Viewpoint: How can you innovate with limited resources? Ask the Mittelstand

No one knows more about how important the Mittelstand are to the German economy than the country's leader, Angela Merkel             Photo by Sean Gallup/Getty Images News / Getty Images

No one knows more about how important the Mittelstand are to the German economy than the country's leader, Angela Merkel            

Photo by Sean Gallup/Getty Images News / Getty Images

When the Germany’s Mittelstand are mentioned in conversation the tendency is to think of very efficient, family-controlled middle-market companies. Thoughts would also point to their ability to compete globally through niche innovation. In fact, the general perception is the Mittelstand represent an exceptional model of innovation.

So, if we agree the Mittelstand are an amazing innovation model, the question is: How do they do this? And, more precisely, how do they compete on a global scale, despite their resource and growth constraints? After all, they are all small to medium-sized companies, but they are often global leaders in their sector.

Interestingly, these questions on what constitutes their success have rarely been examined in any detail. And that prompted me, along with David Audretsch, Lorraine Uhlaner, and Nadine Kammerlander, to look at why they are successful and what are the main factors behind their success. In a recent study published in the Journal of Product Innovation Management, we found six main traits that characterised the Mittelstand model and underlined their competitive advantage. All these traits tend to work together, so it’s not just one single trait that makes the difference, they all operate in an integrated fashion. Here are the six traits:

 

Niche focus and customer collaboration

Typically, products made by the Mittelstand are custom designed for a particular customer. A highly focused strategy enables them to develop the superlative expertise and remarkable efficiencies that support their competitive advantage in relation to customised service. It also ensures their high reliability and cost-competitiveness of innovations despite Germany’s high labour costs and tax structure.

A good example of this niche concentration and customer focus is J.D. Neuhaus, a  seventh-generation family owned business. A hoist manufacturer since its founding in 1745, J.D. Neuhaus retains its focus on hydraulic and pneumatic hoists and crane systems. But it also constantly adapts and improves its world-class products, making them suitable also for extreme operating conditions such as the North Pole.

 

Globalisation strategy

The Mittelstand are very focused on a global strategy. Here are some statistics that back this up. German SMEs, most of which are classified as Mittelstand firms, have been shown to lead in exports both within and outside the European Union, surpassing the average in proportion to firms exporting within the EU (20% vs. 14% EU average for SMEs, according to the European Commission). They also account for nearly 23% of all EU SME exports outside the EU, far ahead of second-placed Italy (15.4%), third placed France (10.5%), and the UK in fourth place (9.5%). These figures are remarkable given the strong price disadvantage of German goods in the world market due to high labour costs.

 

Preference for self-financing

The Mittelstand prefer to fund expansion through their family money and internal cash flow, instead of external funds. Mittelstand firms lack not only the ability but also the willingness to seek external capital. They intentionally take a conservative approach to finance through a strategy of self-financing, which, in turn, strengthens their independence and enables them to pursue their preferred strategies.

A good example of this financing strategy is Weisser Spitzenkorper, a family business founded in 1922. Weisser is the global leader in the production of bobbins, boxes, and insulation parts for magnets, motors, relays, sensors, and transformers. As a family member of the firm stated, their source of funding for expansion is internal and consists mostly of family equity to retain independence and make it “self-sufficient.” For example, as part of its production expansion, the recently built automated logistics and storage centre (“Hochregallager”) was entirely self-financed.

 

A long-run mindset

It is often said that family businesses have a long-term perspective on growth - and the Mittelstand reflect this probably better than most. Scholars link the desire to follow long-term strategies rather than maximising short-term profit to the typical owning families’ desire to continue control across generations and to develop companies characterised by transgenerational entrepreneurship.

Hans-Peter Fricke, third-generation owner and head of the Fricke Group, a larger Mittelstand firm specialised in agricultural technology, has succinctly expressed this long-term view of the Mittelstand: “I would describe myself as a marathon runner rather than a sprinter. You just need stamina and you mustn’t make too many mistakes.” Fricke’s long-term orientation has paid off. It has evolved from an agricultural machinery dealer to an innovative service enterprise in the agricultural sector.

 

Superior employee relations

The Mittelstand long-term orientation enables them to build long-term relationships with employees, which help these firms overcome what might otherwise be viewed as human capital resource constraints to innovation, especially in rural areas or smaller towns. Besides their long-term commitment to employment, successful Mittelstand firms are characterised by enhanced training, high involvement of employees in decision-making, and a flat hierarchy.

These practices ensure the continuity in staffing needed to build and retain strong commitment of employees and tacit know-how, a strategy that contributes to consistent and superior service and product quality delivered to customers, and enhanced ability to provide input into incremental improvements and more radical innovations.

 

Community Embeddedness

Mittelstand firms are also embedded into their local communities. Their emphasis on long-term, trust-based relationships relates not only to employees but also the local community, which opens up access to further valuable resources. Due to their ownership structure and historical links to their mostly rural (or small town) communities, Mittelstand firms pay particular attention to forging ties with key stakeholders in the surrounding community. Across generations, they develop strong “connections,” not only with suppliers and customers, as frequently highlighted in family firm and SME research.

 

Alfredo De Massis is a professor of entrepreneurship & family business at the Free University of Bozen Bolzano in Italy, and Lancaster University Management School in the UK. He is also the director of the Unibz Platform for Family Business Management.

Academic reference: De Massis, A., Audretsch, D., Uhlaner, L., Kammerlander, N. (2017). Innovation with limited resources: Management lessons from the German Mittelstand, Journal of Product Innovation Management