Creative destruction: The benefit of failed start-ups

Recently there have been some very interesting success stories on the Israeli technology front, including one significant story with a Pittsburgh connection. As you may have heard, the Israeli crowd sourcing navigation app company, Waze, was recently bought by Google for between $1.1 and $1.3 billion. Although the transaction is being reviewed by the FTC, it has created a strong ripple effect throughout the Israeli technology sector, with the demand for mobile and internet app developers up by 40 percent, according to Globes.

A few months ago, another Israeli technology company, this time in the field of healthcare IT, also had a successful exit. dbMotion, an Israeli company with its U.S. operations in Pittsburgh, was sold to Allscripts for more than$230 million. According to published reports, Pittsburgh-based healthcare system UPMC was a significant investor in dbMotion. This was a very successful exit and has whetted the appetite for investment in medical device and healthcare IT coming out of Israel.

Not all of the news out of the Israeli tech sector is good, however. For example, Better Place, the electric car battery changing system company, recently went into liquidation in Israel. Although Better Place created an alternative to slow charging electric cars by creating battery-changing stations where the depleted battery would be replaced with a new, fully charged battery, the economics of the new system just did not add up; at least not in the near term. According to published reports, Israel Corp invested over $230 million in Better Place and will most likely never see that money again.

Success stories and nightmares, which provide the true picture of Israeli hi-tech? The answer is that they both do. The fact of the matter is, most start-ups fail, whether in Israel, Pittsburgh or the Silicon Valley. Some say that only one-in-ten succeed. Some say that out of ten start-ups, three or four will fail, three or four will be minor successes or return investors’ capital, and only one will be a home run. This sounds like a recipe for disaster; why would anyone ever found a start-up company with those odds, and even more importantly, why would anyone invest in an early stage technology company?

The answer is that failure is a necessary part of the growth of a technology industry and the creation of a serial entrepreneurial class. In essence, start-up failures are creative destruction. Without the experience of failure, successful entrepreneurs would not have learned how to be successful in their next company. On the other hand, if their previous, unsuccessful companies were not shut down, those entrepreneurs might have spent years and tremendous sums of capital beating a dead horse rather than investing their time and energy into a new venture. This is the technology version of creative destruction. Without something unproductive, like an unsuccessful company, being destroyed, there is no room for the creation of a new, potentially more successful company, from the aspect of both available capital and entrepreneurial talent.

Back to Waze, that $1.1-$1.3 billion company. According to Globes, Waze was founded in 2008. Of course, Waze was not the first company that its founders were involved in. I wonder what would have happened if after their initial start-up failure, they had given up and joined a large corporation, rather than created a new crowd sourcing navigation app? I am glad they did not, and I bet that their investors are even happier still.