In the past decades, US economic growth has been achieved by driving down costs through outsourcing and by keeping wages low through globalisation. A harsh lesson learnt during the 2008 crisis was that lowering costs alone cannot fuel the economy. In May this year, manufacturing’s share of employment in the US fell to 8.48 percent, the lowest ever since the Labor Department first began keeping records in 1940. In a recent article (Financial Times, June 26, 2017, Rana Faroohar, “Why US big business listens to Bernie Sanders”) CEO of GE Jeff Immelt opined that one could learn from the German Mittelstand.
Germany was the world’s second largest exporter in 2016. Its export of products and services accounted for more than one third of its national output. In the last 20 years, Germany is the only OECD nation that has held on to its proportion of world trade, while US’ and Japan’s share of the pie shrank. What is Germany doing right?
The answer may lie in its Mittelstand companies. “Mittelstand” means medium-sized companies but the term is generally used to refer to SMEs which are family owned, or operate with a family-like culture. Their output makes up approximately 68% of Germany’s exports and is the “backbone” of its economy.
Mittelstand companies have established themselves as global leaders in many niche areas, and have strong export markets. Examples include lesser-known brands Flexi in dog leashes; 3B Scientific in teaching equipment; Klett in textbook publishing; Playmobil in toys, Staedtler Mars in writing equipment; Sennheiser in audio equipment; and Miele in white goods.
We studied what makes Mittelstand so successful:
- Family business-orientation: Mittlelstand companies are focused on the long term. Financially conservative, they generally do not list on financial markets. Though recently some firms have started to raise capital through issuing bonds, generally, they rely on retained earnings and bank debt. They are community-based; their HR policies do not include a hire-and-fire strategy but instead focus on building skills in their employees. The smaller companies tend to keep their production facilities in the locale where they started, while setting up sales and service centers globally.
- Global niche dominance: Mittelstand companies share the same national trademark values of performance, reliability, safety, durability and design. They pride themselves as solution providers rather than just producers of products or services. They cater to small niche market segments, on a worldwide basis (“two-pillar strategy”), avoid industries requiring high levels of capital outlay and eschew competing against large corporations.
- Strategic geographical position: With Germany sharing borders with nine countries, Mittelstand gained huge benefits from the unification process and porous customs arrangements. Its strategic position between Asia and the Americas also gives it the advantage of shorter travel times and accessibility of communication.
- Strong educational ties: Mittelstand is supported by a nation-wide culture of education, basic research and technology transfer. This is implemented via a structured and pro-active approach to produce a supply of well-trained vocational manpower—Fach Hochschule (FH) and Technische Hochschule (TH) produce strong vocational training graduates (equal in status with varsity graduates); technology transfer is enabled by research organisations like Fraunhofer; while basic science is promoted centres like Max Planck institutes.
- Technological leadership and innovation: The foundation for these firms’ market success is products and services that often define the state of the art in their respective markets. They stay cost competitive via continuous investment in advanced production methods and ongoing R&D through collaboration with research institutions.
- Strong government support: The German government plays an important role too. Kurzarbiet is a work subsidy mechanism whereby employees get about 80% of their pay while working half time. This is especially useful in an economic downturn. The German tiered banking system has as its third pillar, small cooperative banks which are owned by their members. These banks operate on a mutual guarantee basis, are subject to a regional principle and are the principal source of Mittelstand funding. The German Chambers of Commerce Abroad, present in 130 locations, supports Mittelstand companies in their search for global markets.
Other countries have tried to emulate the Mittelstand model. In 2012, Spain’s youth unemployment rate was more than 50%; it had 1.5 million university students and only 270,000 trade school students. Its Education Minister signed an agreement to bring Germany's “dual system” of vocational training, which combines classroom instruction with work experience, to its youth. Similarly, the Confederation of British Industry wanted Britain “to have its own version of the German Mittelstand”.
Even when President Trump’s meeting with Chancellor Merkel did not go well, he still found common ground in praise for the Mittelstand. Via a programme called Skills Initiative, German and American businesses and local education providers were brought together to develop training programmes based on business needs. Successful implementations have been recorded in the Greater Charlotte area, Michigan, Tampa Bay, Georgia and Wisconsin. Large German companies like BMW also participated.
Nevertheless, such efforts are by no means sufficient in scale; they are also not designed to deal with challenges such as high drop-out rates from US schools and the preference for college degrees. Besides, the success of Mittelstand companies’ stems from more than its training programmes. Many other factors — the culture of a family-run business, niche specialisation, export-orientation and the availability of government support — are what make Mittelstand successful and sustainable. Unless American can emulate these as a package, Mittelstand may not be what it takes to make America great again.
About the authors
Dr. K. Ravi Kumar is Shaw Chair Professor and Associate Provost (Special Projects) at NTU Singapore. He is also the Centre Director for the Centre for Business of Culture at Nanyang Business School. Subrata Chattopadhyay Banerjee is a research associate at Centre for Business of Culture.
This commentary was published in The Business Times on 5 October 2017 and Transfin on 9 March 2018.