Europe: Wet Dog to Wild Wolf

Europe’s economy has felt a bit like a wet dog in recent years. Loveable and familiar, but bathed in a patch of muddy water for over fifteen years – EU GDP hasn’t made any meaningful net strides since 2008. Many are aware, including former ECB Chairman Mario Draghi, who in late 2024 issued the report on the future of European competitiveness to deal with this wet dog and its stench of stagnation. In keeping with the biomimicry metaphor: Can Europe mirror the resilience and resurgence of the Wild Wolf and make a comeback? Just like the wolf’s role in the ecosystem, a resilient and thriving European economy affects the broader ability of our People to live healthy and prosperous lives, and their capacity to sensibly use the resources sustaining life on this Planet.

There has been some relief and renewed belief in the European market in light of recent efforts to boost European spending on resilience and defense. This does not change Draghi’s fundamental diagnosis of Europe’s problem: the cause behind Europe’s absolute and relative stagnation is the unfavorable input-output equation of our economies, i.e. weak productivity. The input costs are too high, and the output is too low, relatively speaking, to remain globally competitive in the long term. The levers to solving this are decreasing input costs and/or increasing output returns.

The Draghi report is structured into Part A, which issues a general recommendation of strategic direction, and Part B, which deals with specific industry sectors.

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A. Decreasing input costs - Competitiveness Strategy

Economies thrive when they make things the world wants in a better, cheaper, or faster way than everyone else in the world. This can be a source of sustainable competitive advantage. How can Europe become better, cheaper, or faster and build such a sustainable competitive advantage?

Being better: Lack of qualified labor has been a constant pain point for the European manufacturing industry, particularly in construction, healthcare, ICT, and STEM. Digital skills are lacking, especially for sectors that have experienced digitisation in recent years (e.g. manufacturing) – skills of workers have been neglected and the resulting investment needs for retraining for the green transition alone are estimated between €2 Billion and €4 Billion up to 2030. 

Targeted labor migration from non-EU countries can contribute much needed skills to the European economy. Reforming labor laws in major European economies to favor innovation and allow corporate agility can accelerate this. For instance, for corporations to move quickly, they need to be able to fire, hire, and retrain in direct response to market changes. Indefinite employment agreements and barriers in ending those – in contrast to the common at-will employment in the US – make corporate agility difficult.

Being cheaper: Surges in energy costs eroded profit margins for many European manufacturers. Between September 2021 and October 2022, average Euro area industrial energy prices increased by ~95%, adversely affecting production and profitability (ECB). In response to escalating energy expenses, companies considered scaling back production or relocating operations outside Europe. For instance, the percentage of German industrial firms contemplating such measures rose from 21% in 2022 to 37% in 2024 (DIHK).

Cheap and reliable energy supplies are the key ingredient to fixing this mismatch. This point is elaborated on in later parts of this piece.

Being faster: High bureaucracy impedes labor training, new technology adoption, and increases transaction costs for startups and cross-border expansion and growth. Europe’s largest economy, Germany, ranks 22nd globally in the Ease of Doing Business Index – for one of the subcategories “Starting a Business”, it only ranks 125th globally. While these regulatory barriers protect incumbents’ market position, it stifles innovation by deterring startups and limiting industry disruption. Further, markets in Europe remain fragmented, with low levels of legal, technological, commercial, and cultural standardization. This creates incremental costs for doing business across national borders. Although nominally a single market, Germany, France, and Spain have distinct laws and cultures that make the commercial growth journey from one country to another arduous.

For startups aiming to scale to millions of customers, reducing cross-border barriers is essential. EU-Inc aims to create a common legal entity for startups to facilitate cross-border activity and is making a good start of it [and 4impact capital is a signatory]. In the startup space, we saw a first (pre-pandemic) and second (post-pandemic) ESG reporting/compliance waves in response to EU regulation. Perhaps there is a third AI-native wave of reporting/compliance startups coming that can significantly lower the administrative burdens placed on European companies and accelerate burgeoning innovation in Europe?

Being better, cheaper, and/or faster is a recipe for sustainable success and ought to be Europe’s ambition – what might this look like for specific industries? Part B explores this question and we extract problem statements and resulting opportunities, with a focus on 4impact’s investment universe of scalable software startups that make a meaningful impact on People or Planet.

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B. Increasing output - Analyses and recommendations of sectoral policies

The Draghi report proposes sector-specific policies to foster innovation and increase economic output in order to build a resilient European economy, and with that, a resilient European society. We investigated these sectors and identified unique and relevant software and impact growth opportunities in sectors 1. Energy, 2. Critical Raw Materials, 3.2 Computing & AI, 4. Energy-Intensive Industries, 8. Space, and 10. Transport. We elaborate on the reasons for selecting these sectors below.

B.1 Energy

‍Problem: Companies in the EU paid €390 billion for fossil fuel energy imports in 2023; this is up 90% vs. the 2017-2021 average. Because many industries depend on a continuous and predictable supply of energy, fossil fuels are often preferred for industrial production. The intermittency of renewables make them an unfavorable option for many industries. European industry is thus highly dependent on external sources for sufficient energy generation and subsequent industrial production.

Explanation: Solving the intermittency problem is the best way of securing long-term energy independence for European industry. It decouples production capacity from external factors and helps Europe access cheap renewable energy supply. Theoretically, supply of cheap renewable energy is not a problem. Practically, challenges lie in the storage, transfer, and management of said energy. 

Conclusion: Better coordinating the flow of energy can reduce the expressed fluctuation of renewable energy intermittency. Price volatility turns this coordination game into a demanding stratagem, while congested energy grids add sharp limitations to the toolkit of Europe’s grid managers – notably, there remain meaningful differences between the different (sub-)national grid systems, adding to the complexity of finding a European solution. Important problems attract important solutions, and as every subsequent sector in this analysis depends on access to energy to function, we consider Energy the most important issue to address. 

Market size & timeline: This is partially an infrastructure problem, but in large parts a coordination challenge. And smart, scalable software solutions are best placed at solving those most efficiently. The market for artificial intelligence (AI) solutions in energy alone is estimated at around $13 Billion. This includes predictive maintenance for infrastructure, energy trading, and demand forecasting and response management through software. Growth in the energy space seems imminent in Europe: an ever-increasing share of renewables in the energy mix triggers investment needs in the energy grid of c. €584 Billion in the next ten years. The European Grid Action Plan, for instance, stipulates a doubling of cross-border electricity transmission infrastructure until 2030 to unlock synergies in the grid. Specific investment budgets from the EU-level are allocated, e.g. €5.8 Billion for enhancing interoperability of energy networks. We expect major movement and high growth rates in this sector to occur within the next five years.

Portfolio & Deals: Our portfolio company ETPA enables large energy assets to trade over- and underproduction with the grid, thus providing liquidity to the renewable energy market and facilitating efficient trading. Deftpower stabilizes the grid by using electric vehicle batteries as a virtual power plant. At the same time, we see many other interesting players on new opportunities relating to energy management including withthegrid, infinigrid and flexecharge. This is a crowded space but large market with imminent growth in the next five years. Risks may include vague competitive differentiation, high valuation expectations, and consolidation pressure in the next two to five years. Due to the large market size and imminent growth for software opportunities specifically, we expect interesting and relevant movement in this space.

B.2 Critical Raw Materials

‍Problem: Europe depends almost exclusively on non-European countries for critical material needs in renewable technologies and infrastructure. 

Explanation: Europe’s mining glory days seem behind it – yet, there are relevant current opportunities on the continent. For example in lithium mining, where up to ten new mining sites are expected to open in Europe until 2030. Europe’s lithium reserves are currently around 60 times larger than its predicted demand in 2050. This is an opportunity to reduce lithium reliance on China, who currently supply 90% of Europe’s rare earth demands. Outside of lithium, Europe is unlikely to take a meaningful step towards self-reliance as the natural reserves are not currently known to be present in adequate amounts.

Conclusion: To alleviate the dependence on external suppliers of critical resources, we can either use existing materials more efficiently, or accelerate the discovery of new and alternative materials. Remote sensing technologies and big data analytics for intelligent mining extraction and increased mining efficiency are one way of improving extraction; processing plant optimisation through smart sensors and software can help accelerate post-extraction value chain activities. Traceability solutions for resource streams can enhance raw materials management. Due to the global value-add chain of critical raw materials, alleviating Europe's problems here will require management solutions of global scale, for which software solutions may be well suited in the traceability domain - extraction and processing efficiency software are likely to only represent a fraction of the EU’s domestic market size in extraction and processing. 

Market size & timeline: On the raw materials management side, the Critical Raw Materials Act prioritises creating a singular circular market for raw materials and sets EU-wide benchmarks for self-reliance in certain critical raw materials by 2030. While this could incentivise further investment in the space, overall growth in this sector is comparatively less imminent (vs. the other sectors explored in this analysis). Market size for software solutions in extraction and processing is limited to a fraction of EU critical raw materials production, which remains a negligibly small, but unknown number (e.g. EU-27 accounted for less than 7% of global critical raw material production in 2020). We expect growth rates to significantly increase around and after 2030 as opening of European mines and new materials discovery respectively take relatively long.

‍Portfolio & Deals: Our portfolio company Circularise is the global leader in sustainability management and circularity in plastics and increasingly, mining as well. We also see opportunities in remote sensing and big data for intelligent mining extraction and increased mining efficiency, e.g. companies like Terraprisma. Materials discovery can yield increasingly relevant opportunities on the continent, where we see e.g. Materials Nexus or Hedera-22 can become interesting players. In the sustainability management and circularity space, we see companies such as Sirius and Circunomics. The critical raw materials value chain requires incremental investment to keep Europe competitive, which could suggest a flurry of incoming government subsidies, making investments for private capital relatively more attractive. However, due to the limited market size for software solutions and long run-up time for the sector to kickstart in Europe in earnest, finding sensible investment opportunities may make the cost-benefit analysis of looking for deals in this space unfavorable.

B.3.2 Computing & Artificial Intelligence

Problem: We may be reaching the physical limits of improving computing power – smaller chips pack more performance into the same computers with near quantum-level accuracy in chip design. However, we start hitting a ceiling (or floor, if you will) as electrons become ungovernable at quantum scale (see also: quantum tunneling). How do we satisfy our growing compute needs?

Explanation: While scientists across the world are working on exciting ways around the (supposed) physical limitations of computing infrastructure, they are racking up massive capex – although showing exciting potential solutions. In the interim to the next major breakthrough, we need to operate existing hardware and infrastructure more efficiently to satisfy our growing compute needs. As AI can be of relevance in solving complex problems like energy grid congestion or new materials discovery,  the need for solutions to our compute bottlenecks is clear.

Conclusion: There will remain a European market need for servers and data located on EU soil. They may still be operated by foreign cloud providers, but represent a hybrid solution to achieve data sovereignty – this need forms the growing EU cloud market! As the demand grows, supply of infrastructure and operations that satisfies European needs is slow to catch up. This puts pressure on existing infrastructure and creates a need to achieve more with less. On the R&D front, Europe can leverage its excellent academic infrastructure to advance knowledge of potentially revolutionary technologies like quantum computing.

Market size & timeline: The EU cloud market size is expected to reach €196 Billion by 2028, half of which is expected to be spent on SaaS solutions alone. While this number represents the provision of general (not necessarily impactful) software services, there will be an increasing need to execute compute in the most-energy efficient way possible, due to a.o. energy grid congestion. Computing will continue its ferocious growth in the immediate future and as US cloud providers still serve 65% of Europe’s cloud demands today, the expected growth in demand for EU-sovereign cloud solutions should provide ample opportunity for European startups to play in this space, starting right now.

Portfolio & Deals: Our portfolio company Coolgradient leverages AI to make data center cooling operations more resource-efficient, saving money, energy, and water. We also see Nano-API and Perian and Helio. Provisioning compute infrastructure, whether through building new hardware or operating existing hardware, increases access to AI and helps companies and industries remain globally competitive. Impact opportunities are likely to be found in the operational part of this market, where resource efficiency is key to offering access in the first place – this is likely in places with resource constraints such as limited hardware, limited energy, limited operations infrastructure, or limited access to AI (e.g. through regulatory blockades). This is where software solutions can make an impact and be of economic value at the same time. Hype and growth rates make for high valuation expectations. Those might only be justified by startups with truly global potential. As a wildcard opportunity, Quantum Computing could become interesting, but any investments will be marred by high risk and require a long investor breath.

B.4 Energy-Intensive Industries

Problem: Volatile energy prices and skilled labor shortages put pressure on energy-intensive industries that are critical to reducing the EU’s strategic dependencies and advancing decarbonisation.

Explanation: Energy-intensive industries (EII) include chemicals, metals, non-metallic minerals (ceramics, glass, cement), plastics, and paper and wood products. Price pressure leads to shutdown and/or relocation sooner in industries where machines and equipment are easily replaced (i.e. the company can easily relocate to another location with cheaper energy prices) and the labor is more transient (and therefore also easily replaceable). The lower the skills and remuneration required to do a certain job, the more likely a relocation becomes. Steel, in particular, has been hard hit with production down 34 million tonnes since 2018. Overall production in EII had decreased 12% since Q1 2021 up to 2023. Yet, these industries remain important and harbor decarbonisation opportunities through making the actual infrastructure for a green economy or decarbonising its own, carbon-intensive operations.

Conclusion: Macro pressures have not been kind to EII in the past years. The industries likely to remain stronger for longer are the ones with higher capital expenditure and more highly-skilled labor required. This makes the chemicals industry one with a high grade of stickiness out of European EII. 

Market size & timeline: Chemicals is one of the few sectors where Europe outshines the US. In 2022, European chemicals registered sales of €760 billion (vs. €606 Billion in the US). China by far outnumbered both with €2.39 trillion worth of product sold in 2022. Just twenty years prior, China was far behind Europe’s then leading sales of €363 billion. Let us assume that energy, compliance, and waste management comprise 15%, 5%, and 5% of operating costs respectively. Software solutions that can optimise these processes by 20% would face a related market opportunity of ~€38 billion. In the face of China’s tremendous growth, Europe has maintained a global leadership position in chemicals. Today, the DACH and Benelux regions combined make up over 50% of Europe’s chemical industry and we expect these industries to be most receptive to efficiency-optimising solutions in the near term, out of all European EII. 

Portfolio & Deals: If the chemistry space shows more resilience in Europe than other industries, startups that can strengthen this industry are in a good position with more relative certainty of a large and thriving customer base compared to other sectors: DUDE Chem, Carbon Minds, SimBeyond, ExoMatter. We expect chemicals to remain among the most resilient out of Europe’s EII. Opportunities in steel are well-known and 4impact has exposure to them through its Tvarit investment. Where are the resource-optimisation SaaS for chemicals? A large domestic market with particular strengths in the 4impact capital core geographies of Benelux and DACH could mean relevant investment opportunities in a sector that generally flies under the radar of mainstream hype and may offer relatively more attractive valuations.

B.8 Space

Problem: When was the last time we sent a dog into space? The EU faces challenges in many critical areas of this new Space Race: lack of coordination between member states, and far inferior R&D expenditure compared to the US and China threaten Europe’s leading position in space.

Explanation: Europe has achieved a whole lot with comparatively little, and maintained global leadership positions in Earth Observation where the EU is on par with the US at a ~40% global market share. Impressive, as the EU has done so with less than ¼ of the government expenditure as the US! Yet, there are many other metrics where Europe is falling behind (commercial launchers, payload launched, export sales, public and private investment). These are hardly challenges software startups can solve. However, there may be relevant opportunities when Europe doubles down on its remaining strengths in Space.

Conclusion: Europe has shown clear leadership in Earth Observation technologies and the application of such data in commercial contexts. Environmental data management as well as natural disaster response are important areas where European startups can play a relevant global role.

Market size & timeline: The value of the global space economy in 2023 stood at $630 billion, with some estimates expecting a tripling of that until 2035. And this is only the direct market, and does not include the sectors of the economy where space plays an important enabler role. It is important to note that these numbers are due to high capex. The applicable market opportunity for software is likely closer to $20 billion, globally. Conversely, this data may underestimate the opportunity for software-derived space data applications, as they can be so broad, it is difficult to capture them. So, is there enough room to grow for software in space? At this time, EU public budgets are still far behind competitors US and China, and we expect it will take at least three years for new policies to come into effect and act as a catalyst for the sector.

Portfolio & Deals: Satelligence and Solar Monkey use satellite data smartly and effectively to deliver a superior service to their customers in the food & ag and energy space, respectively. Orbio uses remote sensing data to manage methane leakage in heavy industries. When looking at future opportunities, we observe that privatisation and start-up activity has grown significantly in the Space sector. There is lots of movement at the early stages of company formation, but attracting late-stage growth capital is difficult due to relatively long lead times and reliance on government contracts for commercial growth. The importance of Space can hardly be overstated and will likely remain a key strategic priority for the EU and many of its member states. Many opportunities within software and impact using space tech take time; often, governments are clients and their decision cycles are long. Investors ought to take care when considering dual-use applications of these technologies as well.

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Conclusion

Whether it ends up being a widespread infusion of smart software into the energy sector, a resurgence of smart mining for critical materials, an efficient use of energy-gulping artificial intelligence, a catalytic chemicals sector, or patient and responsible exploitation of space resources – Europe’s economy is full of hidden strengths that need to come to the forefront of founder, startup, corporate, investor, and political agendas. In times of global uncertainty, sovereignty over critical resources, critical information, and critical infrastructure are the basic pillars of a resilient Europe that values a symbiotic relationship between People and Planet where both sides end up winners. Germany recently made its first major commitments to building these foundations with a €500 Billion spending package aimed for the climate and economic transformation fund (€100B), as well as federal (€300B) and regional (€100B) defence and infrastructure budgets.

There are many things we as Europeans can do to turn this wet dog into a wild wolf. Let’s get to it!

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