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4 Steps to Harnessing the Arab Startup Revolution

McKinsey & Company: McKinsey on Society

The Takeaway: The author of Startup Rising: The Entrepreneurial Revolution Remaking the Middle East explains four steps Arab governments and communities can take to leverage the digital start-up revolution in the region.

Of the countless “aha” moments I have had while studying entrepreneurship in the Arab world, few impressed me more than the first mobile spectrum auction in Morocco in 1998. The Moroccan government expected the auction to raise $50 million to $70 million. Moroccan officials were stunned when the first bid came in at $1 billion.

The lesson? Government officials looked backwards and concluded that mobile telephony was a luxury toy. Meanwhile, businesses looked forward and saw a world where everyone uses mobile devices. Today, most countries in the Arab world have more than 100 percent mobile penetration, because many of their citizens own more than one device. As a result, the face of political, business, and social activity has changed for good.

Two years after the Arab uprisings, political repression and civil strife are alive and well in affected parts of the Middle East. Behind the grim headlines, however, a quieter revolution has begun to emerge, one that might ultimately do more to change the face of the region: tech-enabled entrepreneurship. A new generation of Arab entrepreneurs isn’t waiting for public institutions to solve traditional problems or create business opportunities. Instead, they are using technology to address them now.

They are inventing apps to crowdshare navigation of traffic-clogged Arab cities and creating online platforms to crowdfund start-up ideas. They are launching video platforms offering classes in languages, math, and computer programming to supplement often-inadequate formal education. They are building enterprises that use solar energy to add arable land or create fresh water. They are testing countless initiatives in health and wellness.

The Arab world has a collective GDP the size of India’s and per-capita GDP nearly twice that of China. To reach the region’s growing population of digitally savvy consumers, local entrepreneurs are building e-commerce capacity and innovating in mobile payments. With the world one click away, entrepreneurs who were once confined to local markets can reach virtually any market connected to the Internet.

When I ask US and Arab officials how they plan to engage with the Arab start-up revolution, I am frequently greeted with blank stares or token gestures. For decades, local and international officials have applied a command-and-control mindset to the Arab world. They live in a top-down world of mass programs and bureaucratic machinations. They are unclear what to do in a bottom-up world where millions of citizens have instant access to each other and nearly all the world’s knowledge. Crucially, officials often fail to understand the implications of these shifts for economic growth and job creation in the region.

Local and international officials often pay lip service to the importance of promoting entrepreneurship in the service of growth, job creation, and social progress in the Middle East. It’s time for them to start walking the talk. Here are four steps that Arab governments and the international community can take right now to leverage the digital startup revolution in the region.

1. Loosen trade restrictions

E-commerce is set to explode in the Arab world, where consumers now spend more than $1 billion a year online. This figure is expected to double within two years. To give a sense of the opportunity here, offline retail sales in the Arab Middle East total about $425 billion a year. However, each country in the region has its own obscure, cumbersome, and costly shipping regulations. Moving goods between Arab countries is like launching in the United States if every state had its own customs bureaucrats checking each package and adding fees and taxes at every step.

One promising sign is that the member states of the Gulf Cooperation Council have agreed to loosen restrictions on trade between members. The next step is a region-wide convention to streamline the movement of goods and services throughout the Middle East. Such an agreement would quickly increase trade volumes in the region, to the benefit of entrepreneurs and consumers alike.

2. Encourage the free circulation of knowledge and ideas

The Arab world urgently needs a system to transfer promising technology developed in universities and other research institutions into the start-up ecosystem. For example, universities in Gulf countries are developing advanced solar-power and desalinization technology. What’s missing is the web of connections among research labs and the start-up community that one finds at MIT or Stanford.

Another problem is that Arab countries generally lack investment laws designed to encourage tech-based innovation. The legal picture is not entirely bleak. For example, it’s easier to enforce a contract in parts of the Arab world than it is in many East Asian countries. Yet most countries in the region lack clear and coherent legal protections for real and intellectual property rights. Most Arab countries restrict financial flows, making it difficult for businesses to repatriate capital. Laws that criminalize bankruptcy tend to stifle the ability of entrepreneurs to fail quickly and then restart. Such restrictions deter entrepreneurs and investors from pursuing new ventures in the Middle East.

3. Modernize regulatory regimes

Some of the most interesting mobile payments startups I’ve seen anywhere are in the Middle East. But Arab entrepreneurs have told me that government permitting institutions can’t move fast enough to keep up with them. In most Arab countries, separate bureaucracies regulate telephony, banking, domestic transactions, and foreign transactions. Yet mobile payment technology touches all these sectors. By updating regulatory regimes so that they reflect 21st century economic realities, Arab governments can help accelerate the growth and impact of innovative tech companies.

4. Facilitate risk protection for early stage investors

In an effort to encourage foreign direct investment in emerging markets, large aid institutions such as the US Overseas Private Investment Corporation and the World Bank have long offered debt financing and political-risk insurance for companies that invest in these markets. While not everyone agrees about the overall efficacy of these programs, risk-mitigation products have certainly helped a number of Western companies reach middle-class consumers in the Middle East and other emerging markets that combine economic potential and political volatility.

However, start-ups rarely qualify for debt financing, and multilateral aid organizations are often ill-equipped to support equity investment. Moreover, the amounts required to launch a typical tech start-up are much smaller than these institutions are used to disbursing. I encourage multilateral aid organizations to support the emerging Arab start-up economy by focusing on “bottom up” investment products and strategies.

Looking ahead

I can’t predict how the politics of the Middle East will unfold over the next three years, or even the next three months. I can say with virtual certainty that there will be many more Arab consumers carrying the computing power that put a man on the moon in their pockets. Every mobile operator I have met expects 50 percent smartphone penetration across much of the Middle East within three years. Many Gulf states have already surpassed this level.

As a result, the nature of problem solving in the Arab world will change dramatically. We will see more bottom-up innovation that challenges the technical and regulatory capacities of governments and other large institutions. In my view, these institutions are missing a generational opportunity to embrace new drivers of economic growth and job creation. As a matter of common sense, Arab officials and the international community should listen and adapt to the needs of start-up entrepreneurs across the Middle East. As a mentor of mine wisely noted, however, common sense is not that common.

Originally Published at McKinsey on Society, November 26, 2013. 

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