Handelsblatt: Beating Silicon Valley With the Mittelstand

By Steven Hill, Handelsblatt, June 16, 2017

(German version “Warnung und Verheißung für die Wirtschaft” here)

Instead of chasing Google or Facebook, Germany should take the best of its innovative Mittelstand and combine it with a homegrown startup scene.

All over Germany, I hear various political and business leaders asking the same questions: “Where are the German Facebooks, Googles, Amazons and Apples? Why isn’t Germany more innovative? Should Germany follow the Silicon Valley model of development?”  But is copying startups in Silicon Valley really the best way forward? Is it even realistic? And if not, what other strategies exist to infuse the economy with innovation and digital progress?

The dirty little secret of Silicon Valley, that practically no one wants to admit, is that 7 out of 10 startup companies fail and nine out of 10 never become profitable. Many of these startups specialize in what initially seems like a cool product or service, but eventually it turns out there is no market for it at a price that creates profitability. At that point, the investor subsidies, which is what keeps startups alive, dry up and the business dies. It happens all the time. Venture capitalists in Silicon Valley invest like they are rolling the dice in a casino, wasting vast amounts of money and talent on many bad ideas in a bid to find that rare Facebook success.

There are currently around 6,000 start-ups in Germany, which means that if they have no more success than Silicon Valley, 4500 of these will fail and only 600 will ever earn a profit, despite all the billions of euros being spent. Startup boosters vehemently defend this approach, saying “you never know which investment will pay out” so you have to throw a lot of mud against the wall to see what sticks. But if government programs had such a failure rate, taxpayers would mount a rebellion.

There are other problems with the Silicon Valley model – namely, these companies are not big job creators. Historically, technology and innovation have led to the creation of new jobs and industries – tractors replacing the horse and plow created even more jobs and higher living standards. But is that still true today?

Facebook employs only about12,000 direct, full-time employees.  Google and Apple employ around 70,000 each, and Uber, Airbnb and Twitter weigh in with only about 5,000 direct employees each. These are small-time job creators compared to traditional economy companies like Volkswagen, BMW, Bosch and Siemens, which each employ hundreds of thousands of people.

When computer and electronics store Circuit City declared bankruptcy, more people lost their jobs than the combined global workforces of Facebook, Yelp, Zynga, LinkedIn, Zillow, Tableau, Zulily, and Box. In fact, the tech gurus are boastful about how their inventions are injecting software and algorithms into ever smarter machines, in a bid to replace the humans. These companies supplement their core workforce by hiring armies of freelancers and contractors, but many of those jobs are precarious, with no security or welfare benefits. That type of employment is not a good foundation for a strong economy.

Also, as a result of globalization, Germans and Europeans have as much access to the products and services of Facebook, Google, Apple and Amazon as does an American. Since these companies are not big job creators, and their markets are global, then the advantages of their home of origin, and the casino-like business model that creates them, are greatly over-valued.

Germany can do better. Instead of encouraging such an uncertain investment model, Germany needs to seek its own path. That should be founded on startup companies and innovation, yes, but also on what Germany does best – execution, implementation, precision — all qualities that are a natural fit with Germany’s long-standing engineering prowess.

Nowhere are these qualities more successful than in Germany’s Mittelstand. That is the remarkable sector of small and medium enterprises (SMEs), some 3.6 million companies, which collectively produces 60% of all German jobs, 56% of its economic output and powers an export machine. The Mittelstand is a unique economic dynamo, representing a brand of “innovation” that is more quietly impressive than all the Facebook’s, Google’s, Amazon’s, and Apple’s combined. In fact, the total employment from those Silicon Valley companies is less than one percent of the 25 million jobs generated by the Mittelstand.

But the Mittelstand is now faced with a new dilemma:  how will it adapt to the emerging digital transformation?  No question these smaller companies must adjust, which raises a provocative notion: what if it were possible to create a hybrid of the Mittelstand and startup world?

On the one hand, you would think it’s impossible. These two sectors appear to be utterly different. “There is a clash between the Internet culture and the industrial culture, between manufacturing and digitalization,” says Dr. Martin Botteck, a professor of engineering at Fachhochschule Südwestfalen. “One of these cultures says don’t worry about designing a perfect product before launch, because you can always fix problems with the latest software update. Just throw it out there as soon as you can, because you need to get there first and grab market share.”

The other culture, he says, plans everything carefully, methodically, with a strong emphasis on industrial design, precision and execution, not only of the product itself but of the production process. Mittelstand companies thrive on a very German brand of “family capitalism” in which the manager is often the owner of the company and the employer-employee relationship is valued. That’s the opposite of the brash, flashy startup culture and its armies of freelancers and entrepreneurs.

But with the right amount of grooming and shaping, these two worlds could produce a cross-hybridization of the best qualities of each. Startups need money, which Mittelstand companies have; small and medium companies need talented and motivated digital workers, which flock to the startups in Berlin, Hamburg and Munich. SMEs have difficulty attracting top tech talent because they are located in areas that are not so urban.

Philipp Semmer from Motu Ventures, which is a private investment fund that provides seed funding for startups, says these ventures “have something to offer to the SMEs since everything will eventually be digitalized. Startups can help the Mittelstand.”

And vice versa. Many of these Mittelstand companies are world-class exporters, they know how to scale. “Find the good small startups, then use German engineering to help them go bigger,” says Lars Zimmerman, vice president of Hy!, a leading digital and startup consultancy associated with Axel Springer.

Examples of cross-hybridization already exist. Deutsche Bahn has used startup companies to experiment with ticketing machine technology and other service improvements. Axel Springer has transformed from a traditional paper-and-ink publisher into an online digital media empire, including building its own startup incubator known as Plug and Play.

Most innovative of all is Trumpf, which is one of the world’s biggest providers of machine tools. This company has leaped into the digital age by creating a networked platform composed of thousands of sensors within an industrial plant that connect numerous machines and allow data collection that improves operating efficiency. For instance, the network can precisely monitor the production process and alert managers when they are running short of supplies, and even automatically place an order for replacement materials. This “smart manufacturing” and other innovations provide fertile ground for a joint venture between the talents of digital startups and Mittelstand businesses.

The role of political leaders in trying to smooth this collaboration between contrasting business cultures is crucial. While some leaders have tried to be forward-looking, no compelling vision has yet emerged. “There is no real strategy for the SMEs, especially about how to bring them into the digital and tech world,” says Zimmer.

One sometimes gets the feeling that many German politicians don’t really understand how much is at stake in this transition to a digital economy. And the startup hipsters, clinging to the comfort of their coffee shops and urban hangouts, seem to disdain these traditional companies in the hinterlands. How many of them have ever toured an auto plant, or visited a Mittelstand company or two or three?

Germany needs a “targeted startup strategy” that is focused on collaborations between these two sectors. Some political and business leaders need to bring them together and say, “Berlin, meet the Mittelstand.”

This may mean steering away from trying to invent the latest, greatest consumer product or service like Apple or Facebook. Germany’s strength has always been industrial, not consumer-oriented. Germany will never have the financial resources of the United States to throw at a Silicon Valley-style scattershot investment approach. Germany needs to be smarter, more strategic and more targeted with the resources it has.

The Mittelstand is Germany’s miracle, its competitive ace in the hole. It is unique, and sets Germany apart from its global competitors. And those coffeehouse hipsters represent a vital part of Germany’s future as well. They are channeling the youthful enthusiasm, optimism, computer talent, and futuristic vision of a new generation.

In short, these two need each other like the heads and tails of a coin. Let’s call it Rocket Mittelstand — a hybrid combining the engineering and innovation of the industrial sector with the Berlin incubator Rocket Internet’s ability to quickly scale.

Motu Ventures’ Semmer sees a lot at stake in this relationship. He says the startup economy and the Mittelstand will “either jointly succeed or jointly fail.” His words are both a warning and a vision for moving the economy forward.

[Steven Hill is a journalist and the author of the recently published Die Startup Illusion: Wie die Internet-Ökonomie unseren Sozialstaat ruiniert. He is a former Holtzbrinck Fellow of the American Academy in Berlin. He is on Twitter @StevenHill1776 and his website is www.Steven-Hill.com.]