Forbes.com's Joshua Levine: "If It Works, You Can Break It"

Prudent Investor Says: Instead of continuously yammering and yacking all day long, why don't we consider the Estonian solution...an E-Republic!!!

"If It Works, You Can Break It"
Joshua Levine, 12.20.04
Forbes.com

Since independence in 1991 little Estonia has used a knack for technology and a ravenous appetite for change to make itself a largely wired e-republic.

It proved to be a lucky break for Estonia that the Soviet Union took such pains to dampen any yearnings for freedom in the Baltic States. It meant that Estonian universities were not allowed to offer too many courses in philosophy and the social sciences. Philosophy is a dangerous thing among a patriotic people longing for the brief independence they lost.

What did the Soviets want Estonians to study instead? Computer science, cybernetics, artificial intelligence and information technology. Estonians did much of the software programming and development for the Soviet space program, not to mention the KGB. The Soviets placed one of their most important centers of AI research near the capital city of Tallinn.

Independence came anyway in 1991, of course, but by squelching any budding Tom Paines the Soviets unwittingly helped foster one of the more remarkable post-Soviet success stories. There are only 1.4 million Estonians in a country a little bigger than Holland. Half of it is covered in forest. But beneath the trees Estonia hums. With virtually no outmoded infrastructure to weigh them down, the resourceful Estonians have constructed a kind of e-republic that has already outpaced many of its new, much richer European neighbors.

Internet and mobile phone usage per capita, for instance, is higher in Estonia than it is in France. Over half of all Estonians now pay for their street parking spaces automatically, using their mobile phones. The same system flopped when Estonian Mobile Telephone's technology was marketed in Oslo, which is not exactly backward technologically. And Swedish companies often test ideas first in Estonia, since Estonians are known to have a heartier appetite for change than even the forward-thinking Swedes.

"People like to say, don't touch things that work," says Linnar Viik, who lectures at Tallinn Technical University. "But Estonians like to look behind the thing and wonder whether there's anything we can change about it. In Estonia you might say, if it works, you can break it."

Viik is considered one of the founding fathers of this little e-republic on the Baltic. In the mid-1990s, when Estonia was still determining what it wanted to be when it grew up, Viik figured in Estonia's Tiger Leap program. Tiger Leap was designed to weave computer literacy and IT into the fabric of the new nation, rather than just promoting them as specialized skills for a technological elite. "It was a lucky coincidence for us that we got our independence at a time when the Net was the cheapest, easiest-to-learn data transfer protocol," says Viik. "Developed countries were still depreciating their huge investments in mainframes and couldn't adopt the new technologies as easily as we could."

You can feel Tiger Leap's broad reach as you connect to the Net while filling up at one of Statoil's Wi-Fi-equipped gas stations-just some of the hundreds of Wi-Fi hot spots and wired public Internet access points scattered around the country. According to the latest figures 52% of Estonians use the Net regularly.

The government runs its Thursday-morning cabinet meetings on computer, and it is close to doing away with paper altogether. Sessions that used to take most of a day now take half an hour as ministers politely tap out their comments instead of grandstanding. Next year the official record of government business will no longer be printed on paper, except for a single copy for the archives. It will exist solely on the Web. "If the Internet was reborn as a country, it would be Estonia," United Nations Development Program administrator Mark Malloch Brown has said.

Two years ago Estonia introduced an optional smart ID card that is making documents and money obsolete in a growing range of public and private transactions. An Estonian can use it instead of a passport to travel within the EU, to get on the bus and subway and to file taxes with a card reader attached to his computer (refunds in five days for the electronic filers, several months for the paper filers).

"I rarely sign pieces of paper anymore," says Sten Hansson, the information adviser to the Estonian state chancellery. Hansson is 31 now and has already served in government for ten years. Siim Raie, the 27-year-old director of Estonia's chamber of commerce, just took out a personal home loan without picking up a pen. But this is not just a demographic revolution. Hansson's 84-year-old grandfather just got his smart card.

The government was going to make the smart card mandatory, but the libertarian-minded Estonians always prefer choice to diktat. So far 620,000 out of 800,000 working-age Estonians have asked for one because it makes life easier. It doesn't appear to bother anyone that the chip is gradually ingesting every detail of an Estonian citizen's life. Next up: e-voting and e-police, which will put a driver's entire history of traffic violations on the card's chip.

When Estonia determined that its traditional customs process was keeping it from winning mobile phone assembly projects, it got an e-customs system that cut average processing time from several hours to about 20 seconds today. That proved key to snaring a 4,000-man assembly line from Finnish manufacturer Elcoteq, which might otherwise do that work in China. The Elcoteq plant is fully responsible for 25% of Estonia's manufacturing exports.

Estonia is often lumped together with two other new republics, Latvia and Lithuania, as the so-called Baltic tigers. All three joined the EU in May. All three have thrived since independence and stand in marked contrast to other former Soviet republics for their speed and agility in adapting to the hard realities of capitalism. GDP growth in all three countries is chugging along in the neighborhood of 6% a year, compared with under 2% in the rest of the EU.

Each of the Baltic republics differs markedly from its neighbors in culture and language, however. Estonia looks across the Gulf of Finland for its cultural and linguistic roots. Like the Finns, Estonians can be dour and tend toward an almost pathological industriousness (when they aren't singing, that is: There are 133,000 Estonian folk songs, one of the largest numbers in the world).

This is no Scandinavian welfare state. Top individual taxes in the $10 billion economy are 26% and heading down to 20%, and all reinvested profits are free of corporate income taxes. "To get your primary needs met, you have to do something," says Linnar Viik. "We are a very pragmatic society, which can be quite horrible sometimes. An Estonian might ask what is the efficiency factor of the new museum of modern art."

Old Tallinn stretches out below Hansson's chancellery office atop Toompea, the 9th-century fortified hill at the city's heart. Cobblestones slickened by mist lead down past austere Lutheran churches with stiff spires and squat lemon-colored mansions from Tallinn's prosperous trading past.

The town's medieval echoes have lately reached fresh waves of tourists- 2.7 million last year. This pillar of the old Hanseatic trading league is getting hip. The shops that line the town's fine squares do a brisk trade in hand-knitted sweaters and linen, and its traditional restaurants serve up a mean elk steak. Just as important to Tallinn's coffers are the Finns who hop a 90-minute ferry from Helsinki for bargain booze and affordable prostitutes-the unsurprising windfall from Estonia's low taxes and low wages.

Harder to see are the small workshops where a new generation of software designers is looking to turn Estonia into a kind of Silicon-Valley-with-herring. Within tech-savvy Scandinavia, however, the secret is already out. SEB, the huge Swedish bank, recently moved most of its code-programming operations to Estonia.

Sander Mägi is a typical Estonian go-getter. In 1996 he dropped out of college after his first year to take a programming job with a cable modem company that went bankrupt soon after. In 2000 he joined with Oliver Wihler, a Swiss programmer who had left his job in London for Tallinn's more agreeable lifestyle and shorter commute. "My friends were mystified-they thought I was going to the Balkans," jokes Wihler. The two founded Aqris Software, and introduced RefactorIT in 2002. Refactor basically works like a kind of spreadsheet for programs written in Java code, automatically remodeling an entire application to reflect changes in parts of its code. The benefit here is speed, saving the thousands of man-hours it would take to reprogram manually.

The biggest customer is Zed, a digital content supplier for mobile phones. Small sales have been made to Nokia, Philips and Fujitsu. Aqris has pretty much doubled every year, earning $1 million cumulatively. Last year it made over $400,000 on revenue of $1 million and won an award as Estonia's best technology developer.

"We're obviously not going to compete with India on projects that require hundreds of developers," says Wihler, "nor are we necessarily going to do exactly what we're told to do."

The feisty subversive streak surfaced flamboyantly in the peer-to-peer networks Kazaa and Skype. Kazaa has driven the record industry crazy by letting pc users around the world join forces to share one another's recorded music, free. Skype offers free telephone calls over the Internet.

Under the hood of both products are peer-to-peer engines built in a three-man Estonian garage called Bluemoon, headed by 32-year-old Jaan Tallinn. Tallinn met Kazaa founders Niklas Zennström and Janus Friis when he was writing the software that pays for parking spaces via mobile telephone. All three were working at the time for Sweden's Tele2, a breeding ground for many of the region's entrepreneurs. The trick for Skype was developing a system that allowed each computer to index a wider network of computers than Kazaa does. A technology called Global Index did this, allowing Skype to handle traffic that passed 1.3 million simultaneous users last month. "These guys are the best software developers I have ever seen in my life," says Niklas Zennström. "They're very skillful at problem-solving."

Zennström and Tallinn are already training their peer-to-peer sights on new applications, though neither will say exactly what. It might well be banking, says Linnar Viik, who has seen prototypes of peer-to-peer payment systems, where the network itself manages the customer base, reducing transaction costs to zero.

Estonia's problem now is how to inject enough capital and managerial know-how to bring its Baltic wonder boys to the world stage. "I can see tons of interesting products in Estonia today, but they've stopped their development at €2 million and ten people," says Allan Martinson.

Martinson recently resigned as chairman of MicroLink, which he had transformed from the Dell Computer of Estonia to a diversified IT services company. He has just launched Martinson Trigon Venture Capital. "It's a good time to be in VC in Estonia," he says, "but it remains to be seen whether Estonia can be a truly global player. It's not just about IT, it's about attitude."

Martinson is investing in a company called Oskando, which markets a GPS tracking system for car security. Oskando plans to develop a simple, cheap unit for use in, say, a child's lunch box. The trick is getting the price below $100, which Oskando thinks it can do. "We did some innovative stuff with solar cells," says Martinson. "Estonians are great at finding interesting shortcuts."

With their natural reserve Estonians aren't exactly the world's slickest self-promoters. Word of what's happening up on the Baltic is slowly starting to leak out, however, thanks, in large part, to the hype surrounding Kazaa and Skype. Steve Jurvetson of Silicon Valley VC firm Draper Fisher Jurvetson first did business in Estonia after falling in love with Kazaa. His firm negotiated the deal in December 2003 that made Draper Fisher the largest investor in Skype, and Jurvetson stuck around when he saw Tallinn's entrepreneurial beehive. It didn't hurt that both of Jurvetson's parents are Estonian, although he says that growing up he had little connection to the culture.

Jurvetson has invested in an Estonian company called Egeen, which has the exclusive rights to collect blood samples from Estonian hospital patients. It uses the patient information to conduct clinical studies for pharmaceutical clients all over the world. The Estonian kicker here is an IT database that links all patients throughout the country in real time. This lets Egeen easily and quickly assemble a sample group according to the exact criteria a client needs for a particular study.

"That's the key to why Egeen wins business competing globally with much larger companies," says Jurvetson. "After Skype, we saw tons of opportunities here to follow up. It's like the entire country has this eager, immigrant mentality. Except that in this case they immigrated back to their own country."