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Europe has no shortage of tech entrepreneurs, but they rarely grow to be very big. That is changing.

We’re always hearing how the European Union has missed the tech boat, having failed to produce a world beating tech giant, supposedly because it doesn’t create the ‘right’ conditions for innovation and entrepreneurship. The evidence seems clear enough: there is no European Google, Facebook, Amazon or Apple. But look closer and the picture is more nuanced.

Innovation – where do we start?

If the internet is the terrain for the tech communications revolution, then the World-Wide-Web (WWW) is the city built on it that revolutionised global commerce. Created by Tim Berners-Lee, born in London and educated at Oxford, who worked at CERN and for the British government. WWW is a thoroughly European innovation.

If the internet and WWW are the scene, then mobile communications is the action – and it has a fine European pedigree. Most of the world’s mobile phones are powered by the Android operating system, which Google built using Linux, opensource software code developed in 1991 by Linus Torvalds, then a computer science student at the University of Helsinki. Meanwhile, nearly all modern electronic devices incorporate Bluetooth connectivity, a 1990s innovation by Jaap Haartsen while he was working at Ericsson. Does the fact that none of these innovations is a profit-generating corporation make them less important?

Linus Torvalds

Skype was one of the first profitable firms that exploited voice over internet protocol (VOIP). It was developed by Niklas Zennström and Janus Friis, Swedish and Danish entrepreneurs, and supported by Estonians Ahti Heinla, Priit Kasesalu, and Jaan Tallinn; and although it was sold to Microsoft, it still dominates in computer-to-computer telephony. Nokia and Ericsson, both European brands, broke ground for affordable mobile handsets, and between them sold more 2G phones than all other providers. At number three, Motorola of the US, lagged.

Europe’s innovation credentials extend further: take efficient car design, pioneered by European designers, such as Bertone, Pininfarina and Issigonis, Their genius gave us compact, sleek body designs, rack-and-pinion steering, fuel-efficient engines and radial tyres – later adapted by Japanese and American manufacturers. And don’t forget the revolutionary suspension pioneered at Citroën, among other breakthroughs. Similarly, France’s high-speed trains, built on the Spanish Talgo suspension system, have led the world since the mid-1970s. Britain’s jet engine technology is a world leader, while Italy’s design belt sets world standards in elegant, functional design. The list goes on.

What of entrepreneurship?

Is Germany’s Mittelstand economy not a model of an entrepreneurial hub, a cluster of independent businesses built on advanced engineering and high precision manufacturing? Europe’s tech entrepreneur tradition continues in, for example aerospace, where we see small sat technology being pioneered at the Technical University of Berlin powering constellations of low orbit communications satellites; the Finnish firm ICEYE and Clyde Space, based in Glasgow, launching and running satellites and KP Labs of Poland specialising in processing data using AI in orbit.

When you think about it, innovation and entrepreneurship go naturally together and both have long thrived in Europe. Up to a point: with few exceptions, they rarely grow to be global giants. Why hasn’t Europe produced a Google, Facebook, Amazon or Apple?

What does it take to build a tech enterprise?

A great idea and the willingness to turn it into a business. Yes, but will enough people use your innovation to make it profitable? Will it be crushed or swallowed by incumbents? Does it need to comply with technical or safety standards or other regulations?

Along with your great idea, you need a sizeable, competitive market with clear, established rules and standards. You also need, or will find very helpful: patent protection for your idea, risk finance and time.

European regulators are often fingered for stifling both innovation and budding entrepreneurs. That is not entirely fair, competition rules that limit the scope for incumbent behemoths to snuff out new entrants and their innovation, clear rules and product standards, all encourage consumers and businesses to try new and innovative products. That, in turn, encourages both innovation and new start-ups.

A good example of EU standards leading the way for others, including the US, to follow, is GSM, the technology that allows you to talk and send texts to any mobile phone in the world. The EU agreed this at an early stage, allowing firms like Nokia and Ericsson to establish their lead, and for mobile phones to become ubiquitous in Europe. America eventually fell into line, having trialled a range of competing standards that made mobile use there more cumbersome. The EU has gone further by taking the lead in holding tech giants, such as Microsoft, Google and Facebook, to account, to protect all consumers against unfair pricing and incursions into their privacy and to clear the way for new innovators to challenge the giants’ dominance. The USA is now doing something similar.

The next factor, patent protection, is where Europe’s tech entrepreneurs only recently caught up, through the new Europe wide patent system. It is now much easier and cheaper to register ownership of your ideas throughout Europe’s 510 million strong market, just as Americans have long benefitted from a single patent system.

In raising risk finance, the Americans excel.

This is not because, as they like to tell you, that Americans are ‘culturally’ much readier to take risks. That is glib. You don’t have to be American to be more likely to quit your job and start a business with the backing of personal savings, family wealth or well off friends. Without those blessings, wherever you are, you are less likely to start a business of any kind, let alone a risky, high-tech venture. But two related financial factors do make things easier for Americans than for they are for Europeans.

America has long benefited from a good supply of venture capitalists and incubator investors: a whole industry that specialises in investing in risky new firms, providing not just capital, but business advice that can make the difference between success and failure for a tech entrepreneur. Helped by favourable tax provisions, they are prepared to lose money on some, even most of their investments, in the pursuit of a blockbuster that makes up the losses. When they want to exit the investment, to crystallise profits or to cut losses, they can sell it into deep markets for corporate bonds. You will notice that bank lending barely figures, if at all, in the startup and early growth of a new American firm.

The other factor underpinning the fabled American ‘risk loving culture’ is Chapter 11 – a sort of corporate social safety-net. You are much more likely to take risks if the cost of failure is cushioned by a forgiving bankruptcy code. You are also more likely to take a punt on someone else’s bright idea if you can easily sell on the investment as a corporate bond.

By contrast, Europe has no equivalent of Chapter 11, and its corporate bond market is much less developed. Banks still dominate corporate lending, and like banks everywhere, they usually demand physical collateral to support a business loan, which is hard or impossible for many people, raises the cost of failure and can make it hard to get back on your feet again if things go wrong. With potentially high costs of failure, capital light European entrepreneurs are more likely to sell their budding enterprise than to take the risk of assuming more debt to develop it.

Deep and liquid corporate bond markets, Chapter 11 protection and the venture capital and incubator industry, mean that America is much better than Europe at raising risk finance. But that is changing as Europe actively develops its market for corporate bonds. Changes to tax codes in some jurisdictions that make it easier to offset profits against losses on investments also help. Lively tech hubs in Berlin, Paris, London and elsewhere are emerging as a result.

Defence spending is about more than defence

American entrepreneurs also benefit from, whisper it, public, especially defence, spending. Much ‘world beating’ technology was financed by US tax-payers through the Defence Advanced Research Projects Agency (DARPA), NASA, and university research programmes.

An important by-product of US defence spending is the research and development that the defence department commissions from private firms, who then retain ownership of the technology for use in commercial applications. This gave us, for example, advanced robotics developed for the war in Afghanistan and subsequently made available cheaply to firms like iRobot, explaining why its vacuum cleaners are cheaper, with better robotics, than otherwise formidable Japanese or Swedish competitors. Other DARPA gifts include GPS, voice recognition, advanced encryption, the Tor network, which facilitates anonymous web browsing, and revolutionary materials science, such as carbon fibres, that make things like aeroplanes more efficient. Besides Teflon frying pans and biros that write upside down, NASA made huge technological strides that go well beyond space travel. Lucky fledgling entrepreneurs sprout with the big advantage of fully tested technology, all paid for by someone else.

Likewise, many important European technological breakthroughs – think encryption, the world’s first programmable computer and radar – were the product of wartime necessity. As Europe increases its defence spending and its space programme, new advances in things like AI, cryptology, high-precision GPS and quantum computers will flow through to commercial applications and seed new industries.

Size begins at home

The size of your home market matters: if you are a new firm with a new product, it is much easier to build your business at home than abroad, where you will encounter unfamiliar cultural, legal and regulatory environments, consumer preferences, local competitors and of course languages. It follows that the bigger your home market, the easier it is to become big, to accumulate the resources and borrowing capacity you need to venture abroad and continue to grow. This is so for all industries, not just technology: firms such as Coca Cola and MacDonald’s were already huge by the time they ventured beyond their US comfort zone. They could by then tolerate plenty of losses and false starts until they got it right, putting them in a strong position to undercut, overwhelm, or simply buy, any likely competitors. If you fail, as many have, you can retreat to a still profitable home market.

Size effects are even more dramatic for hightech, partly because of large upfront capital costs and partly because of the extreme scale economies of software, with its near zero cost of replication and serving each additional client. Compounding this are powerful network effects, which benefit firms like Facebook and Amazon, while Google feeds its search engines with data harvested from its vast user base: more users, more data, better search results, a positive feedback loop that keeps competitors at bay. The huge, relatively uniform US home market is critical to the early building and harnessing of scale, data and networking effects.

A single European market of 510 million people has the potential to catch up fast – when it happens. But it hasn’t yet: it will become a reality only when new startups see their home market as Europe, rather than, say, Germany, Poland, Italy or Spain. But, while the unified patent initiative, forward looking regulations and technical standards are important steps; and capital, goods and information flow seamlessly within the EU, the fourth critical freedom, labour, flows much less freely than it does within America.

Despite cheap flights within Europe, the cost of moving from one part of Europe to another is still relatively high; housing markets, schooling and language are still local affairs, so Europeans tend to think of themselves as, say, German, Polish, Italian or Spanish. Yet mobility is increasing. European professionals and senior executives routinely up sticks to take up opportunities away from home and young, unskilled people readily leave home to work in bars and restaurants, for example to hone their language skills. Skilled folk too, such as plumbers and nurses, happily move to meet demand in another country, a trend that will accelerate with the expansion beyond universities of the Erasmus programme. Progress is slow, but the direction of travel is clear.

The right conditions

European policies providing certainty of standards, robust and accessible patent protection, coupled with a forward looking legal, regulatory and competitive environment that discourages domination by established firms, provide a sustainable environment to foster the innate innovative, enterprising European spirit. A long tradition of quality public education further spreads the opportunities for ordinary Europeans to have a go. When they and their prospective investors see their home market as a Europe of 510 million dynamic consumers and skilled innovators, the possibilities for Europe’s budding tech entrepreneurs will really flourish.

A Bertone design

Watch this space

And here we come to the other critical factor: time. Apple sold its first desktop computers in 1976; Amazon, Google and Facebook started in 1994, 1998 and 2004 respectively. When today’s toddlers are 15, 21, 25 and 43 years old, which flag will tech giants fly?

Notes:

To bust yet more rhetoric: While narrow European streets spawned compact and sleek body designs, it was Europe’s openness to market forces that made the biggest difference to car design. The oil shocks of the 1970s prompted contrasting responses from Europe and the US. The government of Richard Nixon sought to stabilise prices at the petrol pump with tax-payer-funded subsidies while Europe allowed the price increases to flow through to the consumer. Europeans adapted with leaps in fuel efficiency, while the USA remained stuck with its gas-guzzlers.

One example of a European tech enterprise that did become very big is SAP, a world leader in enterprise software.

Chapter 11 is a legal provision that greatly reduces the cost of failure to both entrepreneur and investor by allowing the entrepreneur to retain control while they reorganise, under the supervision of a court, the business and its debts; instead being forced into liquidation, as in most jurisdictions.

The importance of banks in financing enterprises is partly a legacy of WWII, the end of which brought the US-sponsored Marshall Plan, which dominated post-war reconstruction investment, and delivered fabulous returns to investors everywhere. This massive expansion was, for expediency, administered through Europe’s banks, as they were among the few institutions left standing after the conflagration. They’ve dominated European financial markets ever since.

A big part of the ongoing argument between Boeing and Airbus is about subsidies. Whereas the EU subsidises Airbus more or less directly, subsidies to Boeing are indirect, through commissioned defence projects.

Network effects: A telephone by itself is pretty useless, two telephones are more than twice as interesting, two hundred million telephones change everything.

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Frances Cowell
Australian-born and European by adoption, Frances Cowell writes and speaks at conferences about investment risk and governance, financial market stability and business ethics in financial markets – and the implications for the wider political economy. She believes Europe must urgently assume the lead in protecting and preserving liberal democracy, the rule of law and the multi-lateral institutions and alliances that it depends on.

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