The heart of the German economy

©BDI/FBrueg

The Mittelstand is often described as the heart of Germany’s economy – and rightly so, given that mid-sized firms account for the largest share of the country’s economic output, employ about 60 percent of all workers, provide crucial training, and contribute significantly 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. Waelzholz Schubert & Salzer and G.A. Röders 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 and comfortably on airplanes. These mid-sized and family-owned businesses successfully create value and develop markets in cooperation with larger enterprises. There is probably no industry in which mid-sized firms are not represented. And, of course, many big players listed on the stock exchange today once started off as mid-sized family businesses. Some of them are, in fact, still Mittelstand companies today – or at least consider themselves as such.

Domestic and international challenges

But, despite their success, growing international competition, an increasing digital transformation as well as an accelerating demographic change are putting pressure on the German Mittelstand. The same applies for complex regulations, excessive bureaucracy and an opaque tax system. Mittelstand companies are confronted with risks, impediments and costs that are stifling their entrepreneurial freedom and jeopardizing opportunities for growth.

According to figures of KfW-research, however, only 28 percent of Mittelstand companies are investing in the development of 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 eurozone seem to be far away from the German Mittelstand, 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.

Lacking political vision causes deficits

The focus of policymakers 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. According to him, economic policymaking in Germany over the past years 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 German Mittelstand, the very heart of Germany’s economy.

The irony is that it is precisely these companies that provide pragmatic answers to global issues: they are flexible enough to implement the “think global, act local” philosophy; they have their finger on the pulse of the market; and 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 channels 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. In many mid-sized companies, however, it is very true.

The broad mid-sector

Opinions vary as to what exactly the German Mittelstand is, so we need to clarify the similarities and differences between the Mittelstand and large companies. Either way, there is no denying that it forms the backbone of the German economy. But major challenges remain, and the Mittelstand often has to face them without the appropriate political support.

The media sometimes give the impression that Germany’s economic landscape is made up entirely of large companies. In reality, 99.5 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?

Varying definitions

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 a balance sheet total of up to €43 million. This has been an official definition of 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 define SMEs differently. Based on the definition provided among others by the Institut für Mittelstandsforschung in Bonn (IfM): enterprises with up to 500 employees and an annual turnover of no more than €50 million are considered to be an SME. In this definition, the balance sheet total is irrelevant as a defining characteristic.

Mittelstand companies, on the other hand, are defined on a qualitative level by the unity of ownership and management according to the IfM. Based on this definition, the terms Mittelstand, family business, owner-managed business and family-owned company should be regarded as synonyms. This means that the intersection of medium-sized companies and family businesses on the one hand and independent SMEs on the other hand is very large. At the same time, however, companies with 500 or more employees or annual sales of more than €50 million also belong to the Mittelstand if they meet the above criteria. Small and medium-sized enterprises that are dependent on another company are – by that definition – not part of Mittelstand.

Leaders of Mittelstand firms are liable for the decisions they make with their own assets. This clearly sets them 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.

Major challenges

Politicians never tire of highlighting the economic and social importance of the Mittelstand – for good reason. But for many medium-sized companies this seems to be more of a lip service than a guiding principle. They experience that many words are followed by little action. They miss passion, commitment and willingness to take risks with which they themselves carry out their tasks and business. All too seldom do they feel the entrepreneurial spirit in politics that acts today and thinks about tomorrow. So, what are the most important topics for the Mittelstand sector today?

The IfM 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 this IfM-survey, is the shortage of skilled labor. With birth rates among the younger generation in decline, it is becoming increasingly difficult for companies to find qualified employees. The same applies 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. 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 facing according to the IfM-survey is the digital transformation of their business processes and the emergence of new business models. The digital transformation can be extremely profitable, but it also carries numerous risks of which small and medium-sized enterprises are aware. The Mittelstand, in order to secure a successful future, needs to develop new skills for a digital world and new forms for cooperation. It also requires sufficient sources of funding, since smaller firms in particular can only finance their future growth if enough offers with attractive conditions are available.

Financial support during the coronavirus pandemic

With the German economy currently being threatened by the coronavirus pandemic, government must keep an eye on the Mittelstand and meet its specific needs: During shutdown, Mittelstand companies require massive financial support to compensate for collapsing sales markets and to secure liquidity. In addition, they need grants for short-time work. During rebooting and economic consolidation, the German Mittelstand has to direct even more efforts towards innovation than before in order to reinvent themselves in a post-coronavirus economy and find their new competitive position. It will have to preempt and adapt to new sourcing and sales channels as well as new ways of collaborative working in a digital age. After all, the aim is for the German Mittelstand to remain what it is today: the strong backbone of the German economy.