A new tech hub has emerged in the Baltics

Whenever we speak of links within a defined space, we tend to use the term ecosystem in all its forms: biological ecosystem, territorial ecosystem, digital ecosystem, etc. This notion of ecosystem is based on the interaction of a more or less large set of entities distinct from each other in the middle of the same environment.

???????????The one that interests us here is of course the startup ecosystem. Here we find not only entrepreneurs and their innovative ideas, but also investors, researchers, engineers, and other institutions that define the rules by which these ecosystems can grow. Of course, how can we not instinctively think of Silicon Valley, the cradle of the technologies that are now part of our daily lives? According to CB Insights, as of July 2020, the United States, led by Silicon Valley, has 48% of all unicorns, i.e. startups valued at more than 1 billion dollars. They are nevertheless being followed by China, which is growing in power and accounts for a quarter of them. Far behind, Europe seems to be struggling with only 12% of the world's unicorns. Yet the dynamism of the European startup ecosystem is attracting the attention of investors from all over the world. This is particularly the case for the countries bordering the Baltic, and I will try to explain this here.

???????????The Baltic is that little-known Europe, the Europe no one talks about, which rhymes in our minds with night, cold and winter. Yet the Baltic has become a "Northern Mediterranean", a key geopolitical area since the ideological opposition between the United States and the former USSR. Within this space there are obviously many disparities: it is difficult to compare the standard of living of a Swede with that of a Pole, but from a technological point of view, the whole region is tending towards digitalization... and startups are flourishing! So how do we explain this dynamism that gave birth to Bolt and Vinted, among others? Why are some areas overflowing with innovative ideas and concepts? What are the factors that enable a startup ecosystem to become successful? This article aims to shed light on the advent of the "startup nation" on the shores of the Baltic Sea.

???????????The first industrial revolutions taught us that the dynamism of a region can be explained by a combination of geographical, economic and sociological factors. Let us take the city of Manchester in the United Kingdom as an example. Geographically, Manchester is located on the Irwell River, a tributary of the Mersey that flows into the Atlantic. This connection to the ocean by river transport, together with its proximity to many coal mines, has allowed Manchester to blossom as an industrial city, rich in textile and coal mills. This very dense industrial fabric allows me to explain the economic side of Manchester's working-class success. A new company needs premises, raw materials, labour and suppliers. By creating itself in the middle of an industrial technopole, it benefits from the assets necessary for its growth while sharing the fixed costs of its external resources with other companies in the area. As a result, the more companies there are in the same territory, the lower the fixed costs per company, and the more business can thrive. Finally, the sociological aspect of Manchester's success cannot be neglected. The people that the workers like most are the workers. In Manchester the workers' culture has enabled the city to develop a workers' identity, sharing the same values, interests and dreams.

????????????I have chosen Manchester as a digression to show that this reasoning crosses time and that we can duplicate it to our own, that of the technological revolution, the advent of NICT and digital technology. Like the Manchester of more than a century ago, Silicon Valley seems to me to be the best example to illustrate this point. The founder of the Y Combinator, Paul Graham, explains the success of Silicon Valley in three ways: the number of rich people, that is, investors who understand the technologies and the returns they can make; the nerds, those entrepreneurs with ambitious ideas; and the great universities. We can see here that we find the same pattern as in Manchester: where Manchester enjoyed advantages thanks to its location, those of Silicon Valley are the great universities of the San Francisco Bay Area (UC Berkeley, Stanford...) from which come out the nerds with ambitious ideas that will convince wealthy investors. And of course, those that geniuses love the most are people like them, those with innovative ideas ready to change the face of the world.

???????????Now that we have identified the conditions necessary for a startup ecosystem to establish itself in a territory, what can we make of the Baltic? Geographically, we can consider that in the multipolar world in which we operate, the Baltic has the advantage of being at the crossroads between Western ideology and Russian influence as a regional superpower. High-quality universities such as Kaunas University of Technology, Vilnius University and Helsinki University form the golden youth of the countries bordering the Baltic Sea. The education systems give pride of place to science and technology and the population is up to date with new technologies: 98% of Estonians have opted for an electronic identity card which offers many possibilities (voting, paying taxes, picking up medicines from pharmacies, etc.). Estonia has succeeded in making digital technology a reflex in the daily life of its inhabitants... and this is having an economic impact. Already, digital technology offers a precious time saving that allows Estonia to save up to 2% of GDP each year according to its Minister of Entrepreneurship and Digital Economy Urve Palo. This digital culture has therefore favoured the emergence of technological hubs such as the "sTARTUp HUB" near the University of Tartu, or the Vilnius TechPark. It is precisely these innovation hubs that allow the emergence of a rich ecosystem where external economies of scale are possible while collaboration between startups is strengthened. Many unicorns like Revolut, listed at $5.5 billion after a $500 million round led by venture capital fund TCV in February 2020, have recently established themselves in Lithuania after obtaining an EMI (Electronic Money Institution) license from the Bank of Lithuania. These movements and trends reflect the obvious dynamism of an increasingly tech-driven region.

???????????While Finland and Sweden withstood the Soviet yoke, the Baltic countries and Poland did not free themselves from it until the early 1990s and, as a result, their economies had adopted the central planning and management system of the USSR. Industrialized without being leaders in their field, digital technology emerged as a lever of choice for these countries for economic development. However, this position carries its share of risks.?

???????????Already, for any country experiencing late development, external competition is tough, and the risk of brain drain is high. Indeed, "geniuses" are more likely to study at prestigious universities in Western Europe or North America, but above all to develop their ideas in already confirmed ecosystems. The case of Stripe is particularly eloquent here: the fintech dedicated to online payments was born in San Francisco thanks to the Irish Collison brothers who went to study at MIT. A recent survey conducted by startupheatmap.eu among European entrepreneurs revealed that if they had to relocate their startup, 54% of them would choose Berlin, against only 12% in Warsaw, which is interesting from a price-land point of view. The reason? Entrepreneurs are mainly looking for already established and successful startup ecosystems with a real culture of technology. This brain drain is also partly linked to the low salaries that developers receive in this region. The graph below shows that the salaries received by Polish and Estonian developers are half as low as those received by German and British developers. Therefore, why wouldn't an Estonian developer prefer a position in a Berlin startup to the one they are offered in a startup in the Estonian capital?

Salary Median and Interquartile (%25-%75) Range ($) - Source: Stack Overflow

????????????Beyond these financial aspects, demographic issues need to be taken into account. When an entrepreneur establishes his business model, even before thinking about the expansion of his startup, he first tries to define his targets within his territory, i.e. the part of the population to which he will sell his product or service. However, many countries bordering the Baltic Sea are experiencing a decline in their population due to a lower birth rate and emigration. Clearly, launching a startup in a shrinking market does not seem relevant for an entrepreneur. Finally, another challenge I see is the lack of investors in the region. Let's take the Lithuanian example here. Over the last 5 years, co-working spaces, innovation poles and start-up accelerators have been growing like mushrooms in Lithuania. As a result, the number of startups has also increased in the region. Nevertheless, although the most present VC fund is Lithuanian (Practica Capital), a significant part of investments in the territory's startups comes from foreign funds.

A problem may therefore arise from the lack of investors, called Limited Partners, on the territory, who are able to understand the technology and invest money in it; this forces startups to look for foreign investors with whom a personal relationship and tailor-made support will be more difficult to find.

????????????However, the Baltic region is increasingly emerging as a driving force for technological development in Europe. If the geographical, economic and sociological framework is favourable, this is also due to the policies put in place by governments to catch up with the Western wagon at the end of the Cold War. Lithuania has become a flagship R&D destination where related expenses are fully tax-deductible three times. According to the Digital Disruption Lab, the Lithuanian government invested 411 million euros in R&D between 2006 and 2013, which represented almost 2% of its GDP. Moreover, it has been possible to set up a startup in Lithuania thanks to the "startup visa" since January 2017. This visa allows legislative amendments to the Immigration Law to facilitate the process of acquiring permanent residence rights for citizens of non-EU countries who wish to set up their innovative company in Lithuania. A startup visa committee, consisting of institutions such as venture capital funds and accelerators, has been established to assess applications and grant visas. This positive climate for the creation of startups is reinforced by the close cooperation between the Baltic Sea countries and the countries of Western Europe. For example, former French Prime Minister Edouard Philippe chose Estonia for his first trip abroad to coordinate European projects related to digital technology, a sign of Estonia's acquired status in this area. This new status is in fact based on solid foundations that continue to establish the legitimacy of the Baltic countries among the technological powers. Nokia, a Finnish multinational company, remained the leader in mobile telephony from 1998 to 2011. Since then, startups such as Skype, Vinted or Bolt are a testament to the ingenuity and success of entrepreneurs in the Baltic startup ecosystem.

???????????Currently, the region's most talked-about startup is undoubtedly the Polish Brainly. This EdTech startup (i.e. technology used in education) enables peer-to-peer learning among students in a market valued at nearly $250 billion according to EdTechXGlobal. Brainly has raised €30m in Series C from Naspers to further penetrate the US market where about 10% of students use the application for their studies. After having conquered Poland and Russia with nearly 80% of users, Brainly is now taking on the United States and can take the lead in a market where no one has yet succeeded. Currently, their revenues come from outside of the USA and it will probably don’t change. They signed on to work with some of the leading Eastern Europe universities, and I think that the pandemic crisis we knew in early 2020 may have strengthened its position. Therefore, as long as education is key in governments’ politic and highly skilled turnover is needed in top-tier firms in the world, there’s going to be a high customer lifetime value. Also, as long as the service is efficient the churn rate will be sort institutionalized because students will keep using it wherever they go. All that aside, with globalization, Brainly is starting to reach Asian countries and it would be interesting to know how many school partnerships they’ll get in those countries knowing that they sum up currently 150 million users.

????????????The Baltic has become a global tech hub and some of its startups are starting to be valued at more than $1bn. Perhaps this will encourage more local investors to position themselves, but also entrepreneurs from all over the world to try their luck in what is emerging as a new Eldorado.

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Written by Ugo Le Borgne

Sources:

Paul Graham, "How to be Silicon Valley", may 2006?

Deniz Kayahan, "Challenges and Opportunities of Developing Startup Ecosystems: Central and Eastern Europe and Turkey Example", Medium article.

"Le pari des nouvelles technologies en Lituanie", DG Trésor, 19 février 2020

Brainly raises $30m for US push", Sifted article, https://sifted.eu/articles/brainly-raises-30m-us-push/