Building capacity to help Africa trade better

Where to for Africa’s Silicon Valley?


Where to for Africa’s Silicon Valley?

Where to for Africa’s Silicon Valley?

Approximately a year ago, tralac published a working paper that overviewed South Africa’s software development industry cluster in the Western Cape Province[1]. The Western Cape Software Development Sector (WCSDS) is a globalised and leading services sector within Africa. The sector has named itself ‘Silicon Cape’ in an attempt to identify itself with the ‘Silicon Valley’ node near San Francisco, United States. Silicon Valley is host to technological leaders, including Apple, FaceBook and Google. Likewise, the greater Cape Town metro (including Stellenbosch and Somerset West), is home to tech leaders such as Amazon (South Africa), Thawte, Naspers, Entersekt, PayFast and Snapscan. ‘Silicon Cape’ is the name given to the initiative – a hub of ICT firms, collaborative initiatives, funders and governmental partners.

The WCSDS is part of a growing services sector in South Africa (SA). Services value-added is growing in absolute terms as well as relative terms, partly displacing manufacturing output as a share in total value-added. While the share of the broader ICT sector in total output is around 3%, the contribution of the software sub-sector is much smaller and the sub-sector makes up less than 12% of the overall ICT sector[2]. It is apparent therefore, that the WCSDS is a niche sector within a sector, albeit one that boasts high-skill, high value-added activities and has the potential for rapid growth.

A unique feature of the software development sector in general is its ability to disrupt established business modes. While other sectors – such as public transport, combustion vehicles and hotels and accommodation – have shown themselves to be vulnerable to disruption, the software sector (in conjunction with underlying hardware infrastructure) is the sector from which disruption primarily emanates. This disruption is key to the advancement of society, the optimisation of resource use and the conservation of the planet. This underscores the importance of the sector, its capacity for growth and value-contribution, and the valuable role of technological advancement in general.

The WCSDS is one of only two significant technology hubs in the developing world, the other located in Bangalore, India. When rated on quality of life indices however, the Western Cape outscores Bangalore by a significant margin. It is also first in the world for purchasing power (affordability) by mean salaries for tech staff.

Given these credentials, the sky would appear to be the limit for the WCSDS as a leading light of Africa’s technological future. However, significant ‘roadblocks’ and ‘bottlenecks’ threaten to hamper the sector’s progress. We interviewed several tech entrepreneurs in the sector, some of whom were part of the survey in last year’s tralac working paper, and identified areas that need priority policy intervention if the sector is to achieve its potential.

Firstly, South Africa needs to urgently revise its draconian restrictions on the movement of intellectual property (IP). Although these were slightly relaxed earlier this year[3], they remain highly restrictive and out of step in a globalised world. Basically, SA laws require any sale of locally-innovated IP to acquire approval by ‘authorised agents’ – usually commercial banks. These sales can be disallowed in the buyer is not at arm’s length or the price is not considered a ‘fair market price’.

Also disallowed is sale of IP and licensing back to SA entities; and there is also no tax preferential treatment as a reward for innovation. Sales of IP are also restricted to outright sales – meaning that tech startups cannot invite shareholding in their IP by international investors. Finally, the seller requires an auditor’s letter affirming the price for the IP, which involves more time and cost.

These controls effectively discourage innovation within South Africa and encourage tech entrepreneurs to found their startups on foreign soil instead. Our respondents indicated that there is interest in their startups from US investors but that the local regulations are a hindrance to progress in investment. For this reason, startups move to places like Mauritius or take up ‘e-residency’ in places like Estonia[4].

E-residency is a new concept in which a country attracts investment to its legal entity rather than its geographic location. E-residents of Estonia can establish businesses registered in Estonia and conduct business with an Estonian bank account without being physically resident. Given that Estonia is part of the EU, this allows South African tech entrepreneurs to bypass our exchange controls on IP and trade freely within the European Union.

A further constraint on the ease of doing business relates to the regulation of international payments. Software startups trade services, not goods, but when they sell these internationally they encounter difficulties with Reserve Bank clearance. The Reserve Bank requires paperwork for every international transaction, and part of these requirements is the seller’s importer’s code and a custom’s declaration. Of course, where there is no physical trade there is no custom’s event triggered and this creates problems. This fundamental restriction on trade in services needs to be addressed by the Reserve Bank and the Southern African Revenue Service (SARS).

A second major constraint to the WCSDS is the shortage of true risk capital. All new ventures require seed capital initially, which in South Africa is about R600k to R1.5m. These funds are burnt up over about six months, after which it will be apparent whether the venture can proceed to series ‘A’ funding and so forth. However there is a shortage of seed capital in SA, meaning many tech initiatives are still born. Instead, venture capitalists look for ‘safe’ options by investing in ventures that replicate established overseas businesses.

The Department of Small Business Development’s Small Enterprise Development Agency (SEDA) does offer seed funding, but the amount offered – R250k – while perhaps appropriate for non-technical small businesses, is less than half of what would be required for tech startups. This is simply due to the value of the skills required for tech innovation. Additional complaints relating to SEDA (and the Department of Science and Technology’s Technology Innovation Agency (TIA)) is that the pace of response is too slow. If startups need to accomplish their seed phase in 6 months, it does not help if it takes half that time to get a response from an agency.

By comparison, French startup incubator the School Lab[5] has a 6 month accelerator program in which startups initiated by students, retrenched persons and even foreign applicants are fostered and mentored in a highly relational, supportive environment. The success of initiatives like this suggest that government agencies in SA should look at establishing intermediate entities, like the School Lab, that are better able interface with entrepreneurs and provide the responsive support they need. South African university-based incubators such as the Launch Lab[6] at Stellenbosch University provide a good case study, albeit at a much smaller scale and funded by the private sector.

A third major area impacting on the success of the WCSDS is that of skills. Of most importance are entrepreneurial skills – the set of unique qualities that endow the individuals who are able to see opportunities, match ideas with clear need and are willing to put in the hours and take the risks to see the idea through to realisation as a business. These are in short supply in South Africa and we do not necessarily have an environment that encourages such behaviour. Instead our economy is dominated by relatively few market players and many industries are not competitive. We need to create mindsets among young people that encourage them to start businesses in their garages and in their bedrooms. The digital economy is far more accessible than the real economy but a saturation point will come after which the rate of innovation will be constrained. The time to act is now.

When it comes to technical skills, the WCSDS is well served by the local tertiary institutions, producing graduates who are able to obtain jobs at locally invested tech giants such as Amazon. The banking, finance and consulting sectors also absorb our tech graduates and salaries are close to or at dollar parity (international rates) in many cases. These incentives ensure that talented school-leavers are encouraged to follow these tech career paths, which further helps to resource the educational institutions. The only drawback is that these international-parity salaries contribute to pricing software engineers out of the market for the nascent tech sector. Assuming intake into tertiary universities is already at a maximum, one possible alternative solution is to encourage specialists in other areas to learn coding, such as auditors, database administrators and business analysts. This increases the supply of ‘skills’ while not necessarily increasing the supply of the skilled.

Another approach to the skills shortage is to encourage more skilled immigration. Unlike many other nations, South Africa did not have an effective preferential path for skilled foreigners to obtain residency prior to May 2018. Although now amended, the legacy of this will be felt for a few years. Avoiding bottlenecks like this in future requires more of a cross-silo approach within government, where the Trade and Industry department is able to coordinate with the Departments of Education and Home Affairs to achieve national goals.

Other policy measures that would assist the sector include:

  • The establishment of Special Economic Zones (SEZs) for tech innovation, for which exchange control regulations are greatly relaxed or dropped entirely.

  • Simplification and minimisation of regulation to reduce compliance costs. The BEE thresholds, for example, could be raised for this sector. Over regulation should be reduced and compliance requirements streamlined.

  • Tax exemption – startups in receipt of DTI or DST funding could be given tax exemption for a window period, such as two years.

  • The application process for the 150% innovation tax write-off could be greatly simplified.

The Western Cape Software Development Sector is unique in Africa and one of only two such significant sectors in the global south. It has the potential to lead innovation and disruption in Africa and abroad, and be a vanguard of the fourth industrial revolution. However its value and potential must be seen and taken seriously by policy makers, and appropriate action taken to offer it more support.

[1] Stuart, J. 2017. Value Chains in the Global South: Case Studies of the Cape Town ICT Sector. tralac Working Paper. Stellenbosch: tralac. https://www.tralac.org/publications/article/12286-value-chains-in-the-global-south-case-studies-of-the-cape-town-ict-sector.html

[2] Statistics SA. 2017. Information and communication technology satellite account for SA 2013-14. Pretoria: Statistics South Africa

[3] https://www.businesslive.co.za/bd/national/2017-03-14-intellectual-property-exchange-control-eased-but-dont-get-too-excited/

[4] https://techfinancials.co.za/20 17/03/27/estonia-offering-virtual-residency/

[5] http://theschoolab.com/en/startups/

[6] https://launchlab.co.za/startups-entrepreneurs/. The Launch Lab provides IP legal protection for innovations and provides other support, such as industry match-ups every quarter to match startups with established businesses.

About the Author(s)

John Stuart

John Stuart

John Stuart is an economist and policy analyst with special interests in trade, economic integration, technology & ICT and economic modelling. He began his career in academia at Rhodes University and later the University of Cape Town, after which he entered private consulting first with AFReC (Pty) Ltd and subsequently with management consultancy PBS (Pty) Ltd, where he served as Chief Operations Officer. Following his time at PBS he created agri-tech startup AgriDrone, one of the first UAV startups in Africa. He has subsequently researched and written extensively for tralac and also consulted to various organisations including the UN Economic Commission for Africa and the OECD. He holds an M. Com degree in Economics from the University of Natal (Durban).

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