Another Israeli company, Mirabilis, developed the first Internet messaging service, ICQ. The list goes on: Checkpoint developed the first commercial Internet firewall and its technology is now installed at more than 250,000 sites around the world, including more than 90 per cent of the Fortune 500; VocalTech was the first company to develop Voice-over-Internet Protocol (VoIP) technology.
One of the first global companies to recognise the great value of Israeli innovation was Intel. It opened its first R&D center in Haifa in 1974. By 1979, this development center gave birth to the 8088 microprocessor, the core processor for the first IBM personal computer. Ever since, Intel has continually increased its R&D presence in Israel, and in the past 10 years, two major innovations have come out of Intel’s Israeli labs: the Centrino chip and dual-core processors.
Following in Intel’s footsteps, many other high-tech firms now have R&D centers in Israel. IBM, Cisco, Google, Microsoft, Qualcomm, Autodesk, and Oracle all have substantial R&D presences in the country.
Even Apple, which until very recently conducted all its R&D work at its California headquarters, has made a significant investment in Israel. The company purchased Anobit for $500 million and will turn it into the company’s first R&D center outside of California. Anobit developed the proprietary memory-signal processing technology that enhances the flash memory performance in iPhones and iPads.
There is much more to Israel than technical know-how. It is a small, highly networked country with a high concentration of educated workers. Interdisciplinary skills are common, and most workers are multilingual.
While the country has attracted a few European and Asian firms including SAP and Samsung, the vast majority of investments and M&A bids are made by US companies - this despite the fact that Tel Aviv is much closer to London than it is to New York.
What does all of this mean? There is still great potential for European and other non-US companies to enjoy the fruits of Israeli innovation.
Mapping pockets of opportunity
In our joint effort with Technion to uncover the sectors most ripe for collaboration with global companies, we analysed thousands of Israeli companies. In addition to the semiconductor and software sectors, which have been well-known innovators, we identified four new sectors in which we believe Israel’s innovation leadership has reached critical mass: telecommunications, medical devices, water treatment, and agriculture.
In telecommunications, Israel’s leadership in innovation is concentrated in three subsectors: mobile applications and services, infrastructure and network technologies, and security-related technologies such as encryption, fraud protection, and mobile surveillance.
We found more than 700 Israeli companies working in these subsectors, and their accomplishments are legion - the GSM Association treats Israel as a separate continent when giving out prizes to distinctive companies at its annual Mobile World Congress in Barcelona.
In our analysis of the medical-device sector, we found that Israel is distinctive in three major areas. The first is imaging and diagnostics, with specific emphasis on gastrointestinal, ophthalmological, and cancer diagnostics, as well as new Xray, magnetic-resonance-imaging, and computerised-tomography equipment.
A second area of strength is in the area of neurology and degenerative diseases. Israeli innovation leads the way on brain/machine interfaces and neurostimulation devices to treat these conditions.
The third distinctive subsector is implantable and disposable therapeutic devices. Israeli companies have distinguished themselves in the areas of cardiovascular, orthopedic, and dental devices. These fields typically require strong interdisciplinary collaboration, which is a key area of strength in a small and highly networked country like Israel.
The lack of fresh water in Israel spurred innovation in the areas of water treatment and agriculture. We have identified more than 250 Israeli companies in these sectors. Israel leads the world in the development of desalination technology. By 2014, all of the country’s water for human needs will be supplied by rain collection or desalination plants. Israel is also a leader in wastewater treatment.
It currently reclaims roughly 75 per cent of its reused effluents for agriculture. The second- and third-place countries with respect to reclamation are Spain and Australia, with 12 per cent and 9 per cent reclamation rates respectively. Israeli has also developed IT-based technologies for water safety and security and other technologies that manage water efficiency and water infrastructure.
In agriculture, Israel is the undisputed world leader in drip irrigation, with four local companies and their home-grown products accounting for about 50 per cent market share in the $2bn international drip-irrigation market. Israel also has a strong edge in crop technologies such as plant genomics, breeding, and crop protection. Israeli seed companies typically maintain strong relationships with local growers leading to quick adoption of new breeding technologies. These relationships also give the seed companies rapid exposure to changing market trends, and access to markets in Asia and other regions of the world.
Leveraging the Israeli innovation engine
How can foreign companies benefit from Israeli innovation? We have observed six models that global companies have used to work with innovative Israeli companies - indeed these are approaches that work well in any cluster of innovation. And, while it is beyond our scope here, we have also identified a way for companies to choose the model that best suits them and their innovation agenda. These models are listed in the order of commitment required to pursue from low to high.
1. Partnering with a local company allows a foreign company to leverage Israeli innovation while sharing R&D risk. This is best for companies looking to match Israeli R&D know-how with their international marketing and sales engines.
2. Investing in a local company provides early benefits derived from the development of leading-edge technologies. This is primarily done by companies looking to encourage further development in a given field.
3. Setting up a corporate venture-capital arm in Israel can be a mechanism for scanning relevant innovations and gaining early access to new technologies. Such an investment approach allows a foreign player to benefit from the financial upside of helping young companies grow, while maintaining minimal involvement in the investment target itself.
4. Establishing incubators in Israel can allow foreign companies to gain exposure to innovative companies at an early stage of development, and it also allows the local companies to benefit from coaching provided by the incubator. This approach works best for companies looking to make long-term, strategic, low-cost investments in Israeli companies.
5. Establishing local R&D centers allows foreign players to leverage local innovation talent, as well as the entrepreneurial spirit and problem-solving skills of Israeli workers and focus them on long-term strategic topics. This model is for companies looking to establish remote activities in a location featuring attractive government support and tax benefits.
6. Acquiring a local start-up is a fast track to absorbing Israeli innovation. Such a move allows foreign players to obtain innovative technology, intellectual property, and local talent, in a turnkey fashion. This model would give a foreign player quick access to an established market for a particular product or service.
R&D is accelerating around the world, in both size and scope. Israel is relatively close to the main business centers of Europe - less than five hours by air to Paris, London, Milan, or Frankfurt. It also has strong trade relations with the European Union, as well as a free trade agreement with the continent.
We believe it has enough potential to become the innovation hub, or Silicon Valley, of Europe. To tap into the Israeli innovation pool, foreign companies need to articulate an R&D strategy and develop a systematic approach to scan for new technologies and potential partners. They also need to be thoughtful about their needs and select the right engagement model for partnering with Israeli innovation talent.
This article was written by Michael Bloch, Jonathan Kolodny, and Dana Maor of McKinsey Tel Aviv for the Financial Times.