Reading time: 6 minutes

Germany’s success has been built on its SMEs, but why do they succeed? Will the pandemic put an end to this remarkable journey?

Today, Germany is the 4th largest economy in the world in terms of nominal GDP, enjoying the biggest current account surplus on Earth, in absolute terms, even greater than that of China’s, and a high level of quality of life. It is, therefore, no wonder that it is seen as a role model for aspirating economies to follow. However, unlike many others, the engine of the German economy is not the big multinationals, even though it is home to quite large corporations, such as Siemens, Bosch, Daimler and Allianz. Rather, what allows the German economy to have an edge are its Mittelstand.

The Mittelstand are small- and medium-sized companies, which often only employ up to 500 workers. In fact, while Germany only counts for 28 of the global 500 biggest companies worldwide, in terms of niche markets – the main focus of the Mittlestand strength – the economic giant is most definitely a market leader, accounting for around 48% of these small “hidden champions”. They are given this nickname, because, although the markets in which they operate are not very large and they themselves are not well known, they are the market leaders of these niche fields. Examples of Mittelstand include sausage packaging, cabin pressure control systems for passenger jets, realistic 3D anatomical models, food for ornamental fish and shoe manufacturing machines.

Furthermore, the Mittelstand are normally family businesses which are mostly export-driven, being the main contributor for Germany´s long-standing positive trade balance. These small- and medium-sized firms account for around 99% of the total companies in Germany and employ close to 60% of the total employed workforce of the country. Moreover, these approximate 3.3 million firms are responsible for about 35% of the total country turnover. 

Figure 1 – SME shares 2018 in Germany; Source – Federation of German Industries (BDI – Bundesverband der Deutschen Industrie)

Why the Mittelstand Succeed

First of all, they focus on customer satisfaction, they are committed to establishing a long-lasting relationship with their customers, striving to attend to their wishes and not solely focusing on the profit side of the trade.

Secondly, they invest a lot in state-of-the-art technology, deploying significant resourceson innovation and differentiation. Indeed, data shows that Mittelstand enterprises have five times more patents per employee than large businesses, but that these are also five times less costly. Innovation and efficiency are key to continue leading the market.

Thirdly, they are less focused on immediate and short-run profit, instead opting to think carefully on their business choices, maintaining high equity ratios and sometimes foregoing short-term success for perhaps a lower, but steadier and longer lasting growth. In fact, most prefer not to rely on debt as a means for growth preferring to avoid it and grow more slowly, in a more “sustainable” manner. This aversion to debt may arise due to deep rooted cultural factors, as the word for guilt and debt is the same in German, “schuld”.

Moreover, they also value the workplace, with their workers being a detrimental part of their business. As such, they employ a lot of resources into guaranteeing a healthy working environment, striving to keep their employees motivated and, hence, promoting productivity gains.

Besides, this appreciation of the workforce is also seen in the effort they put into apprenticeship programs, a lot of which are aimed at newly graduates looking for an entry in the job market. In most countries, there are either very qualified college educated workers or very low skilled ones, and not much in between. In Germany, thanks to the close connection between high school education and the Mittelstand, there is a sizable medium-skilled workforce, ideal for complex manufacturing jobs.

Furthermore, in Germany, it is also common for labor unions and workers to have a greater saying in how companies are managed. In fact, large companies with more than 2,000 workers are required to have union representatives on their administrative boards. This shows that, in Germany, there is greater cohesion and connectiveness between workers and management, allowing companies to sometimes take tough decisions, such as reducing salaries in times of crisis without as much unrest, as workers are more aware of the firm’s difficulties.

Finally, the fact that most of these firms are passed down from many generations serves as a guarantee that the future owners were born into the trade and are well aware of the goals of the company, as well as of the structure of their operations, ensuring a great knowledge of the market in question.

Challenges for the Mittelstand

However, as competitive as the Mittelstand are, they also face a myriad of challenges. The pandemic, in particular, is pushing these hidden giants to the brink. Here are some of them:

The Mittelstand do not have as much bargaining power with their suppliers as their larger, publicly listed rivals may have, which may lead to lower profit margins.

Secondly, due to increasing globalization and freedom of exchange of goods and services between countries, the Mittelstand are facing growing international competition, especially as China transitions its economy to the production of more added-value goods.

An ageing German population is also a cause for concern, as this will mean fewer consumers for the internal market and a smaller labor force from which to recruit young and talented workers, which may reduce the total production capacity of the Mittelstand and also stifle the fervorous innovation these companies need to stay on top. German companies are actually already facing shortages of skilled labor.   

Sometimes, the family business characteristic can also be a disadvantage, as it may lead to problems of succession or even disputes among future potential heirs of the business.

The Mittelstand face a growing challenge regarding the digitalization of the economy too, and increasingly important technologies, such as AI and Big Data, have not yet been adopted at a wide range. Overall, there is still much to be done if these companies want to stay on top when the Industry 4.0 takes flight.

Nonetheless, all the challenges referenced so far have been ones that the Mittelstand had been facing even before Covid. As suggested before, however, the pandemic is bringing a new array of challenges.

Figure 2 – Top issues of business associations; Source: IfM Bonn 2020

Among them, lack of liquidity has been of particular concern, as business activity has greatly fallen and, unfortunately, due to the slow resolution of the pandemic, businesses have not recovered much. Although lay-off programs and other support measures from the German government have mitigated some of these problems, the fact is that they are no full replacement for normal business activity.

Due to the spread of the virus, companies have also been forced to shut down their facilities, which has caused halts to their production. Some firms have been able to cope with this shutdowns better than others, though, as industries that mainly rely on the so-called “white collar” workers have been able to maintain part of their activity through remote working models. Models that have also come with their fair share of challenges with regards to adaptation one must admit, but still these companies have performed better than the many that rely on blue collar workers.

Finally, the Mittelstand have also had to cope with pressure on their supply chains, as these too have been subject to restrictions, therefore causing delays and problems in terms of acquisition of inputs and for the export of products. Going forward, many of these firms are rethinking their supply chains by possibly decreasing their reliance on overseas suppliers and switching to more local networks to a greater degree than before.

Final Remarks

Although the large German corporations may catch everyone’s eye, Germany’s success lays in the giants one does not see. The Mittelstand focus their attention on niche markets, too small for the big companies to get involved in, but too complex for the average smaller company. Their achievements are the result of many factors, but the challenges they face are equally as many. Nevertheless, one ought not to bet against them not coming out on top of those.

Sources: BBC, BDI, Entrepreneurial Living, Financial Times, IfM Bonn, McKinsey and Company, Harvard Business Review, PwC Reuters, The Economist

Rodolfo Carrasquinho

Inês Lindoso

Jorge Lousada

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s