Japan’s startups are finally dreaming big

This article is from an episode on Disrupting Japan. This is heavily revised from the original show transcript. For the full episode, go here.

In this episode, we’ll take a step back and take inventory of the Japanese startup ecosystem. We’ll take a look at what’s working and what’s still lacking. We’ll also look at the state of startup financing and innovation in Japan. Then, we’ll wrap up by talking about where exactly the second era of Japanese innovation will come from.

nStartup financing in Japann

There is plenty of risk capital in Japan and, by all measures, the amount is increasing. Japanese venture firms raised more than US$2.5 billion in 2017, which is more than a 400 percent increase from 2012.

But numbers don’t tell the whole story. The biggest effect of this increased funding is that it has made founders a lot more confident and aggressive – and a lot less stressed.

Years ago, when I began asking founders why and how they started their companies, most had stories about how they had to convince their wives, parents, or even their wives’ parents to let them build a startup. Most founders had people begging them not to do it and some even lost friendships. And at the time when financing was hard and valuations were low, many founders had to scrimp and deprive themselves of basic necessities.

But these just don’t happen anymore. Newer founders rarely have a dramatic origin story as they tend to receive social support. Over the past decade, starting a company in Japan has gone from, “Am I really willing to bet my entire future on this?” to, “Hey, why not? What’s the downside?”

And that’s the way it should be.

When you are not worried about your next meal, pay, or a loan, you are going to dream bigger. You are far more likely to grow a billion-dollar company with this attitude.

Photo credit: Ispace

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This is exactly what we’re seeing in Japan. From dozens of newly minted founders who are explaining how they are going to disrupt their industry to the likes of iSpace, which raised over US$90 million to commercialize the moon, Japan’s startups are finally dreaming big.

On the venture capital side, however, while the progress has been impressive, the transformation is less complete. VCs everywhere in the world are basically skittish and risk-averse. We see the same dynamic in Japan, but it’s a bit more pronounced.

Japanese VCs are very willing to invest in standard startup business models with clear metrics. If you have a B2B SaaS startup or a mobile marketplace with promising metrics, you will get funded. If your idea is a little more innovative but you have a good pedigree, you’ll get funded. If you are more off the beaten path, well, you’ll have to work a lot harder and raise money at lower valuations.

There is another odd effect that is a result of both the herd nature of Japan’s VCs and the fact that there are still relatively few deals. When a startup becomes a “hot startup” – either because it has proven itself with rapidly growing revenues or because it has a great tech story – everyone wants in on the deal, and valuations get kind of crazy.

But this is hardly unique to Japan, and we have a long way to go before we are anywhere near nosebleed valuations we’ve seen for companies like Uber. Besides, 15 years ago, these companies would not get funded at all, or they would be funded at much lower valuations than they deserve.

What about the startups who are not Uber for X or Airbnb for Y? What about the companies that have genuinely new and innovative business models? Well, they exist and do get funded, but more slowly and at lower valuations.

And frankly, I think these non-mainstream startups represent a fantastic opportunity for both angels and VCs who are more independent-minded and contrarian.

nWhere are Japan’s unicorns?n

I can tell you that the quality of startups – from what I see in pitch events and funding news – is without question going up. But these are very soft and subjective measures. Let’s look at an objective quantitative measure of quality.

People, especially the international audience, always ask, “How come we haven’t seen a Japanese Facebook, a Japanese Google, or a Japanese Uber? Where are the world-changing companies?”

First, I should point out that as of writing, Japan has two startup unicorns: Mercari and Preferred Networks. Second, and far more importantly, screw unicorns!

The point is that counting unicorns is a poor way to measure the health of a startup ecosystem and an incredibly stupid way to measure innovation. Yet, this seems to be the metric that everyone understands. People like big numbers – they make great headlines. But it is not an indicator of innovation.

Think of it this way: There were no pre-IPO unicorns at all before 2009, and now there are about 300 of them. Does that mean we are hundreds of times more innovative now than we were during the PC or dotcom investment booms? Of course not.

nUnicorn count is a backward-looking metric.n

However, it is undeniably true that any healthy startup ecosystem should eventually generate high-value companies and substantial economic activity. The important thing to realize when counting unicorns, however, is that the count is a trailing indicator, not a leading one.

Unicorn count is a backward-looking metric. It tells us what has already happened rather than what’s going to happen.

Now, the most truly transformative startups are those that have innovative business models. Google, Uber, iTunes, Facebook, and Airbnb have become wildly successful not because they have great technology, but because they defined new business models. They changed the way we interact with the world.

Over the past 15 years, the Japanese startup ecosystem has transformed itself from something that basically didn’t even exist into something truly world-class, and companies like Preferred Networks and Mujin are doing things in AI and robotics that are way out in front of their global competition.

But are they really going to change the way business is done?

I’ve been discussing this with a lot of well-informed people over the past few years. You would be amazed at the number of people – both Japanese and foreign – who tell me that Japanese people will always have trouble experiencing business model innovation because their conformist nature discourages them to challenge the way things operate.

We don’t see a lot of business model innovation in Japan but, in fairness, we don’t see a lot of meaningful business model innovation anywhere.

So where is innovation most likely to come from?

nEvocative machines
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There is a unique Japanese technology emerging from the nexus of AI, robotics, and healthcare, and it’s something that could utterly transform our world.

Machines are unquestionably becoming smarter, and recently, there has been a lot of good work being done on creating empathetic machines. But there is a different technology I call “evocative machines.”

The distinction is that empathetic machines are those that can understand our emotions and empathize with us; evocative machines are those which evoke emotions in us, causing us to empathize with them.

So why is this disruptive?

The whole point of automation is to get things done more simply. The history of industrialization and modern prosperity is very much the history of automation. We don’t want to walk past an ATM, stand in line, and talk to a bank teller in order to make a deposit.

Today, we are all perfectly capable of operating elevators and pumping gas on our own. And 10 years from now, we will get used to self-checkout and self-bagging at grocery stores – or maybe we’ll skip the stores entirely and just order our groceries online or with an app.

Automation makes us all more efficient. But the thing is, we humans are deeply social creatures. The future envisioned by Silicon Valley is one where we work gig-economy jobs, conduct most of our social life online where we can be properly analyzed and marketed to, and make friction-free purchases at the tap of a button. But the rational benefits from automation are overwhelming, so what we need is something to soften the emotional blow.

The solution is evocative machines.

The idea first struck me during a discussion with my friend, Shunsuke Aoki, who is a mad scientist and the founder of Yukai Engineering. We were discussing the obstacles facing robotics in healthcare, and he mentioned that he thought we would someday interact with robots the same way we interact with our pets – understanding intellectually that they are not humans and do not have human emotions, but treating them as if they did.

Evocative machines is not a branding gimmick or a tactic for short-term competitive advantage. It’s a necessary shift that we have to go through to allow increasing levels of automation as well as enough emotional connection.

If you want to keep an eye out for an early adopter, watch the healthcare industry. The entire developed world is facing an aging population, increasing healthcare costs, and a shortage of healthcare professionals. The only way to make this work is via increased automation and efficiency. But the only way automation will take hold in this environment where emotional connection is so important is if we actually like the machines we are working with.

Photo credit: Tomasz Sienicki

Japan is far ahead of the rest of the world in evocative machines, even though it’s not yet a formal discipline.

Perhaps, a trivial example of this is the tamagotchi craze from 20 years ago. Over 75 million of those little tamagotchi eggs have been sold, and all they did was make the users care for a machine – literally. Tens of millions of people have spent billions of hours interacting with a little machine that offered them absolutely nothing – except the chance to care about something, to form an emotional bond.

Evocative machines are the key to opening up a massive new wave of automation in every industry, and it’s going to come out of Japan first.