[This post paraphrases an interview I gave last week to Japan’s ITmedia group. The original interview is here.]
Over the past decade Europe has witnessed such a dramatic transformation in innovation and entrepreneurship that I submit that the region now represents one of the most compelling areas of the world for investment from Japan.
This was not always the case. European countries faced many of the same hurdles and cultural inertia which are familiar in Japan. It was only following a convergence of efforts from multiple stakeholders that things begin to evolve, including European government policies, the evolving cultural mindset of the European populace, the European educational systems, and the incentive structures in the private sector.
At the macro level Europe, represents a large market with a collective population of over 500 million. Disposable income per capita of Western European countries is comparable or even higher than that in Japan ranging from $24k in Spain to $36k in Germany.
Similar to Japan, and thanks to concerted government initiatives and fiscal stimulus, many European countries have built up extensive infrastructure to foster innovation. This includes of course physical infrastructure, such as high-speed train systems linking almost every European capital’s city center, expensive yet extremely transformative projects like the Channel Tunnel and Eurostar train system, and elaborate public transportation networks in most cities. Yet it also includes communications infrastructure. Nearly every European urban area offers high-speed fiber-optic internet access to the home. Mobile 4G networks are ubiquitous and priced competitively. Europe leads the world in information privacy and data protection regulation.
Also similar to Japan, many European countries possess elite educational institutions with a strong emphasis on science and technology. I can think of over 60 advanced universities specializing in deep technology curricula in Western Europe (see infographic). Traditionally, graduates of these elite institutions would either apply for cushy government posts or pursue private sector careers practically mapped out in advance for them, often with promises of lifetime employment. I understand this phenomenon may also be similar in Japan historically. However a sea change in Europe over the past 15 years or so has ushered in a new mindset where even the smartest new graduates consider joining risky tech startups or even starting their own companies upon graduation.
The advanced educational institutions have seeded the market with a proliferation of talented individuals in deep technology areas of innovation, such as blockchain and artificial intelligence. Some of these talented individuals join multinational corporations — for example, the AI heads of 10 of Silicon Valley’s most reputable technology firms come from France. Many others launch startups. Almost 300 startup companies focused on AI exist in France alone by last count.
Perhaps in stark contrast with Japan, unemployment levels of educated workers are stratospheric. Specifically, unemployment rates of college-educated youth exceeded 20% in many European countries a few years ago. These rates are starting to come down in light of the increased attention and investment in Europe; however they still remain in the teens in most countries.
The result of these two drivers i) high unemployment rates among workers with advanced degrees, and ii) the depth of advanced educational institutions, have created conditions where talented human capital is both abundant and available.
Furthermore, perhaps for historical and cultural reasons, European workers tend to hold much greater loyalty to their employers (in contrast for example with their American counterparts). Professional loyalty and labor regulations in Europe make the labor market slightly less fluid then say in the United States. However, I would suggest that startups feel freer to innovate within a longer time horizon if they can count on continuity among their talent base. For instance, the risk of having one’s top developers solicited every month by a another local technology company offering higher compensation is relatively non-existent in Europe, compared to Silicon Valley.
As a matter of fact, one of the growing practices increasingly adopted by European entrepreneurs is a structure which maintains their engineering and development resources in their local European country while shifting their sales and marketing activities to a larger single market, such as the U.S., or branching out in a distributed fashion in a pan-European conquest.
For although Europe represents one of the largest developed markets in the world, it is not homogeneous. Rather it is a diverse collection of small, distinct countries, markets, and cultures. In order to grow to a significant scale, European startups have finally figured out the importance of expanding beyond their home countries’ borders. This represented an evolution in the mindset of innovators that took place only over the past 10 to 15 years. Some figured it out quite early — such as the Dutch, the Belgians, the Scandinavians — whereas others took longer to acknowledge it but finally came around, such as France and Germany.
On the funding side, governments historically filled the void left by the absence of university endowments and pension funds (which are more prevalent in the U.S.) to support innovation financially. Many European countries offer some form of startup financing and subsidies for innovation. Governments offer tax incentives to companies who invest abundantly in R&D. This system undoubtedly produced a bit of waste and abuse to some extent, but it also helped encourage risk-taking and innovation, particularly the kind of disruptive innovation that can only come from outside incumbent corporations.
Historically, large corporations in Europe excelled at incremental innovation, conceived and performed internally, yet corporate inertia and the dilemma of cannibalizing existing revenue lines prevented them from embracing the radical innovations which threatened to disrupt the very foundations of their businesses.
Europe’s relatively small venture capital industry has flourished and matured over the past 10 years. Government-backed funds and captive investment subsidiaries of banks and corporations gave way to a vibrant collection of independent VC funds laser-focused on generating outsized financial returns, typically by scaling innovative startups globally. Total VC funding in Europe in 2017 reached a new record of $6.5 billion, which represents a 50% increase in just two years (total was $4.3 billion in 2015). Maturing fintech startups accounted for $1.8 billion of this total. Some of this was contributed by foreign investors, especially many noteworthy American VC funds, who have recognized the appeal of Europe and the relative attractiveness of valuations and deal parameters compared to the U.S.
Startup valuations in Europe are lower than in the U.S.: 60% lower at Seed stage and 40% lower at the Series A stage. I expect that this pricing gap will continue to narrow over time as more investors wake up to the value Europe holds in innovative sectors like fintech, AI, blockchain, and IoT. America’’s tier-1 VC firms such as Union Square Ventures, Andreessen Horowitz, Insight Venture Partners, and Sequoia Capital are increasingly investing in European tech companies, as are a few Chinese investors. VC funding from foreign investors (mostly U.S. but some Chinese) into European companies has more than doubled over the past 5 years, from $210M to $425M.
All of these above factors combined over the past decade have produced fertile grounds for widespread innovation across Europe. Europe now counts approximately 30 technology unicorns, as well as hundreds of “centaurs” (startups that have surpassed the $100 million valuation threshold). The percentage of fintech unicorns in Europe is more than double that in the U.S.
We are only now just beginning to witness the fruits of a two decade-long effort. I submit that Europe should be on the agenda of every global corporation’s innovation strategy.
