Israel's High-Tech Sector Navigates Uncertainty: Annual Israel Innovation Authority Report Shows Resilience and Challenges

04/06/2024

‘State of the High-Tech Sector in Israel 2024’ highlights continued growth in 2023 amid investors and companiesconcerns for the future

The Israel Innovation Authority today released its annual report assessing the state of the Israeli high-tech sector, revealing a mixed landscape of both resilience and uncertainty. The “State of the High-Tech Sector in Israel 2024” report shows that despite numerous challenges over the past year, the sector has demonstrated growth, with several macroeconomic indicators trending upwards. However, the report also highlights a decline in some indices related to key business activities, reflecting underlying concerns for the sector.

Despite this year’s challenges, which have included political turmoil and the fallout from the ongoing war, several indicators have shown continued growth in the high-tech sector. Employment in the sector rose by 2.6% in 2023, reaching 396,000 high-tech employees, with an additional ten thousand people joining the sector during the year. Notably, the high-tech sector’s contribution to Israel’s GDP reached nearly one-fifth (19.7%) in 2023, approximately 340 billion shekels, while its share of Israeli exports stood at 53% last year, totaling 73.5 billion dollars, a consistent figure in recent years.

At the same time, however, employment growth in high-tech has significantly slowed, barely outpacing population growth rates, and various business activity indices have returned to 2018 levels or earlier. For example, investment in Israeli startups saw a sharp decline of around 55% in 2023, with later funding rounds suffering the most significant impact. This downturn raises concerns about the sector’s future sustainability and growth potential, highlighting the need for strategic initiatives to stimulate investment and innovation in the coming years.

Gila Gamliel, Minister of Innovation, Science and Technology: “Innovation is our most important natural resource, and the high-tech industry is the main growth engine of the Israeli economy. We see the high-tech industry continuing to develop and lead globally. However, to ensure that Israeli high-tech continues to grow and thrive, we as a government must continue to support companies and develop the necessary infrastructure. We will continue to act decisively and collaborate with all relevant parties to maintain our position as leaders in global technological innovation.”

Alon Stopel, Chairman of the Israel Innovation Authority: “Israeli high-tech is the leading industrial sector in Israel. Despite global and local challenges, it continued to grow in 2023, accounting for about 50% of exports, highlighting Israel’s technology-driven economy. However, continuous challenges and lack of human and geographic diversity require significant government involvement to maintain leadership. Unlike major global tech hubs, Israel’s government budget for R&D is relatively low. Most high-tech investments come from non-governmental sources, with a significant portion from foreign investors. Therefore, the resilience of the high-tech sector must be strengthened through diverse budgetary additions, including governmental, to address market failures and reduce dependency on external investments. We must focus efforts and gather additional resources to support the development of companies in later growth stages, challenging R&D in mature companies, and international collaborations in tech manufacturing. Driving Israel’s high-tech forward, as a beacon of success, is key to maintaining economic leadership and enhancing Israel’s global impact.”

Dror Bin, CEO of the Israel Innovation Authority: “Despite numerous challenges in 2023, Israeli high-tech continued to grow. However, past success does not guarantee future success. The report indicates that Israeli high-tech is now at a crossroads: Israel’s excellent fundamental data has not changed; the country still has top-tier entrepreneurs, investors, and researchers. However, the high dependency on foreign investments and the increasing competition, backed by massive government investments in other global innovation hubs, require a reassessment of how the Israeli government invests in this sector, which contributes about 20% of the GDP and nearly half of the exports. In 2024, with special government funding, we launched several strategic initiatives, including the Fast Track, the Startup Fund, and the new Yozma Fund. However, significant additional government investment in the ecosystem is needed in the coming years to ensure the continued growth of Israel’s economic engine. This is the time to act, as the impact of the war, already reflected in the credit rating downgrade, could lead to a decrease in investments and capital inflows to Israel. In a sector reliant on foreign capital for growth, this is a significant threat, and we must ensure that a funding shortage scenario does not materialize.”

High-Tech State of Affairs – 2024/Q1 Surveys

Surveys conducted as part of the annual report among 500 tech companies revealed concerns about the future, with a prominent percentage of startups (around 40%) engaged in fundraising anticipating lower valuation rounds (Down Rounds). The central impact of the October 7 events on tech companies has manifested in slowed business activity, product development delays, or failure to meet company goals. During the months of the war, Israeli startups reported scaling back their hiring plans for the upcoming year, primarily expected to hire local staff. Only 39% of startups raising capital are highly likely to secure the needed funds successfully.

Furthermore, data collected from 30 Israeli venture capital funds, in collaboration with the Israeli Advanced Technology Industries (IATI), indicate that nearly 40% of these funds witness at least one company in their portfolio relocating intellectual property abroad due to local instability. Almost a quarter of venture capital funds estimate that over 30% of their portfolio companies have either shifted significant operations abroad in the past year or plan to do so in the coming year, not solely due to organic growth.

Regarding investment activity in Israel, venture capital funds anticipate that foreign funds will reduce their investments in Israeli startups in the coming year more than in Israeli funds. They believe that local instability negatively impacts how Israeli startups are perceived and has already led to the relocation of operations and intellectual property out of Israel. According to the funds, these trends may intensify in the coming year.

Challenges and the Importance of High-Tech to the Israeli Economy

The report indicates that Israeli high-tech faces a crossroads after a period of rapid growth since 2018. The question is whether, looking forward, high-tech will return to a growth trajectory, enter a stagnation phase similar to the post-dot-com bubble burst in 2001, or, worse, shift towards contraction.

The role of high-tech as an “economic shock absorber” has been significant for the economy, especially during crisis periods like the COVID-19 pandemic and geopolitical upheavals in 2023. Evaluating the period from 2018 to 2023, high-tech accounted for over 40% of Israel’s GDP growth, consistently mirroring economic growth in recent years. The centrality of high-tech to Israel’s economy resembles natural resources in other countries, but unlike resource-reliant nations, Israel relies on high-tech, and the number of employees in this sector directly impacts economic activity and growth.

Continued employment growth in high-tech above the natural population growth rate (about 2% per year) is critical for its positive influence on the economy, including its contribution to GDP, exports, and tax revenues. Moreover, the sector’s extensive international connections (investors in startups, multinational corporations as significant employers and acquirers of startups, clients of Israeli companies, international research and industrial collaborations) underscore its sensitivity to Israel’s international relations.

The importance of high-tech is increasing as the state’s security and civil funding needs rise. Therefore, it is crucial to maintain the significant economic activity of the sector, which generates substantial tax revenues for the country. The report shows that the average salary in high-tech has increased nearly four times more than the average salary rise in other sectors over the past decade. Damage to Israel’s reputation due to the current situation, which may result in declines in various activity indicators mentioned above, puts the future of Israeli high-tech at risk in the short term and beyond. The downgrade of Israel’s credit rating already reflects foreign investors’ concerns about the future of the Israeli economy. Despite the centrality of high-tech in Israel’s economy, government investment in high-tech in Israel is lower than that of countries ranked above Israel in innovation indices like the US, UK, and Korea. The sector may struggle to weather crises as it relies heavily on foreign investments and lacks a significant local safety net.

To address these challenges, the Israel Innovation Authority recommends managing market expectations and creating certainty, especially given the sector’s reliance on foreign investments. One possible way to increase certainty is through a multi-year government investment plan in high-tech.

For continued long-term growth in high-tech, the Authority also recommends investing in quality education for all population groups across the country and at different stages of the educational and professional path. Additionally, given the growing competition with other innovation hubs, it is important to learn from places that have surpassed Israel in various innovation indices, such as London, where startup and innovation ecosystems have developed in recent years. In response to the challenges outlined in the report, the Israel Innovation Authority has presented several investment plans in the past year. Key initiatives include the Fast Track channel for companies with a short runway exceeding 400 million shekels, the launch of the Startup Fund with an investment volume of around half a billion shekels, and the Yozma Fund 2.0 totaling around 600 million shekels, expected to leverage around 2 billion shekels from Israeli institutional funds. Furthermore, the Venture Creation Incubators program was updated with a sum of approximately 150 million shekels.

Additional notable data from the report:

The sector:

In 2023, 396,000 individuals were employed in the tech sector, marking a 2.6% growth compared to 2022. Although the increase in employee numbers is positive, the growth rate in 2023 was significantly lower than the annual growth rate since 2018.
There are approximately 9,200 tech companies in Israel, including 600 newly established ones in 2023.
There are 515 R&D centers of multinational companies employing nearly 90,000 workers. Over 70% of these employees work in software companies or semiconductor leaders.
393 Israeli technology public companies traded with a cumulative market capitalization of $234 billion (as of April 2024), employing approximately 320,000 workers worldwide (a significant portion of the market value and employees in these public technology companies belong to the organizational software sector).
There are 843 active venture capital funds in Israel, including 537 foreign venture capital funds and 306 Israeli venture capital funds.
Israeli venture capital funds raised a total of $1.52 billion in 2023.

Salary:

The average monthly salary in the tech sector in 2023 was 30,217 shekels – 2.74 times the average across industries, after a 7% increase in that year. From 2013 to 2023, the average monthly salary in the tech sector increased by 10,460 shekels – nearly 4 times the increase in the average salary across other industries.
Salary disparities within the tech sector: In the IT services sector (software), the average salary is over 4,000 shekels per month higher than in the IT hardware sector.

Employment:

In 2023, there were 395.7 thousand employees in the tech sector, an increase of about ten thousand compared to 2022. The number of employees in the tech sector in 2023 accounted for nearly 12% of all employees in Israel.
From 2014 to 2023, the number of employees in the sector increased by about 150 thousand, a growth of about 60% (reflected in an annual increase of a two-digit number of employees each year since 2018). The main growth was in IT services companies (software).
The main growth in tech employment over the past decade has been in R&D positions. The number of employees in managerial positions more than doubled from over 94 thousand in 2014 to over 190 thousand in 2023.
In the last decade main growth in high-tech employment was in R&D positions. R&D employees accounted for 48% of all high-tech employees in 2023, compared to 38% in 2014.
No change in demographic diversity in tech: 65% of tech employees are Jewish men (non-Haredi). Almost one in every five non-Haredi Jewish men in the labor market works in tech. Among Arab women, one in every hundred women in the labor market works in tech.
Military enlistment in tech: In the fourth quarter of 2023, 28 thousand tech professionals served in the reserves, 60% of them in R&D roles (more than any other group of employees). In January and February, this number decreased to less than 12 thousand, about 3% of those employed in tech.
Following October 7, there was a decrease in the number of job vacancies in tech, mainly in the Tel Aviv and Central districts. Recovery began in the first quarter of 2024, returning to pre-war levels – the lowest since the beginning of 2019.
Employees in technical roles outside the tech sector: In 2023, 165.8 thousand people were employed in tech-related positions outside the tech sector (i.e., technology employees in non-tech industries). This number increased by 45 thousand jobs over the decade – a significantly slower growth rate compared to tech-related roles within the tech sector.

High-tech Production:

In 2023, the high-tech sector’s share of Israel’s total output reached nearly one-fifth (19.7%) – around 340 billion shekels. The high-tech sector’s share of Israel’s GDP in 1995 was 6.2% – meaning its relative share has tripled over a period of almost three decades. At the same time, the value of high-tech output grew by more than ninefold in real terms.

Exports:

The high-tech sector accounted for 53% of Israel’s exports in 2023 – $73.5 billion. This proportion has remained consistent in recent years – in three out of the last four years, high-tech exports were above 50% of Israel’s total exports.
The main growth in high-tech exports stems from the expansion of exports by companies in the IT services sector, primarily software companies. In contrast, exports by industrial companies, including those in security, hardware, and pharma, have maintained their size over the past decade (around $20 billion per year).

Investments:

Israeli technology companies raised around $8 billion across 512 funding rounds in 2023 – a decrease of about 55% compared to the total funding raised in 2022. The main decline was in advanced funding rounds, of over $50 million, although the average round size remained similar to recent years.
60% of investments in Israeli startups in 2023 were in three leading sectors: cybersecurity, fintech, and enterprise software, marking a 53% increase from 2022.
The majority of private market investments in early-stage rounds, up to $10 million, were in software (over 70%). Conversely, government investments in the high-tech sector, primarily by the Israel Innovation Authority, focus mainly on life sciences and climatech (energy, water, foodtech, and agritech).
In 2023, there was a noticeable trend of decreasing funding rounds for startups, which began in the second quarter of 2022. Quarterly fundraising totaled around $2 billion for the year. Based on current data, quarterly fundraising in the first half of 2024 is expected to exceed this amount.
The number of fundraising rounds continued to decline throughout 2023 and into the first quarter of 2024, reaching the lowest quarterly number since 2017.
Fundraising for venture capital funds in Israel decreased by 70% in 2023 compared to the average fundraising from 2018 to 2022, contrasting with a 30%-40% decline in other hubs worldwide that were examined.