Despite its small domestic market, Israel has managed to build a vibrant start-up scene that competes with those of much larger countries. In this episode of The Committed Innovator podcast, two leaders of Israel’s innovation culture, Avi Hasson and Chemi Peres, talk with McKinsey’s innovation leader Erik Roth in this first in a series of episodes on innovation in Israel. Avi leads Start-Up Nation Central, a not-for-profit that facilitates business in Israel’s start-up sector, while Chemi leads Pitango, the venture capital firm, and a not-for-profit that promotes peace and innovation. The latter organization, the Peres Center for Peace and Innovation, was started by Chemi’s father, former Israeli prime minister Shimon Peres.
This is an edited transcript of their discussion. You can listen to the full episode on your preferred podcast platform.
Erik Roth, McKinsey: It is an absolute honor to have two of the originators of the Israeli ecosystem of innovation with us today. If we roll back the clock to when you were first thinking about what innovation and entrepreneurship mean for Israel, how do you think about that?
Chemi Peres, Peres Center for Peace and Innovation: When I think about innovation, I think about Israel as the first state that was created, built, and envisioned based on innovation. The reason for that is this is a country that was blessed with nothingness—no water, no food, no land, no shelter, no market. How do you create a nation when you have nothing? You have to turn to your brainpower. For me, the story of Israel is a story of innovation. At the Peres Center for Peace and Innovation, we explain our origins starting with Theodor Herzl [the Austro-Hungarian Zionist] and his plan to create a new country. Everything you needed—from food to water to energy to the economy—was based on innovation.
Erik Roth: One of the things we often talk about in innovation is how constraints are innovation’s best friend. Given what you just said, the constraints that Israel started with were huge.
Chemi Peres: I think as Israelis and as Jewish people, we see ourselves as having a role in the world to repair the world. We call it tikkun olam, and here at the Peres Center we have a mission statement, which is to introduce innovation and new ideas and new technologies, not only for ourselves but to solve the problems of the world. If you had asked my father, he would have said the biggest contribution of the Jewish people to the world is dissatisfaction: since we’re never happy with what we have, we have to create new things and innovate.
Erik Roth: Avi, you were the chief scientist of the Israeli Innovation Authority. What was your role in creating Israel’s start-up ecosystem and the innovation model?
Avi Hasson, Start-Up Nation Central: Something Israel did very well was to acknowledge early on the economic value that innovation can bring. If you look at the Israeli economy, it basically is a knowledge-based economy. Over half of our exports, 54 percent, are high-tech, which means they’re strategic. It’s our business plan as a country.
Today, every country, every region, every city is somewhere on that journey, transforming its economy from a resource-based economy to a knowledge-based one. Israel did that really, really early. One of the key parts of that was to build the office of the chief scientist, acknowledging that public and private sectors need to work together in order to achieve that goal.
Erik Roth: Knowledge and education were clearly one critical ingredient. What were the other critical ingredients that made up the formula that turned Israel into the innovation center it is?
Avi Hasson: We had excellent universities and research institutions even before the establishment of our modern state. A lot of what those places cared about was to serve the needs of the country. How do we feed the people? That was an excellent foundation later to have as one of the important parts of an ecosystem.
But to do that, you need to add other ingredients. Some of them are unique to Israel. In order to have innovation hubs, like Israel has become, you need to develop not just the discrete components but also the interconnectivity between them. The public and private sectors play a role. But at the end of the day, it’s quite simple. To build innovation, you need two things: human capital and financial capital. That’s all you need.
The problem is that once you start analyzing what I just said, you realize that in order to scale in that innovation pyramid and build the ecosystem, you need very different types of human capital along the way: from basic scientists to entrepreneurs, to product people, to marketing people. And you need government money, and you need venture capital, of course. Then you need growth capital, and you need public markets. And having all of those together synced in the right way is something which may be easy to explain but is quite hard to imitate.
Erik Roth: Let’s unpack some of those two sides. Public funding and public involvement played a very important and special role, such as interventions the government made in terms of the commercial sector as various businesses evolved. How would you rate the criticality of that? And then of the public portion of the system: What were the things that made it uniquely special?
Avi Hasson: I would argue that regardless of your theology regarding government’s intervention, free market, and so on in the world of innovation, the smart or the right public policies are crucial in order to have a vibrant and active ecosystem. First, we started very, very early. The office of the chief scientist was set up 50 years ago. This is really early in the history of start-up ecosystems and knowledge economies and so on.
I would say the most important thing is public–private partnership—figuring out from the early days that government has a role to play, which it can and should play better than the private sector would. But it should not try to replace the private sector in the things it does best. That sort of coordination or balance is really what drove Israel’s policies in the past 50 years.
Erik Roth: Chemi, it would be great to hear from you representing the private side but with a tremendous perspective on the public side. What makes that partnership work?
Chemi Peres: I believe the best enterprises in Israel have been public–private partnerships, but I think things are changing. At the beginning, the government was behind everything because we had to take care of our sustainability and survivability. Survivability calls for government funding, even though my father’s prime project as a young man, the establishment of the nuclear facility, was done with no government funding. But all the investment in our water system, food system, and energy system has been done by government.
The source of innovation is moving from pure necessities into purpose necessities, or necessities with values, which have been defined primarily by the United Nations through the 17 Sustainable Development Goals.
Through the years, there has been a shift of power from governments to private individuals—to entrepreneurs, enterprises, and companies. In many cases, they’re taking the role of a government by initiating and creating new systems.
Erik Roth: Do you see that shift being very prominent in Israel today?
Chemi Peres: Earlier this morning, I spoke about the impact of technology on infrastructure. For example, when Israel was created, the water system was pumping water from the Sea of Galilee and streaming it down to the south. With the introduction of water desalination, we could create water desalination factories on the coastline and move water from west to east, helping Israel almost reach water independence in its ability to sustain its economy—not only for drinking water, but for industry and agriculture. I believe that free enterprise, entrepreneurship, science, technology, and innovation are driving forward humanity and evolution and, in many cases, taking the role of government.
Erik Roth: Avi, as more corporates or commercial enterprises take the role of government, who gets to define what challenges are solved and whom those challenges benefit when they’re solved? One could imagine a world in which the forces of more capitalistic-type funding models may not be as egalitarian in terms of which challenges get chosen, which entrepreneurs get funded, and what benefits then result from those investments.
Avi Hasson: First of all, going back to the old days in Israel, the model was never top-down. It was never, “Here are the things we want to solve,” but rather, “Let a thousand flowers bloom”—create the right infrastructure and environment and then try to help mitigate the risk and help those enterprises grow.
By the way, that approach has trade-offs. I think it’s part of the result that, while Israel has created one of the world’s leading innovation hubs, the rest of the economy is underwhelming in many aspects because the implementation of those technologies in Israel was quite limited in general, with a few exceptions. It was always a very bottom-up kind of ecosystem, and that continues today.
Where I agree with Chemi is that it’s a blessed trend that we should encourage and nurture. More and more, we’re driving the forces of innovation to the right places and trying to tackle the biggest challenges, which I think we all agree on.
If you interview ten families in the world and ask them what’s top of mind, you’ll hear the same things over and over again. People will talk about health, about safety. And safety, by the way, is personal safety, but it’s also the risks of the changes we’re all experiencing with our planet’s climate and so on.
Chemi Peres: But generally, I think there is no hierarchy, and it’s an open system. It’s an encouraging system. It lets us have free enterprise.
Erik, to your question of who’s going to decide which challenges get solved, let’s consider that governments are elected every once in a while, but when you are an enterprise, you are elected every day by your customers, by your partners, by your investors. So you must be doing something right. And you must have the tailwind to be successful in what you do. It’s really the customers—it’s the stakeholders, so to speak. Today there is much more openness to collaborate on a global basis. For example, agreeing on the 17 Sustainable Development Goals and adopting that at a country level or enterprise level is basically a global collaboration.
Avi Hasson: I would also point out that the legend of two founders in a garage who dream of an idea and all of a sudden it becomes a unicorn doesn’t work that way. In order for those two founders to succeed, they need to work as part of an ecosystem. It’s not surprising that Silicon Valley is probably the best example of a well-functioning, effective innovation ecosystem, even though they have their challenges as well. The importance of an ecosystem is crucial in order for those innovators, those dreamers, those entrepreneurs to fulfill their potential.
If you want to achieve that, you have to go through a journey. It took Israel 30 years to become an “instant success.” We’re all excited about that, but it was a journey. It was an evolution, and we scaled up. And while scaling up, by the way, we had to keep our talent and capital from going away to other innovation hubs, like Silicon Valley.
I think that’s where the lesson lies. That’s why I honestly think Israel is an interesting case: because everybody wants to be Silicon Valley, which is almost impossible, but you can actually become Israel if you don’t copy and paste but rather follow the journey and try to learn and adapt. I think a lot of countries can go that route.
Erik Roth: What makes up the Israeli ecosystem? One of the things Israelis do not have is a massive domestic market, so in many ways, the ecosystem is not localized. A lot of countries and organizations think about tech and innovation hubs in terms of commercializing at scale locally as an important first step. That’s not the case in Israel. What other ingredients have to be in the mix for the ecosystem to thrive?
Chemi Peres: It goes all the way to the education system, to funding, to regulation, to a lot of things that all together are creating the ecosystem and allowing you to build those enterprises. The ecosystem needs to be able to do three basic things. Number one is to be able to identify new trends, new technologies at the time they are born and not in a delayed way.
Second, once you are spot-on with new things, your ability to scale up is critical, and scaling up is based on the size and power of your ecosystem. We cannot match Silicon Valley here; they have local and global reach in one place, and you can do things on the ground before you scale on a global basis. In Israel, you have to have the ability to scale up very quickly out of a tiny ecosystem.
The third thing is to address challenges that are not yours but are global. If you address only your own markets or your own needs, you are doomed to fail. For example, in France in the 1980s, they created the Minitel, which was the first online service. They used it in Paris for scheduling trains or horoscopes or weather, but they didn’t think globally. They could have been the capital of the internet, but they kept it as a local business. In Israel, there’s no way you can keep a business local.
Erik Roth: While there certainly have been lots of successes coming out of Israel, some critics might say its success with technology has yet to fully translate to an ability to wrap business models around the technologies. Would you agree with that criticism?
Chemi Peres: I would disagree, but I would say it takes time to build some kind of a tradition. The ecosystem needs to have not only knowledge and people, et cetera, it needs to have lessons learned, tradition, and processes that have evolved over time before you can reach the next step. In the first ten years of the Israeli ecosystem, we could barely approach markets. We could definitely develop things for others, but we were too late in the game still and could not scale up, so most of our start-ups ended up being acquired by others. When we started to get the connectivity of the internet and the data flow and automation, we stopped thinking as an island and started to think in terms of creating category leaders.
Our mission statement back then was to build value through getting unicorns. Now we are in a new age, and we understand it’s not only about building valuation. You need to reach a scale of business of billions of dollars in order to create the category leaders. I think you will discover that Israelis are very good executives. They have strategies. They know how to run a business, not only develop one. But it takes time.
Avi Hasson: A lot of the first-generation entrepreneurs Chemi talked about that sold their companies, often to American companies, then spent a few years working for those companies and gained firsthand experience in running a whole business, global in its reach and so on. And when they came back, they aimed higher. They’ve gained the training confidence and know-how that enables them to build a global business.
Also, advances in infrastructure have helped. Marketing has changed, for example. It’s no longer about taking a suitcase and traveling to your customers. A lot of marketing today is actually performance marketing. It’s digital, and Israelis are quite good with numbers and algorithms.
Some of the world’s best marketing companies—B2C, the hard-core marketing companies, gaming companies, adtech—come out of Israel, because all of a sudden, it’s numbers you need to master to drive business value and not necessarily presentation skills or big Rolodexes or anything. And Israel does have inherent efficiency compared to other markets.
Erik Roth: You both have mentioned the importance of public–private partnerships. It’s notable that quite a few large tech companies came to Israel early on and started to enmesh themselves into the market. Do you think that had a major role?
Chemi Peres: Absolutely. I think that one of the main two engines of growth in Israel has been global enterprises coming to Israel. Originally, they came in for R&D purposes, because the Israeli engineers were sitting on an island, so they were loyal by nature. There’s nowhere you can run. But over time, these companies started to see that Israeli engineers can do more than just R&D. They can actually develop products. They can create open innovation within companies and help them become more competitive, or serve as executives. For example, companies like Meta—Facebook—and Google have started to see Israel as a market.
We are small. If you sell something for the consumer market, Israel cannot represent more than 0.5 percent of the market. But if you are selling digital assets or digital services like marketing, then the Israeli companies that emerge here are becoming significant customers.
Start-Up Nation Central found that 90 percent of the global enterprises that came to Israel said they’ve achieved what they wanted and even more. Israel has contributed to their competitiveness on a global basis, more than just getting the R&D services in Israel.
Erik Roth: Given the digitization of so many things, what have you seen changing the most, relative to the beginning of the Israeli innovation ecosystem to today?
Chemi Peres: Culture. People are dreaming bigger. People are thinking long-term, people are interested in building businesses for the long run. They are becoming much more patient. They are becoming much more interested in building their executive teams and global expansion, educating and building the DNA of the company to scale, and gaining dominance in markets. This has been changing in a dramatic way. The biggest change I see as an investor is the kind of culture that the new generation of entrepreneurs is bringing. A lot of them are also bringing the idea of sustainability, the idea of impact on fulfilling values. It’s a fantastic development that we see in the market.
Avi Hasson: I think if you tell the Israeli story in general, it’s always a blend of culture, the values, and then capacities or infrastructure and so on. Israelis had chutzpah and big vision also in the fifties and sixties, right? Yet we did not have an innovation ecosystem at the time. Culture is just one piece of it. The other one is simply that we have grown and learned as an ecosystem. We’ve mastered that first layer, the start-up layer, and we continue.
We still have a very strong start-up engine. What we’ve added to that in the past five to ten years is valuation. Think about tech companies that have revenues of $50 million or more. Until recently, there were very few such companies, and today we have dozens, if not hundreds. It took time to do that journey and to add the missing components. The big guys are coming to Israel for the first time. Why? Because now they have the right deal flow to fuel their business. That’s a new phenomenon.
Erik Roth: With all this inflow of foreign venture capitalists, how has that affected the way entrepreneurs raise money?
Chemi Peres: As a result of the evolutionary process Avi spoke about, the same is happening with valuation fluctuations. I think we’ve learned to weather it because we’ve been there. We’ve been in the 2000 bubble burst. We’ve been through the 2007–2008 global financial crunch. We’ve been through [COVID-19]. We’re going now through the downturn. I think we learned how to weather the fact that markets are fluctuating, that valuations tend to go up and tend to go down.
At Pitango, for example, when things got overheated and there was global competition on investing in Israeli companies in very high valuations, we did not try to compete. We did not believe in the sustainability of this, and we tried to play in an area that was safer in terms of absorbing the shockwaves of valuations.
As a venture capitalist, when you have a portfolio and you make new investments, the market timing is always beneficial to one point of your business and unfortunate to another one. If you are trying to exit a company at the time of depression, it’s tough, but if you want to make new investments, it’s a great time.
You have to take a clear look at the global trend, where the world is heading, and forget about the shockwaves of valuations, which always tend to be either overpessimistic or overoptimistic, and just be focused on the things you do. Be profitable and grow in a sustainable way, and let valuations follow you; don’t pursue them.
Erik Roth: Thank you both for joining us today.
Chemi Peres: Thank you very much. Erik. With your permission, I’d like to recommend a film and a book. The film is on Netflix. It’s called Never Stop Dreaming: The Life and Legacy of Shimon Peres and launched in July in 192 countries. It’s an amazing film that tells the story of Israel through the life of my father. The book is the last book he wrote before passing away, called No Room for Small Dreams. It’s about Israel achieving things, changing reality, realizing dreams, with a conclusion that we always need to dream big and never stop dreaming.
Avi Hasson: Thank you, Erik, and thank you, Chemi, it was a great discussion.