Start-up Nation

CHAPTER 1 Persistence

SCOTT THOMPSON LOOKED AT HIS WATCH.[26] He was running behind. He had a long list of to-dos to complete by the end of the week, and it was already Thursday. Thompson is a busy guy. As president and former chief technology officer of PayPal, the largest Internet payment system in the world, he runs the Web’s alternative to checks and credit cards. But he’d promised to give twenty minutes to a kid who claimed to have a solution to the problem of online payment scams, credit card fraud, and electronic identity theft.

Shvat Shaked did not have the brashness of an entrepreneur, which was just as well, since most start-ups, Thompson knew, didn’t go anywhere. He did not look like he had the moxie of even a typical PayPal junior engineer. But Thompson wasn’t going to say no to this meeting, not when Benchmark Capital had requested it.

Benchmark had made a seed investment in eBay, back when it was being run out of the founders’ apartment as a quirky exchange site for collectible Pez dispensers. Today, eBay is an $18 billion public company with sixteen thousand employees around the world. It’s also PayPal’s parent company. Benchmark was considering an investment in Shaked’s company, Israel-based Fraud Sciences. To help with due diligence, the Benchmark partners asked Thompson, who knew a thing or two about e-fraud, to check Shaked out.

“So what’s your model, Shvat?” Thompson asked, eager to get the meeting over with. Shifting around a bit like someone who hadn’t quite perfected his one-minute “elevator pitch,” Shaked began quietly: “Our idea is simple. We believe that the world is divided between good people and bad people, and the trick to beating fraud is to distinguish between them on the Web.”

Thompson suppressed his frustration. This was too much, even as a favor to Benchmark. Before PayPal, Thompson had been a top executive at credit card giant Visa, an even bigger company that was no less obsessed with combating fraud. A large part of the team at most credit card companies and online vendors is devoted to vetting new customers and fighting fraud and identity theft, because that’s where profit margins can be largely determined and where customer trust is built or lost.

Visa and the banks it partnered with together had tens of thousands of people working to beat fraud. PayPal had two thousand, including some fifty of their best PhD engineers, trying to stay ahead of the crooks. And this kid was talking about “good guys and bad guys,” as if he were the first to discover the problem.

“Sounds good,” Thompson said, not without restraint. “How do you do that?”

“Good people leave traces of themselves on the Internet—digital footprints—because they have nothing to hide,” Shvat continued in his accented English. “Bad people don’t, because they try to hide themselves. All we do is look for footprints. If you can find them, you can minimize risk to an acceptable level and underwrite it. It really is that simple.”

Thompson was beginning to think that this guy with the strange name had flown in not from a different country but rather a different planet. Didn’t he know that fighting fraud is a painstaking process of checking backgrounds, wading through credit histories, building sophisticated algorithms to determine trustworthiness? You wouldn’t walk into NASA and say, “Why build all those fancy spaceships when all you need is a slingshot?”

Still, out of respect for Benchmark, Thompson thought he’d indulge Shaked for a few more minutes. “So where did you learn how to do this?” he asked.

“Hunting down terrorists,” Shaked said matter-of-factly. His unit in the army had been tasked with helping to catch terrorists by tracking their online activities. Terrorists move money through the Web with fictitious identities. Shvat’s job was to find them online.

Thompson had heard enough from this “terrorist hunter,” too much even, but he had a simple way out. “Have you tried this at all?” he asked.

“Yes,” Shaked said with quiet self-assurance. “We’ve tried it on thousands of transactions, and we were right about all of them but four.”

Yeah, right, Thompson thought to himself. But he couldn’t help becoming a bit more curious. How long did that take? he asked.

Shaked said his company had analyzed forty thousand transactions over five years, since its founding.

“Okay, so here’s what we’re going to do,” Thompson said, and he proposed that he give Fraud Sciences one hundred thousand PayPal transactions to analyze. These were consumer transactions PayPal had already processed. PayPal would have to scrub some of the personal data for legal privacy reasons, which would make Shvat’s job more difficult. “But see what you can do,” Thompson offered, “and get back to us. We’ll compare your results with ours.”

Since it had taken Shvat’s start-up five years to go through their first forty thousand transactions, Thompson figured he wouldn’t be seeing the kid again anytime soon. But he wasn’t asking anything unfair. This was the sort of scaling necessary to determine whether his bizarre-sounding system was worth anything in the real world.

The forty thousand transactions Fraud Sciences had previously processed had been done manually. Shaked knew that to meet PayPal’s challenge he would have to automate his system in order to handle the volume, do so without compromising reliability, and crunch the transactions in record time. This would mean taking the system he’d tested over five years and turning it upside down, quickly.

Thompson gave the transaction data to Shvat on a Thursday. “I figured I was off the hook with Benchmark,” he recalled. “We’d never hear from Shvat again. Or at least not for months.” So he was surprised when he received an e-mail from Israel on Sunday. It said, “We’re done.”

Thompson didn’t believe it. First thing Monday morning, he handed Fraud Sciences’ work over to his team of PhDs for analysis; it took them a week to match the results up against PayPal’s. But by Wednesday, Thompson’s engineers were amazed at what they had seen so far. Shaked and his small team produced more accurate results than PayPal had, in a shorter amount of time, and with incomplete data. The difference was particularly pronounced on the transactions that had given PayPal the most trouble—on these, Fraud Sciences had performed 17 percent better. This was the category of customer applicants, Thompson told us, that PayPal initially rejected. But in light of what PayPal now knows from monitoring the rejected customers’ more recent credit reports, Thompson said, those rejections were a mistake: “They are good customers. We should never have rejected them. They slipped through our system. But how did they not slip through Shaked’s system?”

Thompson realized that he was looking at a truly original tool against fraud. With even less data than PayPal had, Fraud Sciences was able to more accurately predict who would turn out to be a good customer and who would not. “I was sitting here, dumbfounded,” Thompson recalled. “I didn’t get it. We’re the best in the business at risk management. How is it that this fifty-five-person company from Israel, with a crackpot theory about ‘good guys’ and ‘bad guys,’ managed to beat us?” Thompson estimated that Fraud Sciences was five years ahead of PayPal in the effectiveness of its system. His previous company, Visa, would never have been able to come up with such thinking, even if given ten or fifteen years to work on it.

Thompson knew what he had to tell Benchmark: PayPal could not afford to risk letting its competitors get hold of Fraud Sci-ences’ breakthrough technology. This was not a company Benchmark should invest in; PayPal needed to acquire the company. Immediately.

Thompson went to eBay’s CEO, Meg Whitman, to bring her into the loop. “I told Scott that it was impossible,” Whitman related. “We’re the market leader. Where on earth did this tiny little company come from?” Thompson and his team of PhDs walked her through the results. She was astounded.

Now Thompson and Whitman had a truly unexpected problem on their hands. What could they tell Shvat? If Thompson told this start-up’s CEO that he had handily beaten the industry leader, the start-up’s team would realize they were sitting on something invaluable. Thompson knew that PayPal had to buy Fraud Sciences, but how could he tell Shvat the test results without jacking up the company’s price and negotiating position?

So he stalled. He responded to Shaked’s anxious e-mails by saying PayPal needed more time for analysis. Finally, he said he would share the results in person the next time the Fraud Sciences team was in San Jose, hoping to buy more time. Within a day or two, Shaked was on Thompson’s doorstep.

What Thompson did not know, however, was that the Fraud Sciences founders—Shaked and Saar Wilf, who served together in Israel’s elite army intelligence unit, called 8200—were not interested in selling their company to PayPal. They just wanted Thompson’s blessing as they proceeded down a checklist of due diligence requirements for Benchmark Capital.

Thompson went back to Meg: “We need to make a decision. They’re here.” She gave him the go-ahead: “Let’s buy it.” After some valuation work, they offered $79 million. Shaked declined. The Fraud Sciences board, which included the Israeli venture firm BRM Capital, believed the company was worth at least $200 million.

Eli Barkat, one of the founding partners of BRM, explained to us his theory behind the company’s future value: “The first generation of technology security was protecting against a virus invading your PC. The second generation was building a firewall against hackers.” Barkat knew something about both these threats, having funded and built companies to protect against them. One of them, Checkpoint—an Israeli company also started by young alumni from Unit 8200—is worth $5 billion today, is publicly traded on the NASDAQ, and includes among its customers the majority of Fortune 100 companies and most national governments around the world. The third generation of security would be protecting against hacking into e-commerce activity. “And this would be the biggest market yet,” Barkat told us, “because up until then, hackers were just having fun—it was a hobby. But with e-commerce taking off, hackers could make real money.”

Barkat also believed that Fraud Sciences had the best team and the best technology to defend against Internet and credit card fraud. “You’ve got to understand the Israeli mentality,” he said. “When you’ve been developing technology to find terrorists—when lots of innocent lives hang in the balance—then finding thieves is pretty simple.”

After negotiations that lasted only a few days, Thompson and Shaked agreed on $169 million. Thompson told us that the PayPal team thought it could get away with a lower price. When the negotiating process began and Shaked stuck to the higher number, Thompson assumed it was just a bluff. “I figured I’d never seen such a convincing poker face. But what was really going on was that the Fraud Sciences guys had a view of what their company was worth. They were not sales guys. They weren’t hyping it. Shaked just played it straight. He basically said to us, ‘This is our solution. We know it is the best. This is what we think it’s worth.’ And that really was the end of it. There was a matter-of-factness that you just don’t see that often.”

Soon after, Thompson was on a plane to visit the company he had just purchased. During the last leg of the twenty-hour flight from San Francisco, about forty-five minutes before landing, as he sipped his coffee to wake up, he happened to glance at the screen in the aisle that showed the plane’s trajectory on a map. He could see the little airplane icon at the end of its flight path, about to land in Tel Aviv. That was fine, until he noticed what else was on the map, which at this point showed only places that were pretty close by. He could see the names and capitals of the countries in the region, arrayed in a ring around Israel: Beirut, Lebanon; Damascus, Syria; Amman, Jordan; and Cairo, Egypt. For a moment, he panicked: “I bought a company there? I’m flying into a war zone!” Of course, he’d known all along who Israel’s neighbors were, but it had not quite sunk in how small Israel was and how closely those neighbors ringed it. “It was as if I were flying into New York and suddenly saw Iran where New Jersey was supposed to be,” he recalled.

It didn’t take long after he stepped off the plane, however, before he was at ease in a place that was not shockingly unfamiliar, and that treated him to some pleasant surprises. His first big impression was in the Fraud Sciences parking lot. Every car had a PayPal bumper sticker on it. “You’d never see that kind of pride or enthusiasm at an American company,” he told us.

The next thing that struck Thompson was the demeanor of the Fraud Sciences employees during the all-hands meeting at which he spoke. Each face was turned raptly to him. No one was texting, surfing, or dozing off. The intensity only increased when he opened the discussion period: “Every question was penetrating. I actually started to get nervous up there. I’d never before heard so many unconventional observations—one after the other. And these weren’t peers or supervisors, these were junior employees. And they had no inhibition about challenging the logic behind the way we at PayPal had been doing things for years. I’d never seen this kind of completely unvarnished, unintimidated, and undistracted attitude. I found myself thinking, Who works for whom?”

What Scott Thompson was experiencing was his first dose of Israeli chutzpah. According to Jewish scholar Leo Rosten’s description of Yiddish—the all-but-vanished German-Slavic language from which modern Hebrew borrowed the word—chutzpah is “gall, brazen nerve, effrontery, incredible ‘guts,’ presumption plus arrogance such as no other word and no other language can do justice to.”[27] An outsider would see chutzpah everywhere in Israel: in the way university students speak with their professors, employees challenge their bosses, sergeants question their generals, and clerks second-guess government ministers. To Israelis, however, this isn’t chutzpah, it’s the normal mode of being. Somewhere along the way—either at home, in school, or in the army—Israelis learn that assertiveness is the norm, reticence something that risks your being left behind.

This is evident even in popular forms of address in Israel. Jon Medved, an entrepreneur and venture capital investor in Israel, likes to cite what he calls the “nickname barometer”: “You can tell a lot about a society based on how [its members] refer to their elites. Israel is the only place in the world where everybody in a position of power—including prime ministers and army generals—has a nickname used by all, including the masses.”

Israel’s current and former prime ministers Benjamin Netanyahu and Ariel Sharon are “Bibi” and “Arik.” A former Labor Party leader is Binyamin “Füad” Ben-Eliezer. A recent Israel Defense Forces (IDF) chief of staff is Moshe “Bogey” Yaalon. In the 1980s, the legendary IDF chief was Moshe “Moshe VeHetzi” (Moshe-and-a-Half) Levi—he was six foot six. Other former IDF chiefs in Israeli history were Rehavam “Gandhi” Zeevi, David “Dado” Elazar, and Rafael “Raful” Eitan. The Shinui Party founder was Yosef “Tommy” Lapid. A top minister in successive Israeli governments is Isaac “Bugie” Herzog. These nicknames are used not behind the officials’ backs but, rather, openly, and by everyone. This, Medved argues, is representative of Israel’s level of informality.

Israeli attitude and informality flow also from a cultural tolerance for what some Israelis call “constructive failures” or “intelligent failures.” Most local investors believe that without tolerating a large number of these failures, it is impossible to achieve true innovation. In the Israeli military, there is a tendency to treat all performance—both successful and unsuccessful—in training and simulations, and sometimes even in battle, as value-neutral. So long as the risk was taken intelligently, and not recklessly, there is something to be learned.

As Harvard Business School professor Loren Gary says, it is critical to distinguish between “a well-planned experiment and a roulette wheel.”[28] In Israel, this distinction is established early on in military training. “We don’t cheerlead you excessively for a good performance, and we don’t finish you off permanently for a bad performance,” one air force trainer told us.[29]

Indeed, a 2006 Harvard University study shows that entrepreneurs who have failed in their previous enterprise have an almost one-in-five chance of success in their next start-up, which is a higher success rate than that for first-time entrepreneurs and not far below that of entrepreneurs who have had a prior success.[30]

In The Geography of Bliss, author Eric Weiner describes another country with a high tolerance for failure as “a nation of born-agains, though not in a religious sense.”[31] This is certainly true for Israeli laws regarding bankruptcy and new company formation, which make it the easiest place in the Middle East—and one of the easiest in the world—to birth a new company, even if your last one went bankrupt. But this also contributes to a sense that Israelis are always hustling, pushing, and looking for the next opportunity.

Newcomers to Israel often find its people rude. Israelis will unabashedly ask people they barely know how old they are or how much their apartment or car cost; they’ll even tell new parents—often complete strangers on the sidewalk or in a grocery store—that they are not dressing their children appropriately for the weather. What is said about Jews—two Jews, three opinions—is certainly true of Israelis. People who don’t like this sort of frankness can be turned off by Israel, but others find it refreshing, and honest.

“We did it the Israeli way; we argued our case to death.”[32] That’s how Shmuel “Mooly” Eden (he has a nickname, too) glibly sums up a historic showdown between Intel’s top executives in Santa Clara and its Israeli team. It, too, was a case study in chutzpah.

The survival of Intel would turn on the outcome. But this fierce, months-long dispute was about more than just Intel; it would determine whether the ubiquitous laptop computer—so much taken for granted today—would ever exist.

Eden is a leader of Intel’s Israeli operation—the largest private-sector employer in the country—which today exports $1.53 billion annually.[33] He told us the story of Intel in Israel, and Intel’s battles with Israel.

Throughout most of the history of modern computing, the speed of data processing—how much time it takes your computer to do anything—was determined by the speed of a chip’s transistors. The transistors flipped on and off, and the order in which they did so produced a code, much like letters are used to make words. Together, millions of flips could record and manipulate data in endless ways. The faster the transistors could be made to flip on and off (the transistor’s “clock speed”), the more powerful the software they could run, transforming computers from glorified calculators to multimedia entertainment and enterprise machines.

But until the 1970s, computers were used predominantly by rocket scientists and big universities. Some computers took up whole rooms or even buildings. The idea of a computer on your office desk or in your home was the stuff of science fiction. All that began to change in 1980, when Intel’s Haifa team designed the 8088 chip, whose transistors could flip almost five million times per second (4.77 megahertz), and were small enough to allow for the creation of computers that would fit in homes and offices.

IBM chose Israel’s 8088 chip as the brains for its first “personal computer,” or PC, launching a new era of computing. It was also a major breakthrough for Intel. According to journalist Michael Malone, “With the IBM contract, Intel won the microprocessor wars.”[34]

From then on, computing technology continued to get smaller and faster. By 1986, Intel’s only foreign chip factory was producing the 386 chip. Built in Jerusalem, its processing speed was 33 megahertz. Though a small fraction of today’s chip speeds, Intel called it “blazing”—it was almost seven times faster than the 8088. The company was solidly on the path imagined by one of its founders, Gordon Moore, who predicted that the industry would shrink transistors to half their size every eighteen to twenty-four months, roughly doubling a chip’s processing speed. This constant halving was dubbed “Moore’s law,” and the chip industry was built around this challenge to deliver faster and faster chips. IBM, Wall Street, and the business press all caught on, too—clock speed and size was how they measured the value of new chips.

This was proceeding well until about 2000, when another factor came into the mix: power. Chips were getting smaller and faster, just as Moore had predicted. But as they did, they also used more power and generated more heat. Chips overheating would soon become a critical problem. The obvious solution was a fan, but, in the case of laptops, the fan needed to cool the chips would be much too big to fit inside. Industry experts dubbed this dead end the “power wall.”

Intel’s Israeli team was the first group within the company to see this coming. Many late nights at Intel’s Haifa facility were dedicated to hot coffee, cold takeout, and ad hoc brainstorming sessions about how to get around the power wall. The Israeli team was more focused than anyone on what the industry called “mobility”—designing chips for laptop computers and, eventually, for all sorts of mobile devices. Noticing this tendency, Intel put their Israeli branch in charge of building mobility chips for the whole company.

Even given this responsibility, Israelis still resisted fitting into the Intel mainstream. “The development group in Israel, even before it was tasked as the mobility group, pushed ideas for mobility that went against the common wisdom at Intel,” explained Intel Israel’s chief, David “Dadi” Perlmutter, a graduate of the Technion (Israel’s MIT) who’d started designing chips at Intel Israel in 1980.[35] One of these unconventional ideas was a way to get around the power wall. Rony Friedman was one of Intel Israel’s top engineers at the time. Just for fun, he had been tinkering with a way to produce low-power chips, which went blatantly against the prevailing orthodoxy that the only way to make chips faster was to deliver more power to their transistors. This, he thought, was a bit like making cars go faster by revving their engines harder. There was definitely a connection between the speed of the engine and the speed of the car, but at some point the engine would go too fast, get too hot, and the car would have to slow down.[36]

Friedman and the Israeli team realized that the solution to the problem was something like a gear system in a car: if you could change gears, you could run the engine more slowly while still making the car go faster. In a chip, this was accomplished differently, by splitting the instructions fed into the chip. But the effect was similar: the transistors in Intel Israel’s low-power chips did not need to flip on and off as fast, yet, in a process analogous to shifting a car into high gear, they were able to run software faster.

When Intel’s Israel team euphorically introduced its innovation to headquarters in Santa Clara, the engineers thought their bosses would be thrilled. What could be better than a car that goes faster without overheating? Yet what the Israeli team saw as an asset—that the engine turned more slowly—headquarters saw as a big problem. After all, the entire industry measured the power of chips by how fast the engine turned: clock speed.

It did not matter that Israeli chips ran software faster. The computer’s engine—composed of its chip’s transistors—wasn’t turning on and off fast enough. Wall Street analysts would opine on the attractiveness (or unattractiveness) of Intel’s stock based on performance along a parameter that said, Faster clock speed: Buy; Slower clock speed: Sell. Trying to persuade the industry and the press that this metric was obsolete was a nonstarter. This was especially the case because Intel had itself created—through Moore’s law—the industry’s Pavlovian attachment to clock speed. It was tantamount to trying to convince Ford to abandon its quest for more horsepower or telling Tiffany’s that carat size does not matter.

“We weren’t in the mainstream—clock speed was king and we were on the outside,” Israel’s Rony Friedman recalls.[37]

The head of Intel’s chip division, Paul Otellini, tried to mothball the whole project. The clock-speed doctrine was enshrined among Intel’s brass, and they weren’t about to hold a seminar to decide whether or not to change it.

The “seminar” is part of a culture that Israelis know well, going back to the founding of the state. From the end of March to the end of May 1947, David Ben-Gurion—Israel’s George Washington—conducted an inquiry into the military readiness of Jewish Palestine, in anticipation of the war he knew would come when Israel declared independence. He spent days and nights meeting with, probing, and listening to military men up and down the ranks. More than six months before the United Nations passed its partition plan for dividing Palestine into a Jewish and an Arab state, Ben-Gurion was keenly aware that the next phase in the Arab-Israeli conflict would be very different from the war the pre-state Jewish militias had been fighting; they needed to step back, in the midst of ongoing fighting, and plan for the existential threats that were nearing.

At the end of the seminar, Ben-Gurion wrote of the men’s confidence in their readiness: “We have to undertake difficult work—to uproot from the hearts of men who are close to the matter the belief that they have something. In fact, they have nothing. They have good will, they have hidden capacities, but they have to know: to make a shoe one has to study cobbling.”[38]

Intel’s Otellini didn’t know it, but his Israeli team was giving him a similar message. They saw that Intel was headed for the “power wall.” Instead of waiting to ram into it, the Israelis wanted Otellini to avert it by taking a step back, discarding conventional thinking, and considering a fundamental change in the company’s technological approach.

The executives in Santa Clara were ready to strangle the Israeli team, according to some of those on the receiving end of Intel Israel’s “pestering.” The Israelis were making the twenty-hour trip between Tel Aviv and California so frequently that they seemed omnipresent, always ready to corner an executive in the hallway or even a restroom—anything to argue their case. David Perlmutter spent one week each month in the Santa Clara headquarters, and he used much of his time there to press the Israeli team’s case.

One point the Israelis tried to make was that while there was risk in abandoning the clock-speed doctrine, there was even greater risk in sticking with it. Dov Frohman, the founder of Intel Israel, later said that to create a true culture of innovation, “fear of loss often proves more powerful than the hope of gain.”[39]

Frohman had long tried to cultivate a culture of disagreement and debate at Intel Israel, and he had hoped this ethos would infect Santa Clara. “The goal of a leader,” he said, “should be to maximize resistance—in the sense of encouraging disagreement and dissent. When an organization is in crisis, lack of resistance can itself be a big problem. It can mean that the change you are trying to create isn’t radical enough . . . or that the opposition has gone underground. If you aren’t even aware that the people in the organization disagree with you, then you are in trouble.”

In time, the Israelis outlasted—and outargued—their U.S. supervisors. Each time the Israelis showed up, they had better research and better data, one Intel executive recalled. Soon they had a seemingly bulletproof case as to where the industry was heading. Intel could either lead in that direction, the Israelis told management, or become obsolete.

Finally, this time as CEO, Otellini changed his mind. It had become impossible to counter the Israelis’ overwhelming research—not to mention their persistence. In March 2003, the new chip—code-named Banias after a natural spring in Israel’s north—was released as the Centrino chip for laptops. Its clock speed was only a bit more than half of the reigning 2.8 gigahertz Pentium chips for desktops, and it sold for more than twice the price. But it gave laptop users the portability and speed they needed.

The switch to the Israeli-designed approach came to be known in Intel and the industry as the “right turn,” since it was a sharp change in approach from simply going for higher and higher clock speeds without regard to heat output or power needs. Intel began to apply the “right turn” paradigm not just to chips for laptops but to chips for desktops, as well. Looking back, the striking thing about Intel Israel’s campaign for the new architecture was that the engineers were really just doing their jobs. They cared about the future of the whole company; the fight wasn’t about winning a battle within Intel, it was about winning the war with the competition.

As a result, the new Israeli-designed architecture, once derided within the company, was a runaway hit. It became the anchor of Intel’s 13 percent sales growth from 2003 to 2005. But Intel was not clear of industry threats yet. Despite the initial success, by 2006, new competition caused Intel’s market share to plummet to its lowest point in eleven years. Profits soon plunged 42 percent as the company cut prices to retain its dominant position.[40]

The bright spot in 2006, however, came in late July when Otellini unveiled the Core 2 Duo chips, Intel’s successors to the Pentium. The Core Duo chips applied Israel’s “right turn” concept plus another Israeli development, called dual-core processing, that sped chips up even further. “These are the best microprocessors we’ve ever designed, the best we’ve ever built,’’ he told an audience of five hundred in a festive tent at Intel’s Santa Clara headquarters. “This is not just incremental change; it’s a revolutionary leap.” Screens lit up with images of the proud engineers behind the new chip; they were joining the celebration via satellite, from Haifa, Israel. Though Intel’s stock was down 19 percent over the whole year, it jumped 16 percent after the July announcement. Intel went on to release forty new processors over a one-hundred-day period, most of them based on the Israeli team’s design.

“It’s unbelievable that, just a few years ago, we were designing something that no one wanted,” says Friedman, who is still based in Haifa but now leads development teams for Intel around the world. “Now we’re doing processors that should carry most of Intel’s revenue—we can’t screw up.”

What began as an isolated outpost an ocean away had become Intel’s lifeline. As Doug Freedman, an analyst for American Technology Research, put it, the Israeli team “saved the company.” Had midlevel developers in the Haifa plant not challenged their corporate superiors, Intel’s global position today would be much diminished.

Intel Israel’s search for a way around the power wall also produced another dividend. We don’t think of computers as using a lot of electricity—we leave them on all the time—but, collectively, they do. Intel’s ecotechnology executive, John Skinner, calculated the amount of power that Intel’s chips would have used if the company had kept developing them in the same way, rather than making the “right turn” toward the Israeli team’s low-power design: a saving of 20 terawatt hours of electricity over a two-and-a-half-year period. That’s the amount of power it would take to run over 22 million 100-watt bulbs for an entire year, twenty-four hours a day, seven days a week. Skinner noted, “We calculated about a $2 billion savings in electricity costs. . . . It’s equivalent to a small number of coal-fired power plants or taking a few million cars off the road. . . . We’re very proud that we are dramatically reducing the carbon dioxide footprint of our own company.”[41]

The significance of the Intel Israel story is not, however, just that the team in Haifa came up with a revolutionary solution that turned the company around. A good idea alone could not have carried the day against a seemingly intransigent management team. There had to be willingness to take on higher authorities, rather than simply following directives from the top. Where does this impudence come from?

Dadi Perlmutter recalls the shock of an American colleague when he witnessed Israeli corporate culture for the first time. “When we all emerged [from our meeting], red faced after shouting, he asked me what was wrong. I told him, ‘Nothing. We reached some good conclusions.’ ”

That kind of heated debate is anathema in other business cultures, but for Israelis it’s often seen as the best way to sort through a problem. “If you can get past the initial bruise to the ego,” one American investor in Israeli start-ups told us, “it’s immensely liberating. You rarely see people talk behind anybody’s back in Israeli companies. You always know where you stand with everyone. It does cut back on the time wasted on bullshit.”

Perlmutter later moved to Santa Clara and became Intel’s executive vice president in charge of mobile computing. His division produces nearly half of the company’s revenues. He says, “When I go back to Israel, it’s like going back to the old culture of Intel. It’s easier in a country where politeness gets less of a premium.”

The cultural differences between Israel and the United States are actually so great that Intel started running “cross-cultural seminars” to bridge them. “After living in the U.S. for five years, I can say that the interesting thing about Israelis is the culture. Israelis do not have a very disciplined culture. From the age of zero we are educated to challenge the obvious, ask questions, debate everything, innovate,” says Mooly Eden, who ran these seminars.

As a result, he adds, “it’s more complicated to manage five Israelis than fifty Americans because [the Israelis] will challenge you all the time—starting with ‘Why are you my manager; why am I not your manager?’ ”[42]

CHAPTER 2 Battlefield Entrepreneurs

ON OCTOBER 6, 1973, as the entire nation was shut down for the holiest day of the Jewish year, the armies of Egypt and Syria launched the Yom Kippur War with a massive surprise attack. Within hours, Egyptian forces breached Israel’s defensive line along the Suez Canal. Egyptian infantry had already overrun the tank emplacements to which Israeli armored forces were supposed to race in case of attack, and hundreds of enemy tanks were moving forward behind this initial thrust.

It was just six years after Israel’s greatest military victory, the Six-Day War, an improbable campaign that captured the imagination of the entire world. Just before that war, in 1967, it looked like the nineteen-year-old Jewish state would be crushed by Arab armies poised to invade on every front. Then, in six days of battle, Israel simultaneously defeated the Egyptian, Jordanian, and Syrian forces and expanded its borders by taking the Golan Heights from Syria, the West Bank and East Jerusalem from Jordan, and the Gaza Strip and Sinai Peninsula from Egypt.

All this gave Israelis a sense of invincibility. Afterward, no one could imagine the Arab states risking another all-out attack. Even in the military, the sense was that if the Arabs dared attack, Israel would vanquish their armies as quickly as it had in 1967.

So on that October day in 1973, Israel was not prepared for war. The thin string of Israeli forts facing the Egyptians across the Suez Canal was no match for the overwhelming Egyptian invasion. Behind the destroyed front line, three Israeli tank brigades stood between the advancing Egyptian army and the Israeli heartland. Only one was stationed close to the front.

That brigade, which was supposed to defend a 120-mile front with just fifty-six tanks, was commanded by Colonel Amnon Reshef. As he raced with his men to engage the invading Egyptians, Reshef saw his tanks getting hit one after another. But there were no Egyptian enemy tanks or antitank guns in sight. What sort of device was obliterating his men?

At first he thought the tanks were being hit by rocket-propelled grenades (RPGs), the classic handheld antitank weapon used by infantry forces. Reshef and his men pulled back a bit, as they had been trained, so as to be out of the short range of the RPGs. But the tanks kept exploding. The Israelis realized they were being hit by something else—something seemingly invisible.

As the battle raged, a clue emerged. The tank operators who survived a missile hit reported to the others that they’d seen nothing, but those next to them mentioned having seen a red light moving toward the targeted tanks. Wires were found on the ground leading to stricken Israeli tanks. The commanders had discovered Egypt’s secret weapon: the Sagger.

Designed by Sergei Pavlovich Nepobedimyi, whose last name literally means “undefeatable” in Russian, the Sagger was created in 1960. The new weapon had initially been provided to Warsaw Pact countries, but it was first put to sustained use in combat by the Egyptian and Syrian armies during the Yom Kippur War. The IDF’s account of its own losses on both the southern and northern fronts was 400 tanks destroyed and 600 disabled but returned to battle after repairs. Of the Sinai division’s 290 tanks, 180 were knocked out the first day. The blow to the IDF’s aura of invincibility was substantial. About half of the losses came from RPGs, the other half from the Sagger.

The Sagger was a wire-guided missile that could be fired by a single soldier lying on the ground. Its range—the distance from which it could hit and destroy a tank—was 3,000 meters (or 1.86 miles), ten times that of an RPG. The Sagger was also far more powerful.[44]

Each shooter could work alone and did not even need a bush to hide behind—a shallow depression in the desert sand would do. A shooter had only to fire in the direction of a tank and use a joystick to guide the red light at the back of the missile. So long as the soldier could see the red light, the wire that remained connected to the missile would allow him to guide it accurately and at great distance into the target.[45]

Israeli intelligence knew about the Saggers before the war, and had even encountered them in Egyptian cross-border attacks during the War of Attrition, which began just after the 1967 war. But the top brass thought the Saggers were merely another antitank weapon, not qualitatively different from what they had successfully contended with in the 1967 war. Thus, in their view, doctrines to oppose them already existed, and nothing was developed to specifically address the Sagger threat.

Reshef and his men had to discover for themselves what type of weapon was hitting them and how to cope with it, all in the heat of battle.

Drawing on the men’s reports, Reshef’s remaining officers realized that the Saggers had some weaknesses: they flew relatively slowly, and they depended on the shooter’s retaining eye contact with the Israeli tank. So the Israelis devised a new doctrine: when any tank saw a red light, all would begin moving randomly while firing in the direction of the unseen shooter.

The dust kicked up by the moving tanks would obscure the shooter’s line of sight to the missile’s deadly red light, and the return fire might also prevent the shooter from keeping his eye on the light.

This brand-new doctrine proved successful, and after the war it was eventually adopted by NATO forces. It had not been honed over years of gaming exercises in war colleges or prescribed out of an operations manual; it had been improvised by soldiers at the front.

As usual in the Israeli military, the tactical innovation came from the bottom up—from individual tank commanders and their officers. It probably never occurred to these soldiers that they should ask their higher-ups to solve the problem, or that they might not have the authority to act on their own. Nor did they see anything strange in their taking responsibility for inventing, adopting, and disseminating new tactics in real time, on the fly.

Yet what these soldiers were doing was strange. If they had been working in a multinational company or in any number of other armies, they might not have done such things, at least not on their own. As historian Michael Oren, who served in the IDF as a liaison to other militaries, put it, “The Israeli lieutenant probably has greater command decision latitude than his counterpart in any army in the world.”[46]

This latitude, evidenced in the corporate culture we examined in the previous chapter, is just as prevalent, if not more so, in the Israeli military. Normally, when one thinks of military culture, one thinks of strict hierarchies, unwavering obedience to superiors, and an acceptance of the fact that each soldier is but a small, uninformed cog in a big wheel. But the IDF doesn’t fit that description. And in Israel pretty much everyone serves in the military, where its culture is worked into Israel’s citizens over a compulsory two- to three-year service.

The IDF’s downward delegation of responsibility is both by necessity and by design. “All militaries claim to value improvisation: read what the Chinese, French, or British militaries say—they all talk about improvisation. But the words don’t tell you anything,” said Edward Luttwak, a military historian and strategist who wrote The Pentagon and the Art of War and co-wrote The Israeli Army. “You have to look at structure.”[47]

To make his point, Luttwak began rattling off the ratios of officers to enlisted personnel in militaries around the world, ending with Israel, whose military pyramid is exceptionally narrow at the top. “The IDF is deliberately understaffed at senior levels. It means that there are fewer senior officers to issue commands,” says Luttwak. “Fewer senior officials means more individual initiative at the lower ranks.”

Luttwak points out that the Israeli army has very few colonels and an abundance of lieutenants. The ratio of senior officers to combat troops in the U.S. Army is 1 to 5; in the IDF, it’s 1 to 9. The same is true in the Israeli Air Force (IAF), which, though larger than French and British air forces, has fewer senior officers. The IAF is headed by a two-star general, a lower rank than is typical in other Western militaries.

For the United States, the more top-heavy approach may well be necessary; after all, the U.S. military is much larger, fights its wars as far as eight thousand miles from home, and faces the unique logistical and command challenges of deploying over multiple continents.

Yet regardless of whether each force is the right size and structure for the tasks it faces, the fact that the IDF is lighter at the top has important consequences. The benefit was illuminated for us by Gilad Farhi, a thirty-year-old major in the IDF. His career path was fairly typical: from a soldier in a commando unit at age eighteen, to commanding an infantry platoon, then a company, he was next appointed a spokesman of the Southern Command. After that he became the deputy commander of Haruv, an infantry battalion. Now he is the commander of an incoming class of one of the IDF’s most recent infantry regiments.

We met him at a base on a barren edge of the Jordan Valley. As he strode toward us, neither his youth nor his attire (a rumpled standard-issue infantry uniform) would have pegged him as commander of the base. We interviewed him the day before his new class of recruits was to arrive. For the next seven months, Farhi would be in charge of basic training for 650 soldiers, most of them fresh out of high school, plus about 120 officers, squad commanders, sergeants, and administrative staff.[48]

“The most interesting people here are the company commanders,” Farhi told us. “They are absolutely amazing people. These are kids—the company commanders are twenty-three. Each of them is in charge of one hundred soldiers and twenty officers and sergeants, three vehicles. Add it up and that means a hundred and twenty rifles, machine guns, bombs, grenades, mines, whatever. Everything. Tremendous responsibility.”

Company commander is also the lowest rank that must take responsibility for a territory. As Farhi put it, “If a terrorist infiltrates that area, there’s a company commander whose name is on it. Tell me how many twenty-three-year-olds elsewhere in the world live with that kind of pressure.”

Farhi illustrated a fairly typical challenge facing these twenty-three-year-olds. During an operation in the West Bank city of Nablus, one of Farhi’s companies had an injured soldier trapped in a house held by a terrorist. The company commander had three tools at his disposal: an attack dog, his soldiers, and a bulldozer.

If he sent the soldiers in, there was a high risk of additional casualties. And if he sent the bulldozer to destroy the house, this would risk harming the injured soldier.

To further complicate matters, the house shared a wall with a Palestinian school, and children and teachers were still inside. From the roof of the school, journalists were documenting the whole scene. The terrorist, meanwhile, was shooting at both the Israeli forces and the journalists.

Throughout much of the standoff, the company commander was on his own. Farhi could have tried to take charge from afar, but he knew he had to give his subordinate latitude: “There were an infinite number of dilemmas there for the commander. And there wasn’t a textbook solution.” The soldiers managed to rescue the injured soldier, but the terrorist remained inside. The commander knew that the school staff was afraid to evacuate the school, despite the danger, because they did not want to be branded “collaborators” by the terrorists. And he knew that the journalists would not leave the roof of the school, because they didn’t want to miss breaking news. The commander’s solution: empty the school using smoke grenades.

Once the students, teachers, and journalists had been safely evacuated, the commander decided it was safe to send in the bulldozer to drive the terrorist out of the adjacent building. Once the bulldozer began biting into the house, the commander unleashed the dog to neutralize the terrorist. But while the bulldozer was knocking down the house, another terrorist the Israelis didn’t know about came out of the school next door. The soldiers outside shot and killed this second terrorist. The entire operation took four hours. “This twenty-three-year-old commander was alone for most of the four hours until I got there,” Farhi told us.

“After an event like that, the company commander goes back to the base and his soldiers look at him differently,” Farhi continued. “And he himself is different. He is on the line—responsible for the lives of a lot of people: his soldiers, Palestinian schoolchildren, journalists. Look, he didn’t conquer Eastern Europe, but he had to come up with a creative solution to a very complex situation. And he is only twenty-three years old.”

We then heard from a brigadier general about Yossi Klein, a twenty-year-old helicopter pilot in the 2006 Lebanon war. He was ordered to evacuate a wounded soldier from deep in southern Lebanon. When he piloted his chopper to the battlefield, the wounded soldier lay on a stretcher surrounded by a dense overgrowth of bushes that prevented the helicopter from landing or hovering close enough to the ground to pull the stretcher on board.[49]

There were no manuals on how to deal with such a situation, but if there had been, they would not have recommended what Klein did. He used the tail rotor of his helicopter like a flying lawn mower to chop down the foliage. At any point, the rotor could have broken off, sending the helicopter crashing into the ground. But Klein succeeded in trimming the bushes enough so that, by hovering close to the ground, he could pick up the wounded soldier. The soldier was rushed to the hospital in Israel and his life was saved.

Speaking of the company commanders who served under him, Farhi asked, “How many of their peers in their junior year in colleges have been tested in such a way? . . . How do you train and mature a twenty-year-old to shoulder such responsibility?”

The degree to which authority devolves to some of the most junior members of the military has at times surprised even Israeli leaders. In 1974, during the first premiership of Yitzhak Rabin, a young female soldier from the IDF’s Unit 8200—the same unit in which the founders of Fraud Sciences later served—was kidnapped by terrorists. Major General Aharon Zeevi-Farkash (known as Farkash), who headed the unit—Israel’s parallel to the U.S. National Security Agency—recalled Rabin’s disbelief: “The kidnapped girl was a sergeant. Rabin asked us to provide him an itemization of what she knew. He was worried about the depth of classified information that could be forced out of her. When he saw the briefing paper, Rabin told us we needed an immediate investigation; it’s impossible that a sergeant would know so many secrets that are critical to Israel’s security. How did this happen?”

Rabin’s reaction was especially surprising since he had been the IDF chief of staff during Israel’s Six-Day War. Farkash continued the story: “So I told him, ‘Mr. Prime Minister, this individual sergeant is not alone. It was not a mistake. All the soldiers in Unit 8200 must know these things because if we limited such information to officers, we simply would not have enough people to get the work done—we don’t have enough officers.’ And in fact, the system was not changed, because it’s impossible for us, given the manpower constraints, to build a different system.”[50]

Farkash, who today runs a company that provides innovative security systems for corporate and residential facilities, quipped that compared to the major powers, Israel is missing four “generals”: “general territory, general manpower, general time, and general budget.” But nothing can be done about the shortage of general manpower, Farkash says. “We cannot allocate as many officers as other countries do, so we have sergeants that are doing the work of lieutenant colonels, really.”

This scarcity of manpower is also responsible for what is perhaps the IDF’s most unusual characteristic: the role of its reserve forces. Unlike in other countries, reserve forces are the backbone of Israel’s military.

In most militaries, reserve forces are constructed as appendages to the standing army, which is the nation’s main line of defense. Israel, however, is so small and outnumbered by its adversaries that, as was clear from the beginning, no standing army could be large enough to defend against an all-out assault. Shortly after the War of Independence, Israel’s leaders decided on a unique reserves-dominated military structure, whereby reservists would not only man whole units but would be commanded by reserve officers as well. Reserve units of other militaries may or may not be commanded by officers from the standing army, but they are given weeks or even months of refresher training before being sent into battle. “No army had relied for the majority of its troops on men who were sent into combat one or two days after their recall,” says Luttwak.

No one really knew whether Israel’s unique reserve system would work, because it had never been tried. Even today, Israel is the only army in the world to have such a system. As U.S. military historian Fred Kagan explained, “It’s actually a terrible way to manage an army. But the Israelis are excellent at it because they had no other choice.”[51]

Israel’s reserve system is not just an example of the country’s innovation; it is also a catalyst for it. Because hierarchy is naturally diminished when taxi drivers can command millionaires and twenty-three-year-olds can train their uncles, the reserve system helps to reinforce that chaotic, antihierarchical ethos that can be found in every aspect of Israeli society, from war room to classroom to boardroom.

Nati Ron is a lawyer in his civilian life and a lieutenant colonel who commands an army unit in the reserves. “Rank is almost meaningless in the reserves,” he told us, as if this were the most natural thing in the world. “A private will tell a general in an exercise, ‘You are doing this wrong, you should do it this way.’ ”[52]

Amos Goren, a venture capital investor with Apax Partners in Tel Aviv, agrees. He served full-time in the Israeli commandos for five years and was in the reserves for the next twenty-five years. “During that entire time, I never saluted anybody, ever. And I wasn’t even an officer. I was just a rank-and-file soldier.”[53]

Luttwak says that “in the reserve formations, the atmosphere remains resolutely civilian in the midst of all the trappings of military life.”

This is not to say that soldiers aren’t expected to obey orders. But, as Goren explained to us, “Israeli soldiers are not defined by rank; they are defined by what they are good at.” Or, as Luttwak said, “Orders are given and obeyed in the spirit of men who have a job to do and mean to do it, but the hierarchy of rank is of small importance, especially since it often cuts across sharp differences in age and social status.”

When we asked Major General Farkash why Israel’s military is so antihierarchical and open to questioning, he told us it was not just the military but Israel’s entire society and history. “Our religion is an open book,” he said, in a subtle European accent that traces back to his early years in Transylvania. The “open book” he was referring to was the Talmud—a dense recording of centuries of rabbinic debates over how to interpret the Bible and obey its laws—and the corresponding attitude of questioning is built into Jewish religion, as well as into the national ethos of Israel.

As Israeli author Amos Oz has said, Judaism and Israel have always cultivated “a culture of doubt and argument, an open-ended game of interpretations, counter-interpretations, reinterpretations, opposing interpretations. From the very beginning of the existence of the Jewish civilization, it was recognized by its argumentativeness.”[54]

Indeed, the IDF’s lack of hierarchy pervades civilian life. It can even break down civilian hierarchies. “The professor acquires respect for his student, the boss for his high-ranking clerk. . . . Every Israeli has his friends ‘from the reserves’ with whom he might not otherwise have any kind of social contact,” says Luttwak. “Sleeping in bare huts or tents, eating dull army food, often going without a shower for days, reservists of widely different social backgrounds meet on an equal footing; Israel is still a society with fewer class differences than most, and the reserve system has contributed to keeping it that way.”

The dilution of hierarchy and rank, moreover, is not typical of other militaries. Historian and IDF reserve officer Michael Oren—now serving as Israel’s ambassador to the United States—described a typical scene at an Israeli army base from when he was in a military liaison unit: “You would sit around with a bunch of Israeli generals, and we all wanted coffee. Whoever was closest to the coffee pot would go make it. It didn’t matter who—it was common for generals to be serving coffee to their soldiers or vice versa. There is no protocol about these things. But if you were with American captains and a major walked in, everyone would stiffen. And then a colonel would walk in and the major would stiffen. It’s extremely rigid and hierarchical in the U.S. Rank is very, very important. As they say in the American military, ‘You salute the rank, not the person.’ ”[55]

In the IDF, there are even extremely unconventional ways to challenge senior officers. “I was in Israeli army units where we threw out the officers,” Oren told us, “where people just got together and voted them out. I witnessed this twice personally. I actually liked the guy, but I was outvoted. They voted out a colonel.” When we asked Oren in disbelief how this worked, he explained, “You go and you say, ‘We don’t want you. You’re not good.’ I mean, everyone’s on a first-name basis. . . . You go to the person above him and say, ‘That guy’s got to go.’ . . . It’s much more performance-oriented than it is about rank.”

Retired IDF General Moshe “Bogey” Yaalon, who served as chief of staff of the army during the second intifada, told us a similar story from the second Lebanon war. “There was an operation conducted by a reserve unit in the Lebanese village of Dabu. Nine of our soldiers and officers were killed, and others were injured, including my nephew. And the surviving soldiers blamed the battalion commander for his incompetent management of the operation. The soldiers at the company level went to the brigade commander to complain about the battalion commander. Now, the brigade commander, of course, did his own investigation. But the battalion commander was ultimately forced to step down because of a process that was initiated by his subordinates.”[56]

Yaalon believes that this unique feature of Israel’s military is critical to its effectiveness: “The key for leadership is the soldiers’ confidence in their commander. If you don’t trust him, if you’re not confident in him, you can’t follow him. And in this case, the battalion commander failed. It might be a professional failure, like in this case. It might be a moral failure in another case. Either way, the soldier has to know that it is acceptable—and encouraged—for him to come forward and to talk about it.”

Former West Point professor Fred Kagan concedes that Americans can learn something from the Israelis. “I don’t think it’s healthy for a commander to be constantly worrying if his subordinates will go over his head, like they do in the IDF,” he told us. “On the other hand, the U.S. military could benefit from some kind of 360-degree evaluation during the promotion board process for officers. Right now in our system the incentives are all one-sided. To get promoted, an officer just has to please more senior officers. The junior guys get no input.”

The conclusion Oren draws from displays of what most militaries—and Fred Kagan—would call insubordination is that the IDF is in fact “much more consensual than the American army.” This might seem strange, since the U.S. Army is called a “volunteer” army (not unpaid, but in the sense of free choice), while the IDF is built on conscription.

Yet, Oren explains, “in this country there’s an unwritten social contract: we are going to serve in this army provided the government and the army are responsible toward us. . . . The Israeli army is more similar, I would imagine, to the Continental Army of 1776 than it is to the American army of 2008. . . . And by the way, George Washington knew that his ‘general’ rank didn’t mean very much—that he had to be a great general, and that basically people were there out of volition.”

The Continental Army was an extreme example of what Oren was describing, since its soldiers would decide on an almost daily basis whether to continue to volunteer. But it was a “people’s army,” and so is the IDF. As Oren describes it, like the Continental Army, the IDF has a scrappy, less formal, more consensual quality because its soldiers are fighting for the existence of their country, and its ranks are composed of a broad cross section of the people they are fighting for.

It’s easy to imagine how soldiers unconcerned with rank have fewer qualms about telling their boss, “You’re wrong.” This chutzpah, molded through years of IDF service, gives insight into how Shvat Shaked could have lectured PayPal’s president about the difference between “good guys and bad guys” on the Web, or how Intel Israel’s engineers decided to foment a revolution to overturn not only the fundamental architecture of their company’s main product but the way the industry measured value. Assertiveness versus insolence; critical, independent thinking versus insubordination; ambition and vision versus arrogance—the words you choose depend on your perspective, but collectively they describe the typical Israeli entrepreneur.