This article first appeared in my column on the investor magazine Equities.com and has been updated since.
Historically, investors looking for potential growth opportunities have hyper-focused on American companies emerging from tech hubs such as Silicon Valley, New York, Boulder and Austin. However nowadays, with early stage valuations on the rise, increasing political instability and possible economic isolation caused by recent elections, it may be time to rethink the original framework for predicting future growth investment spaces.
President Trump’s ‘legacy’, if you want to call it this way, has increasingly isolated the US if not economically, then at least politically. The same goes for post-Brexit UK and also for the parts of continental Europe which are still being held back by increasingly tense social, political and economic climate.
The evolving political climate across the global economy poses multiple questions for investors, startups and strategy departments. Will this have an impact on businesses? How will it have an impact on the engines of our economies, the growth companies, and how it will effect the expansion of future growth markets? And what factors should we look out for when we assess the macro climate?
How Important are Policies?
In retail the mantra is location, location location.
For corporates and large scale global manufacturing companies, location has traditionally been equally important. Companies choose base countries based on factors such as bilateral trade agreements, political climate, tax regulations and access to suppliers. Recent tendencies of protectionist policies, as well as support for certain corporations and potential bilateral treaties might seem extremely influential factors for corporates, who are constantly looking for new market opportunities.
However, when we look at the growth markets of the future, then these factors are less important nowadays. Such policies are meant to support big conglomerates who know how to make themselves heard in the political space. But the time when European or US oligopolies would have a large headstart over their Asian counterparts has passed. During my time in private equity I have seen a fair share of producers of high quality products who seemed to be well protected until Asian competitors ramped up their skillset to produce the same quality at lower costs. And cost is not a criterion that these western companies are able to compete on.
If companies want to remain competitive, their competitive advantage needs to stem from innovation. The innovative businesses who create entirely new markets or products are the ones that drive not only competitiveness but also job growth, and so far big corporates haven’t been the ones who excelled at this.
Therefore, if we are searching for new growth markets, the typical demands of a location (bilateral agreements, materials, suppliers) become less important. Highly innovative, technologically advanced companies, especially SAAS enterprises, don’t rely on any of these factors.
Like good wine, Growth Companies need a special turf.
The ‘raw materials’ that keep the cogs turning in forward thinking tech companies are the talent which they bring on board, the bright minds which are constantly inventing, and improving. So while location is important, it is for totally different reasons. The key requirements for these growth companies are not based on trade agreements, or suppliers, but instead proximity to universities, space to grow and scale, and a liberal environment that attracts foreign and homegrown talent
Talent Needs Space and the Right Conditions to Grow:
For innovative growth companies different patterns play out that for corporates. The success factors for countries who compete for economic leadership have changed, too.
In his book Startup Communities, Brad Feld first highlights “Feeders” – these are the essential drivers of startup communities like universities, entrepreneurship programs, VCs, non-profits, government schemes, mentors and investors.
Next to these feeders, access to talent is critical for startups and growth companies. This ranges from skilled developers, designer and marketers, to experienced entrepreneurs and an infrastructure of mentors and investors. Richard Florida refers to this abundance of talent as the creative class, and argues that these educated, highly sought after people want to live in nice places and enjoy a liberal culture with a tolerance for new ideas. Most of all, they want to be around other creative-class individuals, which creates a strong network effect between creative communities.
Network effects mean “being in a place where startups are the cool thing to do and chance meetings with people who can help you.” as Paul Graham writes.
Northeastern University has mapped the intellectual migration network in North America and Europe over a 2,000-year span, illustrating how today’s cultural capitals have emerged.
Here is North America:
…and here is Europe:
An open society is crucial. By open, I mean not only tolerant but also a meritocracy where people have the freedom, the means and the education to innovate, try new things, and build ventures, without being held back by ‘old boys’ networks that hinder progress by hoarding opportunities and blocking outsiders from jumping in.
Since the beginning of the startup revolution, we have seen that a society based on old boy networks will not feed talent, but instead lead to inflexible corporations that fail to act at the right time and push change. And change is what these times are all about.
The current political climate with an increasing divide between conservatives and progressives is creating a toxic environment that is far from the perfect field to plant new startup ecosystems. This is why liberal democracies like France and Canada are seeing space to capitalize on their neighbours’ weaknesses and have relatively young leaders that represent a new generation who are ready and willing to shake things up.
While Emmanuel Macron has been courting US scientists after Trump’s withdrawal from the Paris Climate agreement, Canada is successfully tempting U.S. companies and talent north, with Facebook (FB), Google (GOOGL), Uber and Microsoft (MSFT) recently having opened offices there.
The Emergence of the City State
However if you live in a country whose political climate has just made a U-turn, here is some good news. While political leaders, their governments and their policies play a big role in defining how attractive a country is to the creative class, this doesn’t mean that particular cities or ‘hubs’ cannot flourish by themselves.
Led by California, dozens of states and cities across the US have already stated their intentions to ignore Trump’s withdrawal from the Paris agreement. Silicon Valley will continue to boom regardless of Trump’s meddling, and Sadiq Khan remains as influential in the future of London as Teresa May. The impact of the cities on a growth space may actually be higher than the impact of the country, as cities, states and hubs end up micromanaging themselves.
If you live in one of the global cultural centers you will notice how people tend to move almost more between New York, London or Berlin than within their own country. This provides an interesting exchange of talent and knowledge between these hubs. If Silicon Valley’s unicorns have found more innovative or more productive ways to organize their work, then other hubs are likely to follow suit, not only because of the internet but because of talent, which acts as a multiplier.
In calling Berlin home, a city that not only has built and has torn down walls, I am fortunate to find myself in an environment that’s a breeding ground for growth industries. While Berlin has long suffered from extraordinarily high unemployment rates, thanks to liberal immigration policies, a welcoming culture and low cost of living, it has attracted talent from all over the world, which produces an astonishing output of new businesses and jobs.
How to Predict Growth Markets in the New Landscape?
Therefore, for growth companies, political macro factors of a nation are of lesser importance than the type of infrastructure, culture and society that a city or hub offers. Investors equally will shift their focus from macroeconomic factors to the factors that attract talent, and from nations to cities.
But how do you assess such an environment?
1. Follow the talent:
See where migration is happening as illustrated in this map of migration from 2005-2010. These are fast changing times, and to keep up to speed, ecosystems need a steady flow of the best talent out there.
2. Scout for education and an evolving culture:
Assess which educational institutions matter and their admission policies. Do they offer open access or act as a breeding ground for the new generations of old boys clubs? Is society within an area segmented or is it open? Look at income distribution within a society and how it changes over time. Is it monopolized or does it reflect true opportunities for everyone? Resources like Nomadlist provide you with useful insights about local cultures.
3. Spot innovation hubs:
The European Commission and KMPG offer lists of key innovation hubs. Compare several of them and watch how they develop. The magic sauce is in the criteria they apply. While some focus on the quality of local universities, others focus on R&D activities by startups. Some focus on the number of well known unicorns, and others focus on the whole infrastructure. Your focus will depend on the stage you are interested in. While places like Berlin or Lisbon provide attractive early stage opportunities, the more developed US cities will provide a richer supply of larger, fast-growth companies.
Culture drives growth. But unlike economic policies and GDP figures, culture is not always easy to understand and assess. Yet this is why looking through the smoke and finding open climates, where innovative companies can find the space to grow can put you will ahead of the rest of the herd.