The heart of the German economy

©BDI/FBrueg

The Mittelstand is often described as the heart of the German economy – and rightly so, given that mid-sized firms account for the largest share of the country’s economic output, employ the most workers, provide training, and make a significant contribution to corporate tax revenues in Germany.

Sennheiser, Rimowa and Otto Bock, for example, are mid-sized firms that manufacture some very well-known products. Kirchhoff, C.D. Wälzholz and Schubert & Salzer may be slightly less well known, but without them there would be very few cars on the roads, skis on the slopes, or passengers travelling safely on aeroplanes. These mid-sized family-owned businesses successfully create value and develop markets in cooperation with large enterprises. There is probably no industry in which mid-sized firms are not represented. And of course, many big players on the stock market once started off as mid-sized family businesses. Some of them are, in fact, still mid-sized companies today – or at least consider themselves as such.

But, despite their success, growing international competition, increasing digitisation and demographic change are putting pressure on the German Mittelstand, as are complex regulations, excessive bureaucracy and a confusing tax system. Mittelstand companies are confronted with risks, impediments and costs that are stifling their entrepreneurial freedom and jeopardising opportunities for growth. According to the BDI/PWC SME Survey, only a minority of the Mittelstand companies surveyed rate the current economic conditions in Germany as good or very good. Curiously enough, this finding does not reflect the current economic situation in most mid-sized firms; their order books are full, and their financial liquidity solid. Indeed, almost half of the companies included in the SME Survey describe their situation as good or very good, and only around 15 percent as poor or very poor.

However, according to figures from the KfW, only 28 percent of Mittelstand companies are investing in new products, and even that percentage is decreasing. This does not mean, however, that around three quarters of German Mittelstand companies assume they can maintain their lead for the foreseeable future. The truth is that they are battling with tough competitive pressure and bureaucratic hurdles resulting from the lack of a clear political vision for the future of mid-size industry. Although geopolitical conflicts and the unstable development of the euro area hardly affect Mittelstand companies, they still have a major impact on their activities. Many are wondering how they can maintain a strong position in Germany and worldwide in the face of such an unstable future. They have largely been left to their own devices in trying to answer this question.

The focus of policy-makers is increasingly geared towards managing, rather than creating, wealth. Instead of addressing the challenges of the future, they seem caught up in a self-propelled process. As Marcel Fratzscher, President of the German Institute for Economic Research (DIW) says, there is basically no clear vision for the future. Economic policymaking in Germany over the past few years, he says, has missed some crucial turning points as far as forward-looking technologies, innovations and investments are concerned. Deficits in these areas mostly affect companies that lack the financial and human resources to tackle these aspects independently, and this puts a strain on the Mittelstand, the very heart of the economy.

The irony is that it is these very companies that are providing pragmatic answers to global questions: they are flexible enough to implement the “think global, act local” philosophy; they have their finger on the pulse of the market; they often know their clients personally, enabling them to address their needs with unparalleled precision. Mittelstand firms often have flat hierarchies and rely on close cooperation with all market partners. They are run by creative, committed and patient individuals with a long-term perspective; communication paths are short and contacts binding. The classic image of the manager who regularly drops by in the production, research and sales departments and discusses ideas with the workers is usually dismissed as a cliché, but it is actually true in many mid-sized companies.

Politicians never tire of highlighting the economic and social importance of the Mittelstand – for good reason. But for many Mittelstand companies, this comes across as lip service rather than a guiding principle. They have come to think that policymakers generally lack the passion, commitment and willingness to take risks that characterises their own way of working and doing business. They rarely see any signs of the entrepreneurial spirit that acts today while thinking about tomorrow. What they do see is a lot of talk and no action. That would be fine if enterprise were granted the freedom it requires. But the opposite is true: entrepreneurial freedom is increasingly stifled, squeezing the heart of the economy and jeopardising the health of this vital sector, countless jobs and the future of Germany as a business location.

The broad mid-sector

While opinions vary as to what exactly the Mittelstand is, there is no denying that it forms the backbone of the German economy. We need to clarify the similarities and differences between the Mittelstand and large companies.

The media sometimes give the impression that Germany’s economic landscape is made up entirely of large companies. In fact, 99.6 percent of all German companies belong to the mid-size sector – more than in any other industrial nation. So what exactly is the Mittelstand? What are its defining characteristics? What drives it forward?

There is no single, clear-cut definition. The European Commission, for example, defines the term as small and medium-sized enterprises (SMEs), in other words, companies with a maximum of 249 employees and a turnover of up to €50 million or total assets of up to €43 million. This has been the official definition of an SME since 2005. It is used to draw international comparisons between countries and as reference for EU aid schemes concerning decisions on EU funding for companies. Others, including the German federal government, use the term Mittelstand in a more flexible way, using the definition provided by the Institut für Mittelstandsforschung in Bonn: enterprises that have up to 500 employees and that generate an annual turnover of no more than €50 million. In this definition, the total assets are irrelevant.

According to the statistics, Mittelstand companies in Germany employ about 21.6 million people, meaning that this sector provides over three quarters of all jobs in the country. But the figures alone don’t tell us a great deal. There is another factor that is a crucial part of the definition of Mittelstand firms: the people who work there. The leaders of Mittelstand firms are often also the owners. They hold significant shares, at least, in the business and are liable for the decisions they make with their own assets. This sets them clearly apart from managers of large companies. It is a fair assumption, after all, that company owners will strive to make long-term decisions that safeguard the existence of the company, so as not to reduce their own assets. Incidentally, as soon as a large company becomes the majority shareholder of a Mittelstand business, this business ceases to belong to the Mittelstand sector.

It is also important to differentiate between Mittelstand businesses and family businesses. Many family businesses do indeed belong to the Mittelstand – after all, 95 percent of all German firms are family-controlled businesses (where two or, at most, three families hold half the shares and are also on the management board), but some of these are large corporations. And, in turn, not every Mittelstand company is necessarily a family enterprise. In management buyouts (MBOs), for example, the head of a company assumes ownership by acquiring majority shares from the company founders or their descendants, and continues to run the business alone. In this case, he or she is no longer dependent on the founding family in running the business.

So what are the most important topics for the Mittelstand sector today? The Institut für Mittelstandsforschung recently put this question to 770 firms in order to pinpoint the biggest challenges currently facing the mid-size sector. The answers were clear: At the top of the list is the challenge to continuously develop new products, introduce innovations to the market, and thereby achieve higher returns. Much like for any other company, in fact. After all, smaller companies are just as engaged in competition as large ones. And competition is getting fiercer in the Mittelstand sector. Many company directors say this is leading to increasing pressure to adapt.

The second major challenge, according to the survey, is the shortage of skilled labour. With birth rates among the younger generation in decline, it is becoming increasingly difficult for companies to find qualified employees. And the same goes for the junior generations of the employer’s own family and the question of who will take over the business. Securing the succession of the family business is the third most important concern of Mittelstand managers. This is usually something that Mittelstand directors want to arrange themselves – and preferably within their lifetime – as they want to leave their business in capable hands to ensure its future success. This is what they are working on today.

The BDI sees tax policy in particular as another important challenge in this respect. The transfer of a business from one generation to the next can only be successful if the planned reform of the inheritance tax regulations is adapted in a way that does not put the Mittelstand at a disadvantage through high tax claims. A Mittelstand-friendly tax policy is therefore just as important as reducing bureaucracy in supporting the mid-size sector in Germany.

A further challenge many Mittelstand companies are currently facing is the digitalisation of their business processes. Digitalisation can be extremely profitable, but it also carries numerous risks, of which small and medium-sized enterprises in particular are well aware. For the Mittelstand to secure a successful future, it also requires sufficient sources of funding. Smaller firms can only finance their future growth if enough offers with attractive conditions are available. After all, the aim is for the Mittelstand to remain what it is today: the strong backbone of the German economy.