In this episode of the McKinsey on Start-ups podcast, McKinsey executive editor Daniel Eisenberg speaks with McKinsey senior partner Kim Baroudy and associate partner Jaap Vriesendorp about the recent resurgence in the European start-up ecosystem and what the continent’s growing roster of new companies can do to become true tech champions. An edited transcript of their conversation follows.
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What makes the difference for Europe’s top start-ups
Daniel Eisenberg: Hello and welcome to McKinsey on Start-ups, I’m Daniel Eisenberg.
In the past two decades, as technology and startups have radically reshaped our daily lives and the global economy, Europe could be forgiven for wondering if this new moment might pass it by.
Europe is still, of course, a global economic power. But slowing growth and a relative lack of innovation have contributed to a significant reduction in the continent’s share of the global economy; in fact, its share of global market cap and profits has dropped by half, from roughly a third to around 15 percent.
The entrepreneurial deficit is an area of concern as Europe contemplates its future economic and technological competitiveness. Both its number of startups, and those that go on to become unicorns, have significantly lagged its global peers such as the US. A range of explanations has been posited for this disparity, from regulation or talent to a risk-averse culture or a fragmented value pool.
In just the last few years, however, there have been encouraging signs that the tide is starting to turn. Greater amounts of foreign and domestic venture capital have flowed into both early and later stage startups to help close the funding gaps, and the pace and number of unicorns being created has accelerated.
For both aspiring entrepreneurs and investors, the recent momentum raises the question of what exactly it takes to become a European Tech Champion.
A team at McKinsey recently examined that issue in a report titled Winning Formula: How Europe’s Top Tech Start-Ups Get it Right. The groundbreaking research looked at the top 1,000 European start-ups founded after 2000 in 33 countries.
Today we are joined by two of the co-authors of that report, Kim Baroudy and Jaap Vriesendorp.
Kim, Jaap, thanks so much for joining us on the podcast today.
Let’s start by talking about the tech sector broadly. We know it’s been booming globally over the last few years. But what does it look like in Europe these days?
Kim Baroudy: If you look at Europe as a region, 20 years ago we represented roughly a third of the global economy, a third of the market cap, and almost a third of the global profits. And we had a little bit above our fair share of the top 100 companies in the world.
Fast-forward to this year and the picture looks very different. First of all, we represent one-fourth of the global economy due to slower growth rates than India, China, and others. But it’s interesting to see that we only represent roughly 15 percent of global market cap and profits.
The reason why we’re losing not only relatively on macro, but even more so on companies, is the lack of global technology champions. North America and China have produced not just an outsized number of companies, but companies that are producing significant profits, and, as a result, market cap.
So, although we all get excited around the fantastic growth and momentum in Europe, unfortunately over a 20-year horizon we have seen Europe lose relevance and size mainly due to the lack of technology leadership companies.
Daniel Eisenberg: I assume the challenge that you just outlined is what spurred your decision to take an in-depth look at the European start-up scene?
Kim Baroudy: Absolutely. McKinsey & Company has always been thought leaders for large institutions, incumbents, and attackers. When we look at this picture of losing relevance as a European region, that is obviously a “flag” that we would like to at least attend to.
But even more importantly, we believe that the world needs some sort of balance, and Europe needs to have at least a fair share of the companies and the solutions. If we don’t, then we will have to accept the fantastic solutions and companies that are being produced predominantly in North America and China, as well as the values those companies bring to the table.
If Europe is to have a seat at the table, to produce the values, the business logics, and business models, to some of the most important problems around climate change, and health care, we will have to actually up the ante and produce leaders, not only within European countries, but also on the global stage.
So that’s why we initiated this “cookbook”: to provide some insights on transparency, but even more so a guide for companies on how to scale and become global champions.
Daniel Eisenberg: Jaap, in your recent research you looked at the top 1000 start-up companies in Europe, “the tech champions”. What specifically drove this approach to the study? And what were the key insights and findings?
Jaap Vriesendorp: What we did was take a data-driven approach to solving the problem of what makes great European companies great. In order to solve that riddle we built a very large database and spent nine months creating a coherent and structured data lake to look at the top thousand companies founded since 2000.
When we looked at those companies we weren’t very hypothesis-driven, as we normally are. We took a little bit of a different approach, and said, “What will the data tell us about the success of these companies?”
In a way that was very enlightening. What came out were three very interesting insights. The first one was that when we looked at the top thousand, there were four very distinct roads to success. Companies either took a network approach, a product approach, a deep tech approach, or a scale approach. And each approach had its own characteristics regarding revenue growth, employees, and other similar markers.
The second thing we found was that, for each of these different roads to success, there are different success factors. Some categories of companies over-indexed on commercial roles, some companies had a successful approach to M&A, and some took an initial product hook.
The third thing was around funding. We got a good understanding of the amount of funding it takes to become a unicorn. It obviously differs very much across these four archetypes of companies described. But it also gave a sense of what you need to put in, to get back.
Daniel Eisenberg: Can you explain in a little more detail the four different plays?
Jaap Vriesendorp: The first strategic play that we found was the network play. These are companies that become more valuable as they gain users. These companies drive product adoption and use this to become winning platforms. They are often marketplaces, mobility players or social media start-ups, such as Deliveroo, TIER, BlaBlaCar, or Just Eat Takeaway.
The second play was scale players. They achieve early sales growth to reach critical size and economies of scale. They are frequently e-commerce companies, consumer companies, or media companies. Spotify, for instance, or Zalando, or Farfetch.
Then we have product players, the third category. They prioritize developing superior product and outstanding customer experience that are very distinct and have a competitive advantage. These are usually B2B SaaS companies, or fintechs, such as N26, or software companies like Personio.
The last strategic play that we saw was the deep tech play, which is really focused on research and development early on to commercialize scientific breakthrough. These are generally companies that work on Artificial Intelligence, hardware, biotech, or health care and include examples such as Lilium, Graphcore, BioNTech, or Northvolt.
Daniel Eisenberg: Kim, how can this kind of insight help other entrepreneurs in Europe, as they plot their strategy and attempt to scale their way to unicorn status?
Kim Baroudy: It was actually a bit of a surprise to us. We obviously talked to a lot of founders, CEOs, and even investors. They all said, “You can’t do this, Because the reality is that all companies are unique, and they have their own recipe for success.”
So, we started with that mindset, and said, “we probably will not find anything here. Perhaps we’ll find something on funding, or other things.” But although companies look and behave very differently, when you screen them, from an analytics point of view, they group into these four archetypes. It was a surprise, both to us, and also to the founders.
It’s difficult to have a conversation with founders who themselves feel unique, but you’ve put them into a box and said, “you are in this archetype. That means you need to do certain things to be successful as a company.” Or in another archetype, “you might expect a specific type of funding, you should probably not do M&A, or you could consider having 50 percent of your resources in sale and marketing, or commercial roles. It doesn’t mean that’s a perfect answer for you, but it justifies some of the actions that you do, and helps you in your prioritization of scarce resources.”
Daniel Eisenberg: Jaap, can you talk about whether there was a stronger push towards one or more of the paths? Which ones were more dominant among the thousand tech champions you were looking at?
Jaap Vriesendorp: When we looked at the data we found that about 11 percent of the top thousand European tech champions were network plays. About 14 percent were scale plays. Another 45 percent were product plays, and about 30 percent were deep tech plays.
What you see is that there are more product plays and deep tech plays than scale plays and network plays. This, in a way, is typical for European markets.
For the network plays and scale plays, which are more consumer-facing, it’s logical that the natural barriers of Europe prevent them from growing too fast too quickly and require a significant amount of funding.
With the product plays and deep tech plays, which are more business-focused, we see that Europe is very well-positioned and has a great number of successful companies, in that respect.
Kim Baroudy: It can appear complicated, but it’s not when you boil it down. If we have an overrepresentation on what we would call product and deep tech, that is fantastic for all kinds of things, including founders and investors, because they give premium returns. But, from a regional perspective, in areas like employment, welfare and taxes, being overrepresented on product and deep tech is actually a problem.
If you look at network and scale, those companies typically employ two to three times more people compared to product and deep tech, even at the same rate, at the same market value.
It’s similar on revenues: a scale play has five to six times more revenue than a product play. That means that even though you create great companies, fantastic returns to investors and founders, they will not have the same impact on the world, and contribution to society, from a numerical point of view. Of course, the investors pay taxes. But they won’t employ the same amount of people, they won’t pay the same amount of income taxes for those people, and that is what drives the welfare systems in Europe.
Even though we have fantastic momentum and fantastic companies in product play and deep tech plays, if over time, we don’t “crack the code” for network and scale plays, and become more ambitious as a region in those type of plays, we will not capture the same amount of employment revenues and profits that will drive the welfare system in the next 20 or 30 years.
So, there is actually an important conversation to be had from a regional point of view. I believe that we should find ways to incentivize. Whether it’s through financial incentives, education, risk-taking, or culturally, we should find ways where we promote network and scale plays to build truly global champions that create employment and profits.
Daniel Eisenberg: Does the fragmented value pool in Europe make it challenging to expand with the kind of pace that a network and a scale business really needs?
Kim Baroudy: Yes and no. We have always asked, “Why is Europe not producing?”
We are producing roughly 35 percent of all the start-ups in the world, but only 15 percent of the unicorns. So why is that? There’s market structure, talent, culture, capital, infrastructure, and finally fragmentation.
If you take market structure we represent a fairly fragmented landscape and footprint with different languages, red tape laws and regulation, even customer behavior.
But in today’s world, diversity is important. Diversity of thought, diversity of gender, diversity of culture. Our companies are better prepared to take multicultural, multilingual, multi-regulation setups, compared to North America. Of course, it’s easier to reach full scale in North America, but in Europe most of the start-ups are born international.
Similarly, I would argue that talent is more fluid and mobility is higher if you go into North America and the west coast. But in the EU, we have almost as many developers as the U.S., if not more software developers.
Of course, the U.S. has two and a half times more venture capital and growth capital than Europe. But, honestly, the growth we have seen in VC and growth capital in the last couple of years is exponential. If you are a fantastic company in Europe, you can attract funding from all over the world.
Then if we look at infrastructure, the whole notion around having hubs like Silicon Valley is also fading a bit. The super hubs drove a lot of innovation, start-up communities, and real talent pools in the U.S. But if you play the movie forward five, ten years, I think it will become less relevant. Now we are more fluid in how we work together, and we can work remotely.
There’s still a problem on culture, which centers around founders, and the ambition they have. The risk appetite in both the U.S. and in China is significantly higher than that of the average European founder, and that’s something we still need to work on.
So, if we look at 2022, I think that we have a level playing field. I realize that over the last 20 years, the data I described before does not prove this. But the situation is different today than it was five years ago.
Jaap Vriesendorp: I agree with Kim. One of the things that is highlighting this change in momentum is that investments in Europe are growing significantly for VC and growth equity. But, also, returns over the last couple of years for VC and growth equity in Europe have been better than the returns in North America and to some extent, in Asia.
Daniel Eisenberg: Let’s talk briefly about the research on the most successful companies, the unicorns in Europe. You got some insights on how long and how much funding it takes to reach unicorn status in Europe. Can you give us some sense of those findings?
Jaap Vriesendorp: When we looked at the data, we saw that most tech companies reach unicorn status within ten years of founding. That differs very much over the four archetypes. It is by far the quickest for network plays. The funding amounts that go in are relatively high, and the valuations go up quite quickly.
The companies that are slowest to reach unicorn status are the deep tech plays. These are the companies that require massive research, that require building technological solutions, filing for patents, and hiring top university talent. Here, there’s much more funding that goes in up front. The value of those companies is high in Europe but comes over a longer period. And the scale plays, the product plays, sit in between those extremes.
Daniel Eisenberg: And in terms of the success factors for each?
Jaap Vriesendorp: We found some quite distinct success factors for the different plays.
For the network plays it was focused on winning local networks one by one rather than losing in too many. As we talked about before, the market structure of Europe is pretty fragmented, and trying to win too many markets at once has proven to be a losing factor.
For the scale plays, it’s about over-indexing on commercial roles, sales and marketing full time employees (FTE), to reach success as early as possible. M&A proved to be a very distinct success factor for network and scale players.
For product plays, it’s really starting with a superior hub product, and moving into full suite later.
And for the deep tech plays we saw a very clear correlation between success and the ability to hire talent from top tier universities.
Daniel Eisenberg: Kim, I’m wondering if the issue of successful start-ups in Europe moving their businesses to the U.S is still a problem that you see out there?
Kim Baroudy: There will always be companies that look to the U.S. because it’s a big part of the economic profit in the world. It’s a very homogenous market: same language, same currency. Of course, we shouldn’t prevent European start-ups looking to the U.S. But a few years ago if you brought in American investors, they typically had a very “strong preference” for these companies to move headquarters, and also to focus on the U.S. as a core market for this company.
Five, ten years ago, eight out of ten of the companies that attracted American VC or growth capital ended up moving over there in some way, shape, or form. That is something we no longer see. So, today, if a U.S. investor comes into a fantastic company in Europe, they leave it to the founder and the management team to judge. If the opportunity’s bigger in the U.S., of course they should make the move. But if they think that there’s a better white space in Spain or Italy or Germany, then they allow the company to do exactly that.
So, at least the founders we talked to are being less pressured to go to the U.S. Also, VC and growth equity funds are trying to diversify themselves from a regional perspective. It is no longer just a U.S.-centric logic.
Daniel Eisenberg: And when you talk to startups and investors in Europe is the mood more optimistic these days?
Kim Baroudy: I would say some of them. There are two things that they are very excited about. We have seen almost 500 new unicorns in 2022, which is amazing. If you look at the last couple of years, we have produced somewhere between 100 and 200. So that, in and of itself, is a motivation for everyone. People are seeing that it is possible and doable to conquer the country, the region, the globe, whatever it is that their ambition and aspiration is.
On the other hand, the flexibility on talent and the ability to attract talent, the mobility of talent, is much more exciting for start-ups and scaleups, especially in the tech sector.
Many years ago most people wanted a real career, and a big corporate job. Now you’re seeing a more diverse picture of what people have as ambitions for their career. There’s a lot of fantastic talent that is being deployed into start-ups and scaleups.
If you combine those two—a lot of success with a lot of talent, plus the cultural dimension of an increasing acceptance of starting your own company and becoming an entrepreneur—I think that the atmosphere, the confidence, and the momentum is stronger and higher than ever.
Daniel Eisenberg: Jaap, which verticals or industries were the most prevalent among the top 1000 start-ups?
Jaap Vriesendorp: The companies that were most often part of the top thousand are those that do B2B SaaS, fintech, biotech or to some extent, hardware. It was more of the B2B-focused companies and the more research-driven companies, rather than the B2C companies that need to scale very rapidly across borders.
Kim Baroudy: Although in some regions and countries it differs a bit. More than 90 percent of what we would call “successful” tech companies are in product and deep tech. There are all kinds of reasons for that, and sometimes when you get a sufficiently small sample size, it’s influenced, of course, by a few companies.
It’s interesting that in some markets, half of the companies are in the product play, which is, de-facto B2B SaaS and fintech, and the other half is in biotech. Of course, I’m simplifying now, but it’s interesting that only in big markets like Germany and U.K. and a few others, do we have a real production of winners and tech champions within scale and network.
It speaks to the culture, the risk appetite, and the funding that we have seen in the last ten years in Europe, which didn’t allow companies to go for too long without producing profits. As a consequence you end up in the product and deep tech play because that is a “safer” pattern or path to profitability. Whereas in the network and scale play, it’s really about domination, and it can take you ten years to produce the first positive bottom line.
Daniel Eisenberg: Just one last question Kim. If you look at the horizon five, or even ten, years from now, what do you hope for the European tech and start-up landscape? What does it look like, competitively by then?
Kim Baroudy: We are producing more innovation, more creativity, fantastic solutions, a lot of talent, more so in Europe now than five, ten years ago. As a result, I’m quite optimistic.
The real hope I have, in addition to growth, GDP growth, market cap growth, is to produce welfare, healthcare, and education. That makes it a reinforcing thing.
Equally important is that when we look at some of the biggest challenges in the world today, around climate and healthcare systems, I want to make sure that these companies that have fantastic solutions also influence the way we do business on a global scale, and don’t just focus on a country, or, for that matter, a region within Europe.
They need to have global reach and make a positive difference in how we do business, but also how we produce healthcare around the world. I think some of the sustainability unicorns that are currently being built, and decacorns in Europe, can make a meaningful difference. They should do that, and we should help them if we can in any way to become successful. So that’s my hope and dream for these European start-ups.
Daniel Eisenberg: Well, I certainly share that hope. I want to thank both of you, Kim and Jaap, for taking the time to speak with us today.
Jaap Vriesendorp: Thank you.
Kim Baroudy: Thanks for having us.
Daniel Eisenberg: That’s the end of our pod for today. A big thanks, as always, to our McKinsey on Start-ups production team: Molly Karlan, Polly Noah, Sid Ramtri, Myron Shurgan, and Katie Znameroski.
And of course, thank you for listening. We hope you’ll join us again for McKinsey on Start-ups.