Europe’s poor investment in digital is threatening prosperity. Here’s what its start-ups need

© European Union , 2018 / Source: EC – Audiovisual Service / Photo: Mauro Bottaro

This article is brought to you thanks to the strategic cooperation of The European Sting with the World Economic Forum. 

Authors:  Felix Staeritz, Founding Partner and CEO, Michael Stephanblome, Founding Partner and CSO and Andreas von Oettingen Founding Partner and CTO, FACTOR10

Europe is one of the biggest economic regions in the world. The European Union’s impressive $17 trillion GDP in 2017 was second only to the US’ $19 trillion, and ahead of China’s $12 trillion. Europe is well-known for its industrial assets, knowledge and infrastructure. It has leveraged these to its advantage over the past 30 years, while globalization has been the dominant driver of growth. However, its position is increasingly under threat now that digitization is the primary driver for economic prosperity and overall growth.

European companies missed the first big wave of digitization, which contributed to a major part of economic growth in China and the US. None of the top ten internet companies originated in Europe. The US alone has approximately 3.5 times the number of unicorns – private companies valued at $1 billion – compared to Europe. Shockingly, current investment numbers suggest that this problem has still not been addressed. In 2018, overall investment into digital transformation reveals a significant gap between, on the one hand, the US ($437 billion) and China, and on the other, Europe, the Middle East and Africa ($280 billion combined). This points towards a potentially major economic gap arising. Europe needs to challenge and drastically change its economic roadmap if it is not to lose significant influence or ultimately risk impoverishment of its population.

So far, a majority of the efforts to increase new digital business creation have gone into copying successful start-up methods from the US and trying to apply them in Europe, primarily by increasing available venture capital and using it to build a larger number of technology companies. While this has been a reasonably successful approach, the problem is that the majority of scale capital is mostly available to a relatively narrow range of business models (e-commerce, mobile apps, software-as-a-service etc.).

This results in some fairly significant investment gaps, especially in later VC rounds supporting growth companies in less proven categories such as medical hardware or heavy industrials. However, since Europe’s biggest strengths lie in having industrial market leaders in sectors such as energy, automotive and healthcare, it needs to start exploiting scientific breakthroughs and innovations in these areas much more aggressively, and with significantly more capital investment.

Large corporations have huge research and development resources at their disposal, but they are typically focused on optimizing and growing their existing core business. A lack of digital commercial know-how and an almost non-existing equity-driven incentive system that rewards digital entrepreneurs to start and grow successful digital businesses often leads to failures in this area. That’s why many large corporate organizations have often approached digitization as simply an effort to digitize the processes of their core business, rather than using large investments for new digital market bets. This is not least because of capital constraints due to stock market listings, and private equity ownership that mostly favours short to mid-term financial objectives.

Therefore, Europe needs to start thinking about models that can leverage the assets of its industrial market leaders better, and combine them with entrepreneurial skills and incentives to achieve quick scale-ups of innovative business models. These include new frameworks, such as ‘entrepreneurial co-creation’, between entrepreneurs and corporates. These would encourage experts from both worlds to collaborate in finding a product-market fit quickly and scaling new business together.

Specifically, this model involves large companies and external entrepreneurs creating joint businesses with shared equity that are detached from the core business of the corporate. This gives both parties the freedom to implement technological, methodological and cultural elements that would not necessarily work in an existing corporate environment. Moreover, entrepreneurs benefit from immediate access to industrial innovations, knowledge and customer networks.

Entrepreneurial models such as this are still in their initial stages. New centralized investment incentives by institutions such as the EU would motivate established companies to pursue similar models more aggressively. The launch of a digital single market would be a step in the right direction, eliminating current difficulties when offering digital services across EU borders. However, this will not be appealing enough to change the overall approach to digitization significantly. Europe needs something bolder, such as a large-scale industrial policy that actively incentivizes and supports the creation of new digital businesses that are detached from the core corporate business.

The idea is simple, yet impactful. Every single euro invested from a corporate’s balance sheet to launch a separate, digital business, with external entrepreneurs and an equity model in a EU member state, should be matched euro for euro by the proposed EU investment start-up policy. Every EU industrial start-up joint venture in need of both growth capital to expand outside Europe and a corporate follow-on round should also be matched euro for euro through an EU international investment expansion policy.

In doing so, corporates and entrepreneurs alike would have the incentive to focus their time and resources on making the most of what made Europe strong in the first place: entrepreneurial spirit and smart commercial exploitation of industrial assets in order to create completely new technology businesses.