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Germany’s Mittelstand: standstill or foundation of the Industrie 4.0 future?

The German economy owes much of its success to the country’s Mittelstand, a uniquely German term used to refer to Germany’s highly developed and export-oriented mid-sized business sector. Mittelstand is roughly translated into English as SME or Small and Medium Enterprise sector, but the Mittelstand is characterised by more than just the simple number of employees or the size of the annual turnover. Due to its ethos and importance, and focus on manufacturing, the Mittelstand has been the subject of considerable study and discussion, as well as concerns for its future when facing the challenges of technological change and international competition. Clearly it can’t afford to stand still if the German Wirtschaftswunder is to continue, so what is the Mittelstand and where is it going? Can small business and manufacturing survive in a world of globalised giants and the feverish flow of investor funds into speculative startups?

Strength in Numbers

Metal Gears

One of the first challenges in discussing the Mittelstand is to understand the surprisingly elastic definitions in use for this category, starting with the statistical ones. The widespread statistical definition used by the German government and the Institut für Mittelstandsforschung (Institute for Mittelstand Research) specifies firms having under 500 employees or up to 50 million euro turnover, regardless of assets, which accounts for 99% of German firms. Some studies also choose to include selected larger firms, such as Bosch, principally because of non-numeric qualifying characteristics, and to refer to these firms as the Upper Mittelstand. This Upper Mittelstand covers revenues from 50 million to 1 billion euro, and comprises at most 0.34% of German firms. A 2009 academic study, Enterprise System in the German Manufacturing Mittelstand  chose to cover a “sample ranged in size between 593 and 1,200 employees, with annual revenues between 64 and 378 million euro.”  By those measures, more German companies belong to the mid-sized sector than in any other industrial country.  By contrast, when comparing countries it helps to know that the strict EU definition of an SME, in particular as applied to grant funding across the EU, is to have under 250 employees, turnover not over 50 million euro, and assets not greater than 43 million euro.

Hidden Champions

How can so many small companies be so important? Numbering over one million companies, the Mittelstand employs over 20 million people or about 75% of the German workforce, and is responsible for almost 40 percent of total German gross investments , accounts for 68% of Germany’s exports, and is up to 80% B2B activity. Consequently the Mittelstand features numerous hidden champions, a term which refers to firms that are in the top three in their speciality, have annual sales under 5 million euro, and are not widely known to the public. Much of this B2B manufacturing supplies components to other manufacturers, and of the 2700 hidden champions known in the world, almost half are located in Germany, with manufacturing making up 25% of German GDP. “Nowhere else on the planet is there an industrial fabric with such density of leading companies, except in Switzerland and Austria. The ‘hidden champions’ are the fruit of the Mittelstand,” states a 2018 report from the Journal of Management Policies and Practices, titled The German Business Model: The Role of the Mittelstand. In fact, 70% of Mittelstand firms are located in smaller cities or rural areas, often benefiting from proximity to related firms and forming clusters of productivity.

Quality and Qualities

Looking beyond the numbers, what are the characteristics of Mittelstand firms? These locally based and largely family owned firms  are typically  focused on quality products, rather than competing on price,  and enjoy close relationships with their customers and suppliers. They can and do re-invest their profits in long-term research and development in response to customers’ needs, rather than paying out to remote investors.  A definitive report by  authors Venohr, Fear and Witt, titled Best of German Mittelstand – The World Market Leaders said of the Mittelstand management model in 2015: “In many aspects, this model is a counter-example to the US-dominated mainstream model of management taught in business schools worldwide. It differs in two core elements: a focus on long-term customer relationships rather than competing transactionally at arms length in anonymous markets; the overriding company objective driven by family ownership is long-term survival, instead of short-term maximisation of company value.” Mittelstand firms also invest seriously in ongoing workforce training, with very low staff turnover of on average 3%, and extensive use of the state apprenticeship system  (Ausbildung) to discover and train staff who are  a good fit for the company.

Germany Supports Research

Technical research and development is strongly supported by German society. The 2018 research paper The German Business Model: The Role of the Mittelstand reported: “A key to success is an innovation policy based on the promotion of public-private collaborations in applied research, and a vocational model of dual education. The support to institutional intermediaries, basically Fraunhofer institutes, act as R&D centres oriented for SMEs, and public investments for financing industrial research.”  The Fraunhofer-Gesellschaft is Europe’s leading organization for applied research, with ongoing commercially focused research conducted by its 72 institutes and research labs all around Germany. Frauenhofer employs over  25,000 people, many of whom are experts who move back and forth freely between positions working in  industry and positions working in Frauenhofer research.  Between state financing and extensive goal-orientated funding from private companies, Frauenhofer enjoy an annual research budget totaling 2.3 billion euro.

Shifting Silicon Sands

Despite the long-term approach taken by Mittelstand companies and the German training and education system, there are debates about how well the Mittelstand can cope with an entrepreneurial future of rapid technological change, which may be steered  by software and AI, monopolistic giants, offshoring and silicon short-termism.  A 2016 Mittelstand study from the Federation of German Industries titled The Heart of the German Economy found the principal concern of the 770 surveyed companies was investment, followed by shortages of skilled labour in a country with low birth rates. Despite the growth of Berlin as a tech hub, some have broadly suggested a more Silicon Valley approach to entrepreneurism might make German industry more innovative, a topic investigated in depth in a 2018 Small Business Economics research report titled The German Mittelstand: antithesis to Silicon Valley entrepreneurship?  which took a pluralistic view of entrepreneurship, advising  that  ” We suggest that the Mittelstand is an excellent example of everyday entrepreneurship and a vibrant segment of the economy which is also competitive, innovative, and growth-oriented, albeit in different ways compared to Silicon Valley entrepreneurship.”

Industrie 4.0 : Manufacturing Futures

Looking ahead, from 2011 the German government has promoted and invested in a programme called Industrie 4.0 which maps out a future of smart manufacturing as the Internet of Things connects up unprecedented numbers of devices and objects, both smart and dumb. Some IoT connections are just sensors delivering data, but in many cases the communication becomes interactive, for example allowing processes to be shut down or reprogrammed when component wear is remotely detected or new needs identified. In this future data and software can become more important than the manufactured devices they reside on, possibly shifting power, profitability and responsibility elsewhere in the manufacturing chain and enabling autonomous or self-programming manufacturing, the key feature of the Fourth Industrial Revolution (4IR).  Using Cyber Physical Systems (CPS) and the Internet of Things and Services (IoTS) to enable autonomous manufacturing processes can bring big gains in efficiency, but requires fundamental investment in the process. In fact IBM, Cisco and Microsoft have all recently opened IoT related labs in Germany.

The I40 Platform Rises

A 2017 European Commission paper titled Germany: Industry 4.0 explains that “The I40 initiative targets knowledge, financial and regulatory framework conditions for enhancing I40. The focus areas are pursued by seeking to integrate concepts such as CPS into manufacturing as well as IoTS into industrial processes, thereby bringing together information, resources and people. These endeavours are expected to improve value creation, work organisation, and downstream services. In a nutshell, I40 enables plenty of Industry 4.0 related opportunities, including: customer-specific design, flexibility through CPS-based networking; improved decision-making and early verification of design; adaptation of resource consumption; interactive collaboration of workers and systems; and improved work-life balance by flexible work models.”

Germany Trade & Invest (GTAI) is the economic development agency of the Federal Republic of Germany, and their upbeat online introduction to  Industrie 4.0  sees real opportunity here: “Germany has the ideal conditions to become a global leader in innovative, internet-based production technology and service provision. Technological leadership and vision in the fields of manufacturing, automation and software-based embedded systems, as well as historically strong industrial networks, lay the cornerstone for the long-term success of the INDUSTRIE 4.0 project.”

So given the success of German investment in research, technology  and manufacturing  to date, this smart Industrie 4.0 investment could  well make the Mittelstand stand the test of time, and grow.