Land of tech and honey: Israel is a quiet leader in many tech fields, and is exporting much of its innovation.

In Tel Aviv, Israel's hippest city, you won't see the usual signs of technological sophistication--the giant skyscrapers, digital billboards and neon lights of New York or the sleek buildings and sprawling campuses of Silicon Valley. For all the cell phones jangling on street corners and all the Internet cafes dotting the streets around Dizengoff Circle, Tel Aviv looks positively quaint by Western standards. Even the brown awning that hangs over the entrance to the Tel Aviv Stock Exchange looks more like an old movie house marquee than the billboard of a major financial center.

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But looks can be deceiving, as Yadin Kauffman of the Israeli venture capital firm Veritas Partners is quick to point out. "Let's remember that the archetypal place to run a high-tech company is in your garage," says Kauffman, who was a manager of Israel's first venture capital fund, Athena Venture Partners, in 1985.

Kauffman and other VCs saw plenty of those during the Israeli tech boom of the late 1990s, which earned Israel the nickname of "Silicon Valley East." The country known best for olive trees, orange groves and ancient religious shrines spawned hundreds, of high-tech start-ups as capital poured in from investors around the globe, and Israel's venture pool rocketed to $7.5 billion in 2000 from just a few million dollars 10 years earlier.

Then came two coincidental calamities: the resumption of the Palestinian intifada and the fall of the Nasdaq, to which Israel's tech sector is tightly connected. Investors pulled out of startups and the economy spiraled in 2001 and 2002. Add to that "the collapse of three Israeli governments, three Palestinian prime ministers and the war in Iraq," says Cliff Goldstein, president of Amidex 35, a fund that invests in the top 35 publicly traded Israeli companies, "and it should have put Israel out of business."

But the economy began rebounding in 2003, and despite the violence and political unrest, innovation continues to flourish. It's evident in the numbers: The Tel-Tech 15--the 15 largest high-tech shares traded on the Tel Aviv Stock Exchange--soared 129 percent in 2003 and was up another 11 percent by mid-2004. Israel's benchmark index, the TA100, shot up 62 percent in 2003 and was up 6.5 percent mid-year, although a cooler summer eroded some of that gain.

The numbers tell only part of the story. More instructive is a look at the high-tech and medical industries; Israel has a major player in many of them. Teva Pharmacenticals is one of the world's largest generic drug makers as well as an innovator of drugs for neurological and auto-immune diseases. The $3.8 billion company reported record results in the second quarter, and has been relentlessly dogging drug companies like Pfizer and GlaxoSmith Kline with cheaper versions of their products. Amdocs, a $1.7 billion provider of customer relationship management software, has solidly wedged itself into the back-office fabric of the big telecommunications companies, with a customer roster that boasts most major Bells in the West and phone companies across Europe and Asia. Check Point Software leads the network security sector, despite encroachment by Nortel Networks and Microsoft. And newer companies such as $45 million Given Imaging, which in 1998 came out with the first ingestible disposable video camera for viewing and diagnosing the small intestine, has three more products awaiting FDA approval and more than 120 patents and patents pending in the U.S.

"If you opened up a lot of the leading technology developments in communications, software and the medical area, you'd find Israel inside," says Kauffman.

Many of the major tech players in the U.S., such as Microsoft, Intel, IBM, Hewlett-Packard, Nokia and Motorola, to name just a few, also have outsourced R & D to their centers in Israel. Yet Israel has so little brand recognition as an R & D host country, at least in the U.S., that products developed here don't tend to sport the "Made in Israel" label. Few know, for example, that Intel's new Centrino chip was designed in Israel, although the silicon maker has had R & D operations there since 1974 and now houses its entire mobile technology design center in Israel. The same is true for products made by Israeli companies. Kauffman blames a lack of branding expertise. "Branding is not one of our strengths here," he says.

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Given the controversy surrounding the Israeli-Palestinian conflict, many companies may simply be wary of having their technologies or products become associated with that region. For their part, Israeli CEOs typically identify their companies as global, since Israel represents only a tiny fraction of their overall businesses. Amdoes serves Israel's three largest telecommunications carriers. "But it's less than 2 percent of our worldwide revenue," says Dov Baharav, CEO of the software company based in Ra'anana, just north of Tel Aviv and home to many high-tech companies and VCs. The majority of Amdocs' revenue, or 65 percent, comes from North America, where it has a significant presence with headquarters in St. Louis; about 30 percent comes from Europe and the rest from various other countries. The company's main R & D center, however, remains in Israel.

Amdocs spends $120 million annually to develop and enhance its CRM and billing software products, which aim to seamlessly link all customer-facing business processes, such as marketing, sales, ordering, fulfillment, billing, service and support. Phone companies have not typically won awards for their high levels of customer service, but Baharav's customer-obsessed sales pitch seeks to convince CEOs that they ignore CRM at their own peril.

"We see substantial progress in most of the large carriers with substantial investment in this area," he says. "The way they will make money is not just by land-grabbing or increasing the number of subscribers, but mainly by holding onto existing customers and selling more to them. "Customers that have gotten on board with Amdocs include British Telecom, Japan Telecom, Cable & Wireless, Denutsche Telekom, Sprint, Verizon and Bell Canada. The company has plans to migrate its solutions to the financial industry, although Baharav notes that with the customer care and billing industry at about $40 billion for telecom alone, Amdocs has plenty of room to grow within that sector.

Inspiration Despite Chaos

While Israel represents only a fraction of business, it is home to 40 percent of Amdocs' work force, and, despite the chaos of the past few years, Baharav doesn't see that as a liability. "We have a large development center in St. Louis and we are losing on average two to three days of work every year there, but we have not lost even one day of work in Israel," says the CEO, who shrugs off the notion that Israeli employees might be more distracted or less motivated because of the threat of terrorism. "Maybe it's the other way around," he muses. "We feel one of the main assets of the country is the center in Israel."

Teva Pharmaceuticals CEO Israel Makov agrees. "On the face of it, it makes sense" to assume Israelis would be more distracted from the company mission, Makov says, sitting in his understated office at Teva's headquarters in Petah-Tikva, a sleepy suburb just a few miles northeast of Tel Aviv. But like other Israeli CEOs, Makov points out that the reality of life in Israel is very different from the external perception. "For a tourist who reads the paper, it looks terrible," he says. "But we've grown accustomed to living in this environment." If anything, Makov adds, the political and military tension keeps citizens alert. "There's a lot of inspiration here," he argues.

Makov relies on that inspiration for the development of both Teva's innovative drugs, such as Copaxone for the treatment of relapsing-remitting multiple sclerosis, and its generics. The Israel-based R & D center has managed to stay in lockstep with innovative drug companies, keeping its pipeline full of generics waiting to pounce. "We differentiate ourselves from other companies in that we have both innovative and generic business under one roof," he says, adding that the two sides share information and research freely.

A full 90 percent of Teva's $3.8 billion in sales come from North America (64 percent) and Europe (26 percent), with the rest from Israel and other countries. But while most of the sales force is concentrated in the West, Teva's chief R & D is housed in Israel, where it benefits from uniquely close collaboration among the medical and scientific communities. Scientists at the 103-year-old Teva have direct access to the research going on in Israel's top institutes, hospitals and university labs. "We know the important scientists in this country by their first names," says Makov, noting that Israel boasts more patents per capita than almost any other country in the world.

In looking at Israel's high concentration of science and technology, observers also credit a better-than-average government-funded educational system and the absorption of roughly a million former Soviet emigres, many of whom brought highly specialized science and technology backgrounds. "The country is a Petri dish for innovation," says Amidex's Goldstein.

The government also funds military R & D, which has led both directly and indirectly to innovation in the tech and medical sectors. Because everybody in Israel serves in the military at some point, the majority of Israelis have had--for good and for bad--vastly different experiences from their counterparts in the U.S. and Europe by the time they're 23, says Veritas Partners' Kauffman, a U.S. native who moved to Israel in 1985. "The Israeli may have been managing dozens of people, a budget of tens or hundreds of millions of dollars, having to develop technology under tremendous pressure and under difficult conditions," he says. "The typical, bright 23-year-old American has spent a few years in college and maybe one year working somewhere at fairly low levels of responsibility."

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Turning Missiles Into Medicine

High-tech military innovation has made its way not only into network security software and telecommunications, but medical technology as well. At Given Imaging, the engineer who designed the Capsule Endoscope, Gavriel Iddan, was working in the missiles division of RAFAEL, which researches and produces weapons and other military technology for the Israeli Defense Agency. "[Iddan] was thinking about how to take that technology and benefit mankind rather than for the purposes of war," recalls CEO Gavriel Meron. "I think that in a nutshell puts into perspective where we are in Israel. We fight to survive--but that is not what we want to do. What we want to do is that innovative stuff that really makes a difference in people's lives."

So far, the pillcam has reached consumers on every continent and the company, run by senior managers with long careers at Kodak, 3M and Olympus, has operations in the U.S., Germany, France, Japan and Australia.

Its R & D remains in Israel, and specifically in Yoqneam, at the base of the Carmel mountain range near Haifa. Given has already signed a deal to have its second product--an esophageal capsule still awaiting FDA approval--marketed by Johnson & Johnson exclusively. "So we have another sales force plugging our workstations and platform, which is a very good place to be," says Meron.

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Meron says he hasn't penned deals for two upcoming products--a pillcam for the stomach and another for the colon--but insists he feels comfortable using his own sales force. That may work, given the high demand for the product. But for most Israeli companies, partnerships with U.S., European and Asian companies are a must. Aside from the few Israeli businesses that sell product internally, the vast majority rely heavily on exports and have been forced to think globally from day one. "We're kind of spoiled in America, because exports are nice and sometimes profitable, but there are 250 million consumers here you can focus on," says Goldstein. "Israel doesn't have 250 million consumers, so if it wants to grow mega-companies with world-changing ideas and technologies it's a foregone conclusion that it will have to export."

As Israeli companies gain global experience, many CEOs have recognized the importance of local management in foreign regions. Like Amdocs and Teva, Given Imaging employs local nationals to run its foreign operations. "A person from the country understands that country better than anyone else," says Meron, adding that the leaders of each geographic operation meet virtually--either by phone or video-conference--every week.

It may well be that dominance of local leadership and the acutely global focus that have obscured the the Israeli brand. But it's hard to ignore the fact that doing business in Israel has hardly been free from controversy. Companies such as Home Depot, Starbucks, Intel, Nokia and Revlon have all been targeted for boycotts for selling to or partnering with Israeli companies. In the latest example, the U.S. Presbyterian Church in August voted to divest investment funds from companies doing business in Israel.

Teva's Makov, like Given Imaging's Meron and Amdocs' Baharav, says he has not experienced any such negative repercussions. But he admits that Israel is somewhat hampered, with huge resources being diverted to defense that could be spent on industry and commerce--if there were peace. "We have a huge potential, a huge reservoir of talent," he says. "Once we have peace we will have many more global companies like Teva." But until that elusive peace arrives, the Israelis will continue to tap international technology markets and American companies will continue to draw upon the country's innovative power. All very quietly.

RELATED ARTICLE: Q & A

Made in Israel

Gavriel Meron, CEO of Given Imaging, creator of the first pillcam, recently spoke with Chief Executive.

How did you convince investors that technology first developed in the military would work for the pillcam?

Initially, it was a very high-risk venture. It wasn't clear to anyone, or to me, that a capsule that passes autonomously through the body can transmit any meaningful information. It had never been done, and this is the type of thing that before you do it, you don't know; you just can't simulate a free-floating capsule until you have one. So someone really had to put in risk money and that was a difficult challenge to get people to do that. But the upside was clearly huge if it did succeed and the actual amount of money needed--$700,000 initially--was small.

Have you ever encountered resistance from investors or partners because of the connection to Israel?

I haven't felt that in any of my dealings. We don't flaunt it. Everyone knows we're an Israeli company, but in the countries around the world, the distribution is always a local, domestic company. Since this product is unique and is required all around the world, we have constant requests, including from companies we don't deal with.

Is it true that some companies play down their Israel base?

I can't really speak for the whole business community. I can say from our point of view, we're proud to be an Israeli company. If someone doesn't want to deal with us because of that, then we won't do that deal and it's a price we'll have to pay. But, to this point, I haven't seen us pay that price.