When Eyal Gura and colleague Offir Gutelzon co-founded a digital image “fingerprinting” firm to help copyright holders protect their intellectual property and develop a marketplace to license them, the two men — graduates of Israel’s IDC (Interdisciplinary Center) Herzliya — drew on a combination of military, cultural and business background to develop their business.

PicScout illustrates the way technology developed for one purpose can be leveraged to serve a variety of markets. It also shows how a small country with minimal natural resources can draw on knowledge-based resources to spur an outpouring of high-tech companies, say Wharton business experts.

“We believe that 85% of the images appearing on the Internet infringe on copyrights,” says Gutelzon, who serves as CEO. “PicScout developed image recognition technology that enables copyright owners to see where their images are being used and determine whether or not the usage infringes on their copyright.” Right now, the photo imaging industry loses more than $67 million a year in foregone revenue to unlicensed users, according to the trade association Stock Artists Alliance.

Established in 2002 with offices in Herzliya, Israel, and in Los Gatos, Calif., the privately owned company has grown quickly in recent years, from revenues of $2.5 million in 2006 to $4.5 million in 2009, according to Inc. magazine. In 2010, the magazine ranked PicScout’s percentage growth No. 34 among media companies and No. 2754 overall. PicScout, which has 60 employees, is also active in Europe and plans to expand into China and Russia — both hotbeds of copyright infringement — and possibly into South America.

Just as music and movie companies have long been concerned about Internet piracy — the unauthorized online distribution of songs and films — photographers and other owners of copyright-protected images continue to fret over unauthorized postings of their intellectual property. “It’s a huge potential market,” Gutelzon says. “It includes people who are being infringed on but it’s not limited to that, since we are also creating a central exchange for people who need to use images but don’t know where to legally find and license them.”

A business model like PicScout’s that targets an existing need instead of trying to create demand for a new one can be very effective, says Wharton marketing professor Jerry Wind. “The key is whether the company offers a truly innovative solution or is just trying to piggyback on existing demand. Starbucks, for example, took a commodity product, coffee, and built a premium experience around it. If PicScout delivers something new, rather than just something that’s slightly better, it has a better chance at long-term success.” Targeting the intellectual property market can make sense, he adds, because it’s so pervasive.

But unlocking the value of intellectual property involves determining how to protect and monetize it, notes Gary Shenk, CEO of photo-image supplier Corbis, chaired by Microsoft founder Bill Gates. Corbis and Getty Images, which both utilize PicScout’s services, are dominant players in the expanding photo-image supply market, licensing art to books, magazine, media production companies and other users. “If our images are pirated, it undermines the whole value concept of licensing and of paying artists for their creations,” Shenk says.

Corbis evaluated several of PicScout’s competitors but, “in deciding to go with PicScout, we considered its history, its technology and its proven track record,” he adds. Corbis also considered developing its own image search engine to detect unauthorized use, but the company decided that outsourcing would be more effective. “You want to focus on your strengths,” Shenk says. “We determined that using a company like PicScout would be a better use of our resources.”

Stepping up Enforcement

PicScout’s technology may sound like something a law-enforcement agent would use, but the company itself is neutral about prosecuting copyright violators. “Our competitive advantage is the digital fingerprinting technology,” Gutelzon says. “We turn the information over to partners who decide what steps to take from there. This approach enables each company to focus on what it does best. Because we’re in a complementary position with regards to companies like Getty and Corbis, there’s no conflict. Instead, each company is helping to create more overall value.”

PicScout chairman Eyal Gura says he got the idea “when Offir and I were in the second year of the bachelor’s degree program of Wharton partner IDC Herzliya.” His then girlfriend, and now wife, was working at the Getty Images Israeli branch and “had to spend a few hours every day manually monitoring the web to detect potential image infringements.” After conceiving of a way to automate the process, “Offir and I started the company during our third year at IDC’s Sam Zell entrepreneurship program.”

Competition is always a concern, notes Gutelzon, who says the company stays ahead by continuing to plow funds back into research and development, by exploring new ways to expand its revenue stream and by looking to expand its geographic reach. “Most of our competition [for copyright search protection] primarily focuses on tracking text instead of images,” he adds. “It’s my understanding that one or two may be expanding into image search, but I believe they license the technology from a third-party vendor.”

Some parts of the company’s expansion plans, however, may expose it to potential problems. “We want to continue to expand geographically” as well as technologically, Offir says. “But we’re also concerned about copyright enforcement in some of the [targeted] markets like Russia and China. We’re hoping authorities there understand the need to step up their enforcement activities.”

Wharton marketing professor Leonard Lodish likes the company’s business model. “Contracting with major image providers to provide a significant service is a very good way to enter the market,” he says. He acknowledges the similarities in challenges faced by the digital imaging market and the music and film markets, but adds that there is a big difference.

“When you’re talking video or music file sharing, the users are likely to know that they’re violating copyrights,” he says. “But many people may not know about photographic copyrights. The fact that PicScout doesn’t get involved in enforcement — but focuses on tracking and identifying the images — is a powerful competitive advantage since it lets the company apply its skills in a targeted manner.”

Military Service as a Talent Pool

Lodish has worked with a number of Israeli firms on a consulting basis and is not surprised that many high-tech ventures originate from the tiny Middle East nation. “The book, Start-up Nation: The Story of Israel’s Economic Miracle, goes into this in some detail,” he says. “Because of the political situation, the defense industry is a major part of the country, and many of the big innovations originating in Israel have roots in digital signal processing and other military applications, which are later adapted to civilian use.”

Offir, who served in a technology unit of the Israel Defense Force — Gura served in the Israeli Navy in the submarine division — points out that widespread mandatory service in his country functions as a kind of talent pool, bringing together a wide variety of people from various backgrounds. Israel’s history and politics also plays a big role in Israel’s “remarkable innovation,” enabling the country to have “the second highest number of NASDAQ-listed companies in the world, according to Wind.

In October, Wind will conduct a Wharton Fellows conference in Israel titled, “Israel: The Holy Land of Innovation and Entrepreneurship,” aimed at showing companies outside of Israel how they can use Israeli approaches to spur their own innovation. “To begin with, Israel has few natural resources — although recent natural gas discoveries may change that — and faces hostile forces like Iran, which [compel] it to become self-sufficient,” he says. “Further, since it has a relatively small population, Israeli businesses had to rely on exporting to the global market to be viable. All this helps push the population to be innovative.”

The country’s relatively small land mass — at 22,072 square kilometers, it’s slightly smaller than New Jersey — means it’s relatively easy for entrepreneurs to network with each other and with some big companies, he adds. “Internally, just about everyone in Israel’s VC community knows everyone else through army service or other networking. And though it’s a small country, Israel has attracted tremendous global links. All the [big] high-tech companies, including Intel, Microsoft and Google, have major research and development facilities in the country and benefit from its many learning centers.”

The country wasn’t always so hospitable to startups, Wharton’s Lodish and others have noted. In the early days of modern Israel, from 1948 through the late 1970s, much of Israel’s economy was dominated by government-owned enterprises, and national policy was based on “protecting the cartels,” as Wind put it, instead of encouraging innovation and global competition. But the political climate started to change, and some market restrictions were relaxed in the late 1970s and early 1980s as joint U.S.-Israeli ventures like the Binational Industrial Research and Development (BIRD) Foundation were established to promote “mutually beneficial cooperation between the private sectors of the U.S. and Israeli high tech industries,” according to the BIRD website. Since its inception in 1977, sales of products developed through BIRD-supported projects have exceeded $8 billion, according to the foundation.

Meanwhile, privatization and entrepreneurship made great leaps by 2005, thanks to then-finance minister (and current prime minister) Benjamin Netanyahu, and current president (and former prime minister) Shimon Peres, according to Wind. “The technology segment can offer many opportunities for businesses to launch or expand operations. Even though high-tech originally referred to computer-related business models, it now encompasses biotech and other industries. But there is a great deal of competition in Israel and elsewhere, and the common thread, on a global scale, is the need for innovative discovery.” Companies that can deliver on that may rise to the top, he notes, while firms that don’t are more likely to fall by the wayside.

For entrepreneurs like Gural and Offir, it’s a drive that’s almost part of their DNA. “Growing up in Israel you learn a lot about taking risks and relying on your abilities,” Offir says. “So it’s only natural to apply the lessons learned to your business.”