The Mittelstand Model Remains Desirable

Stephen DeAngelis

August 31, 2012

In a post entitled Entrepreneurs, Medium-Sized Companies, and the Global Supply Chain, I discussed how mid-sized German companies (called Mittelstand) represent “80% of the world’s medium-sized market leaders” and have made Germany “the world’s largest goods exporter after China despite high labour costs and a strongish euro.” The world has taken notice of Mittelstand firms. In September 2010, Jana Randow and Aaron Kirchfeld called these firms “nimble, hungry, and global.” [“Germany’s Mittelstand Still Thrives,” Bloomberg BusinessWeek, 30 September 2010] Randow and Kirchfeld continued:

“Outsiders may think of global champions like BMW and Siemens roaming this landscape, but it’s the Mittelstand—family-owned companies with fewer than 500 employees and annual sales of less than 50 million euros—that employs more than 70 percent of German workers and contributes roughly half of the country’s GDP.”

Ralph Wiechers, chief economist at the VDMA machine makers’ association, told Randow and Kirchfeld, “The Mittelstand is the defining element of our economy.” Randow and Kirchfeld claimed that one of the key elements that make the Mittelstand model successful is an apprentice system that “ensures that Mittelstand companies have a steady flow of qualified workers.” They explained:

“[Mittlelstand firms] take on 83 percent of all apprentices in Germany, more than their share of total employment. The apprenticeship system has roots in the Middle Ages, when master craftsmen across Europe taught young men the skills of stonemasonry, carpentry, and roof-making. Tital GmbH, a company of 420 employees that makes precision-cast products for the airline and race-car industries in North Rhine-Westphalia’s Sauerland region, is training 16 apprentices. Two will be offered a scholarship to study engineering at a nearby university in exchange for returning to the company after graduation, says General Manager Philipp Schack, who, along with five colleagues, owns 80 percent of the company.”

As I have noted in previous posts about manufacturing in the United States, the lack of skilled workers remains a serious problem. The apprenticeship model is one way of addressing that shortage. Randow and Kirchfeld continued:

“The Mittelstand has survived many changes. With the rise of iron, steel, and coal production as well as the chemical and electrical industries, and the establishment of stock corporations, capital shifted away from family-owned businesses to larger private companies. Nazi control of business during World War II led to the strengthening of industrial conglomerates. The Mittelstand rebounded after the war, when the country’s destruction required Germans to start over, and small businesses slowly began to flourish again. Mittelstand companies prove that you don’t have to be big to export. Lunor AG, a six-person manufacturer of high-end eyeglasses, generates half its business abroad. South Korea is its fastest-growing market.”

In June of last year, The Economist reported that “German family firms [were] outdoing their Chinese rivals.” [“Beating China,” 30 June 2011] The article also noted that “Mittelstand firms have refined their supply chains, factories and distribution networks to reach far-flung markets more quickly.” The article continued:

Mittelstand companies have long relied on the enviable network they already have at home. German universities work hand in glove with researchers at local firms. Suppliers cluster round big manufacturers. Owner-managers rub shoulders with workers. The Mittelstand model works well, but globalisation is forcing it to adapt. Many family firms have sales and service outlets and even factories abroad. Even if they have developed their niche and are sticking to it, they cannot compete by staying still.”

Even though they are not standing still, the article noted that Mittelstand companies move cautiously over the business landscape. It concluded, “Despite, or perhaps because of, its caution, the Mittelstand is booming. Sales are reckoned by some to be growing at nearly 12% a year.” Earlier this year, Juliett Mann reported that Mittelstand firms remain “a quiet force” behind Germany’s economic resilience. [“Germany’s mighty Mittelstand,” CNN, 24 May 2012] Mann notes that “Mittelstand companies can be found behind hard to imitate niche products for the manufacturing and engineering markets. They have played a vital role in the country’s export driven economy for over a century.” That’s probably why Britain’s chancellor of the exchequer, George Osborne, believes that the Mittelstand model deserves copying. [“A model that everyone wants,” by Chris Bryant, Financial Times, 6 August 2012] Bryant writes:

“The Mittelstand, Germany’s thriving strand of midsized, family-owned export champions, are the envy of the world. ‘We should all learn the lessons from the successful Mittelstand model,’ George Osborne, Britain’s chancellor of the exchequer, told a business conference in Manchester last year.”

Bryant asks, “But just what is the model?” To answer that question, he conducted “conversations with executives of some of the best-known Mittelstand” firms. As a result of those interviews, Bryant discusses some of the qualities of Mittelstand firms that he believes deserve emulation. The first characteristic is to avoid debt. Bryant writes:

“Avoid debt, maintain independence and focus on the long term. Audio company Sennheiser’s state-of-the art facility in the village of Wedemark, near Hannover, sits just a few strides from the cottage where Fritz Sennheiser founded the business in 1945. The company has always avoided debt, partly to focus on growing at a pace it could manage but also to maintain its autonomy.”

Bryant notes that many entrepreneurs start businesses with an exit strategy in mind. In contrast, Mittelstand managers are … more interested in building and preserving the business for the next generation.” The next trait exhibited by successful Mittelstand firms that Bryant identified through his interviews was that they take the long view. He writes:

“Claas, a manufacturer of agricultural machinery, has outgrown the ‘medium-sized’ bracket with revenues last year of €3.3bn. But its philosophy of focusing on the long term is a typical Mittelstand trait. Theo Freye, speaker of the board, explains: ‘It was a very long process – in our case almost 100 years. We have a very long-term time horizon.”

The next trait identified by Bryant was the ability of Mittelstand firms to innovate. As noted earlier, Mittelstand firms specialize in hard-to-duplicate products. Bryant continues:

“Carl Miele imprinted the motto Semper Melior, or Always Better, on his company’s first washing machines more than a century ago and that ethos of constant improvement remains the same. Like other Mittelstand companies, Miele has always focused on the premium segment. Developing and manufacturing products in Germany has also helped its engineers to develop new ideas. ‘Having production capacity in a country is important as without that it is harder to improve and innovate – some of the knowhow goes missing if production capacity is lost,’ says Markus Miele, great-grandson of the founder. Hermann Simon, chairman of Simon-Kucher & Partners, a consultancy who will this month publish an updated version of his book on Germany’s ‘hidden champions’, says: ‘There are some Mittelstand companies who file more patents in a year than an entire country like Portugal or Greece. That’s where it starts.'”

Perhaps the most important trait of Germany’s Mittelstand firms is that they specialize. Bryant explains:

“Mittelstand companies often focus on sophisticated, expensive products where the barriers to entry are higher. Still, the Mittelstand has also realised that a diversified product range helps to hedge risk. So, although the Brandstätter Group is best known for its Playmobil toy figures, [Andrea] Schauer, [the company’s CEO], is also proud of the company’s ability to harness its knowledge of moulding plastic and apply it to new product categories such as self-watering plant containers. ‘You can stand on one foot for quite a while but on two you stand definitely much more solidly,’ she explains. Miele’s ‘professional’ line for commercial applications account for more than 10 per cent of sales. ‘It’s an extra pillar but also an innovation generator,’ says Mr Miele. ‘We create ideas here that later find application in our consumer products.'”

As Randow and Kirchfeld noted earlier, Mittelstand firms have been very successful in expanding into foreign markets. Bryant claims that this is one of the traits that make Mittelstand companies so resilient. He writes:

“The niche focus of many Mittelstand companies meant they rapidly outgrew the German market and had to tap international markets. … Exports account for 83 per cent of sales and, while the company’s core manufacturing plants are in Germany, Ireland and the US, it also outsources a limited amount of non-critical assembly work. … Sennheiser also vigorously defends its intellectual property overseas by, for example, assisting Chinese authorities in launching raids on companies suspected of producing fakes. It also educates customs authorities on how to spot counterfeit goods.”

The next trait identified by Bryant that makes Mittelstand firms successful is customer service. He writes:

“Selling a product is just the beginning, and services make up a growing portion of revenues and can add value to the premium brand. ‘We don’t focus on the sales of a harvester but rather on a complete package. Just as important are services, maintenance and training contracts related to the product,’ says Mr Freye. Claas’s combine harvesters contain complex telematics systems that provide customers with key data via the internet, enabling them to optimise the threshing process. The telematics system can also transmit data to a Claas dealer whose service team can then provide a remote diagnosis of any problems and notify the customer if maintenance is due.

Another trait identified by Bryant that makes Mittelstand firms successful is employee training. Randow and Kirchfeld also noted that as a real strength of the German firms. Bryant writes:

“Germany’s strength in technical education and vocational training is a boon for the Mittelstand, which in turn offers the vast majority of apprenticeships. Germany’s dual system combines on-the-job training with classroom education, and well-trained employees tend to be loyal. ‘Industrial processes are getting more and more complex and you need people who can do the work on the factory floor,’ says consultant Mr Simon.”

Bryant also insists that Mittelstand firms know how to harness networks. He explains:

“Mr Simon’s research revealed numerous industrial clusters across the country, some with deep historical roots. The region around Nuremberg excels at producing pencils, while the southern area of Hohenlohe has a cluster of ventilator manufacturers. Many of these Mittelstand clusters also span a variety of industries, however, having developed informally over generations.”

Bryant ends his article with a note of caution. He states that a company could implement all of the suggestions noted above but still come up short. The reason, he believes, is that the German society provides support for a culture in which Mittelstand companies can flourish. He concludes:

“Mittelstand companies are highly regarded in Germany society, which in turn helps them recruit talent and remain strong over the generations. ‘In Germany some of our best people are in industrial and technical fields,’ says Mr Simon. Influencing the value system of a society is tricky and takes time, he acknowledges. Indeed, as countries struggle try to imitate the Mittelstand’s success, instilling Mittelstand values may turn out to be the biggest challenge of all.”

It remains to be seen whether the success of Germany’s Mittelstand firms can be duplicated elsewhere. Nevertheless, there appears to be a number of pundits who believe that trying to copy the German model would be worth the effort. The big question is whether a country like the U.S. can adapt its educational and manufacturing systems as well as its culture to support a similar model.