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CHALLENGES FOR NEW ZEALAND COMPANIES IN CAPTURING VALUE FROM INNOVATION INTERNATIONALLYSimon Wakeman

Associate Professor, ESMT

Principal Advisor, NZ Productivity Commission

19 June 2014

Despite a self-belief that NZ is internationally renowned for innovation, international statistics suggest NZ is poor at innovation

NZ’S INTERNATIONAL RANKING IN INNOVATION (OECD)

Source: OECD (2012). “Comparative performance of national science and innovation systems” (40 countries, 2010 data)

6th 15th 19th 20th 31stin scientific publishing

rates

in public R&D expenditure

per GDP

in patenting rates

in scientific as % of total employment

in business expenditure on R&D/GDP

Despite a self-belief that NZ is internationally renowned for innovation, international statistics suggest NZ is poor at innovation

NZ’S INTERNATIONAL RANKING IN INNOVATION (INSEAD)

Source: Cornell/INSEAD (2013). Global Innovation Index 2013 (142 countries, 2011 data)

6th 18th 26th 59th 75th 83rdin scientific &

technical publications

in patenting rates

in research impact

in % exports high-tech

in % man’fghigh- or

medium-high-tech

in ICT exports

Based on New Zealand’s structural policies, OECD predicts our GDP per capita should be 20% above rather than 27% below OECD average

GDP/CAPITA OBSERVED VS. PREDICTED BY ECONOMIC POLICIES

Source: de Serres et al. (2014) An International Perspective on the New Zealand Productivity Paradox (Fig. 3)

OECD estimates low investment in innovation by NZ business could account for 11 points of NZ’s 27% productivity gap

RELATIVE PRODUCTIVITY FROM SOLOW MODEL WITH R&D

Source: de Serres et al. (2014). An International Perspective on the New Zealand Productivity Paradox (Fig. 9)

To understand challenges facing NZ companies commercializing innovation, I interviewed executives from 17 companies

SAMPLE OF COMPANIES

• Initial discussions with people in universities, incubators, VCs, and government interested in commercialization of innovation

• Selected sample of 17 companies for interviews- From all companies that raised seed finance in 2005-2012 (Young Company Finance) - Selected companies:

• Founded to commercialize an identifiable innovation; and• Had taken steps to commercialize the innovation internationally;

- Contacted 35 companies based in Auckland or Wellington- Ultimately interviewed people at 17 companies

• Asked about experience and challenges faced in commercializing its innovation internationally- Founder and/or current CEO (or in some cases chairman and/or member of the board)- Interview lasted 20-80 minutes- Recorded and transcribed interviews (in most cases)

Asked questions about experience and challenges in commercializing its innovation on the global market

INTERVIEW QUESTIONS

• What is the innovation?• What issues has the company had faced in raising finance and

obtaining necessary expertise?• How has the company had sought to protect its innovation

from imitation?• How do the founders/investors plan to `exit’ the company?• To what extent does the company expect to be able to keep a

New Zealand base over the longer term?• What support has the company received from the New

Zealand government?

Findings: Biggest challenges are raising capital and obtaining marketing & management expertise to establish market demand

SUMMARY OF FINDINGS

• Early-stage financing is plentiful in NZ, but has limitations• Harder to raise larger amounts without relocating overseas• Possible to obtain the requisite technical/R&D expertise in NZ,

but much harder to hire the appropriate marketing & sales personnel or recruit the right management

• Despite few having strong patent portfolios, companies find other ways to protect their IP

• Ultimately most companies expected to relocate offshore, although in many cases R&D activities could remain in NZ

• Often it depended on where the company’s finance came from and how the founders and shareholders “exited” the company

“Angel” investment is plentiful but small; larger “venture capital” investments much harder to obtain

RAISING FINANCE IN NZ

• NZ has a very active “angel” investment community but only a few NZ-based VCs- There is quite a vibrant, sort of an excessively vibrant angel investment network in

New Zealand that might provide $100,000 to $500,000 for start-up tech companies. … There is virtually no venture capital, so there is absolutely nowhere for people to turn to do anything like a meaningful round. (#3)

• The amounts are small and so raising this kind of money can take a lot of time.- I definitely underestimated how challenging it would be to raise money in New

Zealand … had I known that before I might have changed my opinion, but that's been really tough. (#1)

- I think the company’s had in total between 2004 and 2009 had about seven rounds of funding, but they were all quite small ... I think the total amount of funding that was brought in was less than two million. (#9)

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Peculiarities of NZ investors may force innovating companies to follow less desirable paths

SPECIFIC CHARACTERISTICS OF NZ INVESTORS

• Limited capital may result in pursuing trivial technology applications rather than path-breaking innovations.- What you end up with is … lots of companies that are doing quite trivial little

technology applications. … I think the lack of capital means that there just aren’t enough companies, early stage aspirational companies, that are trying to solve the real problems of the world with really deep technology. And that does take money, it takes investment. (#3)

• New Zealand investors may also be overly cautious and limiting- When we painted this big picture the first time in NZ, people said "Look, you've got

to be kidding, you're full of shit, you're smoking dope or something“, so we ended up painting a much smaller picture. … We only secured because we toned down our presentation. Now we took that toned-down presentation to the States a year later and … 15 minutes into the [the first VC meeting] he said, "You've got a billion dollar business here, you're underselling it." (#6)

It is very hard to attract foreign VC to NZ, but some able to attract foreign VC by relocating to US or UK

RAISING FINANCE FROM FOREIGN VC FIRMS

• It is very hard to attract foreign VC financing from New Zealand.- There would be maybe five or six NZ tech businesses that raised a bunch of

capital offshore … Certainly less than ten to raise money offshore now (#3)

• Usually it is necessary to relocate headquarters and/or “flip” company registration to US or UK- Despite the fact that NZ has got terrific legal systems and investor

protection rights and all the rest of that … no one is interested in doing something that’s not in their backyard. (#3)

- They don't understand the New Zealand legal framework, they don't understand what regulations may trip them up, they don't understand the framework for producing, and the cost associated with producing, legal documents for doing further capital rounds in a foreign country. (#4)

An alternative – or complementary – source of finance is a large “strategic” investment

RAISING FINANCE FROM A STRATEGIC INVESTOR

• Obtaining a “strategic” investment from actual/potential customers or partners can be cheaper than taking money from VC investors- They don't take equity, so that's the best form of funding. So it's basically non-recurring

engineering or whatever … out of their budget. For us it's basically project revenue. (#6)

• They also add credibility to the company- We're a small player in a space that's getting very hot; a space where there are some big

players in the market … so we may have made a deliberate decision as a board to see large strategic stakeholders who give us muscle and bulk. (#13)

• Generally less concerned about company remaining based in NZ- They, thankfully, over time, have got comfortable with our legal and company structure - it

took a huge amount of negotiation and education to get them to that point - and they have given us a bit of leeway. But we had interest from a bunch of other investors and the whole US domicile thing was something that … wasn’t even negotiable. (#3)

Recruiting right personnel can be as big a challenge as obtaining finance, although easier for R&D personnel

HIRING SPECIALIZED TECHNICAL PERSONNEL

• Usually the required technical skills are available in NZ and/or can be attracted to NZ- People always complain about access to talent in New Zealand and

technology talent, and I have to say we just had no problem recruiting really great engineers … I don’t know if we’ve been lucky or what, or because the culture is good, and also we made quite cool stuff. (#3)

• But may be a shortage of engineers, especially in software development, even where NZ has world-leading programs- It’s difficult to get everybody, engineers, marketing, everybody – it’s tough!

They’re hard to find. (#12)- We've doubled in size from about 16 engineers to about 32 engineers in the

last six months. I can't find enough R&D engineers in this country. (#13)

It is much tougher to hire the right marketing & sales personnel to serve target markets

HIRING MARKETING & SALES PERSONNEL

• Marketing & sales people usually must be based in the target markets- All of our sales, marketing guys are based out of the markets in which the customers exist ...

I certainly don't believe in the traditional NZ seagull approach to sales and marketing. … Fly in, make a lot of noise, shit all over everything and fly out again. (#13)

• It is difficult to hire & manage marketing & sales people, especially in US- We do marketing ourselves, and a bit of engineering, and we make a cup of tea as well.

Whereas the guys [in the US] are, 'I'm marketing,' or, 'No, no, no, I'm sales, I don't do marketing.' And we go, 'God, isn't it the same thing?' … You get a lot of good talkers but they're not very good doers. (#7)

• US marketing & sales personnel demand higher compensation than NZers- The biggest challenge most NZ companies have is that they don't accept that you have to

pay the market rate, and if you pay peanuts in America, you're going to get monkeys, and if you employ monkeys you're not going to get any results, and if you don't get any results you don't survive for very long. (#13)

It is hard to find CEOs with right balance of skills, experience, and mind-set

HIRING TOP MANAGEMENT PERSONNEL

• A CEO needs a balance of technical knowledge, international (market) experience, and management capability, and willingness to “do what it takes”- For NZers: to spend long periods overseas or even relocate at some stage- For foreign recruits: to spend enough time in NZ and fit in with the NZ base

• Despite many NZers with overseas experience, and so many ex-pat NZers in target markets, the right sort of people are hard to find- It's really hard [to find that person in NZ]. … They're typically people who are

either NZers who have worked overseas for a long time, or they're people who have lived in the UK, lived in Ireland, whatever, and they want to emigrate, and they come with a great CV. There are people around like that, but it's not common. (#1)

Risk of imitation is not a major concern, despite few companies having strong patent portfolios

IP PROTECTION FROM LEGAL MECHANISMS

• Although most have patents, few rely them as main form of IP protection- We have patents and our software is copyrighted. But to be honest, what I know, it

would take me probably two months to get around everything that we’ve got. (#5)- We obviously got IP protection, patents around the core aspects of the technology.

Does that stop anyone from actually doing what you’re doing? … No, so I think no one is doing it because it’s hard. … We think we stay ahead from a sustainable competitive advantage standpoint by building very tailored solutions to quite specific industry niche problems”. (#3)

• Often companies obtain patents just to “put a stake in the ground”- We took a bit of early advice about whether we had anything that could be patented

but the view was that would be extremely difficult. We did put one patent application in on the concept of integrative framework just, without the intention of actually issuing a patent, because we knew that would be challenging, but just to stop anybody else from trying to block us out (#9)

Instead they rely on other, non-legal mechanisms

IP PROTECTION FROM NON-LEGAL MECHANISMS

• Predominant way to avoid being copied is simply keep the innovation secret- What we've got in there, really, are trade secrets around how do we take a real-world problem,

convert it to a mathematical problem, solve it with reasonably generic solution tools and then generate it back into a solution that works in the real world, knowing real things, real people, et cetera. (#7)

- A lot of the secret sauces are around processing, how we process the material to maintain the biological composition, so that's covered by confidentiality. … The challenge there is it's really hard to enforce that stuff, so you're better to keep it in-house rather than to expose it publicly. (#1)

• Some innovations are just very difficult to copy because of technical complexity, or the company’s advantage in commercializing or marketing - The biggest protection is probably a hundred man years or more of development that is gone

into it and thinking that is gone into it. … And we continue to innovate. (#11)- Our competitive advantage just comes from … being better and faster than other people around

us in putting out the innovations to the product (#9)- Our greatest value, our greatest value in terms of IP, is now becoming soft IP; it's becoming the

customers we've won, the strategic relationships we've got. (#6)

Politicians and media often complain about NZ companies ‘selling out’ to overseas investors and/or moving overseas

There are some firms that believe they will be able to remain in NZ over the long term

ADVANTAGES OF REMAINING IN NZ

• Some want to remain in NZ over the long term for personal reasons- People think I’m an American transplant or expat and they ask me “So, why did you decide

to start this company in NZ?” Because that’s where I live, I love it here! I’ve got great talent and I’ve got resources and I’ve got a business community that’s supportive. I can list twenty reasons why. (#12)

- We couldn’t see the benefit of relocating the team, … so it comes down to do you relocate the marketing and management of the business to the US. That would mean physically for me … and a few other people, relocating to the States, and my wife wouldn't have a bar of that. (#7)

• Others think that a lot can be achieved from a NZ base- I think the thing that hurt us the most and quite recently was the whole setting up of the US

sales subsidiary because it turned out to be much more complex and much more expensive than anyone had anticipated. … I still think that this is an enormous amount that you can do out of NZ, without having to go and set up expensive sales operations in market, and a good functioning online, transactional business, supported, supplemented by experts flying into market when needed. (#9)

In most cases companies expected to keep R&D activities in NZ, unless they ran out of engineers

KEEPING R&D IN NZ

• In most cases it is better off leaving R&D activities in NZ- Manufacturing is based here and will probably always be … Development's based

here and so that's worked well. We've done some clinical work here as well. So it's been where the company has evolved from. (#1)

- US Defence requires all their R&D be done in the US, but the rest of the product development work continued primarily out of Auckland. … The US guys have got a C-level person directly responsible in Auckland for the R&D activities, and they coordinate the R&D activities between the work done in NZ and the work done in the US. (#4)

• Exception is when the company is unable to recruit R&D personnel- As much as I'd like to keep all of our R&D here in NZ, I can't. … I can't find enough

R&D engineers in this country. … We're likely to keep our core research here in NZ. Why? Because it's close to the university. … Product development we'll probably have to take offshore because we just can't recruit enough people. (#13)

However, for many companies it makes more sense for sales people and executives to be closer to customers

MOVING CLOSER TO CUSTOMERS

• It is much harder to build relationships with customers from NZ- There have been some companies that are purely web-based that are doing things

globally. … But a lot of our business is building faith, going to see the people, understanding, knowing what's going on, being involved in the conferences, being there, being seen, and you can't do that remotely. (#8)

• There are benefits from executives also closer to customers- Headquarters is likely to move offshore at some point. … At the end of the day your

executive and strategic decision-making needs to be as close to your market and its customers as you possibly can get it. It never ceases to amaze me when you look at NZ companies trying to grow in scale with board members who never set foot out of NZ. It just doesn't make any sense whatsoever. (#13)

- I think the company has reached a point where you’re having more executive presence in the US would be beneficial. That’s actually probably the reason why I started spending a lot more time over there. … There is a whole lot of conferences and trade shows … If we turn up irregularly with one or two people, we’re just no experience and faces keep changing (#9)

Other reasons for relocating overseas include a weaker sense of urgency in NZ and tax rules applying to IP

OTHER REASONS TO MOVE OFFSHORE

• Some are concerned that they could be hindered by a weaker sense of urgency in NZ- Mentality down here is just too slow, too small. The big cities worry about spending $1 million

on it, whereas in America they're worried about spending $1 billion and you can't compete if you want to be a global player. (#10)

• This might affect the innovations that are likely to succeed from a NZ base- For a NZ tech business to succeed, it’s got to be doing something really deep from a technology

perspective because … it’s hard to execute as fast down here, things don’t happen at the same pace as in lots of other markets. (#3)

• Another reason to relocate is NZ’s tax rules applying to intellectual property- More and more of our IP is, like most companies in the world, … in jurisdictions like the Dutch

Antilles, like Singapore, like UAE where there are significant tax breaks to warehouse IP. (#13)- I took the company to Singapore, and part of the reason was we got a new investor in from the

UK, and .. they didn't like NZ's tax regime. The company's got 30 patents, and in NZ if you sell your patent suite it's taxable income. (#4)

Ability to remain headquartered in NZ depends to a large extent on company’s ownership

KEEPING HEADQUARTERS IN NZ

• Companies with a few, large customers and financed by “strategic” investors more confident of remaining in NZ over the long term- This is a good example of a company that could run out of NZ, particularly on the

back of our strategic partners who effectively become the channel to market. … We've attracted good people to the company here, although it's a bit like a United Nations here, people from Israel and Denmark and Iran … the people come to New Zealand from all over the place, but there's no reason why we couldn't double that, triple it. (#6)

• Those needing financing from a foreign VC had already or expected to relocate HQ overseas.- We brought in a US VC … and, as you may be aware, just about any offshore investor

requires the company to relocate to their home market, and NZ's - to be polite - somewhat short of capital. We would never have got the funding in NZ that we needed to grow the company further. (#4)

Ultimately the founders & early stage investors will exit, although many are now focused on growing company and satisfying employees & shareholders

EXITING THE COMPANY

• Founders often said they were focused on growing the company and keeping the employers and shareholders satisfied- Ideally at some point there’ll be some sort of exit process that there always is

from a company but that’s not what I’m focused on. I’m focused on, right at the moment, building value for shareholders, building value for employees. I believe in employee ownership, so our key employees, our stakeholders in the company. I want to make that successful for them. (#12)

• But ultimately they all expected there to be an “exit” of some sort- Certainly [the desired] outcome is a liquidity event for the founder and the

shareholders of some sort, but you don't aim for that because that's an outcome. That's the result of something. … But for shareholders and for the founder, at some point in time there needs to be a liquidity event. (#6)

Some companies were considering an IPO, possibly in NZ, although the NZX has its limitations

EXITING THE COMPANY VIA AN INITIAL PUBLIC OFFERING

• The NZX has become a more attractive place to list in recent times- You wouldn’t have said that about the NZ market 6 or possibly even 3 months ago … but it’s

almost as if a switch has been flicked in the NZ capital markets and all of a sudden there is a lot of money on the sidelines and people are looking to move from very risk-averse vehicles into something more risky. And you’ve also got finally the impact of Kiwi Saver and some of those other PIE schemes. And you’ve got these people who used to be financial advisors that are now big fund managers and they’re looking to be involved in high-growth companies. (#3)

• However, the NZX still had limitations in terms of liquidity and expertise- There's a governor on the market sort of cap in NZ. You know, if Xero listed in the US they would

probably be worth twice as much, not because they're worth twice as much, it's just because ... they're more willing to put money in it, there's a different threshold of assessment. (#6)

- The reality is the understanding of tech stock in NZ is at such a fledgling early stage. It's good to see SAS companies like Diligent and Xero starting to develop some market disciplines around the space … but there is still not a single analyst that is an expert in SAS business models. Our market's too thin for that. (#13)

In most cases, a “trade sale” to an existing strategic investor or another large company is seen the best way to liquidate early investors and advance the company

EXITING THE COMPANY VIA A TRADE SALE

• It is usually more straight forward to do a trade sale than make a IPO- I think for everyone it's probably going to be simplest to have a trade-sale. We

didn't expect that we would be holding it to the stage of doing an IPO, so we were growing a company expecting at some stage that the company would be sold, and it was a matter of growing the company to a stage where it became appealing for third-party organizations to want to acquire. (#4)

• Selling to a large, international company opens up opportunities for the company and its people- From the shareholders perspective, they are looking at a trade sale. … How do we

articulate that in our operating plans, in our strategies, and in our discussions with staff? … The positive spin on that is that it enables us to grow, gives them more growth opportunities in their careers, gives them the possibility to work more internationally through a larger firm, and we can leverage off their technologies as well. (#8)

The New Zealand government has a number of programs to support start-up companies seeking to commercialize innovation in New Zealand.

TYPES OF NZ GOVERNMENT SUPPORT

• MSI/MBIE/Callaghan provides direct grants for project funding and capability development

• Venture Investment Fund (NZVIF) co-invests with angel and NZ-based VC investors

• NZTE provides financial support to exporting companies, and has representatives in many major foreign markets who assist NZ companies with connections, etc.

• Publicly funded institutions (universities, CRIs, hospitals) are potential partners, suppliers or customers

Comments about MSI/MBIE support were unanimously positive

MSI/MBIE GRANT FUNDING

• Almost without exception, the people interviewed said they had had received very valuable support through R&D grants from MSI/MBIE- We’ve had a great relationship with MSI ... They’ve been really supportive of us,

we could never say a bad word about them. … I think they are trying to do the right things, MSI are great to work with, really pragmatic. (#3)

- We've had grant funding from MSI, or now MBIE. So we've delivered IP milestones with their support, which has been fantastic. (#6)

- They’ve been very good to this company, they put a lot of cash in and as you know in this country it’s not the obvious thing. It’s no strings attached ultimately. It just goes in. (#9)

• Some would also like to be able to obtain support for marketing, attending customer conferences, etc. or repayable loans rather than matching grants.

NZTE support was also is generally highly valued, although it depended on the NZTE people involved, the country, and the industry

NZTE SUPPORT

• The quality of NZTE support depended on the people that were involved and the strength of the relationship- NZTE do lots and lots of good work offshore and provide introductions and events. And they are the

same as absolutely any organization, they’ve got great people and then they’ve got some not so great ones … NZTE are trying but they spread way too thin. (#3)

• It may be more useful in markets such as China, where they have higher respect government officials, than in others such as North America or Europe. - With NZTE, we have used them heavily into our entry into China, and that's pretty much all; why,

because the Chinese respect government officials. (#13)

• It also depends on the specific industry - NZ being so small, industries tend to cluster. So NZ got well known for the boating industry, and they

clustered, and NZTE set up the Fort Lauderdale beachhead and it made sense because there was enough businesses together … They've been trying to do the same with a Silicon beachhead, which they've been talking about, but the problem is each of the software companies are in a different market space, so it's very hard for them to be able to provide you with specialist advice or introductions … we just don't have those sorts of connections. (#7)

Productivity Hub’s research agenda seeks to understand how the challenges facing NZ innovators affect our economic productivity

PRODUCTIVITY HUB’S FORWARD-LOOKING RESEARCH AGENDA

1. Firm-level demographics

5. Natural and intangible assets

4. Skills, migration and demographic change

3. Innovation ecosystem

2. Efficiency of resource allocation

Ultimately we wish to know what – if anything – the NZ government can do to make sure NZ captures value from the innovation that it creates

ISSUES FOR ONGOING RESEARCH

• Which NZ firms are more likely to generate and/or capture value from innovation?- Small firms vs large firms? New firms vs. established firms?

• What are the barriers to NZ firms in investing in and/or capturing value from innovation?- Why is NZ’s business expenditure on R&D so low?- Are limited aspirations of NZ entrepreneurs – the “bach, beamer, boat” syndrome – a cause or a

consequence of challenges facing NZ innovators?

• How do government policies affect ability of NZ firms to generate and capture value from innovation ?- How to increase the availability of finance and appropriate personnel for NZ businesses?- How to build systems, networks, and institutions to facilitate commercialization of innovation?- How to improve quality of management expertise in NZ?

• How to ensure that the NZ economy as a whole captures value from this innovation?- What are the least-harmful policies to encourage innovative firms to remain in NZ?

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