Will Fragmentation Doom Europe to Another Lost Decade?

European Straits #156

Hi, it’s Nicolas from The Family. Today, I’m reflecting on how fragmented Europe is, and how what used to be an asset has turned into a liability.

This week, I wanted to draft a 10-point manifesto on European tech to prepare the ground for launching a paid version of this newsletter. I logically started by reflecting on fragmentation and how to overcome it, and then realized that fragmentation alone deserved an entire issue of European Straits. So the manifesto will wait a bit, and you can enjoy an in-depth discussion about fragmented Europe.

Read along, and then let me know what you think  👇

1/ The key reason why Europe is lagging behind in the Entrepreneurial Age is the fragmentation of the continent. It extends across many dimensions:

  • It’s about languages. There are dozens of different languages spoken across Europe, and the proportion of Europeans able to communicate in English is much lower than people think. This makes it difficult to build startups with a truly pan-European footprint.

  • It’s also about regulations. There’s a thing called the European Single Market, but it exists only in certain industries such as manufactured goods and financial services. This means startups that aren’t in those industries have to comply with demanding legal frameworks that differ from one country to another.

  • Finally, it’s about culture. Even when they’re able to use a common language, people from various European countries have very different cultural backgrounds. It complicates informal communication and creates frequent misunderstandings within the workplace.

2/ This multi-dimensional fragmentation creates problems on all sides of building business ventures in the Entrepreneurial Age. Take the European market for talent:

  • On a personal level, it’s complicated for, say, a French manager to hire and manage a German employee—and vice versa. And from an organization’s perspective, once you’ve started building a team that’s dominated by one nationality, it becomes extraordinarily difficult to attract and retain people from other countries. Cultural barriers are simply too high, and language is obviously a problem (a large group of fellow citizens will tend to reverse back to their native tongue rather than English).

  • It’s also complicated to move people around, as it’s hard to convince talented people to move from one large European city to another. It’s not that European cities are not attractive, but there are simply too many practical obstacles to an individual moving (like finding an apartment, a job for your spouse, and a school where your children will be taught in their language or, at minimum, in English). Pre-Brexit London might be the exception here, but it can only lose ground from here (Amsterdam might replace it as the major European tech hub).

  • One potential source of aid is the rise of distributed work, in which I’m a firm believer and that we practice at a The Family, but opting for this approach doesn’t solve every problem. Consider employee equity, the regulations regarding which depend on where the employee is located, not where the company is headquartered: the more distributed the team, the more complex the legal details. And that’s just one of the many problems with distributed work. (Others are documented in depth in this ebook How to Manage Scattered Teams.)

3/ Another front on which fragmentation creates problems is fundraising:

  • Despite what they say, venture capital remains a local business. As a founder, it’s easier to raise capital from a firm that belongs to the same local ecosystem as you. And as an investor, it’s hard to build a brand and connect with the best founders if you don’t spend most of your time on the ground in the same city as them.

  • Then there is the fact that many European VC firms have their national government as an LP, usually via a public investment bank of sorts, which usually comes with an obligation to invest primarily in local ventures. So even if the partners and principals are prepared to travel, they still have a big constraint that holds them to their local market. 

4/ Finally, the European continent is fragmented from a customer perspective:

  • Few people realize it, and even fewer understand the reason why. We’re all blinded by products that have long been distributed at a seemingly global scale—the commodities, manufactured goods, Hollywood movies, and apps that are used by billions across the world. But the reality of tech-driven products is that they are so deeply linked to a customer’s private life that they have to account for cultural specificities. So many of them are not that scalable after all!

  • In a way, it’s a bit like cuisine. Most cuisines from all over the world taste good (trust the late Anthony Bourdain on this one). But exporting a cuisine to another market always takes complying with local specificities. Likewise for tech applications and experiences: they might be good, but you really need to fit the local culture if you want your product to be purchased. (By the way, that’s true for enterprise products as well as for consumer products.) 

5/ The persistent fragmentation explains why European tech is lagging behind. Because of the core features of increasing returns to scale, tech businesses have a critical need to reach a very large scale if they want to be profitable and win out over competitors. If European entrepreneurs encounter barriers on all three fronts of building a business (customers, talent, and capital), they can’t grow as quickly and steadily as their competitors from the US and China. And some things are even getting worse, as we’re now having to let go of a hub that concentrates all the capital (which was London, but with Brexit comes the end of freedom of movement and a likely divergence in financial regulations).

6/ Here’s an enigma, however: historians teach us that fragmentation is what made Europe strong and prosperous in the past. So why is that long-time asset now a liability? To understand the reasons, we need to go back in time. In Guns, Germs & Steel, Jared Diamond explains why fragmentation once helped Europe rise as the main Eurasian power at the expense of China, which was much more monolithic than fragmented Europe and thus depended on the (occasionally stupid) decisions of a single sovereign:

Christopher Columbus, an Italian by birth, switched his allegiance to the duke of Anjou in France, then to the king of Portugal. When the latter refused his request for ships in which to explore westward, Columbus turned to the duke of Medina-Sedonia, who also refused, then to the count of Medina-Celi, who did likewise, and finally to the king and queen of Spain, who denied Columbus’s first request but eventually granted his renewed appeal. Had Europe been united under any one of the first three rulers, its colonization of the Americas might have been stillborn.

7/ The key finding here is that Columbus could play on the fragmentation to generate competition between potential sponsors for his venture, and importantly he wasn’t limited by the fragmentation when it came to growing the venture itself. Alas the situation is very different these days:

  • Whereas Columbus had no problem shopping for capital all across the continent, today’s startup founders are much more provincial. Imagine a French founder trying to convince VCs in Warsaw, then Copenhagen, then Barcelona, then Milan to back them. That simply doesn’t happen. Even if they made the effort of travelling there, the meetings would probably not happen (or there would be no follow up).

  • When he finally pulled it off, Columbus managed to find all the talent and capital he needed in one single place—in this case, he raised funds in Córdoba, where he dealt with Ferdinand and Isabella of Spain, and he likely hired most of his crew in Andalusia. Today, you can’t rely on one ecosystem only to staff a fast-growing tech company at a large scale.

  • Finally, Columbus didn’t depend on having access to multiple local markets for his venture to be successful. Discovering the Americas was enough to make his fortune as the Spanish crown, which had sponsored the expedition, was also his sole customer. Yet today a European startup will never become a tech giant if it doesn’t expand and conquer several markets across the continent (or in the US, or in Africa).

8/ By the 19th century, though, things had shifted. Inventors and entrepreneurs were still able to criss-cross Europe (which was then more open and cosmopolitan than today, at least for those who could afford it), but the scale and ambition of entrepreneurial ventures following the Industrial Revolution required amounts of capital that needed to be pooled from several places. This explains the emergence of pan-European haute finance epitomized by the Rothschild family, which formed a network across London, Paris, Frankfurt, Vienna, and Naples. Today we need the equivalent of Nathan Mayer Rothschild (who was in London) and his four brothers, but for financing European tech companies: financiers that are able to pool capital from all over Europe and beyond to finance the most ambitious European tech ventures, wherever they’re headquartered and whatever country their founders come from.

9/ You could argue that the VC industry is becoming more like the House of Rothschild, that is, pan-European rather than local. I agree, and it’s good news indeed. But we still need European entrepreneurs to become more like Columbus: eager to shop around, even to relocate if necessary:

  • Here’s the inspiring example of Malt’s Vincent Huguet: I am moving to Munich. Another one is that of Antonin Cohen, of our portfolio company Harmony, which I documented here: Will Europe Miss the Cannabis Opportunity, Too? 🍁 In both cases, moving was a bold move that came with efforts and sacrifices.

  • If you want to play it like those entrepreneurs, you need to convince your whole family (including any potential spouse and children) to follow, then you need to find someone to replace you at the helm of the parent organization (or relocate your entire organization), and then you need to dive into a different country so as to master a different context and conquer a different market.

10/ This is the main conclusion that we should draw when reflecting on Europe’s fragmentation:

  • You don’t really need to be a Columbus shopping for capital anymore, because capital is on its way to being distributed, even integrated, at the pan-European level. Soon enough, European VC will function more like the Rothschild family than the royal courts of the 15th century.

  • And we can be confident that, in time, you won’t need to shop for talent, either: the management of distributed teams will become easier, and the rise of successful European tech giants will inspire a common culture that, in time, will facilitate talented people joining growing tech companies in Europe.

What we really need today is entrepreneurs that move around like Columbus in order to overcome the strongest barrier of all: the fragmented market for customers (whether consumers or enterprises). It’s an uphill battle because:

  • Europeans are typically unaware of and uninterested in what’s happening in other European countries. As I mentioned in this article by Sarah J. Robbins, Forward to the Past, “In everyday life, you are where you are, and you watch your TV in your language. Weather reports in France are a map of France; we don’t care that it’s raining in the UK.”

  • European governments don’t have policies that encourage entrepreneurs to move. Rather, they’re focused on convincing outside entrepreneurs to come settle with them—and with Brexit, it’s bound to become even worse. But we need the European equivalent of Jiang Zemin’s “Go Out policy”—or an upgraded version of Joe Studwell’s “export discipline”, in which European governments would support local tech champions only if their founders partially relocate abroad so as to establish a foothold on other European markets (or beyond).

The fragmentation is bound to get worse before it gets better—if only because it’s the entire world that’s currently going through a fragmentation process. Over the long term, I’m certain it will force Europe to rediscover itself and embrace its constraints, and so fragmentation will turn into an asset. Let me leave you with this enlightening tweet by Peter Zeihan as a conclusion 👇

Please scroll down for a comprehensive reading list on fragmented Europe.

📣 Our own efforts at overcoming fragmentation at The Family include outreach to ambitious founders, no matter where they’re currently living. My colleague Irina Nikolovska is publishing a series of articles explaining the philosophy and mindset that underlie The Family, with versions in English, German, Serbian, and more. The first was published yesterday (in 🇬🇧), with translations and the rest of the series coming soon. Stay tuned!

🦁 My cofounder Oussama Ammar is a master of the pitch, because he knows it’s not just a question of turning it on when you’re on stage; instead, it’s about pitching simply being part of your daily life. He wrote about some of the big mistakes to avoid as you go around talking about your startup to every audience you can find: 3 Mistakes That’ll Kill Your Pitch.

🇫🇷 Finally, if you’re in Paris tomorrow, I’ll be holding the first of a series of talks (in French) marking the new French edition of my book Hedge, this time published by Éditions Odile Jacob under the title Un contrat social pour l’âge entrepreneurial. I’ve reworked and updated the text, and will be talking about how the social safety net has been evolving since the first edition was published almost 2 years ago. Get your ticket here: Nos Jours heureux : Nicolas Colin présente la version française de Hedge.

Here are more readings about fragmented Europe:

From London, UK 🇬🇧