Conundrums of Ethiopia's Startup Act

For the startup act to induce innovation-driven economic growth, broad deregulation of the Ethiopian economy is necessary.

“የፖሊሲው ሐሳብ ጥሩ ሆኖ ሳለ አፈጻጸሙ ላይ ነው ችግሩ” is a common mantra whenever policy failure happens. Roughly translated, it means “the policy was/is good but the implementers messed it up.” I tend to take such statements with a grain of salt. This is by no means to disregard risks of implementation, but, I would argue that “implementability” of a policy must be considered and resultant risks, where known, ought to be mitigated proactively.

The objective of this article is to reveal 2 conundrums (in innovation and incentives) that will make it difficult to implement the “Proclamation to Provide for Startup Businesses” (or the Startup Act). By sharing some thoughts on these components of the act (and how they may play out), I would like to prevent the likelihood of “good policy, bad implementation” or worse, “no proclamation!”

There has been a lot of excitement around the ratification of the Startup Act since it demonstrates a progressive stance taken by the government by means of high-level endorsement and support towards innovation and supporting initiatives centered around it. Although this has been commended and eagerly anticipated to become law ca. 2020, it still remains in ambiguous territory at the beginning of 2024. Rumor has it that it has been demoted to regulation from its initial status of proclamation.

In this article, I occasionally play devil’s advocate and point out what could be some reasons for the deadlock and suggest a way out. This deadlock has to end since each day the proclamation is delayed (denied), it is taking out the very businesses it intended to foster.

Framing the Problem.

To make sense of this text, let me define a few terms:

1. Let’s call all businesses in Ethiopia operating under the existing rules and regulations “the real economy.” The real economy is regulated by the existing commercial code and receives incentives (or disincentives) on a sectoral basis, regional basis or other considerations made by decision makers from time to time.

2. When talking about the “Startup Act”, it seems to be done in a fashion siloed from this “real economy.” Let’s call the special treatment as a result of the proclamation “the siloed economy.”

3. It’s important to note that the “siloed economy” and the “real economy” integrate and compete for the same market.

Now, let me introduce 2 more definitions from the Draft “Proclamation to Provide for Startup and Establish the National Innovation Fund”

1. “innovation” means implementation of a new or significantly improved product, process, service, a new technology, or a new organizational method in business practices;

2. “startup” means an entrepreneur, a pre-registered company or any other business company who or which aims to implement an idea on a product, process or service which is innovative, disruptive and scalable, and has obtained a startup label;

The “Innovation” Conundrum

From the side of Ministry of Innovation & Technology, there’s an underlying assumption that determining what is an “innovative startup” would be easy to implement. I argue otherwise and think it will be one sticking point when operationalizing the proclamation. Why? Let’s delve into the particulars.

Let’s assume a new startup, “Startup X”, which wishes to be labelled as a “Startup” submits an application to MInT.

Question #1: Significant Improvement?

Quantifying improvement can be quantitative or qualitative. Depending on the sector of intervention, it will vary. To give the task of determining significant improvement across all sectors is definitely a stretch; and is akin to setting up both the ministry and proclamation for failure. Let’s look at the following example:

• If an entrepreneur in healthcare decides to innovate on “CAT Scanners¹ .”Improvement parameters would be ‘Image Resolution’, ‘Speed’, ‘Radiation Reduction’ and ‘Improved Algorithms’ for image construction. This is one item in the vast worlds of medical imaging equipment and medical diagnostic equipment. Now, multiply this by over 980 recognized business titles² one may innovate in.

By delegating the task of determining that an idea or design can bring “significant improvement” to MInT, we are requiring MInT to come up with such measurements for hundreds of business sub-sectors. Coming up with these parameters is daunting, time taking and in some areas (esp. digital) difficult to keep up with.

Question #2: Novelty?

In the proclamation’s definition of innovation, novelty is a core tenet. It refers to newness, originality or innovation in a particular context. However, determining novelty requires research, review of literature, patent searches, market research and examination of uniqueness of a technology, product or service. Is this a burden that should be given to MInT?

Let’s take an example of AirBnB³. If an entrepreneur sees a market opportunity in Ethiopia and decides to 1-to-1 copy AirBnB, can we say it’s a new idea, technology or way of doing business? Or is novelty only limited to what was done in Ethiopia? If that’s the case, do we have the capability to enforce intellectual property theft in the same Ethiopia that struggles to enforce simple copyright laws? If 2 or more startups apply for the label to solve the same problem with fairly similar methods, does it mean MInT will choose one over the other?

In the pursuit of innovative solutions, prioritizing new-ness over efficacy can be a strategic misstep. Startups should be encouraged to evaluate and adopt problem-solving approaches based on their demonstrable impact, regardless of their novelty.

Question #3: Innovation?

Innovation is simple to understand. Yet, very complex to standardize.

The first innovation challenge comes in due to definitional ambiguity of the word itself. Let me present the variance in definition between a few reputable sources:

1. (McKinsey & Company, 2022)⁴, defines innovation as the systematic practice of developing and marketing breakthrough products and services for adoption by customers. This definition emphasizes customer-centric and value-creation aspects of innovation.

2. The (Oslo Manual, 2018)⁵, defines an innovation as a new or improved product or process (or combination thereof) that differs significantly from the unit’s previous products or processes and that has been made available to potential users (product) or brought into use by the unit (process). This definition takes a practical approach by focusing on introduction of ‘significant’ and ‘relevant’ novelty into use — while acknowledging diverse contexts as well as being ‘too fuzzy’ to be measured/accounted for.

3. (Schumpeter, 1934)⁶ defined innovation as not only the development of new products and technologies but also of new markets, of new material sources and of new uses of the same products.

As shown above, innovation defies easy categorization and definition. The ongoing debate reflects the dynamic nature of the concept and makes it unfit as a pillar of an important proclamation.

The second challenge around innovation comes in when distinguishing between incremental innovation and radical innovation - which both contribute to progress but with different impact. Note that both qualify as innovation yet the proclamation requires “significant improvement.” While the measurement problem holds, the fact that the proclamation obligates “significance” disregards the impact of small improvements, compounded.

Question #4: Disruption & Scalability?

Disruption refers to “radical change” to a conventional way of conducting business - usually due to technological innovation. It is an “after the fact” realization and difficult to determine at the registration phase of a startup. Furthermore, disruption is catalyzed (or curtailed) by other factors such as market shifts, changes in policy/regulation, changes in consumer behavior and macroeconomic situations.

Let’s say, hypothetically, on Jan 1, 2024 Startup A receives a label demonstrating how it could disrupt Sector A. And let’s say 10 days later on Jan 10, 2024, Startup B applies to register demonstrating to deliver a specific marginal improvement in the same Sector A - does this justify MInT to withhold granting a label on Startup B, on grounds of non-disruption or redundancy?

From the perspective of MInT, I do not see purpose or value in determining whether a given startup company is disruptive or not on day 1.

The scalability argument is not much different either. Scalability simply means the capacity to significantly increase in size or scale. It refers to a business model, system or process that can handle increasing workload without compromising performance, efficiency and quality.

There is no doubt that disruption and scalability are hallmarks of startup success. However, mandating them as prerequisites makes it near-to-impossible to determine. Disruption and scale can be speculated in the beginning but cannot be a certainty and hence cannot qualify to be a prerequisite.

It is necessary that the proclamation adopts an agile approach to create a more conducive environment for game-changing ideas to emerge, even if their disruptive potential and scalability trajectory remain initially elusive.

Question #5: Pivoting

Pivoting in startups refers to the strategic redirection or change in the company's core business model, product, or strategy in response to market feedback, changing conditions, or new opportunities. A business may pivot in product/service offering, target customers, technologies used, business model or focus market.

• Nokia (3x) started life in the 1860s as a wood pulp mill, then entered electronics and cables, became a leader of mobile phones and now focuses on network infrastructure and telecom equipment playing key roles in 5G tech development.

• Samsung (2x) started life as a noodles exporter, grew to general trading, manufacturing of various goods in agriculture (fertilizers) and financial products (insurance). It entered the electronics business in the 1960s and is now a global leader and innovator in the smartphone market.

For reasons to do with dynamic economic/market realities, a startup may decide to “pivot” to overcome business challenges or grasp new opportunities. Ethiopian startups/businesses are not immune to these conditions. Could this qualify an existing business to a startup? Or disqualify an existing one from being labelled a startup?

The “Incentives” Conundrum

A key tenet of the startup proclamation is that, through it, qualified startups (companies) will immediately or eventually gain access to certain “incentives” that will be defined from time to time by the relevant body. As hinted in the proclamation, classifying initiatives as “startups” and “non-startups” is given to MInT.

Let’s continue with a scenario where X, is labelled as a startup (that will start and grow in the siloed economy). And introduce another “Company Y” which has been enjoying profits for 15+ years (in the real economy) in a sector targeted by Startup X.

Startup X, being ‘the future’ will receive incentives that would enable it to potentially gain significant marketshare where Company Y (who has comfortably thrived for the last 20 years) is challenged and now finds itself competing with a fast-growing startup.

In such a scenario, it is not out of bounds for Company Y to argue that Startup X, through the regulatory sandbox and asymmetric market conditions enabled by the proclamation, has gained an unfair advantage over it. Company Y may try this case publicly, through lobbying or other legal means (if available).

If legally challenging this situation will not bring the desired results in good time, Company Y can adopt a strategy where it will comply with the regulatory requirements and rebrand as a Startup to form “Startup Y” - which is an interim solution to compete with Startup X — with all its existing resources.

And from where the government stands, this means an exodus of taxpayers from the real economy by a magnitude equivalent to the level of incentives provided in the siloed economy. So, as far as GoE is concerned, in the short-term, the more incentives it wishes to provide to startups, the more it takes in short-term losses.

This rapid migration of MSMEs from the “real economy” and conventional tax base to the “siloed economy” could trigger concerns about short-term fiscal sustainability. Presenting at least 3 possibilities:

Option #1: Pursuit & Evasion

This is a scenario where the government chooses to keep “innovation” in the proclamation and undergoes the daunting and endless cat-mouse chase with the business community as to whether a startup is innovative or not — along with the humongous task of managing appeals and crowding out young entrepreneurs.

Option #2: Policy of Inaction

This is a scenario of government inaction and the current de facto strategy of sidelining the startup act, at the risk of stifling crucial innovation and economic growth.

Option #3: Pragmatic Convergence (Recommended)

Pragmatically, the government may choose to converge the 2 systems of doing business — leaning largely towards the siloed economy and working to make rules of the siloed economy the rules of the real economy. This option is viable and considerate of constraints on both sides. Basically, it envisions a more deregulated, business friendly Ethiopia that can become a magnet for all investment (local and international).

This implies adopting a policy of strategic convergence by significantly reducing regulatory requirements in the real economy and bringing them closer to the siloed economy.

This is important to consider as it suggests a broad based economic deregulation to allow for “strategic flexibility” that is much needed to navigate the stormy waters of innovation and enterprise. The government must understand that in this specific scenario, less is more.

To Conclude…

The draft startup business proclamation is a progressive document and can be considered as an anti-thesis to Ethiopia’s convention on regulating business — which many describe as non-friendly⁷, due to economic policies that stem from wealth creation strategies of an ex-socialist country where the government is the biggest economic agent (i.e., over regulation, protectionism, developmental statism, etc.). My key argument here is that this progressiveness should not be limited to a tiny subset of the economy but towards all enterprises in the country.

To create the much needed entrepreneurial ecosystem in Ethiopia, I recommend that the Government of Ethiopia follow an originalist’s interpretation of a “startup” distinct from the broader connotations of “innovation.” A startup, fundamentally, denotes a business that just started — and this is the easiest way to determine whether a business is a startup or not.

Consequently, if the government is concerned about risks of a broad-brush approach to startup incentives, it can consider a sector-specific strategy prioritizing high-impact industries such as digital, agriculture, healthcare, defense, communications and so on.

When regulating startups (and businesses), less is more.

1. Computed Axial Tomography Scanner, more commonly known as a CT Scanner is a type of medical imaging equipment used in radiology departments in hospitals and medical facilities to visualize internal structures of the body for diagnostic purposes.

2. As part of BPR (Business Process Reengineering), Ethiopia adopted a Ethiopian Standard Industrial Classification (ESIC) adapted from the International Standard Industrial Classification (ISIC) and more specifically Singapore and South Africa as they were found “suitable to fit with the Ethiopian condition.” The Ethiopian version has over 980 titles.

3. AirBnB is an online platform connecting travelers with unique accommodations worldwide, offering stays in homes, apartments, or rooms hosted by individuals. It allows hosts to rent their spaces and travelers to find personalized lodging experiences.

4. https://www.mckinsey.com/featured-insights/mckinsey-explainers/what-is-innovation

5. https://www.oecd-ilibrary.org/docserver/9789264304604-en.pdf?expires=1703791485&id=id&accname=guest&checksum=21D8E62090AA98096725B1EDD97EAB91 (Pp. 34)

6. Innovation & Innovation Management Journal pp. 27 (https://www.researchgate.net/publication/331189067_Innovation_and_innovation_management)

7. Ethiopia ranks 159 out of 190 countries per the World Bank’s Ease of Doing Business Index (measured over 10 parameters)