogether and raise money through an
IPO in the United States on NASDAQ. Adler assumed that after several IPOs
had been successful, the Israeli industry would look more inviting to American
investors. In the end this strategy would work, but it would take more
than two decades and a critical state policy initiative.
Thus by 1972 the Israeli IT industry already had its first global success and foreign-listed IT company with leading American VCs on its board. Implementing its “self-reliance” ideology in the development of the high-technology defense industry, the state was gearing the accumulation of resources and skills toward a specific path of new-product innovation. Furthermore, thanks to the high esteem science and scientists enjoyed in Israel, and to the efforts of private industry, the pillars for what would become Israel’s critical high-technology development agency had been established.
[edit] Restructuring S&T Industrial Policy on the Side: The Creation and Early Activities of the OCS
In May 1966, in the midst of Israel’s first recession, Prime Minster Levi Eshkol convened a committee to look into the organization of governmentbacked research. The economic crisis convinced him that Israel’s industrial policy had to change and that one of the only sources of growth for a resource-poor country was science. The second reason for convening the committee was that Eshkol faced a tough political challenge when the legendary leader of the Labor Party and Israel’s first prime minister, David Ben-Gurion, decided to organize a new party and run against him, with the utilization of science in Israel at the top of his political agenda. Eshkol nominated his longtime friend Ephraim Katchalski-Katzir, then head scientist of the Ministry of Defense (as well as a university professor), as the head of the committee. Katchalski was a renowned scientist involved in the early development of defense R&D in Israel.[21]
Contrary to the common myth that credits the Katchalski Committee with the creation of the Office of the Chief Scientist in its present form, its original aim had very little to do with the OCS. It is true that its recommendations started the process that led to the institutionalization of S&T industrial policies in Israel. However, the reconstruction of the OCS had to wait, in what since has become a pattern, until Israel’s political leaders nominated a powerful outsider to head and reconstruct the office.
The mission of the Katchalski Committee was to review the fourteen civilian public research institutions and offer recommendations for their restructuring and management. The committee was also asked to review the working of the Israeli R&D authority (the Israeli equivalent to the American National Science Foundation).[22] The committee met thirty times over the course of eighteen months and conducted the most extensive research ever done in Israel on the role of science in the modern state’s economic life, the role of the state in the advancement of science for the use of the economy, and the workings of the public research institutions in Israel.
In December 1968 the committee submitted its report and recommendations to Prime Minister Eshkol in a very different Israel from that of 1966. In the intervening period, the country had decisively won a war on three fronts and, as a result, had much more faith in its capabilities; it had also begun a massive industrial defense R&D effort and had to deal with the Arab economic embargo.
Apart from its various recommendations for changes in the management of the public research institutes, the Katchalski Committee report had a longterm influence in two areas. The first was its recommendation of the creation of an official position of a chief scientist in each of the main ministries. The chief scientist was envisioned as the overall manager of the public research institutes and other R&D activities that related to the ministry’s jurisdiction. The chief scientist was also to be the personal adviser of the minister for science-related issues. This recommendation gave formal governmental legitimacy to the activities already conducted in the Ministry of Trade and Industry. The chief scientist positions were specifically designed for outside consultants. This allowed the ministries to hire people outside the civil service and offer them better wages.[23]
The Katchalski Committee also argued that the ability to convert basic science into practical technology was the key to national economic success, and then sharply lamented the fact that in Israel there was almost no civilian industrial research. The committee urged the Israeli state to take responsibility and spur civilian R&D activities. It contended that the Israeli state should act through the creation and restructuring of the industrial R&D infrastructure and through the work of the public research institutes. This turned out to be its more lasting influence.
Thus the report not only led to the creation of offices of chief scientists in all of major ministries but also, on the basis of a comparison of Israel with other countries, crystallized a consensus that the national economic future depended on the creation of science-based industries. These industries were portrayed in terms of R&D leading to new products and technologies. This conceptualization, together with the extensive and highly successful defense R&D efforts and a realization after the 1965–1967 crisis of a need to change Israel’s industrial policy, eventually led to the evolution of the OCS as an industry development agency.
[edit] From a Part-time Chief Scientist to Israel’s Pilot S&T Industrial Agency
Between 1968 and 1974 the OCS continued to work in its earlier format, as a part-time job for a university professor.[24] The OCS was inactive, and most of its industrial R&D budget was still channeled to the public research institutions. Even when companies came with proposals, they faced a heavy bureaucracy, at times waiting for more than two years without getting a final answer to their proposals. However, during that time, the Ministry of Defense was busily developing the R&D capability of the defense sector. Most of the data about those activities are still restricted. But it is quite clear that the defense industry stimulated the changes of the Israeli labor force’s skill structure between 1967 and 1980. In that period Israel had the highest growth rate of scientists and engineers employed in the industry in the world: 260 percent, twice the rate of Japan’s economic miracle age (Halperin and Berman 1990). The implementation of self-reliance in defense production doctrine was transformed in these years into major R&D efforts on almost all fronts and on almost all the platforms and equipment used by the military.[25]
Most of the decision makers in these years thought that there was a perfect match between the goals of establishing a strong R&D-based defense industry and the economic goals of the Israeli state, viewed as building a strong globally successful R&D-based high-technology industry. There is no doubt that the structural transformation of Israel would never have happened so quickly without the thrust given by the defense sector. This is especially true until the mid-1980s, when the negative effects—such as the crowding out of the private industry in the labor market—started to overwhelm the positive effects of this strategy.
While these activities in the defense sector were ongoing and an internationally renowned massively R&D-focused defense industry was created, very little happened with regard to civilian S&T industrial policy until the end of the 1973 war. By that time, two major transformations had occurred that would convert the OCS to an active development agency: first, Elscient’s successful IPO on NASDAQ supplied a “proof of concept” and a model for imitation; second, with the 1973 war, the perception of the need to restructure the civilian industry became more urgent. In 1974 the Minister of Trade and Industry Haim Bar-Lev, a former chief of staff of the Israeli military, recruited Itzhak Yaakov as the first full-time chief scientist.
From 1955 to 1973 Yaakov had served in commanding positions within the military’s R&D division. As head of the armament development department and then as the overall head of R&D in the military, he had been responsible for the management of the major transformation in defense R&D. Additionally, Yaakov’s educational background, as an engineer with an advanced degree in technology management from MIT, and his international connections, not the least with the World Bank, made him uniquely suited to this role.[26] Yaakov was promised a free hand and sufficient financial resources, as well as the political backing that allowed him to transfer his ideas to reality.[27] This was the first example of what has since become a pattern of S&T industrial policy development in Israel. Managers within the bureaucracy, many of them recruited from outside, are given a free hand to formulate and implement policies and build programs and agencies.
On taking the position, Yaakov moved on four fronts. First, he formulated the goals and aims of the OCS. He prescribed an S&T industrial policy in which the state’s role was to address the market failure in R&D by lowering but not eliminating the risk associated with R&D activities. The economic goal was the growth of industrial exports based on new science-based products. Private firms were seen as the optimal agents not only to conduct R&D but also to decide what projects to undertake and what technologies to develop. The logic behind this assumption was that private firms, deeply embedded within their markets, are far better equipped than the state or any other research institutions to formulate and devise successful product R&D projects.
Therefore the state’s role was limited to motivate private entrepreneurs to conduct more product R&D. The main way in which this was done was through the central R&D fund, which granted 50 percent of R&D costs to project proposals submitted to and approved by the OCS in repayable loans. (The loans were repayable as royalties only if the products were profitable.) In addition, the bureaucratic processes were simplified, so, for example, a company could sign an agreement with the OCS within ten days of a proposal approval (OCS 1974, 1975).
Second, seeing private companies as the optimal source of R&D ideas and performance agents, the OCS also sharply decreased the support it channeled to the public research institutions, although it guaranteed that for joint ventures with private industry it would sponsor the institution’s 50 percent of the project’s cost (OCS 1974). This was a major break with the past, and since that day the importance of public research institutions to industrial development in Israel has been marginal.
Third, in 1974 Israel reached the upper limit of what the World Bank then defined as a “developing country.” Yaakov, with the backing of Sapir and Bar- Lev, channeled the last World Bank loan to Israel into a program of national R&D projects, which allowed the OCS to give 80 percent grants to up to eight projects. In addition, after President Nixon’s visit to Israel, an agreement was signed to create a cooperative R&D fund for Israeli and American firms (OCS 1974). This fund, under the management of another outsider, Ed Mlavsky, later played a vital role in the development of the IT industry as the BIRD Foundation.
Yaakov also won approval for the OCS to grant the status of “approved factory” to science-based firms, giving them all the benefits provided under the law for the encouragement of capital investment, the same law used to grant aid to plants in the newly constructed peripheral cities.[28] That linkage became more important in later years, when MNCs with R&D centers that registered as a company in Israel were operating de facto under the same favorite tax regime they were granted in Ireland, and when Intel, National Semiconductor, and Tower applied for aid under its provisions when constructing silicon chip fabrication plants.[29]
Fourth, Yaakov transformed the OCS into an active industry-engaged agency. Very shortly after his nomination he initiated company visits throughout Israel and urged the companies’ managers to come up with ideas. These activities by the OCS quickly bore fruit; by 1974 the OCS approved 70 million Israeli lire in proposals, three and a half times the amount approved in 1973. Yaakov recounted that some of his major problems involved changing the mindset of the agency:
Civil servants thought that industrial R&D was a waste of money, that the money could be better used to buy meat in Argentina; it was, don’t forget, the Ministry of Commerce and Industry. There was also this belief that innovation came from public research institutes. . . . I had cases where the office workers came to me and said: “This project has no use and there is no need for it.” I’d usually send them back to the company that proposed the project to check it in person. More often than not they would return with their head between their hands because the company, operating in the market, knew better. I really wanted to get more industrial R&D activities in Israel off the ground, and I must admit I cut corners. For example, I went to the founder of Elscient and told him, “Bring me one R&D project which you want to conduct and you cannot for lack of capital, and I will declare it a national project and use the World Bank’s finance to grant you 80 percent of cost.” He thought about it for a day and told me that he decided that CAT scan is the future. [This is indeed the technology on which Elscient flourished during the 1970s and early 1980s.] I said, “Okay, I will give you a letter granting you up to half a million lire and within a reasonable time send me a proposal and I will make sure it is approved.” Now because it was a World Bank project, I needed to assemble a prestigious research committee with a lot of academics. These professors wanted to show that they are smarter than the industry and argued that in Holland they already work on CAT scan technologies. I had no choice: I fired the whole committee on the spot and filled it with people from my office that did not have a vested interest to show how smart they are. (interview, September 28, 2000)
The same picture of the OCS at the time was reflected in the recollection of one of the OCS’s first employees of that period:
During the Yaakov period we tried to create a dynamic of R&D activities—we wanted the industry to routinely conduct R&D and to create a dynamic that will infuse these ideas that R&D is something that should be done throughout the industry. To create a sort of paradigmatic change in the way businesses thought about what they are doing. Nobody in the industry even thought about R&D at the time; it seemed to them as a horrible risk, so Yaakov just started going around the country trying to convince managers to conduct R&D. We did not really care who, what, why, when, we just wanted to create an R&D dynamic. (interview, May 7, 2002)
Needless to say, this mode of behavior is far removed from Weberian ideals.
In early 1978 Yaakov left the office to become a consultant for the World Bank in Taiwan and then in South Korea, before turning to private business and joining the American firm Control Data Corporation (CDC). True to the revolving door between state and industry, he became instrumental again in the 1980s. Before he left, he submitted a series of policy papers formalizing the goals and aims of Israel’s S&T industrial policy, the role of the OCS in achieving these goals, and the procedures that the OCS should use in order to achieve them. These policy papers defined the role and scope of the OCS for years to come as a quasi-independent agency and became the basis for the OCS operation, with many of their provisions incorporated into the 1984 law for the encouragement of R&D (OCS 1974, 1975, 1977, Yaakov 1974).
The most enduring legacy of these years, however, has been the ideological one. In a 2000 interview, Yaakov expressed his belief that industrial R&D remains Israel’s only economic future:
From the national point of view, a failure in a research-and-development project is not a loss. This is especially true in the case of developing and resource-starved countries such as Israel. This was my sole guiding principle when I gave grants to companies. This is the philosophy that guided me all the time, and I had many arguments about it with the civil servants at the Ministry of Commerce and Industry. If truth be told, if you took the long term, there was almost no approved project that failed to deliver some tangible results from the national point of view in the end. This is another thing typical to industrial development. Like old soldiers, old R&D projects never die. There is always the sequel. (interview, September 28, 2000)
Over the years the OCS developed a core of professional, long-serving, high-level personnel with a special ethos and a strong identity. This is true even though a large percentage of its staff, including the chief scientists and many of its top advisers, has been recruited for a limited period of service from the private market. Nevertheless, the early recruitment processes of the OCS clarify more than anything the differences in bureaucratic structures between Israel, Taiwan, and Ireland. People who were deemed worthy were recruited to jobs at all levels of the organization disregarding formal channels. For example, a top executive of the OCS recalled the ways, and the reasons for which, she was recruited:
Just before the enactment of the R&D law in 1984 the state comptroller came out with a report strongly lamenting the grant-giving procedures of the OCS. This was the reason I was recruited. It was quite amazing when I arrived. There were neither coherent financial procedures nor procedures of how to manage the relationships with firms and how to recognize R&D costs. My first job was to create some semblance of order in this mess; the chief scientist at the time was very thankful. He was quite worried and no one here had a clue what to do. (interview, May 7, 2002)
Looking at our theoretical framework we can see that by formalizing the OCS’s role as fixing the general market failure associated with industrial R&D, Israel has become the first state in the world to employ as its main S&T industrial strategy a set of policies that are both neutral and horizontal in regard to industrial sectors and technology (Justman and Teubal 1995, Teubal 1983, 1997). The aim of horizontal technological policies is to stimulate a certain set of activities and capabilities throughout industry, without targeting particular industries or technologies. However, with the success of companies in certain sectors, the buildup of more focused capabilities, and the general trends of demand for certain technologies in the market, the system began over time to specialize in certain areas. The private market, not the state, determined the areas of technological specialization. In Israel, for example, we see a buildup of capabilities in IT, particularly in telecommunication and medical equipment.[30]
[edit] The Reaffirmation of the Local-International Division of Labor: BIRD Foundation
In 1976, two years after the initial agreement between the governments of United States and Israel was signed, the Bi-national Industrial Research and Development Foundation (BIRD) started operation. As with the reconstruction of the OCS, only after a strong-willed outsider was put in charge did BIRD become the critical and active developmental agency it is today. The idea behind the creation of BIRD was to encourage cooperation between firms from the United States and Israel to jointly develop and sell new products. An endowment, later increased to $110 million, provided the financial basis of the foundation. BIRD was put under the jurisdiction of the OCS and under the auspices of the U.S.-Israel Advisory Council on Industrial R&D, which consisted of senior scientists, officials, and businessmen from both the United States and Israel.
At first, BIRD had no impact. Under its first director, Wade Blackman, an MIT graduate recruited in the United States, BIRD did not manage to make even one investment. Ed Mlavsky, then an American member of the U.S.- Israel Advisory Council on Industrial R&D and a cofounder and executive vice president of Tyco International, described these times and the chain of events that led him to become BIRD’s second director in 1978:
I got a frantic phone called from Jack Goldman [then the vice president for technology at Xerox]. “Ed,” he told me, “we must find a new director for BIRD. Not even one single project has been started, Wade is leaving, and the Israelis are impatient.” The council convened a committee to select a suitable candidate. We met in New York. The committee was filled with very impressive people. However, the candidates were not at all impressive. It was then that I made a fateful remark that just shows you that one has to take full and firm control of his mouth at all times. I said: “Gentlemen, this is horrible, even I can do a better job than any of them.” Before I knew it all these notable people, including Jordan Baruch [then the undersecretary of state under President Carter], started to pressure me to go to Israel and check it out. I told them that they are insane, that there is no way I will do it. I even reminded them that I am married and my new family is not Jewish, that we have no emotional connection to Israel. In the end I agreed to come for two years. We put our U.S. furniture in storage, and I took a two years’ Sabbatical from Tyco. (interview, June 12, 2000)[31]
Mlavsky came to Israel in June 1979, originally for two years, and stayed as BIRD’s director until January 1993, when he cofounded Gemini, one of the first VC funds established under the OCS’s Yozma initiative to encourage domestic venture capital. Under his management BIRD became an active organization that, like the OCS, did not follow the Weberian ideas for bureaucratic management and development. Mlavsky described this process: “We just started to do things and crystallized a model after we had some cases to build on.”
This model is still the cornerstone of BIRD to this day. BIRD funds up to 50 percent of a joint project in which two companies, one from Israel and one from the United States, agree to develop and sell a joint product and to share the revenues. BIRD’s aim has been for the Israeli firm to concentrate on R&D and the American one on product definition and marketing.[32] BIRD coaches Israeli firms on how to approach, and cooperate with, American companies, a key skill that was not widely available to the Israeli IT industry until the end of the 1980s. BIRD also helps in the matching process and to that end maintains a database of American companies that might be interested in R&D, including their product R&D areas of interest. This database is gathered by visiting hundreds of American firms.
Starting in the early 1980s BIRD became prominent in luring MNCs to open R&D centers in Israel. BIRD helps, first, by exposing the American firms to Israel’s R&D capabilities in a low-risk friendly environment. Second, BIRD actively convinces MNCs to open operations in Israel. BIRD employs two modes of operation, one assisting Israeli R&D executives who wish to come back to Israel, and the other approaching an MNC that participated in several successful BIRD projects and urging it to open an Israeli-registered R&D subsidiary. The financial benefit that BIRD offers is to recognize some of the R&D projects (starting with the first) of the Israeli-registered subsidiary as a BIRD project between the MNC’s American headquarters and the Israeli subsidiary. Moreover, as the OCS also recognizes Israeli-registered MNCs’ subsidiaries as Israeli firms for the purpose of R&D grants, these subsidiaries can enjoy both BIRD and OCS grants, enabling the MNC to start R&D operations in Israel at low cost. Both Dan Vilenski, who replaced Mlavsky as BIRD’s director, and Dov Hershberg, who was the director until 2006, emphasized the importance that BIRD gives to luring American MNCs to open R&D centers in Israel.
As with OCS, BIRD’s financing is in conditional repayable grants, with the grants repaid as royalties of 5 percent of sales of the product to third parties, and for up to a maximum 150 percent of the original grant. For many years BIRD has also been following the logic of neutral horizontal policy and does not limit itself to targeting only specific sectors or technologies. BIRD became a spectacular success and a model for other binational R&D funds both in Israel and abroad.[33] It supports up to thirty-five full-scale projects (a support of $500,000 to $1 million over two to three years) and twenty miniprojects annually ($100,000) (BIRD 2000, 2004, various years). BIRD uses the royalty payments to increase the number of grants given. By the end of 2000 it had received a total of $64 million in repayments, of which $6 million accrued in 2000. The reuse of royalties by both BIRD and the OCS is another unique feature of the Israeli system.
Until the mid-1990s, when VC financing became available in Israel, BIRD and the OCS were the only two available sources of finance. Both of these institutions diffused a particular model of high-technology companies in Israel. This model views companies as R&D vehicles for the creation of new exportoriented products. The one and only high-technology industry model it stimulated in Israel sees the industry as consisting of companies selling novel products based on intensive in-house R&D efforts. By financially supporting only firms that followed this view, BIRD and the OCS were key factors in the creation of the particular model of the Israeli IT industry as a supplier of new technologies to the global IT industry production networks.
BIRD was also important in strengthening the R&D focus by enhancing a particular division of labor between Israeli companies and American MNCs. In this division the Israeli firms concentrate on R&D while their American partners participate in the product design stages and concentrate on marketing and sales. The relationship of Israel to the global IT industry’s production network, in which Israel is a supplier of new technologies, was further reinforced by BIRD’s activities, with OCS’s support, in luring MNCs to open R&D facilities in Israel.
Furthermore, BIRD influenced the Israeli IT industry by enhancing its already existing propensity, after the success of Elscient, Elbit, and Scitex, to look on the United States as the main market for both products and finance. In an environment where other financial resources were lacking, BIRD’s encouragement of this American orientation throughout the Israeli IT industry cannot be underestimated. For example, in an internal evaluation of its activities, BIRD found that 75 percent of the Israeli companies listed on NASDAQ in 1992 enjoyed the support of BIRD, with a large percentage of these companies building their business around the basis of their BIRD project.[34] Last but not least, apart from opening the doors of leading American companies to small Israeli businesses, BIRD infused the Israeli system with two key skills: (a) knowledge of designing new products for the American market and (b) knowledge of conducting business based on new-product R&D in the American market.
A remark by the founder and CEO of one company that received BIRD grants exemplifies these specific features of the foundation:
For us BIRD was extremely important. We had a few BIRD projects. They enabled us, a company consisting of eight young people, who [had] just finished their military service, to collaborate with big successful American software companies. BIRD not only put us through the door so we could actually talk to them and see what are the needs of the American market from the best sources possible, but also enabled us to offer them a risk free model. They did not need to put a dime on developing the product, and if it was successful they distributed it using their channels. I see no other way in which an R&D team of eight Israelis could profitably sell so many copies in such a short time and also offer the needed customer support. Later when we decided to open facilities in the U.S., our BIRD experiences proved invaluable. Our first two American employees knew us from earlier BIRD projects, and they brought their friends. It would have been amazingly difficult for us, a godforsaken start-up from Israel, to recruit American employees of such quality otherwise. (interview, January 15, 2002)
As the creation stories of the OCS and BIRD show, unlike the Irish and Taiwanese cases, in Israel the policy was not built as a part of an orderly overall strategic plan. Both the policies and the agencies were built in a process of trial and error, which was managed at levels equivalent to a ministerial division head. In addition, proper bureaucratic procedures of orderly administration did not constitute a defining attribute in the creation and development of the Israeli industrial development agencies.
Nevertheless, there are a few firm principles that have always made up the backbone of Israeli S&T policies. These can be defined as Israel’s particular variant of “technonationalism” (Samuels 1994). First and foremost was the belief that new R&D on the technological edge, with the aim to create novel products, is the sole and proper basis for Israel’s high-technology industry. The second principle is a clear definition of the role of the state, limiting it to a role of promoter and facilitator of R&D activities. The state goal is to maximize industrial R&D demand in private industry and to lower the risk associated with it. As a result, throughout the specific co-evolution of stateindustry relationships that was built on the basis of these ideals, private firms were seen as the loci of both R&D activities and ideas, a striking contrast to conditions in Taiwan.
With the formation of BIRD the Israeli state also started to advance a particular division of labor between the local and the global IT industries, where Israeli firms and MNCs that opened facilities in Israel were urged to focus on the R&D stages and specialize in the innovation of new products. This specialization in R&D was further enhanced with the state’s efforts to lure MNCs to open R&D subsidiaries in Israel, a very different policy from that followed by both Ireland and Taiwan in the same period.
[edit] The Rise of the New Industry: The Evolution of the IT Industry in the 1980s and Early 1990s
After the 1973 war, Israel suffered multiple economic crises that lasted for more than a decade. Economic growth was almost halted, balance-ofpayments deficits rose in alarming proportion, and inflation rapidly rose to more than 400 percent annually.[35] From 1977 to 1985 the first political transfer of power intensified the economic crisis. In 1985, a rainbow coalition government pushed a stringent stability plan. The plan succeeded in some areas; however, by the late 1980s, unemployment had become a problem, especially in the periphery.[36]
In the same years that the IT industry grew, the traditional and midtech industries, as well as agriculture, continued to decline. Already by 1988, 59 percent of Israel’s industrial exports were high-technology products; by 1998 more than 71 percent of Israel’s industrial exports were high-technology, and in 2000, the IT industry alone accounted for more than 70 percent of GDP growth, by far the highest percentage in the world (CBS 2001). At the same time, in direct contrast to the developments in Ireland, Israel’s neocorporatist wage agreement regime had been crumbling, with labor union membership in rapid decline and the socialist ideology in rapid retreat.[37]
By the end of the economic crisis in 1985, an IPO on NASDAQ was a legitimate and well-trodden path for the more successful Israeli high-technology companies. However, the IT sector did not pass through the economic crisis unscathed, and with the collapse of the banking system, both the Elron group and Scitex were faced with their biggest crises to date.
During the 1970s the growth of the IT industry was slow, the OCS found it difficult to allocate its maximum annual budget, and not many new NTBFs were formed. The main inhibiting factor, as in Taiwan and Ireland, was the unwillingness of private entrepreneurs to take risk. This entrepreneurship failing was identified as acute in the OCS’s annual reports:
It is evident that despite the opportunities described in this section on the one hand, and the massive government support on the other, too few new technology-intensive industries are being established. . . . Clearly we have here a problem of technological entrepreneurship. Despite opportunities and massive government aid, there are not enough people willing to take the risk. To reach the ultimate goal of industrial R&D, i.e., new increased exports, particular attention must be given to this phenomenon as well. (OCS 1975, italics added)
After Yaakov’s departure, the negative side of Israel’s more flexible and highly embedded bureaucratic structure became evident. The OCS lost some of its standing. Not anchored in law, it was to fight chronic budgetary battles. The OCS’s image was tarnished: question marks over its capture by the industry appeared in the sociopolitical context of only a few relatively strong high-technology industrial groups with political sway, and few new entrants (Stigler 1971). This was particularly true following political lobbying by Elscient that ended with a tax-sanction law, aptly nicknamed the Elscient law.
Until the mid-1980s, when a decision was made to reduce defense R&D efforts and cancel the development of the biggest project—the development of a fighter jet (the Lavi)—the strategy of self-reliance in advanced weapon systems continued, and was implanted mainly in the R&D phase. In 1984, the year before the decision on the major budgetary cuts was made, the annual defense R&D budget stood at $750 million (in 1984 terms [Halperin 1987, Halperin and Berman 1990]). However, it is also important to remember that unlike the industrial defense sector, the military did not cut down on its inhouse R&D operations.[38]
The intensification of the economic crisis gave another window of opportunity for the OCS to restructure itself and advance new programs, especially as it had the backing of two strong ministers of trade and industry, Ariel Sharon from 1984 to 1990 and Moshe Nissim until 1992. The approval of the R&D law in 1984, the recognition of software as an industrial branch in 1985, and the cancellation of the Elscient law in the same year marked a change in S&T industrial policies and the move of the high-technology industry to the forefront of Israel’s industrial landscape. The period from 1984 until the beginning of the 1990s is the reconstruction period of the institutional basis of Israel’s political economy.[39]
Under the new R&D law the OCS was quickly expanding its activities, together with BIRD’s. Sanctioned by the R&D law, which designated the OCS as Israel’s official S&T industrial agency, the OCS regained its independence and public image as a professional agency. Critically, until the mid-1990s the R&D law authorized the OCS’s main R&D fund to finance all of the projects that passed its due-diligence process. These expanded financial resources significantly enhanced the ability of the OCS to create and sustain the industry’s demand for R&D. Private IT entrepreneurship became more common, active, and successful.
[edit] The IT Industry in the 1980s and Early 1990s: The Growth of the Hardware Sector
Throughout the 1980s, with the available funds from OCS and BIRD reserved solely for R&D, two models of new company formation and growth emerged. Both of these models utilized the OCS and BIRD grants while answering two other financial needs: (a) the lack of working capital, especially for marketing and sales; and (b) the lack of expansion capital, especially acute during the first stages of international expansion.
Of the two broadly defined prominent organizational development models in this period the first was the creation of company groups. Successful entrepreneurs quickly found that they were being approached by other would-be entrepreneurs looking for organizational and financial help.
Probably the one group that was critical to the industry’s development is the Elron group, founded by Uzia Galil. It was Elron that pioneered the NASDAQ model, created the first connection with the American VC community, and was influential in the creation and early development of Israel’s S&T industrial policy. Many of the group’s companies, such as Elron, Elbit, and Elscient, and even less closely held ones such as Zoran, grew to become leading companies in the industry and listed on NASDAQ.[40] The Elron group, unlike other groups, did not have a common technological sector but supported spin-offs and start-ups in areas that seemed to suggest to its management an opportunity at the time.[41]
One of the companies growing out of this organization model, Orbotech, is also one of the only cases of an Israeli company managing not only to pioneer its market niche—automatic optical inspection (AOI) systems for printed circuit boards (PCB)—but also to control it for a significant period. Orbotech’s history also illuminates the wild competition and lack of planning in the Israeli IT industry in comparison with Taiwan and Ireland. Orbotech is the product of the 1992 merger of Orbot and Optrotech, two Israeli companies that between them controlled the global market (85 percent) in their niche during the late 1980s. Dr. Shlomo Barak founded Optrotech in 1981 with the backing of the Elron group. Orbot was founded shortly thereafter by a group of Israelis who first met in Boston, where some of them were MIT professors or students. Ormat, another of the first globally successful Israeli high-technology firms, backed Orbot, which commenced operation in December 1982.
The second model of organizational growth was to build a company on the basis of OCS and BIRD foundation projects (as OCS grants are given on a per-project basis, companies can win several of these grants). Among the most successful were Gilat Satellite, Comverse, and Mercury, all of which became globally prominent companies in their market niches. In the second half of the 1980s, the move of defense-oriented companies into the civilian market accelerated. The most successful of these has been ECI Telecom, which successfully transformed itself into a civilian company and listed on NASDAQ in 1982.[42]
During the 1980s the flexibility and reach of the “porous borders” structure of the Israeli bureaucracy were crucial in securing another source of finance: investor limited partnerships. These partnerships provided a classic example of state-business collaboration to achieve a common goal. The limitedpartnership model was organized after Yaakov, at the time working for CDC, discovered the existence of R&D tax incentives in the United States. Yaakov (with others following him) collaborated with the OCS to create a specific set of legal entities to use the American tax shelter to channel finance into Israeli IT firms. Groups of U.S. investors were assembled to form limited partnerships investing in the R&D efforts of a preselected set of companies. The OCS then assisted these limited partnerships with additional financing that was classified as loans for tax purposes, maximizing the tax returns for the American investors and minimizing their risk exposure. The first limited partnership started to invest in 1980, and a few more followed, under the titles of Israeli R&D Associates (IRDA) or Israeli Technology Ventures (ITV). In 1985 the Reagan administration changed the tax regulations that were the basis of the limited partnerships. Activity continued until the late 1980s in those that had already raised their funds. All in all, the limited partnerships invested in twenty-five different newly created companies, the most successful of which were Technomatics, Comverse, Teledata, and Lannet. The main effect of these limited partnerships was to further strengthen both the R&D focus within the Israeli IT industry and its connection to the American financial markets.
In the late 1980s the growth of the telecommunication subsector of the Israeli IT industry helped another group of companies, RAD, to rise to prominence. The story of RAD is illustrative in several ways. Apart from the importance of the group itself, its growth marks a generational shift in the Israeli IT industry and with it the growing importance of graduates of the military R&D and intelligence units. Even more importantly, the growth and limits of the RAD group provide one of the best examples of the strengths and the weaknesses of the Israeli model: the ability to secure a technological edge and to react quickly to changes, on the one side, and, on the other, the relative lack of professional management, long-term planning, and business development skills.
The Zisapel brothers, Zohar and Yehuda, formally established the RAD group (or the RAD-Bynet group, as it is known in Israel) in 1981.[43] The Zisapels are engineers, and Zohar was a commander in one of the Israeli military’s most respected electronic R&D units before he joined his brother in the civilian market. In 1985 the brothers decided to use their two companies as an incubator for R&D-based companies. Not having any specific plan or product in mind, they recruited Benjamin Hanigal, a young engineer who had just left the Lavi project, and the three started to search for ideas.[44] In 1986 Lannet was established and raised its first financing from the OCS and a limited partnership.[45] Just as Lannet was raising its limited-partnership financing, U.S. tax regulations were changed and Lannet managed to get only a third of the anticipated sum. As a result, the company quickly changed course, starting operations with a different and smaller project. During its first year of operation Lannet started a second line of products using the technology on which it would grow, Ethernet. A former Lannet senior manager argued that Lannet could develop a product that sold successfully worldwide because a large pool of engineers were users of local access networks (LANs) and could be asked to play the customers, helping in building the product specifications.
As Lannet had no other sources of capital, it needed to rapidly increase its revenues and became profitable at a very early stage of operations. In 1991 Lannet had its first public offering on NASDAQ, having already achieved an annual revenue stream of a few million dollars.[46] However, very quickly, the LAN market matured and started to consolidate. Lannet decided that it could not compete with the better-organized and more financially capable American firms. It merged with Madge, demerged, and was finally bought by Lucent. In the end Lannet’s Israeli R&D operations became Lucent’s R&D center in Israel.
Motivated by the success of Lannet, the Zisapel brothers expanded the
RAD group and opened about thirty companies following more or less the
same strategy, recruiting or backing engineer-founders with ideas for a new
product within the telecommunication market broadly defined. From one
point of view, RAD is an immense success story, with the group backing the
largest number of companies listed on NASDAQ apart from Elron. From another
view it is a perfect example of the limits of the Israeli IT industry, if
only for the reason that none of the RAD companies managed to grow even
to the size of the still–privately held anchor company, RAD Data communications.[47]
The story of Lannet and its end as Lucent’s Israeli R&D center also symbolizes
another trend that grew in importance in the 1980s, the R&D activities
of hardware MNCs in Israel. The rise in the scope of MNCs’ activities was so
rapid that it caused a concern in Israel that the IT industry had become no
more than a node in the MNCs’ global activities, with most of the innovation
and spillovers going overseas and with only few local spillovers (Felsenstein
1997). In the 1980s the MNCs that had major R&D operations in Israel were
almost solely American semiconductor MNCs. The most important of these
MNCs in the 1980s, apart from Intel and IBM (which, in 1972, opened its second
research facility outside the United States in Israel; the first IBM research
lab was opened in Zurich in 1956), were Digital, Motorola, and National
Semiconductor.[48] All of these companies, apart from IBM, had VLSI chip design
centers in Israel, with all except Digital also having manufacturing facilities
in Israel in the 1980s.[49]
The relative importance of Israel as a supplier of new technologies is evident when we take into account that with one exception these Israeli R&D centers were the first that the MNCs had opened outside the United States. The exception was Motorola, but even Motorola’s Israeli R&D VLSI center was the largest and most autonomous outside the United States, and in 1964, when Motorola Israel was established, it was Motorola’s first fully owned daughter company outside North America. (R&D operations started in 1972, the VLSI design center in 1982.) These centers became crucial as one of the main training grounds for the technological capabilities that enabled the Israeli IC design industry to grow to become the fourth-largest in the world, and the most innovative after the United States and Canada, in the 1990s.
Thus MNCs in the 1980s already viewed Israel, unlike Taiwan and Ireland, as a preferred location for R&D and the development of new products and technologies. These R&D efforts were in some of the most advanced areas of research in the world at the time, such as microprocessors and applications of DSP technology. By the beginning of the 1990s, following the success of Israeli-based R&D operations of a growing number of MNCs, many more American MNCs started to look seriously at Israel and to acquire Israeli firms for their technologies. The fact that by that time both BIRD and the OCS were actively offering MNCs R&D-activities-related benefits served as a catalyst.
The importance of the OCS in that period, both in increasing the formation rate of new IT firms and in focusing their operations on new-product R&D, cannot be underestimated. Two prominent examples, out of a few hundred, are Comverse and Mercury Interactive, respectively the second- and third-largest software companies in Israel. The entrepreneurs behind both companies came back to Israel specifically in order to utilize the OCS’s help.[50]
As is evident from the stories of ECI, RAD, and Comverse, this period brought the early rise of the telecommunication sector to prominence within the Israeli industry, a position it still holds, as can be seen in figure 2.1.
Changes in both the domestic and international market in the telecommunication industry completely transformed this industry and made it the fastest-growing IT industry worldwide in the late 1980s and all through the 1990s. These changes created a profitable market for niche companies with new technology, a category of firms in which the Israeli IT industry, with its strong focus on R&D and new products, excels.[51] The first change was the transformation in the regulation of the telecommunication industry and the worldwide move from a regulatory regime that viewed the industry as a “natural” monopoly to one that specifically aimed to spur competition, opening a market for small R&D-based companies to sell into. The second comprised advances in telecommunication technologies, specifically in wireless and data communication, both of which opened up new, rapidly expanding markets with big firms looking for new services to offer and new ways to manage their old businesses.
Israeli firms quickly excelled as suppliers of new technologies in all niches of the telecommunication subsector, pioneering, for example, voice over Internet protocol (VoIP) technologies, LAN systems and chips, DSP chips, urban networks, switches, routers, software, mobile phone technology, and Internet wireless and “last-mile solutions,” among others.
However, even in this sector success and sustained growth necessitate not only a technological edge but also some access to management and business skills, as well as logistics and distribution resources. Acquiring these was not systematic and had more to do with good fortune and random effect. The story of Amdocs, the only Israeli company to date to become one of the top thirty software companies in the world, and its critical relationship with SBC, is such an example. By 1984 Amdocs, then called Aurek, became a leader in selling automated telephone directory systems (Yellow Pages) in Europe. This proved to be of immense strategic importance when on the first of April 1984, AT&T was divided into seven regional telephone companies that were desperate to buy reliable software systems from companies other than AT&T. Very quickly Southwestern Bell (now SBC) and Aurek started a joint venture to develop and sell automated directory systems. With SBC backing and with a few software systems all aimed at this market niche, Aurek soon became the global leader in this small niche.
However, Aurek’s transformation from a leading player in a marginal market niche to one of the world’s top thirty software companies came in the early 1990s and was prompted not by Aurek but by SBC. SBC asked for, and assisted Aurek in developing, a telecommunication billing system. In 1995 the new package, called Ensemble, was ready for the market. The former partners in Aurek, together with SBC and a few other investors, established a Channel Island company called Amdocs, a new holding company for all of the Aurek group companies. Very quickly Amdocs, with the clout of SBC behind it, became the leading provider of billing systems for telephone companies in the United States and later worldwide. In 1998 it went public on NASDAQ. Amdocs then showed remarkable strategic planning skills for an Israeli company and employed a strategy of mergers and acquisitions to become the leading supplier in another related niche—customer-relationship management (CRM) systems to the telecommunication industry. In 2002 Amdocs concluded its second strategic transformation by becoming a full-service provider to the telecommunication industry, offering integrated systems of billing, CRM, and order-management systems. At the same time Amdocs started to offer outsourced services, and a few companies, such as Nextel, turned over all their billing functions to Amdocs. While Israeli managers and engineers have been controlling and navigating this growth, without SBC’s early guidance and constant support, Amdocs would not have been able to grow in the way it did, and probably could not even have recognized and realized the market opportunity in billing systems.
Thus the success achieved by many Israeli IT companies in these years should not make us disregard the weaknesses of the Israeli R&D-focused model of development. The particular limitations of this model are apparent on both the micro company level, and the macro level of the industry as a whole, and may be attributed to an overemphasis on R&D and technologicalengineering capabilities. This focus creates an Achilles’ heel in other areas of management, from marketing and market research to planning and business development. The lack of these capabilities—in particular of managing sustainable long-term expansion and defending market niches against new entrants— leaves most Israeli IT firms vulnerable to competition from better-organized and -managed foreign firms.
[edit] The Beginning of the Software Industry: The 1980s and Early 1990s
In the late 1960s and early 1970s, while the seeds of the Israeli IT industry were planted and a few hardware companies achieved worldwide success, the software industry was practically nonexistent. The industry consisted of a few service-oriented data-processing centers and the IT units of government offices, including the defense apparatus and a few big organizations. However, the rapid expansion of defense R&D and the fast accumulation of IT skills by both university graduates and graduates of the military technological units created local demand for IT usage, the knowledge base to supply it, and a positive attitude toward this nascent industry.[52]
The first product-oriented software companies appeared only at the end of the 1970s and the beginning of the 1980s.[53] Unlike the first software companies in Taiwan and Ireland, they appeared within an industrial system that already had a few highly successful IT hardware firms that were publicly listed on NASDAQ, as well as an already well-developed local market that had many sophisticated users, most of whom were sponsored directly or indirectly by the state’s defense R&D efforts.[54] Even more important, these software companies appeared in an industrial system where many R&D activities, both civilian and defense oriented, were taking place. Hence a critical mass of knowledge on the problems associated with IT usage, the IT R&D process itself, and software development was amassed in Israel, and a large market existed for software products that solved them. As problems in R&D and software development are similar worldwide, an Israeli software company that developed solutions for these had products that answered global needs. Moreover, the customers for these products, being engineers and programmers, are more sophisticated than the average consumer. Hence software products that were too complex and crude in their user interface to be sold to the consumer market could still be sold to these highly skilled customers.
It is not surprising, therefore, that the common thread of most of the successful companies established in these years is that their products offered solutions helping with IT development. As we usually categorize companies by industrial subsectors and not by their cognitive focus across sectors, some examples of the more successful companies are in order: OptiSystems Solutions, established in 1982, focused on optimization of computer systems; Magic, established in 1983, developed a rapid application development (RAD) tool for relational database applications; Cimatron, established in 1982, has been offering CAD/COM software for the tool industry; Nikov Haifa, now known as Attunity, established in 1988, moved away from its origins in ERP consultancy and started to develop RAD tools for reports programming, a product line which brought it to NASDAQ in 1997 and has since been abandoned; and Sapiens, established in 1982, has been focused on rule-based systems for RAD.[55] All of these companies were assisted, after 1985, by OCS R&D grants that enabled them to conduct large-scale R&D efforts, and each of these companies had an IPO on NASDAQ in the 1990s.
As venture capital to the industry was not available, the business model of many of these companies was either to create a joint venture with a moreestablished company that acted as the financial backer and/or the main customer, or to find their first customer before they started their development phase. A few also developed from an IT consultancy business, but not many of these managed to transform to a product-based business model successfully. In addition, as most of these companies could not secure enough capital to open an American branch, their first export market tended to be the European market.
Another common thread in this period is the importance of the state apparatus either as the origin of the entrepreneurs, the companies’ first and main customer, or the source of the technology itself. Thus Amdocs had its origin in a team that worked for the Israeli Postal and Telecommunication Ministry and in a system developed as a joint venture with the company that had the license to organize and sell the telephone directory of Israel. A team of former officers of the military’s central computer unit (MAMRAM) established Magic Software Enterprises, and its first breakthrough sale was to the Israeli military. In addition, the state was sometimes the source of the software product itself; for example, the Fourth Dimension (later known as the New Dimension) acquired from the Ministry of Defense a product for operations automation developed internally for the Air Force, in exchange for a promise to update and maintain it.[56]
In the late 1980s both the domestic factors described in the earlier section and external factors influenced the growth of the Israeli software industry. The external factors in these years that completely changed the software industry were the rapid diffusion of PCs, not only to the consumer and home market but also in the corporate market, and the growth of Microsoft’s operating-software (OS) and programming platforms (first DOS and then Windows) as the dominant platforms and the de facto standards of the industry. The two most important effects of these technological changes on the Israeli software industry were: (a) the opening of new markets to the industry, while at the same time the cost of development declined, and (b) the manifold enlargement of the global need for platform crossover and conversion technologies. This was a demand that the Israeli software industry, already experienced in developing solutions for problems that directly relate to IT development, was well positioned to supply.
Thus during the second half of the 1980s and the beginning of the 1990s many software companies managed to enlarge their activities and penetrate foreign markets. Two examples of veteran software companies that took advantage of the growth of the global market and the new technologies are those of Magic and New Dimension. During the second half of the 1980s, the two companies managed to first secure critical sales in Israel and abroad and then move into the American market. Both went public on NASDAQ, in 1991 and 1992, respectively. Another development in the second half of the 1980s and the beginning of the 1990s was a new cohort of internationally successful companies. The common ground of all the Israeli software companies established in this period, differentiating the industry from that of Ireland and Taiwan, is that all these companies were developed by software programmers who were actively looking for product ideas that offered solutions needed in their own industry—software programming.
As was true of Israel’s hardware companies, founders of these companies lacked business, management, and financial skills. This led many of them in the era before the advent of the Israeli VC industry either to join forces with other companies or to rely on luck and intuition in their early product development and expansion to foreign markets phases. Precise is an example. Established in 1990, Precise specialized in software systems optimization, and almost went bankrupt before it recruited Shimon Alon, a former manager of Scitex. Under his management the company stabilized, listed on NASDAQ, and was sold to the American software MNC Veritas in 2003.
The 1980s also brought the advent of the subsector in which the Israeli software industry truly achieved global fame—data security. In addition, more than a few Israeli software companies have focused on the creation of new software technologies or new applications of software technologies. The most prominent subsector in which these companies operate has been the telecommunication market, which is also the subsector of strength of the Israeli hardware IT industry. A well-known example of that period is Vocaltec. Established in 1989 to develop speech recognition technologies, Vocaltec was the first company to sell VoIP telephony products for the PC. Vocaltec went public in 1996 and was soon followed by a wave of Israeli companies in the same market niche, such as Mind CTI, which develops VoIP billing solutions, and Arel Communication, which develops video conferencing over IP.
These trends continue today, as we can see in table 2.1, which briefly describes the history and activities of the top ten public software companies in terms of sales during 2001–2004.
[edit] Industry-State Co-Evolution: The Restructuring of S&T Industrial Policy
From the second half of the 1980s until the early 1990s the IT industry was rapidly expanding, and Israeli companies, both hardware and software, achieved growing international success. However, industry growth was limited by some severe weaknesses. Two in particular were venture financing— especially at the preseed, seed, and the early sales and distribution stages—and business management skills and capabilities. While the knowledge of how to do business, and especially how to interact with the American financial markets, already existed within the Israeli industry, it was limited to the few firms that had been successful, and there was no systematic sharing and dissemination of that knowledge.[57]
By the beginning of the 1990s the two bottlenecks of the Israeli IT industry had become evident. First, venture funds were not available to enable both deeper and more consistent R&D activities, especially in projects that related to the technological edge and, accordingly, necessitated longer R&D efforts without any revenues. Second, management skills and knowledge were lacking, especially with regard to planning, marketing, and finance.
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In 1989 the latest period in the development of the IT industry began. The USSR started to democratize and break up, and Jews, who had been unable to emigrate until that time, began the last large immigration wave into Israel. Because this wave brought the best and the brightest technologically educated workforce from the USSR to join the thousands of engineers who had been made redundant by the defense industry, the question of tapping this body of knowledge sprang to the top of the political agenda.[58] In addition, the Israeli government secured the United States’ help in raising $10 billion in bonds to finance the settlement of so many immigrants (20 percent of the total population in less than one decade), giving it some financial resources.
Thus the political and bureaucratic apparatus of the Israeli state, knowing it had to act and having sufficient finances to do so, was very open to new initiatives led by the OCS.[59]
Starting in 1991 the OCS, led by Yigal Erlich and with the strong political backing of the then–Minister of Trade and Industry Moshe Nissim, initiated and implemented three new programs. The Ministry of Finance initiated another program, which proved to be a failure, aimed at the VC industry. These programs were devised through a process of analyzing the strengths and the weaknesses of the industry, both internally by the OCS and in conjunction with academics.[60] The aim of these new policies was the enhancement of the formation, survival and success rates, and R&D capabilities of firms. All of the programs have been following the logic of neutral horizontal policies. While the OCS’s three programs, the Technological Incubators, Yozma, and Magnet, started operation between 1992 and 1995, they were all planned and approved in 1991, the year that can be seen as the high point of the latest political window of opportunity.[61] In 1991 two new programs started operations, each aimed at remedying a perceived market failure at a different development stage of NTBFs. From the macro level the main effects of these new programs have been twofold: on one side, increasing the R&D focus and usage of business models based around novel products, and, on the other, increasing the Israeli industry’s embeddedness in and dependence on the United States and its financial markets.
The end of the 1990s marks another transformation. With growing public and political interest in the IT industry and the OCS, the institutionalization and public supervision on the OCS increased. The manifestations of this are many, from the establishment of a public committee process to recommend nominees for the position of a chief scientist to the growing supervision of the OCS by the Parliamentary Committee for Science and Technology. Indeed, of all developmental agencies in Ireland, Israel, and Taiwan, currently it is the OCS that supplies the most comprehensive and transparent information about its current and past activities.
[edit] The New Programs of the Early 1990s
The Inbal program, proposed and implanted by the Ministry of Finance, was the first serious government attempt to induce the creation of a private VC industry in Israel. At that time only two VC institutions were present in Israel: Tolkowsky and Adler’s Atena VC fund, a limited-partnership fund established in 1985 based on the American model, and Star, a private equity fund established in 1989 that became a Yozma fund after 1993. The Inbal program was an attempt to foster publicly traded VC companies by creating a government insurance company that guaranteed a minimum value, calculated as 70 percent of the value of their initial public offering, to new VC funds traded on the Tel Aviv Stock Exchange. As such, the program was similar to Taiwan’s initiative, structuring the VCs as companies viewed not as an industry but as a pool of capital, with no attempt to foster learning, or to import and transfer professional VC skills and capabilities.[62] Four funds were initially established, but no follow-up activity was pursued, and the funds’ valuation on the stock exchange tended to be low. The four Inbal funds also faced what their directors perceived as excessive bureaucracy and in the end left the program. Today all the funds are under the management of one holding company, Green Technology Holding (Avnimelech and Teubal 2004).
When the OCS initiated the Technological Incubators Program, in 1991, the program was presented as a solution to two problems. First, many technically oriented or scientific entrepreneurs were inexperienced and unable to become successful commercial entrepreneurs and find early-stage financing for their ideas. Second, many technologically skilled new immigrants from the former USSR had difficulty finding jobs and successfully integrating into a capitalist market. The idea was to open a network of technological incubators that would help entrepreneurs in their very early stages by giving them most of the financing and a large amount of professional business and management help.
The incubator program is also the latest example of the pattern evident in the restructuring of the OCS and BIRD: an outsider coming in as a manager and making the program a reality. However, this time the early crisis period was avoided. Yigal Erlich, the chief scientist at the time, realized the need for a strong leader and rerecruited Rina Pridor, Yaakov’s right hand for many years, both in the OCS and afterward in CDC and the limited-partnership period. Her return is yet another example of the OCS’s porous borders and networked structure. Under Pridor the program quickly commenced activities and grew in importance.
The goal of the program has been that after two years companies will be mature enough to secure private VC financing. In a similar fashion to the other OCS programs, incubation proposals had to come from the market.[63] Until 2001 (when specialized incubators were approved, even if none had yet started operation), the incubators operated on the principle of neutral horizontal policy. While some of the incubators became more specialized over time, overall the technological incubators network did not pick any sectors, and R&D projects from all branches of the industry were admitted. By 2005, according to the OCS reports, the distribution of projects by industry was as follows: electronics and communication 11 percent, software 11 percent, medical 18 percent, chemistry and materials 20 percent, biotechnology 20 percent, and others 23 percent.[64] Starting in 2003 a few established VC funds opted to buy and manage a few incubators.
Two of what may be the most important impacts of the program have yet to be considered and tested properly.[65] First is the major impact that the program has had on changing the preferences of technologically and scientifically educated personnel to become entrepreneurs. Second, as the technology industry crisis between 2000 and 2003 showed, the program is important in ensuring a minimum NTBF formation rate, which is independent of the volatile behavior of the VC industry in regard to the amount of investment, and the herd mentality and fashionlike behavior of VCs in their sectoral investment criteria.
A comparison with Ireland is striking. In Israel, to a great degree thanks to the OCS’s programs, the annual formation rate of new companies remained above a hundred even after 2000. In Ireland, with the Irish VC industry managing record high levels of capital, in the whole of 2001 there were three seed investments, which together equaled $750,000, a sum which is slightly less than the support granted to two incubator companies. For a state like Israel that is economically dependent on the high-technology sector, securing this baseline is of critical priority.
In the same years that the OCS was busily developing and implementing new programs, new developments in the private sector were changing the IT industrial landscape in Israel. Before 1990 there had been a total of ten IPOs of Israeli firms on NASDAQ. In 1991 alone three Israeli companies went through IPOs, and in 1992 there were another nine. Moreover, unlike the lowvaluation IPOs of the past, some of these IPOs resulted in a large enough market capitalization to allow a respectable exit for an American VC at the time. In addition, 1991 was also the year in which the first pure software companies went public on NASDAQ.
In 1992, learning from the failure of Inbal, the OCS initiated another program aimed at inducing the creation of a vibrant VC industry in Israel: Yozma. The aims of this initiative were fourfold: increasing the amount of venture capital available to Israeli firms, especially in their expansion phases; creating a professional VC industry that would possess the business skills that the IT industry was lacking at the time; injecting the Israeli high-technology industry with systematic knowledge of the American markets, both product and finance; and expanding what the OCS perceived as a too limited group of financiers.[66]
This time, in almost complete opposition to its policy in the past, the OCS, again led by Yigal Erlich as chief scientist, decided that the necessary skills and knowledge did not exist in Israel, and that in order to succeed an Israeli VC industry would need strong networks with foreign financial markets rather than with the Tel Aviv Stock Exchange. Yozma was created as a government VC fund of $100 million that had two functions. The first was to invest $8 million in a series of ten private limited-partnership venture funds, which would be 40 percent or less of the total capital, the rest to be provided by the other private limited partners. Second, a separate fund of $20 million started operation at the same time. In order to get this financing, the funds’ managers had to secure investment and partnership from at least one established foreign financial institution and from at least one local one. Moreover, the OCS made a deliberate decision to pick one organizational model for the future Israeli VC industry, the American-style limited-partnership fund, and focused on early-stage financing VC.[67]
Unlike Inbal, Yozma became highly successful and was a model for VCdevelopment policy worldwide. The precise construction of the program—in particular, its treatment of VC as an industry with specific skills to be acquired and capabilities to be nurtured, unlike similar initiatives in Ireland and Taiwan—had a few positive impacts. The first effect was the professionalism and education of the venture capitalists themselves. In Israel, with its already long history of the R&D-based IT industry, there was a growing pool of experienced technological entrepreneurs who successfully managed their companies, and this, together with the demand of Yozma to bring in a professional foreign partner, created a VC industry in which the typical background of the VC is as an entrepreneur or manager of an R&D-based IT firm. This VC profile is very similar to the ideal American background, and very different from the typical profile in Ireland and Taiwan, where most VCs do not have entrepreneurial or even IT management backgrounds. Second, the Yozma initiative itself sponsored and cultivated many venues of collective learning within the industry, which enhanced its capabilities (Avnimelech and Teubal 2003a, 2006a, 2006b).
The first Yozma funds had excellent returns on investment, thanks to the growing success of Israeli companies on NASDAQ, the presence on the Israeli landscape at the time of many high-quality NTBFs looking for capital, and the coincidence with the start of a period of rapid growth in demand for IT and the related financial boom. This success resulted in rapid investment of capital into the Israeli VC industry, most of which opted to use the limitedpartnership organizational model. Thus, as can be seen in figure 2.2, by 2000 the American limited-partnership VC funds became the de facto standard of the Israeli industry. In turn, the existence and growth of the VC industry both accelerated the rate of company formation and, even more important, finalized the transformation of the Israeli IT industry into the image of the American one. Today the Israeli IT industry has the same focus on the American financial and product markets and the same milestones as in the American IT industry—either an IPO on NASDAQ or a merger and acquisition (M&A).[68]
As of 2006 the Israeli VC industry consisted of more than seventy local funds, with many of the top U.S. and global VC funds having local operations in Israel and with $2.3 billion available for investment. The industry has also shown its maturity and strengths by recovering from the technology bubble, raising $727 million in 2004 and $1.2 billion in 2005 without governmental interventions of the sort applied in both Ireland and Taiwan. The virtuous dynamics of a growing and successful IT industry co-evolving with a successful VC industry brought another facet of professionalism into the Israeli VC industry—a career pattern where successful entrepreneurs who managed to sell or publicly list one or more companies would later opt to become VCs.[69]
In addition, the success of Israeli companies in the United States in the 1990s transformed the IT industry’s own networks. Lately many Israeli IT companies have raised capital directly from established foreign VCs and financial institutions in all stages of the companies’ development. This is highly important for the Israeli IT industry, which to a large degree imitates the American mode of start-up growth, based on an expensive R&D phase, followed by an even more expensive buildup of marketing and distribution channels, during which the firm is hardly able to secure revenues from sales. Hence the creation of the Israeli technological VC industry, and the ability of the Israeli IT new-product R&D-based firms to secure venture capital abroad, make the Israeli IT industry different from those of Ireland and Taiwan in being able to compete successfully with the amounts of capital that American IT start-ups manage to secure.
The last initiative designed by the OCS in 1991, MAGNET, also started operations in 1992. Unlike the other OCS programs, MAGNET, the Hebrew acronym for generic noncompetitive R&D, aims to solve two problems relating to the later stages of development and maintenance of the long-term R&D-based competitive advantage of Israeli NTBFs. The first problem is the fact that in Israel a large number of companies work in the same technological space, all of them too small to be able to compete on the basis of cuttingedge infrastructural research activities that are crucial for their ability to sustain the competitive advantage against the bigger MNCs. The second perceived, if more debatable, problem was the underutilization of academic research done in Israel.
Similar to other OCS programs, MAGNET grants aid to programs initiated by private industry and operates on the principles of a neutral horizontal policy. However, as MAGNET aims to create a consortium to develop generic technologies, a consortium is created for a period of up to three years, and all IP outputs are shared among the consortium members, who also agree to license this IP to local companies at a cost that does not reflect monopoly status. A consortium, consisting of at least a few companies and one researchacademic institution, applies in a competitive fashion to MAGNET and, if accepted, is granted financing to the level of 66 percent of cost. MAGNET financial aid is given as grants with no need to repay. A parallel process exists for users’ consortia, with the aim of distribution and implementation of generic technology.
Again a comparison with Taiwan is illuminating. As we will see, in Taiwan, research consortia were created by the government in an effort to assist technological learning, upgrading, and catch-up en route to industry creation. In Israel the aim of the state in establishing research consortia was to help precompetitive advanced R&D. Thus the national goals behind the usage of a structurally similar policy vehicle are as different as can be, symbolizing the different policy and development paths of the IT industries in the two countries.[70]
In addition to the new initiatives, the OCS’s budgetary growth during the 1990s was quickly transformed into extensive investment in the industry. As can be seen in Table 2.2, the success of projects financed by the OCS in turn increased the amounts the OCS was able to channel to industry, even without an increase in the budget allocated to it by the government, creating a virtuous co-evolution cycle throughout the 1990s. It remains to be seen, however, whether the budgetary cuts imposed on the OCS in the past two years will limit its ability to continue this level of support or to open new programs in the future.
While the wave of immigration from the former USSR undoubtedly created the pretext with which the OCS was able to secure finance and political agreement to start these four programs, the Russian immigrants themselves have not, thus far, become successful technological entrepreneurs. They seem to play the important but lesser role of providing highly skilled labor. A preliminary analysis of an original dataset that I collected on the career paths of founders of Israeli IT NTBFs that went public on foreign exchanges did not find one new immigrant from the former USSR among the 151 founders on which comprehensive data were acquired.[71] This finding is reinforced by an analysis done by the Central Bureau of Statistics on the distribution of new immigrants in the IT labor market (Abouganem and Feldman 2002, pp. 27– 28).[72]
| Table 2.2. OCS Budget, 1988–1999 | ||||||
| Year | (in 2000 $USD Million) | Paybacks (% of Investment) | Approved Grants to IT firms (n) | |||
| R&D Grants | Paybacks | Magnet | Incubators | |||
| 1988 | 120 | 8 | — | — | 6.7 | |
| 1989 | 125 | 10 | — | — | 8.0 | |
| 1990 | 136 | 14 | — | — | 10.3 | 380 |
| 1991 | 179 | 20 | 0.3 | 3.6 | 11.2 | 460 |
| 1992 | 199 | 25 | 4.7 | 16 | 12.6 | 458 |
| 1993 | 231 | 33 | 4.6 | 23 | 14.3 | 481 |
| 1994 | 316 | 42 | 10 | |||