GERMANY: Who's afraid of the Mittelstand?

GERMANY: Who's afraid of the Mittelstand? - Everyone needs role models. Nobody has better service industries than the Americans. When it comes to miniaturisation in consumer electronics we cast an eye to the Far East. And when one looks for a model of a

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Last Updated: 31 Aug 2010

Everyone needs role models. Nobody has better service industries than the Americans. When it comes to miniaturisation in consumer electronics we cast an eye to the Far East. And when one looks for a model of a strong and successful small and medium-sized business sector, Germany's famous Mittelstand (group of middle-tier companies) has traditionally provided it. But look a little closer and the picture looks very different. The Mittelstand is labouring through a period of weakness and retrenchment and there has probably never been a better time for Britain's SMEs to get in ahead of their German equivalents in key export markets. There is strong evidence that this has already been happening in the single market. Germany exports nearly twice as much to its EU neighbours as the UK does, but the latest data shows that the gap was reduced by nearly 30% in 1996 alone. The strength of sterling will have taken a little of the shine from that performance in 1997, but with UK export growth outstripping that of Germany in 11 out of 13 EU member states the signs are very good.

The Mittelstand, Germany's legendary sector of three million mainly family-owned small and medium-sized firms employing up to 500 people, most of them in manufacturing, has been credited with doing a great deal for the country's success in the 50 years since the war, including the famous Wirtschaftswunder (economic miracle) of the 1950s. Some economists say they have contributed far more to that success than bigger names such as Siemens, Bosch, Bayer, Volkswagen, Mercedes and BASF. For this reason, and because few of them are household names, they have been described as Germany's 'hidden champions', typically involved in the manufacture of specialist equipment, such as labelling machines for bottles, or specialist components, such as metal filters or car parts.

The Mittelstand remains very important, accounting for about half of Germany's industrial turnover, two-thirds of industrial jobs and, crucially to an economy built on training and skills, the lion's share of apprenticeships.

But Britain's SMEs now have little to fear. Furthermore, in terms of role models, it is perhaps also time to give the lie to the notion that the factors that led to the Mittelstand's creation could and should, be transferred to Britain. That model, which may have been right in the past, is now looking dated as we approach a new century.

In particular, many Mittelstand companies - three-quarters of which are family owned - are experiencing serious succession problems. The Mittelstand's own institute, based in Bonn, estimates that l0% or more of businesses will be on the market for this reason by the year 2000.

'Succession is their most serious problem,' according to Hermann Simon, author of a major recent study on the Mittelstand. Indeed, some commentators in Germany are now talking of a 'post-Mittelstand world'.

And while to be a Mittelstander was once to be part of the stability and quality associated with Germany's economic and business strength, it is now often associated with a stolidness and lack of imagination that bodes badly for the future. Many Mittelstand companies suffer from outdated organisational structures and management methods, new product development is slow and costly and innovation is lacking.

The Mittelstanders' traditional strength, high levels of market share, sometimes 70% or 80% of the world market for a particular niche product, is also under threat from the problems afflicting Germany generally - high wages which can translate into even higher labour costs when employer taxes and social costs are taken into account, enterprise-sapping regulations and a lack of flexibility. In the past, quality and productivity could overcome Germany's high costs. That no longer appears to be true.

Like the rest of the former West Germany, the country's SMEs have had to carry the burden of unification with the former German Democratic Republic.

Unification, indeed, has diluted the importance of the Mittelstand. Right now, too, another problem looms on the horizon. Mittelstand owners tend to be conservative and, like the bulk of the German population, are worried about the impact of monetary union. Surveys have shown that they fear that a single currency could expose their high costs to competition from elsewhere in Europe.

In contrast to the problems currently being experienced in Germany, equivalent firms in Britain are showing far greater dynamism. Although it is not correct to talk of a 'British Mittelstand', a close relation is the so-called 'middle market', firms with an annual turnover of between £5 million and £200 million.

Coopers & Lybrand have been monitoring this group of British companies for the past two years. The results suggest that these firms have been consistently achieving annual sales growth of more than 10% and profits growth of more than 20% a year, alongside strongly rising employment and capital investment.

'UK middle-market companies tend to be more international in their outlook than the Germans,' says Richard Wade. a partner at Coopers & Lybrand.

'The insularity of German Mittelstand companies can be a problem for them.

They have a tendency to be a little rigid. The middle-market companies we have been monitoring can take on the best in Germany and elsewhere; and they are doing so.'

Of all the Mittelstand myths, none is more powerful than the idea that if only Britain could have an institution like the Kreditanstalt fur Wiederaufhrau (KfW) a publicly owned bank which raises funds on the money markets and lends them on at low or subsidised rates to SMEs, then everything would be fine. The KfW had its origins in the post-war Marshall Aid programme and can he said to be one of the most successful legacies of that programme.

During and after the UK recession of the early 1990s when too many SMEs were subject to the short-termism of their banks, there was considerable pressure on the government to consider such an institution for Britain.

It is not clear, however, that given the range of SME finance available - from the banks through venture capital and AIM - that a public institution such as KfW would have much of a role to play. Professor David Storey, head of the SME Centre at the University of Warwick Business School, argues that the long-term relationships between the German banks, including the KfW, and Mittelstand companies may now be acting as a constraint on the modernisation and restructuring of Germany's needs. 'Much of the Mittelstand was created in the 1950s and is concentrated in engineering,' he says.

'It did very well until five or so years ago, but there is now a real concern in Germany that it hasn't got enough businesses in technology-based sectors. German financial institutions have been much more reluctant to lend to technology-based firms than in the UK. The strength of the Mittelstand was always in those traditional sectors. It requires a change of mind-set to think about financing the latest crazy technology wheeze.

That evolution is going to be painful for Germany.'

Such was the strength of the traditional, engineering-based Mittelstand, in other words, that it is hard for the firms themselves, and those who finance them, to move on. Technology-based firms are perceived as more risky, and are often left struggling for funds.

Howard Leigh, a director of Cavendish Corporate Finance, also believes that middle-market companies in Britain now have a financing advantage over their German counterparts. 'We act for people who sell business,' he says. Over 50% of our transactions are now MBOs or buy-ins - institutionally-backed businesses. What we have now has parallels with the German model, but in my view it is better,'

Institutions and venture capital firms are providing the kind of long-term capital in Britain traditionally provided by the German banks to the Mittelstand. The difference, to take Professor Storey's point, is that venture capital is more likely to favour technology-based firms.

Indeed, one feature of the German system is that venture capital is fairly new on the scene, although this may now be changing.

The truth, says Marek Szwejczewski of Cranfield School of Management, is that both the German government and many of the Mittelstand companies themselves recognise the need for change, and are starting to do something about it. 'In Germany there is more and more concern about innovation and reducing costs,' he says. 'Mittelstand firms are going to attempt to be more innovative in the future. The companies may be family-owned but many of the owners are bringing in outside managers. They are aware of the problems and starting to do something about it. There is no complacency there.'

There are also lessons that British SMEs can learn from Germany's Mittelstand.

One is the great emphasis they have always placed, and continue to place, on training and skills. Another has been their traditional ability to spot niche markets and dominate them. For British SMEs, one message is that developing such niche products in the industries of the future is likely to prove a highly successful strategy, which some have already adopted.

You shouldn't write off the Mittelstand firms, but don't be afraid of them.

A DETAILED COMPARISON OF AVERAGE PERFORMANCE ACROSS THE BOARD

Average Average

Performance measures Unit Germany UK

Average changeover times Minutes 82.42 54.85

in component/intermediate

manufacture

Average changeover times in Minutes 36.91 25.00

assembly and packing

Stock-turns per year Turns 2.71 9.36

Average rate of absenteeism % 5.89 3.33

Time taken to bring a new Months 14.03 17.71

product innovation to market

Current innovation rate % 11.29 9.77

Planned (future) innovation rate % 13.54 10.76

Source: Cranfield School of Management.

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