Why start your internet company in California? “Black swan” start-ups have cut paths beyond the hi-tech heartlands.
When Estonia regained its independence from the Soviet Union in 1991 less than half the population had a telephone line. A decade later Denmark’s Janus Friis and Sweden’s Niklas Zennstrom chose its capital, Tallinn, as the launch pad for what would become one of the world’s most valuable start-ups – Skype. Similarly, in the mid-2000s two Swedish music enthusiasts Eric Wahlforss and Alexander Ljung looking for a location to create a website that would be for sounds what Flickr was to photos, visited Silicon Valley and initially set up a small office in Stockholm before relocating to Berlin, a city then in a state of economic decline. Their business SoundCloud went on to become one of the biggest audio-sharing websites in the world attracting over 250 million listeners each month.
Given Stockholm is ranked among the leaders on most indicators relevant to start-ups while Berlin (and Tallinn) are somewhere between the middle and bottom of the lists, the entrepreneurs’ choice of location and subsequent success is somewhat of a surprise. These “black swan” startups are a wakeup call to governments who direct substantial resources towards emulating existing innovative hubs without fully understanding what really influences entrepreneurs to enter or exit a location.
There are many other cases where hi-tech startups have succeeded in places not usually associated with such endeavours, the leading Arabic portal Maktoob was launched in Amman, Jordan while the successful online ticket sales company Sofizar was born, and continues to thrive in Lahore, Pakistan despite high levels of poverty, government corruption and civil unrest. What makes Skype and SoundCloud even more interesting, however, is that their founders originated from, and conceived their business ideas, while living elsewhere and specifically chose a non-traditional location from which to launch their enterprise.
What makes a start-up hub?
Analysts and researchers have identified a long list of reasons why Silicon Valley and other U.S. regions such as Atlanta, Boston and Seattle have been able to attract new talent and develop strong technology hubs. Factors such as a strong entrepreneurial culture; availability of skilled talent; a high level of spin-off activity; the existence of research universities, institutions and anchor firms; a culture of risk-taking; collaborative social professional networks; and access to venture capital, all contribute to the allure for the entrepreneur.
Outside the U.S., economies with strong innovative tech sectors such as Bangalore, Beijing and Taiwan offer many of the same advantages. However in these regions entrepreneurs are even more interested in a city’s low business costs; infrastructure; access to global networks; levels of technological diffusion ; and governments committed to putting appropriate frameworks in place.
The advantages of all these factors (which vary according to local characteristics and culture) are obvious. So what factors influence entrepreneurs to choose to locate in regions not traditionally supportive of start-up activity?
Succeeding outside a hub
In a series of case studies on innovative tech companies, we examined the factors that contributed to the entrepreneurs’ choice of location and the companies’ subsequent success. What we discovered was that many of the so-called “key factors” to technological entrepreneurship did not adequately account for the choices made by these entrepreneurs.
Take Skype for example. When reflecting the company’s success after it’s US$8.5 billion takeover by Microsoft in 2011, Skype CEO Tony Bates noted, “Because of the harsh end of the Soviet Union you could view Estonia as a start-up country… it generates a culture where it is easy to build a start-up company.”
Skype’s founders have noted that the country’s computer developers actually helped write new technology laws for a government that actively encouraged entrepreneurship and was dedicated to the development of a digital economy. The Tallinn community included a large pool of computer scientists and engineers while the economy ensured relatively low start-up and business costs.
But Estonia was not the only former soviet-bloc country undergoing such a transition. Adjacent economies with comparable attributes were going through a similar process, some offering even lower-cost environments. A key point of difference was the founders’ previous positive experience working with Estonian programmers, their understanding of the calibre of the workforce and the local technical capabilities.
This low cost and convenience convinced Skype’s founders that additional value could be created and captured by their being based in Estonia.
Finding your own comparative advantage
Sofizar creator, Zafar Khan, a Pakistani-born U.S. resident, looked outside his new homeland when deciding on a location for his fledgling business after finding too many strings attached to the money available. In Pakistan he could afford to set up on his own without investors and employ high worth IT engineers.
Lahore, explained Khan, had talent, low costs and convenience in that he knew the neighbourhood, customs and language. Given the intangibility of the online world, government corruption and red tape, while rife, had little impact on his activities.
In explaining the decision to relocate SoundCloud to Berlin, Wahlforss noted in an interview that, “Berlin as a city, feels a bit like a start-up. It’s a melting pot of art, tech and creators.” In 2006, the city had the inter-related benefits of a low-cost environment (as governments reduced rent to regenerate areas of East Berlin left derelict after reunification), convenience of access to their core customer base and a high calibre workforce that combined the technical and creative talent required to develop their new venture.
The merging of Germany’s traditional strengths of engineering and technology with Berlin’s vibrant and creative music scene was fundamental to SoundCloud’s success while the city’s counter culture suited creative tech start-ups.
The five Cs
In each of the cases studied, as noted in the working paper What Should Determine Where Start-Ups Choose to Locate? The Five Cs of Place Surplus, the traditional variables associated with successful entrepreneurship did not seem to shape the entrepreneurs’ decisions. Instead these companies appeared to make location decisions influenced by what we refer to as the 5 Cs:
Cost - factors such as rents, living costs, wages
Convenience – including the entrepreneurs’ familiarity with a place, government policies, regulatory and legal environment, proximity to key markets and technological readiness
Community – networks and social capital
Calibre - the quality of the workforce and infrastructure, such as roads, airports and ICT
Creativity – the resourcefulness and ingenuity of the local community.
Companies are most likely to succeed where one or more of the five C’s that create or enhance their advantage are in plentiful supply. Entrepreneurs need to take the time to identify specific factors which are most important to their business. For example, a firm whose business strategy is based on cost competitiveness will derive more advantage from a place whose comparative advantage lies in lower costs.
There is no clear-cut, one-size-fits all formula to finding the perfectly location. These 5 Cs are not automatically a “surplus” or asset in themselves, and in some cases may be seen as an economic disadvantage.
Essentially, it is up to entrepreneurs to match the opportunities and challenges of a location with their products’ capabilities and needs. Entrepreneurs are more likely to succeed if they are able to develop strategies and business plans that leverage local advantages and make up for deficiencies by tapping into surpluses in other locations.
Dr. Sami Mahroum is the Founding Director of INSEAD’s Innovation & Policy Initiative.