At the core of Europe's strongest economy is the Mittelstand, a tier of impeccably run small manufacturers that measure growth not in years but in centuries. Here's how they do it, in five very German lessons.
Discount chains? Convenience stores? Churches?
"No," Max Krawinkel replies mildly, each time I press him on the seductiveness of a potential new market for his company's LED signs. "We only do them for gas stations."
Krawinkel is the seventh-generation owner of PWM, a 120-employee company born 208 years ago in the hilly municipality of Bergneustadt, Germany. Originally a textile producer specializing in undergarments and children's sailor suits, PWM today is the world market leader in electronic gas-station price signs, with most of the major oil companies among its clients. Krawinkel's father introduced electronic price signs in the early 1980s; Krawinkel himself invented so-called profit boards, the electronic signs gas stations use to lure customers into their mini-marts for high-margin hot dogs and breakfast burritos. Virtually any business or organization wanting to post short messages for passersby can use some version of PWM's homegrown product. But they can't buy it from PWM.
We are sitting in Krawinkel's office, and Krawinkel, a trim, soft-spoken man in owlish glasses, is explaining why he isn't all over the kinds of easy adjacent markets that a U.S. entrepreneur would fall on like a starving sailor at a fish fry. "I know I could use my technology for a lot of other applications," says Krawinkel, tenting his fingers. "People always ask, 'Why don't you go there?' But I don't want to lose my focus."
Krawinkel is the stick-to-your-knitting-est business owner I have ever met. He is an archetype of the Mittelstand: the family-owned, small to midsize manufacturing companies that analysts credit with Germany's prosperity and resilience. Mittelstand companies account for 52 percent of the country's economic output and almost two-thirds of its jobs, according to the Federal Ministry of Economics and Technology. Germany is the world's fifth-most-prolific generator of patents and is poised to overtake the United States as the second-largest exporter--largely thanks to the strength of the Mittelstand (and the weakness of the euro).
The size of Mittelstand companies is disputed (up to $250 million in revenue? $500 million? $1 billion or more?), but their characteristics are well defined. Hermann Simon, a German management expert who has studied this cohort for decades, decodes its principles exhaustively in his 2009 book, Hidden Champions of the 21st Century: Success Strategies of Unknown World Market Leaders. Simon found that Mittelstand companies innovate constantly in narrow markets, grow through aggressive pursuit of international sales, work closely with customers, design their own machines and processes, and hoard institutional knowledge by hiring people when they're wet behind the ears and keeping them until they're graying at the temples. (The Mittelstand partners with Germany's vocational colleges to train apprentices, many of whom remain with their first employers for life.)
As the United States pursues a manufacturing renaissance meant to restore middle-class jobs, it is counting heavily on advanced technologies. The subject of how manufacturing companies should be led and managed receives far less attention. Conventional business wisdom--fail fast and often; disrupt or be disrupted; when in doubt, pivot--suits the service sector that dominates GDP, as well as the thriving high-tech industry. But things get trickier for companies burdened with high capital costs and substantial fixed assets. Yes, manufacturers must be nimble. But they also require skilled local work forces, assurances of unimpeachable quality, and a measure of stability. This is where the Mittelstand excels.
As I drive around Germany's North Rhine-Westphalia region visiting these "champions," I imagine American entrepreneurs snorting at these companies' conservative growth targets and no-thank-you response to some opportunities. "If we could decide between 5 percent growth between 2013 and 2014 and 100 percent security that 2014 would be exactly like this year, we would choose the security option," says Ulf Poppel, third-generation managing director of BSW, a 400-employee company that uses recycled rubber to make products like synthetic surfaces for running tracks, tennis courts, and playgrounds. "Germans do more to make sure in three to five years they are in the position they are in now," says Ulf Poppel. "Americans would choose the growth option."
The Austrian business sage Joseph Schumpeter warned that creative destruction takes down old industries. And the Mittelstand does get criticized for being staid. But another Austrian, the equally sage Peter Drucker, took a different perspective. "A factory that is 'dramatic,' a factory in which the epic of industry is unfolded before the visitor's eyes, is poorly managed," wrote Drucker. "A well-managed factory is boring."
You may not share the Mittelstand's conservative philosophy. But when it comes to operations, there is much you can learn from it.
Lesson 1: Narrow your horizons.
The term hidden champions--coined in the 1980s by Simon, the German management expert--reflects the Mittelstand's preference for keeping low profiles outside its industries. This is both a cultural decision and a strategic one. Most Mittelstand companies lurk far back in the supply chain, making parts and machinery that disappear into someone else's product. Laboring largely unnoticed inside narrow niches, they develop unsurpassable expertise vulnerable only to seismic disruptions.
"Underlying this is a fundamental understanding of markets," says Simon. "If you stick to a market that is unlikely to disappear, focusing and optimizing and perfecting over decades, you become the best at this market. Then it is unlikely that anyone will beat you."
Mittelstand companies are antimagpies: untempted by shiny objects. Like PWM with its all-gas-stations-all-the-time creed, they choose depth over breadth, avoiding distraction and minimizing competition. But focused doesn't mean resistant to change. Increasingly, the Mittelstand practices what Simon calls "soft diversification": slowly adding business units just one or two skips from their original markets and technologies.
Christopher Mennekes greets me in the lobby of his namesake company with a flute of champagne. "We don't have to finish it," he tells me as we clink glasses. I'm glad to hear it. We're about to embark on a factory tour, and I like to stay sharp around heavy machinery.
Mennekes, with revenue of roughly $160 million, employs more than 900 people, the majority here in Kirchhundem, a pretty, pastoral town of 2,200. "You come at an exciting time," says Mennekes, who at 34 is the third-generation CEO. Early this year, the European Commission in Brussels chose the company's charging-apparatus design as the standard for electric vehicles across the continent. Of course, other manufacturers are free to adopt the standard, but Mennekes is already ahead in development.
Mennekes is so confident of the embryonic market's potential that he recently launched two more business units: one to build charging posts and one to build components related to the electric automotive industry. They are the company's first new units in 80 years, during which time it made almost exclusively plugs and sockets, plugs and sockets, plugs and sockets.
"Sometimes it is good if you stick to your core competence, and then one day, if you have the patience, there is a topic where you can suddenly jump on," says Mennekes. That word, patience, rarely comes up when you talk to American business owners. Granted, waiting 80 years before testing new waters may sound unacceptably passive to CEOs wired for action. But at a time when technological change mercilessly strikes down first movers, patience is an appealingly simple risk-mitigation strategy.
Lesson 2: Go global fast. Go global hard.
International trade is ingrained in the history of Germany, which until the early 20th century was a collection of nation-states. As Simon points out, "If you were located in Bavaria and did business with Stuttgart, this was international business."
Simon says Mittelstand companies prefer selling direct instead of forming joint ventures. That lets them set the terms for how their products will be sold and used. It is not unusual for one of these companies to field 50 or more subsidiaries. Small to midsize manufacturers account for 70 percent of Germany's exports--more than in countries where large corporations dominate. Philipp Klais captures the Mittelstand's internationalism in an elegant metaphor: "We are bonsai global players," he says. "We do it with the same quality as the big companies, but at a very reduced scale."
Klais is here in Bonn because he has delayed for one day a trip to Spain, for the inauguration of one of his company's pipe organs at the cathedral of León. The sedate brick façade of Klais Orgelbau fronts on a shady street, just down the road from Beethoven's birthplace. Klais's great-grandfather started the company more than 130 years ago. The workshop has modernized some (electricity, AutoCad), but many processes have changed little, and the family still occupies a house in the compound. "The employees and my family are using the same garbage container," says Klais. "If my team finds two bottles of wine in the morning they know, don't talk to me."
In summer and autumn, just half of Klais's 65 workers are on hand to notice those wine bottles. The rest are on three-month sojourns installing organs in Iceland or Venezuela or Texas. (Very large organs may take twice as long to install. One at the Beijing Theater is 40 feet tall and weighs 45 tons.) The company has been global since 1954, when it trained employees of Yamaha in organ building. Klais estimates 35 percent to 45 percent of his sales are in Germany; 30 percent elsewhere in Europe; and the rest around the world.
Igus, on the outskirts of Cologne, is another global player, but there's nothing bonsai about it. Founded in a garage in 1964, the company employs more than 2,000 people, and its modular factory has been expanded seven times. Towering yellow pylons sprout from the roof at the juncture of each module, stabilizing the structure so that panels, which substitute for concrete walls, can be reconfigured on the basis of demand.
For a Mittelstand company, Igus is diversified. It makes two products: polymer bearings and chains. Both enable movement in machines, whether they are mountain bikes or enormous ship-to-shore cranes. The factory is situated next to a large UPS operation and near two airports, the better to serve customers in more than 80 countries. Annual revenue is around $500 million, more than half from international sales, which CEO Frank Blase kicked off when he joined the family business in 1983. "My father and I had different visions for this company," says Blase. "His vision was that we would be about $10 million, and my vision was $10 billion." Blase knew from the start that international business would help get him there. "We always have a drive to target new customers in new countries," says Blase. "We see a market that is underdeveloped from an Igus point of view, and we go there."
That attitude is less common in the United States, where more than half of small to midsize companies have no sales or operations outside North America, according to a study by the National Center for the Middle Market. Such attitudes aren't surprising: The United States is such a juicy, accessible market that international sales feel less urgent. But globalization is the future. It is also a skill that requires development. The Mittelstand companies have had a lot of practice. They are very good at it.
Lesson 3: Innovate incrementallyand internally.
To spend time among the Mittelstand is to become sensitized to the industrial wallpaper of our lives. As I stroll around the conference room at PWM, my eyes are opened to the aesthetic possibilities of gas-station price signs. The technically advanced yet stylistically retro scrolling digits preferred by Conoco. Chevron's crisp white numbers framed in a sleek red case. "We were the first with white numerals in the marketplace," says Krawinkel proudly.
When it comes to innovation, the Mittelstand companies are incrementalists: masters at playing on a theme. Peter Englisch, Ernst & Young's global leader for family business, observes that Germany's lack of natural resources forces it to rely on competitive products and services. Given their narrow areas of expertise, Mittelstand companies grow by "improving the existing products and services, not coming up with things that are radically new," says Englisch.
Much of that incremental innovation happens with customers. Whereas elsewhere companies chafe at modifying products for new markets, the Mittelstand sees the ability to do so as a competitive advantage. So, for a pipe organ in New Zealand, Klais's team developed a stop inspired by the sound of a Maori bone flute. Klais listened repeatedly to a CD of traditional Japanese music to design parts for an instrument in Kyoto.
"Often, innovation is defined as something that changes a market," says Klais. "But to me, it is where you individually develop something for your customer. It may be a very, very small detail. But it shows understanding and respect."
Mittelstand companies innovate not only their products but also their materials and means of production. In its facility in Bad Berleburg, BSW reprocesses rubber to make its signature material--Regupol--and then uses machines, many developed in-house, to manufacture flooring products for the sports and building industries. Igus manufactures its own materials, builds its own tools and molds, and innovates intensively around processes. Among Igus's most popular homegrown offerings are tests that calculate how long products will last in a specific customer's environment. Some of that is math; some is running products through their paces until they break. In the Igus labs, a few cables have been twisting away continuously for 10 years.
There's a defensive basis for this strategy: Competitors find it harder to copy your thing if they must also copy the thing that makes your thing. At the same time, it's easier to maintain equipment you've designed yourself and to ensure quality when you make your own materials. Vertical integration is all about control. As the U.S. recovers from its outsourcing binge, control would be a good thing to get back.
Lesson 4: Go the extra mile for customers.
Igus announces its priority in the entrance hall. One wall depicts the solar system forged in metal. The word customer (in six languages) is the sun. All other departments and activities are small planets arrayed around it.
When I meet Frank Blase, he is wearing his blue Igus vest and a red-and-white-striped tie, perhaps in anticipation of the "very, very large American customer" he expects to arrive at any moment. The orange button pinned to his chest reads: Yes We Can! It is a salute not to Barack Obama but to Bob the Builder, a natural Mittelstand muse. The Mittelstand companies' customer relationships are unusually close because their products are often complex, requiring customization and consultation. Igus has a policy called KNOC KNOC: an acronym (in German) for No 'No' Without CEO. Employees are empowered to make virtually any decision on their own--except for one. Turning down a customer request requires approval, often from the very top.
In orientation sessions for new hires, Blase writes on a whiteboard Peter Drucker's famous dictum: "The purpose of business is to create and keep a customer." "I ask each of them, 'What value do you think that you create for which customers?' " says Blase. "At the end of the hour and a half, we complete the circle: 'How do the employees benefit?' So they understand that their success is through the customer's success."
Like most Mittelstand companies, Igus is generous with pre- and postsales consultations and services. It will cheerfully customize and ship a single tiny part or manufacture discontinued items for customers with aging machinery. The company keeps 100,000 distinct products on-site so it can guarantee shipping worldwide within 24 hours. PWM has a similar delivery guarantee, also made possible by Krawinkel's willingness to hold everything within PWM's walls. "The Mittelstand has a different philosophy when you look at inventory and spare parts availability," says Krawinkel. "The disadvantage is you have to pay for it on your own. But it is a big competitive advantage with customers."
U.S. manufacturers are already customer focused: There's less to learn from Germany on that score. What's interesting, though, is the extent to which the Mittelstand's customer orientation benefits these companies in their roles as buyers. Most companies I visited procure machines, parts, and other products from their compatriots. At least 80 percent of Igus suppliers are Mittelstand companies, according to Artur Peplinski, vice president of international group development. "We ask a lot from our suppliers, so they have to understand our standards and requirements," he says. "Having the Mittelstand makes it easier for us to fulfill our promises to customers."
Of course, stretching supply chains across 138,000 square miles of Germany is easier than stretching them across 3.7 million square miles of United States. Still, as it becomes easier for U.S. companies to buy American--if, in fact, Made in the USA becomes the socially responsible default option--the opportunity exists to raise everyone's game.
Lesson 5: Run your businessas if you expect it to live forever.
In 1935, Aloys Mennekes founded a company that at one time manufactured waffle irons and other small appliances in the basement of the local shooting-club hall. His breakthrough product was a wall-mounted fire lighter invented when matches became scarce during World War II. In Mennekes's building hangs a vast aerial photograph of the company's current site. I can just make out the founder's original home, tucked into the side of the sleek, modern complex like a handmade ornament on a shimmering aluminum Christmas tree.
Mennekes's rich heritage illustrates another Mittelstand characteristic: roots sunk deeply into family and community. Roughly 95 percent of Mittelstand companies are family owned, according to the country's Federal Ministry of Economics and Technology. Of those, 85 percent are managed by their owners. The average CEO tenure is 20 years. Some businesses have celebrated bicentennials. Ernst & Young's Englisch says Mittelstand leaders take the long view because they are building for future generations--a quality he calls dynastic will. "From this comes extra dedication and passion," says Englisch. "The family gives nearly everything to run the business successfully."
That long-term orientation is reflected in a conservative approach to finance. The Mittelstand's equity ratio has been rising since 2002, reaching 20.7 percent in 2011. Equity and bank loans together fund more than 80 percent of investments. During the financial downturn, healthy financial buffers--as well as government aid for businesses that cut hours rather than staff--helped these companies survive relatively intact.
That generational perspective is tough for nonfamily, nonvenerable companies to emulate. And it is increasingly a challenge for the Mittelstand. The pool of potential heirs is growing shallow as Germany's birthrate drops and outside temptations beckon, including the nascent startup scene in Berlin.
However, the lure of entrepreneurship may ultimately benefit succession. Nikolaus Förster, editor in chief of impulse, a German magazine for company owners, says it is common now for the sons and daughters of the Mittelstand to launch startups after university, then return after a few years to run the family business. "Many have said to me, 'We are going to make mistakes, but we are going to do it somewhere else and then come back to our own company to make sure it is successful,' " says Förster. "In Germany, if your family has been running the company for three generations, you have got a lot of employees. So you have a lot of responsibility to the region."
Responsibility. In my conversations with Mittelstand CEOs, that word came up again and again. Leadership, by contrast, they largely dismissed as an abstraction. "I think leadership is a very, very, very strong word," says Klais. "I see it more as a responsibility issue. And not just being responsible for the financial situation but also for a team of 65 people that have supported this workshop for a very long time and for this working place on which they are depending."
That attitude, more than anything else, may be what sets the Mittelstand apart. Several CEOs I spoke with described how, during the downturn, they kept pay stable while employees worked fewer hours because of reduced demand. The understanding: When business picked up, the employees would work off those hours over time. "We financed that ourselves," says Mennekes. "Employees all have bills to pay. As you imagine, this makes identification with the company strong, that they know we are caring for them in bad times. It was the responsible thing to do.
"I am very grateful that the company cared for me during my childhood," says Mennekes. "Now I have a chance to care for the company."