The Strategist

Mittelstand, Germany’s Hedge Against Crisis



01/10/2024 - 18:08



It’s a stormy weather for Europe's biggest economy right now: Germany is facing a recession as high energy costs are becoming a huge burden, for the country's industrial companies especially. All this would be spelling trouble for the entire region if not for the Mittelstand, a bunch of stable German businesses that keep working hard and inspire others.



When it comes to discussions about a German business, one is more likely to think about a giant company like BASF, or at least about the famous carmakers like BMW or Mercedes-Benz - but the problem here is that they don’t think about Germany much. Having been at loggerheads with the state over energy subsidies for some time, most of them are now turning towards China and the USA, lured with ready-to-use clean energy.
 
Another group of German companies is worried as well: “As uncertainties persist into the year ahead, it does not come as a surprise that business leaders have a more subdued outlook on the economy,” says Bernhard Brinker, Head of Commercial Banking for DACH Region at J.P. Morgan, back in January. His next sentence, however, comes as a surprise: “At the same time, we recognize that Mittelstand companies are resilient and have taken thoughtful precautions to navigate through this uncertain environment.”
 
Mittel-what? Who is he talking about? Well, you're not likely to hear their name in a Wall Street cafe. The Mittelstand is a common name for small and medium-sized German businesses. Albeit family-run and situated in smaller cities, most of them is export-oriented and generally described as “resilient”. We find them in various industries, from innovative software (TeamViewer) and testing machines (Test Gmbh) to printing equipment (Koenig & Bauer) and machine tools (Trumpf).
 
The Mittelstand mean a lot for Germany and its citizens: its companies accounted for 57.6% of all jobs in 2020, and they make up over 99% of German enterprises. The concept itself carries two meanings, the first of which is a statistical stratum, and the second is "much more of an ethos and a fundamental disposition of how one acts and behaves in society," in the words of Ludwig Erhard, the late post-war West Germany's Economics Minister.
 
So, what’s so special about them? First of all, it is their history – most of these companies have been on the market for decades, enduring several economic crises as they went on.  Not everyone survived, but those who did accepted the conviction “what doesn’t kill us, makes us stronger”, and now display more openness and international orientation, says Rudolf Vogl, Managing Director of Koenig & Bauer (K&B): “In our 175 years of company history there have naturally been numerous changes and developments - thanks to our adaptability we have always managed to break new ground.”
 
This background sometimes adds to general over-cautiousness in the sector when it comes to taking risks, Armin Schmiedeberg of Bain & Company believes, adding, however, that "this has given them much more financial stability, particularly in the crisis." Indeed, even the youngest of the Mittelstand have already gone through several turbulences that only made them stronger: for instance, TeamViewer, the remote access solutions company, faced growing competition, 70% drop in share price and lost a bunch of clients once the COVID-19 lockdowns were lifted. Despite this, the company has managed to pull through with reorganization and new product development, and is now enjoying an optimistic forecast from market analysts.
 
Resilience like this is typical for Mittelstand, and now that the recession is around the corner, they have to brace themselves once again. The mood is not very optimistic, but what’s helping is the way they do their business. The long history of this sector has kept an old-school approach in: Mittelstand prefer wholly owned firms over joint ventures and like to have everything under control. They focus on responding to customer demands and on constant upgrading of products, and once a new client comes in, the Germans strive to turn him into an old and loyal friend.
 
The Mittelstand has been able to hold its position partly because of this approach, says Kilian Renschler, K&B’s President and CEO: “We’ve established strong partnerships with our customers and support them with new technology and state-of-the-art equipment.” Characteristically, this model applies to all companies and their subsidiaries, and often becomes a winning factor: for example, Koenig & Bauer Banknote Solutions (KBBS), which is a part of K&B, has successfully implemented this strategy in the rather secretive security printing equipment industry, where it holds over 90% of the world market. What's interesting is that the following words of KBBS’s CEO, Éric Boissonnas, are very similar to those of the Group President: “In such a sensitive field, relations between customers and suppliers are guided by the reputation acquired through experience with an ever-wider range of customers.”
 
This client-oriented approach literally compels Mittelstand keep the same pace as their customers. Here, they have one less apparent yet significant advantage over their bigger competitors: the size and structure. Because of this, these companies gain more agility and flexibility, explains Axel Hunsche, Managing Director at Test Gmbh: “Our size and structure enable us to match various customer requests by acting in a more immediate and flexible manner than bigger companies. On the other hand, the family businesses represent commitment and reliability”. In practice, this translates into better responses to customers’ needs, spiced with a pinch of traditional German meticulousness, Éric Boissonnas adds : “Drawing on feedback from some of our customers, we have reorganized our Austrian factory in order to take our assembly lines to the cutting edge of the most advanced industrial processes, with systematic quality control at every stage. This has enabled us to further improve productivity.”
 
Same logic drives the innovation: it is simply not acceptable for Mittelstand to lag behind their customers in terms of technical development. This attitude makes the sector “one of the best search engines for innovation ever invented”, according to Holger Schmieding of Berenberg bank, and the companies’ statistics proves it: for instance, the size of R&D spending stands at 11% of revenue in Trumpf and 15% of revenue at KBBS. Altogether, the business enterprise sector (99% of which, we recall, consists of Mittelstand) bears most of the German innovation expenditures and helps the country stay one of European leaders in the R&D field.
 
So, Mittelstand’s way of doing business certainly has some advantages – but some inconveniences, too. In particular, the focus on better serving the customer and expanding deep into the niche requires similar efforts towards company employees and corporate social responsibility in general. Mittelstand handles it with its own traditional instruments: strong ties with communities and its residents, with established practices of investing in apprenticeship and training programs, offering social support and taking active part in the communal life.
 
There’s one more explanation for this community spirit: despite their export-oriented business strategies, the Germans regard their home-based position as a strategic asset, and strongly believe that their homeland is the best investment: “Mittelstand leaders consider their German “manufacturing home base” as the hub of their operations. This philosophy upholds a belief that innovative products can only be developed in close cooperation with manufacturing operations,” reads a study penned “Best of German Mittelstand”. No crisis can shatter this attitude: in July of this tough year, the same Trumpf announced a €380m investment into its headquarters. “People said we have gone mad,” recounts Nicola Leibinger-Kammüller, Chief Executive of Trumpf.
 
For Germany itself, this position, as well as the fact that most Mittelstand representatives prefer to keep their internationally-sourced revenues at home, means a strong industrial base on which the country can always rely. This fact has always inspired optimism among German politicians: "Other countries wouldn't be in as much of a crisis if they had a stronger Mittelstand," said German Deputy Economy Minister Ernst Burgbacher several years ago – but now most in the sector believe that words alone are not enough.
 
The main feature of Mittelstand, the home-rootedness, is now becoming a hindrance in their work. This firms exist in its own ecosystem, relying on the big German manufacturing industry - which, in turn, is in the middle of an energy crisis. The energy fears that make the big fish think of swimming abroad send shivers down Mittelstand’s spines, too, notes Achim Dercks, Deputy Managing Director of the German Chamber of Commerce and Industry (DIHK): “Large parts of the German economy are concerned about a lack of energy supply in the medium and long term”. The weakened demand from China, which has recently become Mittelstand’s main export destination, pitches in their woes, too.
 
Some companies with branches in other countries and export flows oriented worldwide, like Koenig & Bauer, feel like they are able to manage this. Others express great concern – but the overall outlook still remains positive, adds Stefan Povaly of J.P. Morgan: “We see that the German Mittelstand community is tackling the economic challenges proactively and continues to have conviction about the strength and success of their businesses.”     





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