Australia is not prepared for a future of global disruptors.

We will have to be the best in the world at what we do if we are to survive the AI era, and there are cases for optimism and pessimism.

In business, there is nothing more exciting than a talented group of founders with a shared vision who succeed in building a business that has enormous impact. Disruption is a powerful force that positively impacts society. Innovative companies are making an incredible contribution to society by saving lives, providing solutions to some of our society’s most pressing problems or offering products and services that provide great utility. Those societies that innovate will reap the benefits while there will be significant headwinds for countries that don’t embrace innovation.

Historically, innovation has built upon a specific technological development, such as the invention of the printing press, steam engine or electricity. In our era, the primary form of innovation is via software-enabled business models that are immediately accessible to the entire world via the ubiquity of the Internet. Venture capital-backed start-ups, founded by visionary entrepreneurs with the self-belief and capability to transform their ideas into important businesses, are generating much of this innovation.

Australia must produce a large cohort of start-ups that become the best in the world at what they do.

There are two key themes which create the imperative for Australia to become more innovative. Those themes are the primacy of global businesses and the rise of Artificial Intelligence (AI).

Many of the biggest problems in the world today are being solved by software-enabled business models that are winning globally, not locally. We shop on Amazon, share photos on Instagram, book accommodation on Airbnb and search on Google.

If we reflect on the Australian economy over the last two or three generations, many of our biggest companies – our big banks, major retailers and manufacturers - have been the best in Australia rather than the best in the world at what they do. These are our “national champions”. However, in a software-enabled world, you frequently need to be the best in the world to have a successful business. As a result, many of these companies will be disrupted over the next decade as more and more industries are transformed by software enable business models.

Why do global businesses so frequently beat local businesses in a world of software-driven business models? The Internet enables global access and near-zero costs of distribution, but the scale required in technology spend can be enormous. As an example, Google spends over $US20b on R&D each year. Further, technology companies frequently have high fixed costs and low incremental costs. The marginal cost of adding a new customer is very low. As these businesses expand, they become extraordinarily profitable, and because of the benefits of scale and network effects, market leadership can often be self-reinforcing. This leads to a winner-takes-most outcome in many markets.

Due to our reliance on our “national champions”, Australia is particularly vulnerable to the impact of technology disruption and the emergence of these global giants.

The second key theme occurring is the rise of AI and the increased automation in the workplace. In all parts of the world, we will see jobs disappear due to the impact of AI. However, the bulk of the new highly productive jobs that are generated will be created in most innovative places in the world. For example, Facebook is the second-largest media company in Australia and generates billions in revenue each year from Australian companies, yet it employs about 200 people in Australia compared to about 15,000 people at its head office in Silicon Valley. We need many local companies to become the best in the world at what they do and create the new jobs that our society will require to replace the jobs that will disappear.

Depending on your perspective, there is a case for optimism and a case for pessimism.

We have seen some positive signs in Australia over the last 5-10 years. We are seeing more talented entrepreneurs start businesses and they are increasingly focused on being global rather than local in outlook. We also see more venture capital available to support these entrepreneurs. As a result, we have seen a very significant increase over the last few years in the number of Australian start-ups that have scaled into large companies. By our estimates, the formation of new companies that have the potential to evolve into global successes is occurring at a rate which is 2-3 times faster compared to 10 years ago.

However, we are not the only country that is aware of the imperative of becoming more innovative. Other countries are focused on the same goal, and we need to be moving forward rapidly to be gaining a source of competitive advantage. In their recent report “Australia’s Digital Opportunity” by AlphaBeta they identified that our technology sector contributes 6.6% of Australian GDP and employs 5% of Australia’s workforce and underpins innovation and productivity growth. However, they also found that Australia’s Gross Value Add of Information and Communication Technology industries is about half the level of our peers and is the second-lowest in the OECD, measured as a percentage of GDP. We are a long way behind where we need to be if Australia is to continue to thrive in the twenty-first century.

Our extraordinary track record of 28 years (and counting) of continuous economic growth masks a complex reality.

In the future, success as a nation will be based on different factors to success in the past, and we are not well prepared for a highly disruptive world of global software-driven business models. Australia has a burning platform, but we haven’t yet absorbed that reality.

This article first appeared in the Australian Financial Review, and was adapted from a letter to Square Peg Investors from July 2019.

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Square Peg Capital Pty Ltd (ACN 164 352 229) is an Authorised Representative of Victoria Capital Pty Ltd (ACN 159 228 314) AFSL 428989