Israeli venture capital discovers low tech

Venn neighborhood community in Bushwick / Photo: Kfir Ziv

Israeli VCs are joining a global trend towards investment in innovative operational models rather than in new technology.

More than 20 branches of Shookit, which makes fresh produce deliveries to offices and private homes, have been opened in Tel Aviv in recent months. These branches look like an odd cross between an office and a greengrocer. The windows are darkened and covered with wallpaper bearing the company logo, which is designed like a young startup's logo, and on the inside are boxes of fruits and vegetables. These are actually small local logistics centers for packing and delivery of agricultural produce. The merchandise is brought directly from the farmers, sold via a website, and delivered within a short time to the customer's home or a business.

Shookit works in a conventional business, based on an operational model and with content similar to that of companies like Bikurey Hasade and Bikurei Bitan, wholesale marketers of fruits and vegetables. Does the company offer anything that a local greengrocer cannot supply besides the trappings of a startup? The company says that it is developing technology that enables it to streamline the inventory management and delivery process, but the service is the same.

Shookit has joined many companies that are disrupting conventional sectors: Uber in the taxi sector, Airbnb in the hotel sector, WeWork in the offices sector, and a great many other small and large companies that have brought innovation to conservative spheres. In many cases, the innovation is in the business model, not technology. What all of these companies have in common is that they have raised money from venture capital funds, and to a great extent have challenged the use of the term "startup," because they are not technology companies. In most of these companies, the role of technology is to support conventional operations, such as deliveries, logistics systems, hiring and managing employees, etc.

While the trend towards venture capital investments in companies operating in conventional markets has existed for several years in the US, it is still limited in Israel, but it is growing. For example, Shahar Tzafrir from the TLV Partners venture capital firm and Tal Morgenstern from Lightspeed Venture Partners have invested in Shookit, together with other investors. In order to realize how unusual this investment is, it is enough to look at Tzafrir's previous investments: a cybersecurity company, a company that developed image processing and artificial intelligence technology for the construction industry, and a company that is making cloud computing more effective. TLV usually invests in companies with deep technology, but TLV founding partner Rona Segev Gal recently abandoned her usual practice of investing in companies dealing with containers, cybersecurity, and deep learning in favor of an investment in Flipfit, a company that delivers clothing using an innovative business model. Another investor in Flipfit is lool Ventures general partner Yaniv Golan.

They are not alone. Daniel Cohen, general partner in Viola Ventures, which specializes in B2C investments, recently invested in a California fashion company named Ruti, and before that in Maapilim, a men's grooming brand. 83North Venture Capital invested in food delivery company Wolt and in Mixtiles, which enables people to turn photographs on their phones into framed pictures that can be put on the wall. Pitango Venture Capital invested in real estate company Venn, which operates neighborhood communities. Viola also invested in GlassesUSA, which makes eyeglasses and sells them online, and the list is still longer. The transition is not only to startups whose core activity is not technological but also to some startups aiming at consumers (B2C), rather than at  businesses (B2B). Historically, the Israeli industry has specialized in B2B companies developing technologies used by other enterprises, which is therefore the specialty of most Israeli investors.

Looking for the wow effect

Behind the change in venture capital investment is a process that began in recent years, in which mobile communications and ecommerce have invaded conventional industries and are making it possible to buy a mattress online, order a taxicab by pushing a button, and contact a freelancer to design an ad. In a large proportion of these startups, the technological element is negligible, but many of the entrepreneurs come from the technology industry, and replicate the same working and thinking processes in these companies. The fact that they came from the technology industry and raise money from venture capital funds enables them to create an image of innovation and recruit employees from leading technology companies. If they market their narrative well, they can also raise capital at high company valuations.

The most prominent example is shared workspace company WeWork, which tried to maintain the image of a technology company for several years until its unsuccessful IPO deflated its bubble. Within a short time, the company's valuation tumbled from $47 billion to $8 billion. WeWork is a real estate company, and many people in the industry belittle its inclusion in the technology industry, but to a large extent, it does not differ from some of the companies in which Israeli investors are invested. WeWork has a development center whose purpose is to enable the company to grow faster, for example by developing fintech solutions. In the coming years, as conventional companies such as Walmart, McDonald's and auto manufacturers assimilate technologies, there is a chance that they will set up significant development centers, and the boundary between technology and conventional companies will become increasingly blurred.

Does this make any difference? Here the question arises of how to define a startup. Bessemer Venture Partners partner Amit Karp wrote a column in "Globes" last year, in which he explained that a startup is a business with the ability to grow fast for a long time, and that serves a very large market, such as the US market, for example, so that it will be able to generate high revenue in the future. Karp added that a startup's innovation did not have to be based on technology; it could be in the form of an original way of serving an existing need of customers, or a new business model.

"We see that software is slowly leaving its accustomed sphere from 30 years ago and penetrating into every area of life. It is disrupting taxis, commerce, and finance, and the boundaries between what is and is not software are becoming very blurred," says 83North Venture partner Arnon Dinur. "You have to understand whether the experience has changed, and whether this is a business model that works. An airline selling tickets online now is not a technology company. If I take the software out, how different is the experience? On the other hand, when I look at Uber and take the software out, the experience is completely different, and the same is true of food delivery services such as Wolt. I don't believe that one day we'll go back to ordering food from the restaurant's website or flagging a taxi in the street.

"Usually with these ideas, which are not completely technological, we like to see it in practice first and see how its works. That's how we invested in Wolt. We saw an average person order different food delivery services once a month, and he ordered more on Wolt. So you see that there's something else here. We saw Via when they had a few cars in north Manhattan. You look for signs of a 'wow effect.' People's motivations come from completely crazy places, and the ability to predict in all this craziness which product will succeed is almost non-existent. One of the things we look for is therefore data showing it starting to happen on the ground. In areas that we understand well, or if we know the team ahead of time (or usually from a recommendation by someone we know), we will also invest at the seed stage - almost 30% of our investments are at these stages."

Turning data into money

In the past year or two, there has been growing awareness that an innovative business model is not enough. Many of these companies are facing difficulties. For example, in the shared trips market, Uber, Lyft, and Israeli company Gett are facing intense competition between them, which is making them spend huge amounts on marketing. Instead of investing in market disruption, they invest in competing with each other. On top of this are operating expenses for drivers' salaries; legislation has mandated paying them minimum wage.

"Stereotype venture capital investments are usually in new technology that improves existing technology. In recent years, many companies have arisen that provide technology for disrupting a conventional industry by making operations cheaper, which should lower the price of the product or increase its availability. Beyond that, one of the challenges and opportunities in all of the companies that emphasize the operation is the inherent value of the vast amount of information gathered by converting a certain sphere from analog to digital. It is believed that in the coming years, more and more companies will be able to monetize this information," says Dell Technologies Capital managing director, VP, and venture investment leader for Israel and Europe Yair Snir. "For investors like us, who focus on deep technologies, these companies become interesting when they are already big enough - when they have a substantial database supported by unique technology. Facebook, too, when it started was not especially technological, but today, it's one of the Internet players with the largest technological infrastructure in the world.

"The challenge in the relatively new wave of all the Ubers, Airbnbs, and Shookits is that the cost of operation is very significant. There has to be a formative moment that makes it worthwhile. In the case of shared trip services, it should become profitable and worthwhile as soon as there are autonomous cars. Each of them needs this formative moment, and it is necessary to understand where it is and how far off it is. Meanwhile, these companies are managing to raise billions, and it's unclear how and when they will make back the investment. In my opinion, this is like the difference between an investment in software and an investment in silicon. Someone who invests in silicon understands that it will take a lot of time before he starts seeing a return. Here, too, the realization is developing that the investments are very demanding before they start to bear fruit."

In the case of Uber and Lyft, there is a visible horizon in the form of autonomous cars, although it is not at all certain that this will arrive soon, and the risk is meanwhile being diverted to investors in the public market. In any case, other companies do not necessarily have such a worthwhile horizon. US company Blue Apron, which provides deliveries of goods for meals according to recipes that it offers, and in precise quantities, raised money on the private market in 2015 at a valuation of $2.1 billion. The company held its IPO in 2017 at a valuation of $200 million less, but its share price quickly nosedived. Blue Apron's current market cap is less than $90 million. The steep fall in the share price is caused by intense competition in the sector; the lack of entry barriers enabled many companies to compete for the customers' stomachs, leading to high marketing costs that hurt the company's profits.

Barriers to entry

Could the same thing happen to Shookit? Tzafrir says that Shookit has a model that prevents excessive marketing expenses. "What happens in cases of B2C is that if I get a $1 order and spend $0.98 on advertising, somebody else spends $0.99 on advertising. There's a race to the bottom in profit margins. I don't believe in this; it doesn't facilitate a sustainable model, and I wouldn't make an investment like this. Shookit advertises to consumers, but most of its activity is with businesses. It's more worthwhile where marketing expenses are concerned, and businesses also take out subscriptions for two days or two weeks. In addition to the profit margin on this business, it also makes it possible to reach private customers - the employees - at zero cost. Some of them even get deliveries to their workplaces, and that saves money on another delivery," he says. Tzafrir also notes that the technology can help the company, for example in managing and operating supply centers, forecasting demand, and so forth.

Barriers do not have to be technological. The most prominent example is the network effect. Messenger app WhatsApp, for example, benefits from the trouble users will have in copying all of their groups to a different platform, and navigation app Waze relies on many drivers using it, enabling it to spot traffic delays and calculate the time that a trip will take. Another example is marketplaces, in which the barrier is created by the presence of buyers on the same platform. "The network effect is the best barrier," Cohen says. "As for technology, is the winner in cybersecurity, for example, necessarily the one with the best technology? I'm not at all sure of that. Another barrier is the brand. What's the barrier to competition with Coca Cola? It's not certain that it tastes the best, and people don't necessarily distinguish between tastes."

Yaniv Golan agrees that a brand is a significant barrier. "Take Uber, for example. When you travel in a foreign country and aren't sure what will happen, you look for anchors, and Uber has become an anchor like MacDonald's - with both of them, I know what I'm going to get. It's worth a lot when people feel that they know what to expect. Lyft doesn't have a strong brand on this level; they don't have the global presence. The same is true of Airbnb. This is the first place people look at, and the platform is regarded as reliable. Even if a competitor offers the same properties as Airbnb, it will have trouble overcoming the strength of the brand. The barriers sometimes come later, if the entrepreneurs manage to integrate them. This is the hope of Flipfit, the company in which TLV Partners and lool Ventures invested. Flipfit is developing an online fashion store, but its innovation lies in its delivery model. They realized that returns damage online stores, because they make things hard for their logistics set-up, but it may be possible to turn this to advantage. In every delivery from the site, a return delivery is also scheduled. This enables them to manage their system of returns better, but the objective is different - to simulate the cubicle for trying on clothes in the store as closely as possible in the home. Instead of sending only the two shirts purchased by the customer, they send the same shirts in more sizes, plus other clothes that the customer will probably like, based on the current purchase and the customer's purchasing record. In this way, they hope to increase the sales from each transaction. Furthermore, they are developing an app that will enable people to photograph themselves and consult their friends, or even strangers, about the purchases that they have made.

Two entrepreneurs are behind the company: a former Israeli and an Iraqi living in the US with experience in logistics and ecommerce in fashion. "The company has a fair amount of technology, but the innovation here is the understanding of human motives and identifying the differences between those needs and motives and the current ecommerce shopping experience," Golan explains.

"The world is changing fast; we have to trust the entrepreneurs"

Venture capital funds set their investment policy when the fund is raised, and it is agreed by the limited partners from whom the money is raised. The policy can include investment in a specific sector, such as cybersecurity, for example, or can give the investors freed of action. Any deviation from the policy requires approval from the limited partners. "We decided to remain open to a wide range of sectors," Golan says. "The world is changing at an ever-faster pace, and we think that the entrepreneurial instinct finds the problems that require solutions more effectively than a decision to focus on a specific sector, which may very well become irrelevant during the fund's lifespan."

As technology expands into conventional spheres, however, the question arises whether venture capital funds will emerge that specialize in these areas, or whether certain investors will develop expertise in them. "The expertise of a venture capital investor is to invest in technology and in tools that will help it achieve business results. The required skills here differ from the usual expertise of people in venture capital. They are rarely people who have dealt with the operational aspects, and you almost never see operations people gong into venture capital at present," Snir says. "With time, we'll have investors who are more experienced in these things and more diverse people, not just regular venture capital people. Up until now, we've seen people from a technological or financial background in venture capital; now we'll probably see more and more people with an operative background."

Published by Globes, Israel business news - - on December 9, 2019

© Copyright of Globes Publisher Itonut (1983) Ltd. 2019

Venn neighborhood community in Bushwick / Photo: Kfir Ziv
Venn neighborhood community in Bushwick / Photo: Kfir Ziv
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