Building An Ecosystem

Sir Paul Callaghan’s suggestion that more successful startup businesses are the key to lifting our prosperity moved the goalposts. Creating great companies one at a time was no longer good enough. The narrative shifted. There was a new objective: build an ecosystem of innovative technology startups in New Zealand.

The underlying aspiration is not unique. People thinking about economic development in every country or region all imagine they could be the next Silicon Valley (if you’re reading this in Sydney or Oslo, or wherever, substitute in your own country’s name as necessary). But what exactly do we mean by that? Unfortunately, as we’ll see, most of those words that get repeated over and over are like a dust cloud: our hands go right through when we try to grab them. What’s more, in the rush to build this ecosystem faster we overlook the more fundamental and interesting question: why do we want an ecosystem in the first place?

Let’s start at the very beginning (a very good place to start).

What is a startup?

Most startups exist only because the founders turn up every day, lean in and prop them up. If and when they stop doing that, often the whole thing flops over like a deflated bouncy castle. While that’s flippant, attempting a more accurate definition is harder than it seems on the surface.

The obvious answer is that a startup is any newly established venture. But there are many (most?) small businesses that immediately take on their final form – think a plumber or a dry cleaner, for example. When do they stop being a startup? The word suggests there is an element of ambition involved – a startup is a new thing that is small now but aspires to be bigger. Or a transition – a startup is a temporary state between nothingness and an eventual end point. Or uncertainty – a startup is something that might not work, and as a result we’re perhaps less surprised when they don’t.

The startup phase is sometimes described as the search for, development and validation of a “scalable economic model”.¹ We can break this down into two stages:

The early stage is the genuine start, when founders have a lot to prove and only a limited time to prove it, typically constrained by how much funding is available. Founders face existential questions:

• Can we build the product or service we have in mind?
• Does anybody want it?
• Will enough people pay directly for it (or is there some other indirect way to sustainably finance it)?
• When we add up all the costs of development, marketing, sales and support is there anything left over?

There are now many different philosophies for how to navigate this stage of a venture, but the thing they all have in common is what we might call “the search for product-market fit”. If it’s not clear whether a specific startup has achieved product-market fit yet, the answer is “no”!

Assuming the answer to all of those questions above is emphatically yes, the problem quickly shifts to how the venture copes with a rapid increase in multiple dimensions at once. In the high-growth stage a team faces a new set of challenges:

• More customers – including many who are not a great fit for the product or service as it is, and others who require more hand holding and convincing as we push beyond early adopters.
• More team members (aka more payroll!) – as we need to hire people to manage the people and more people to hire and administer the people who manage the people, etc, soon we won’t know everybody’s name.
• More locations – it’s unlikely these will all be in the same time zone so the team will spend a growing portion of their time travelling.
• More product complexity – often a consequence of having more customers, each of whom will likely have a small tweak they’d like us to make that needs to be prioritised.
• More legacy – as every single shortcut we took in the early stages is a debt that comes due in this stage.
• More competitors – it’s common to feel we’re sandwiched between larger, more established competitors and the smaller, nimbler early-stage companies that pop up in our wake as we grow.
• More visibility – both a blessing and a curse.
• More investors – deciding how to finance all these things is often the most important question at this stage, and we also have to think about the smaller investors who helped us get going in the beginning as they turn their attention to getting a return on their investment, which while understandable can be a big distraction.

Startups are not all created equal. Many early-stage startups never create escape velocity. Only a small percentage survive to become high-growth companies. Throughout this book I’ve used the umbrella term “startup” to describe both stages, but when we talk about an ecosystem of startups we should be more specific. Just creating as many early-stage startups as possible isn’t the goal. We have to understand the differences between them and treat them accordingly. We should be able to explain how having more startups of both kinds helps us.

Made in New Zealand

What is a New Zealand company? Again, the seemingly obvious answer is: a company based in New Zealand. Duh! But what does it mean to be based in New Zealand? It’s surprisingly difficult, when we think about it, to nail down the aspects of a business that might make it distinctly “New Zealand”. We could ask:

• Where is the company registered?
• Where do the shareholders live?
• Where is the team located?
• Where does the company pay tax? (It’s tempting, but simplistic, to assume this is just the same as where the customers are.)

If the answer to all of those questions is “New Zealand” we can say clearly it is a New Zealand company. But as soon as one or more of the answers is something other than “New Zealand” it gets complicated.

Maybe once upon a time there was a cleaner distinction between businesses that were local (those that were entirely based in one country – owners, staff, customers, etc) and those that were called “multinational”. But now it’s not at all unusual for a very small company to be spread far and wide from the beginning. This is especially true of any successful high-growth startup. As the business expands it will likely hire people based offshore, to better serve an international customer base, at which point it will be paying tax in multiple places. When a startup raises capital from investors all around the world who are interested in becoming part owners, is it still a New Zealand company then? What about if a startup does all of those things: re-incorporates overseas, has most of the team and a majority of the shareholders elsewhere (because of how much capital they have raised to fuel their growth)? It gets even weirder when we consider provenance. Was the company started here? Or was one of the founders born or raised here? It’s always a stretch, but New Zealanders do love to collectively claim ownership of any big success.

Who cares? Why does this even matter? It comes back to why we want to build this ecosystem in the first place. We believe there will be significant collective benefits for all of us in New Zealand, if we’re successful in creating more of these companies. Because of that, there are also some costs we choose to share (for example, through public funding). And that leads to the question of who gets this support, how much they get and when they get it. Consider the debate that gets crystallised whenever a company that we consider to be a New Zealand company is sold outright to a buyer overseas. Is it a good thing? Or a bad thing? How do we compare the current value of the company to all of us versus the long-term value of the capital the sellers receive, reinvested in unimagined things in the future? What are we optimising for? In my view – and I’ll return to this shortly – retaining 100% ownership by New Zealanders isn’t optimal at all. Unless we understand what the shared benefits are and how we realise them, how do we share the costs appropriately?

The tech sector

When we talk about technology companies in New Zealand, one of the things we like to say is: the technology sector contributes a large and growing portion of our export earnings, competing with dairy and tourism. We say that over and over and over. It’s diligently reported each year in the media, is amplified by politicians and becomes an accepted part of our narrative, mostly without reference to any source.²

I believe the original source is the TIN Report. This is published by a private business, funded by a range of public sector sponsors. Companies featured are asked to contribute their own data for free, so it can be compiled into a report that is sold back to them (at $450 a copy, more if you prefer a printed version). Ironically TIN does not disclose their own revenue, but given that business model it’s presumably pretty lucrative.³ Because data is supplied on trust it’s impossible to verify. I know of multiple examples where very round numbers have been supplied and printed, and other examples where no numbers have been provided at all, so TIN have just guessed. Greg Shanahan, the founder and managing director of TIN, admits that the report describes exports only in the “colloquial sense” because they include revenue that is earned and spent offshore and never touches New Zealand.⁴ While the intention is to count New Zealand companies, as we’ve seen that is difficult to define, and as a result the report includes some companies with significant international ownership and excludes others that have a large New Zealand presence.

And then there is their definition of the “technology sector”. When we look for it using official Stats NZ data we discover that “technology” is not actually an industry sector at all. To get to their “third largest” headline numbers TIN combines companies from across a range of industry groups, including IT services and support, software development, biotechnology and high-tech manufacturing. We can argue about what should and shouldn’t be included, and different organisations producing reports will choose different combinations.⁵ Either way, it’s all arbitrary. Saying the technology sector is the third largest is just like describing New Zealand as “100% Pure”.

It gets even more complicated. The sector celebrates together each year at the Hi-Tech Awards. How “high” does technology need to be in order to be high? That’s an uncomfortable question for anybody who understands the actual technology involved. Xero, Vend and Timely are SaaS products, so not really very high tech at all, but are all past winners.

While it’s tempting to push for a narrow and pure definition of a technology company (for example, only those companies that develop software and/or hardware and sell it themselves), that’s not at all useful. I prefer a much broader definition: every company is a technology company.

Every business in every sector, including dairy and tourism, can and should be taking advantage of technology wherever possible. Those that aren’t are leaving themselves exposed to competitors who are. Having engineers and designers on a payroll is nothing to celebrate, in and of itself. At the same time, a business that has none should raise an eyebrow.

Describing most startups as “technology companies” makes about as much sense as saying that our local café is in the electricity sector, because that’s how they power their coffee machines. The use of technology isn’t a defining characteristic. That logic leads to the exact same list of real sectors we already use in official statistics.

Once we can accept that it’s mostly nonsense to define what is and isn’t a technology company, we can stop putting our energy into drawing a line around “the sector” and reaching for participation trophies and instead focus on how technology can be applied to make every organisation better.

Innovation vs execution

One of the things that nearly everybody thinking about building an ecosystem seems to agree on is the need to be innovative. But innovation means different things to different people.

A definition of innovation I like is: “fresh thinking, applied to create value”. But, again, when we reach for anything more specific than that it is elusive. The OECD uses the Oslo Manual, which has a particular definition of innovation used to ensure consistency of government data collection. One of their criteria for being an innovative company is having more than five FTEs. The reasons why are not explained, but perhaps it’s a reflection of a steady-state mindset (that is, small companies are likely to stay small). Either way, that’s bad news for nearly every early-stage company who likes to consider themselves “innovative”. You’re not counted.

Often we get stuck on the “fresh thinking” part of the definition and never get to the “creating value” part. That is to say we conflate innovation and invention. Remember, often the person who invents something and the person who works out what that thing is for are different people. An inventor has an idea. A company executes an idea.

An innovative idea is like an algorithm that has been written on a whiteboard but never run on an actual computer. What matters is how well it executes.⁶ The likelihood that any non-trivial software works first time as intended is infinitesimally small. That is the art of software development. And, if we extend the metaphor, the challenge of creating a successful business. We need to get beyond ideas.

Ideas require getting one new thing right. Execution requires getting thousands of little things right, and repeating them over and over. Ideas appear in the “a-ha!” moment of inspiration, when the lightbulb goes on. Execution is perspiration – putting our head down and doing the mahi.⁷ Ideas are new and shiny and exciting and recognised with awards. Execution is exhausting and mostly far away from the spotlight (until a company that has executed consistently is sold and then everybody scratches their head and wonders how a business that didn’t seem very innovative managed to become so valuable). Ideas are the denominator. Execution is the numerator. Ideas are R&D (usually more R than D) and so are often eligible for generous government support. Execution is operating expenses, and so needs to be funded entirely by investors or customers. Ideas are smiling people in stock photos wearing white lab coats. Execution is rent and payroll, distribution, logistics and sales. Ideas require us to dream big. Execution insists that we find the right size – meaning, the scale of the business that can be maintained. Ideas ask “can we make it?” Execution asks “should we?” Ideas are about being the first. Execution is about being the best.

What is more important: being innovative or executing well? The noise about innovation is mostly focused on “new and different”, but what about those companies that do “familiar but better” – take an existing idea and deliver it in a way that means many more people will be enticed to buy it? Look at the most successful companies. We see that pattern repeated again and again:

• Apple was not the first to produce any of the products they are most famous for (they didn’t invent desktop or laptop computers, they didn’t invent portable music players, they didn’t invent smartphones, and so on).
• Google was not the first search engine.
• Facebook was not the first social network.
• Amazon was not the first online store.
• Netflix was not the first streaming video service (in fact, in the beginning Netflix wasn’t even itself a streaming video service, but that’s another story).
• Zoom was not the first video conferencing tool, by a long way.

The list is long. The thing all those companies have in common is that they were each massively successful in convincing people to use and buy the products and services they make and sell. They were often the first to work out what these things were really for, and as a result how a wider audience could be made to desire those things. And that underpins their financial success. Now they all spend millions of dollars each year on R&D, but that’s not necessarily what got them there.

Sometimes the innovative thing isn’t the product at all, but the distribution channel or revenue model. For example, Xero took the existing and familiar (and, let’s be honest, pretty low-tech) category of accounting software and built a massive company by providing free tools (and a lot of love) to accountants; using them to reach a large potential market of small business customers; and charging a small monthly subscription rather than an up-front fee, in the process proving there was still a lot of value to be captured in that existing accounting software category.

So, is product innovation just a distraction? No, not at all. There are startups that have invented something and executed well, and in the process created a big success. In other words, occasionally the people who invent things and the people who work out what they are for are the same people. But the invention isn’t the multiplier in that equation, it’s table stakes. It’s a sometimes ingredient, not a leading indicator or prerequisite. A great product is important, but great product distribution is much more important. This means it’s not enough to say that a company is innovative. Or that it isn’t. That doesn’t tell us much.

One of the reasons why innovation is given so much prominence is that it’s easier to measure. It’s simple to calculate the amount spent on R&D. It’s much more difficult to determine the return on investment (ROI). Plus, the amount invested is immediately obvious whereas we often have to wait a long time to understand the potential returns, and the milestones along the way can be subtle if we don’t know what we’re looking for.

Inventors are a distraction. When we try to pick individual companies that are potential future winners, what we’re really looking for is something much less common, much more difficult and unfortunately much more boring: who can execute well, and do it repeatedly? Maybe when we named a government agency after Sir Paul we should have called it Callaghan Execution.⁸

Abiotic eh?

An ecosystem in the natural world is the combination of living things (the biotic) and the environment they live in (the abiotic). It’s constantly changing in response to both external forces and the natural life cycles that occur within the ecosystem. Diversity within the ecosystem determines how healthy it is, how well it can cope with external shocks and whether it lasts to span multiple generations.

I used to bristle when people used the word “ecosystem” as the collective noun for startups. But many of these concepts do translate. A startup ecosystem is the combination of the founders, the ventures they start and grow, and the people working directly on those (the biotic) and startup infrastructure – the things that exist to support, encourage, protect and grow these ventures (the abiotic). A startup ecosystem is also constantly changing in response to external and internal forces – new ventures are started and funded, some quickly die, some grow large, some are acquired which creates a feedback loop, releasing capital and people with relevant experience back into the system to the benefit of the companies that follow them. Every new beginning comes from some other beginning’s end.⁹ Again mirroring the natural world, diversity within a startup ecosystem determines how healthy it is, how well it can cope with external shocks and whether it lasts to span multiple generations.

I still think it is weird to talk about building a startup ecosystem. We can’t do that, obviously. An ecosystem grows from the bottom up, one startup at a time, not by design or diktat from the top down.¹⁰

This is a chicken-and-egg problem. In any ecosystem, species struggle without an environment to live in, but equally just creating an environment and hoping that biodiversity creates itself is idealistic and likely to fail.

We need to be patient, because growing an ecosystem takes time. It always takes longer than we think, even when we know that it takes longer than we think.¹¹ Trade Me was seven years from start to sale. Vend was 12 years (12 years and one day to be precise!). Timely was nine-and-a-half years. Xero took just under six years to go from IPO to a $1 billion valuation. The scarcest resource at most startups isn’t cash, it’s time.¹² We’re all lucky that most founders don’t appreciate this reality in advance, otherwise they might not bother to start at all.

But that doesn’t excuse us from measuring progress in the meantime. When we celebrate outcomes like these (as we should!) we need to connect the dots back to the initiatives we think have contributed. It’s well past the time when many things we’ve been doing for a decade or more should have had more scrutiny. Sooner is over: it’s later already.

The silver bullet

Have you noticed the pattern yet? The question that keeps coming up is: Why do we actually want an ecosystem of innovative technology startups in the first place? What outcomes are we hoping for?

A growing startup ecosystem creates many benefits. But not all of those are shared. We can’t assume that a rising tide will lift all boats. If we want those benefits to be widely distributed we need to think about which outcomes we prioritise. There is a long list of potential answers…

Is it more early-stage companies? We love to count the raw number of startups. But usually without too much consideration for the current health or future prospects of these companies.

Is it more high-growth companies? We celebrate companies with high revenue growth. Sometimes that growth is eye-watering. Is bigger always better? Or should we instead prefer companies that grow a little slower but are far less volatile as a result?

Is it more established companies based here? For a time in the 1990s we fetishised the idea of creating our own Nokia in New Zealand. This is not a specific ambition we hear so much any more.¹³ Interestingly, the ambition was realised. Xero is a large and globally successful technology company still headquartered in Wellington. Did we get what we wanted from that?

Is it attracting international capital? One guaranteed way to get attention in the ecosystem is to attract a high-profile international investor. This seems like something we want to encourage. For example, NZTE has a whole team of people working on in-bound investment – helping to connect local companies with international investors who can help them grow. On the other hand…

Is it retaining local ownership? When then minister David Parker rebooted and renamed the NZ Venture Investment Fund in 2019 his stated aim was to “help keep more startups in New Zealand for longer”.¹⁴ We only worry about “losing” companies overseas when they are acquired completely. As we’ve discussed, this actually happens whenever we raise money from new investors.

Is it better paying jobs? This seems obvious. As Callaghan highlighted, we have a significant productivity challenge – working longer and harder than others but producing less. Given that technology jobs typically pay so much more than average and technology companies are more productive than average, that would suggest that more people working on these sorts of companies could be a big part of the solution.¹⁵ The question then is: how many more of these jobs have we created in the process of growing the ecosystem? And how well paid are they? The answer, it seems, is we don’t know. That’s a problem, given how much we’ve invested in that objective.

Is it attracting talented and qualified people from overseas? We need to retain the talented and qualified people who are born and educated here and we need to attract the best people from all over the world to come not just for a holiday or to hide in their bolthole, but to live and work and be part of the solution.

Is it tax revenue? Ultimately we need these companies to contribute more cash to the local economy than they take. The easiest way to measure this would be to look at the tax paid. It’s useful to note that very few startup companies are profitable (indeed those that have raised and spent a lot of capital often have significant accumulated tax losses to offset against future profits) so when we look for the tax they contribute it’s going to be mostly GST and PAYE.

Is it export revenue? When goods or services are sold overseas this brings money into the country. So another way to measure what these companies add would be to look at the amount they earn from exports. Unlike our more traditional export categories, which involve putting bulky physical things on a ship or plane, many new companies are selling things that are weightless.¹⁶ Plus they can generate export revenue much earlier in their life cycle. Currently a “high” New Zealand dollar is called a “strong” dollar. Perhaps that will change when we really start to focus on exports?

Is it selling more companies, and recycling the capital? As well as selling goods and services overseas, startups sometimes sell themselves to foreign buyers. The actual product of many startups is the company itself. But when this happens we’re often torn between celebrating a successful exit and feeling disappointed to “lose” a local company.

Is it wealth? Clearly when startups go well they can generate significant capital gains for the founders, their teams (assuming they have some ownership) and investors. However, it’s not clear how that translates into collective benefits. Despite that, we seem happy to provide direct grants, subsidised funding and significant support to companies owned by already wealthy investors (myself included!).

Is it being the place where great companies are started, or even more esoterically the country where founders of great companies were born? This is obviously silly, as soon as you say it out loud, but we do love to claim success by association, even where that link is tenuous. For example, I’m a huge fan of the company Tim Brown and his team built at Allbirds, but I did have to laugh when I heard a former MP describe it at an NZTE event in San Francisco as a “company of New Zealand provenance”. Likewise, many are determined to see Rocket Lab as a local success story, but at the same time reluctant to use its full name: Rocket Lab USA, Inc.

Is it successful local venture capital funds? Given the amount of money and attention that we’ve invested in this objective over many years, and continue to invest, it would appear to be something we’re anxious to solve. Meanwhile local venture funds are promoted to wealthy immigrants from around the world who want to purchase a visa. If the investors in our local venture funds are predominantly from overseas, are they really any different from international funds?

Is it better local services? When companies are homegrown, it guarantees provision of quality products and services to local people. By comparison our local market is often a rounding error to global technology companies. Consider Trade Me, for example. Where would New Zealand rank in the priorities of a global provider like eBay, if they had “won” the local market? Likewise, do we care that most of our banks are regional branches of Australian companies? Does that help or hurt local businesses that depend on their services?

Last but not least…

Is it better use of our scarce natural resources? As well as the various measures above that focus on dollars we should also give more consideration to where Greta Thunberg’s Emissions Curve fits in.¹⁷ We can continue to moan about the impact that sectors like agriculture or tourism have on the environment. Or we can both put more capital and technology to work on creating new businesses that don’t require us to ship raw materials out or fly tourists in, and on improving those that do.

Hugh, from Timaru

Hopefully the problems with this long list of potential objectives are immediately obvious. Many are contradictory. Depending on which we choose to optimise for, the choices we make would be different. Until we’re clear about our why, we’re going to struggle to prioritise the what.

But how about the who? Product teams sometimes use personas to describe their customers. At Trade Me, for example, I imagined a grandmother called Marjorie, which also happened to be my own grandmother’s name (yes, my grandmother was Marge Simpson, long before that was cool). Talking about her helped to inform lots of design decisions: What web browser would she use? How fast was her internet connection? How comfortable would she be entering credit card details online? What was her eyesight like? How would she search for things to buy? What would convince her to tell her friends to use Trade Me?

In that same vein, meet Hugh.

He lives in Timaru. He works for an importer, as a forklift driver in the warehouse and distribution centre. He lives with his partner and has two adult children who have left home. He enjoys a beer with his friends on a Friday after work, and normally needs little excuse to relive his glory days as captain of the Boys’ High School 1st XV.

Hugh is not real, but is still somebody I like to keep in mind whenever I hear people in the startup ecosystem talk about different ways that the government can help them to grow their business. Often you’ll hear ideas like direct cash grants, subsidised facilities or services, or tax credits for research and development expenses. Of course these are not just ideas. We currently do all of these things. There are even some bold enough to suggest that investors should get tax incentives on top of this (as they do in many countries including Australia¹⁸ and the UK¹⁹). This despite the fact that New Zealand already has arguably the most favourable tax environment for venture investors in the world.

These initiatives are all ultimately funded by Hugh via taxes and rates. So what benefits do he and his whānau get for that investment? How can we make these more obvious, so he’s happy to provide that funding? Asking the question this way forces us to separate the things on the list above that benefit us all collectively from the things that are mostly private. For example, startups create the possibility to make individual founders and investors very wealthy, but that seems unlikely to impress Hugh on its own.

To answer that we need to go back to Sir Paul Callaghan’s key provocation. One of the serious consequences of becoming poorer as a country, relatively, is that we increasingly struggle to afford things that could directly improve our collective quality of life – schools and hospitals and the skilled staff required to work in them, expensive drugs and medical treatments, infrastructure like communication and transport networks, and warm and healthy places to live. And it makes it harder to overlook options that generate wealth by exploiting our scarce natural resources.

We need to demonstrate to people like Hugh how growing an ecosystem of companies that use technology to create high-paying jobs based in New Zealand ultimately flows through to fixing some of those things for all of us. To do that we’ll need to focus much less on what the government can do for startups and narrow in on what startups can do for the government, and by extension for everybody in New Zealand. That will make a nice change.

Build vs. Grow

It’s only when you look back far enough, that you truly see how an ecosystem develops. The fundamental building blocks of any successful business – and therefore any ecosystem – are the people. People are to startups what location is to real estate.

There were just 53 of us working at Trade Me at the time of the sale to Fairfax in 2006. Each of us took invaluable lessons to apply to whatever we worked on next. For me that was Xero, then to Southgate Labs, Vend, Timely and others. That’s just one single branch in the tree.

The full canopy would also include ventures started and funded by Trade Me shareholders (just 13 of us). The initial $100,000 invested in Trade Me – what we’d now call a “seed round” – was funded from consulting work. The whole pile of turtles stands on a foundation of “time and materials”. The returns on that investment were significant. But what happened to those capital gains? The $750 million Fairfax paid has multiplied many, many times over in subsequent generations of ventures.

Repeating this exercise for Xero, Vend, Timely and all the other ventures that trace their heritage to Trade Me would reveal an even denser forest. It’s a recurring pattern: many people who worked on these businesses have started their own new ventures or invested in the next generation of companies.

This is how you create an ecosystem. Plant a seed and let it grow.

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