The Hidden Champions:

Germany’s Secret Success

Team Delta:

Katie Adgent

Paige Bigham

Margaret Dischler

Matthew Farmer

Economics 7100

12/9/10

ABSTRACT

On October 12, 2010, 33 Chilean miners were thanking Micon, a small, family-owned company

located in a rural German town for producing such a reliable tool that was necessary for their

rescue. Micon is just one of the companies that falls under the term Mittelstand, a business model

that has allowed German companies to thrive even after the Great Recession. We have used

articles, papers, presentations, and professors to accurately outline the relevant economic history

of Germany, the Mittelstand trademarks, described an elite group within the Mittelstand known

as the “hidden champions,” as well as possible flaws in the model.

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TABLE OF CONTENTS

I. Introduction 3

II. Germany’s Economic History 4

a. Unemployment Before, During, and After the Great Recession 5

b. GDP Before, During, and After the Great Recession 6

c. Germany Compared to Other Countries 7

III. The Mittelstand Companies 8

IV. Governance 10

V. Operational Effectiveness 11

VI. Strategy 12

VII. Market Structure 13

VIII. Potential Problems 15

IX. Conclusion 16

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I. INTRODUCTION

Culture plays a huge role in defining business strategy in each country. In America, we

are known for taking risks and making decisions quickly. The Mexican culture focuses on

building personal relationships before making business decisions. The Japanese like to see that

those looking to conduct business are respectful of cultural traditions. Germany, too, has its own

business culture that is not quite as recognizable as the others. In a time of economic recovery

after the Great Recession, economists are looking to the past couple of years and noticing trends.

Some help to answer questions we have while others generate even more questions. When

observing the trends in Europe, it is easy to see that Germany recovered from the recession much

more quickly than some of its neighbors like Spain and Greece. In this paper, we seek to explain

the exact mechanisms that Germany had in place that both allowed them to flourish over the last

fifteen years and come out of the recession with stable growth and a relatively unaffected rate of

unemployment. We will posit these explanations by first talking about Germany’s overall

economic history leading up to this recent period of prosperity, then going into the details of

their exact economic outlook during the recession. We will then move on to the main secret of

Germany’s success: the Mittelstand.1 Finally, we will draw some conclusions from all of the data

that we have gathered about how effective the Mittelstand is and why it works so well,

particularly in Germany.

1 The German phrase “Mittelstand” is translated to “medium sized” and is now used when

describing “family-owned companies with fewer than 500 employees and annual sales of less

than 50 million euros” (Kirchfeld and Randow 2010). Other distinctive characteristics are the

long-term orientation, family ownership, and a responsibility to stakeholders instead of

shareholders.

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II. GERMANY’S ECONOMIC HISTORY

In order to fully understand where Germany’s economy is coming from in terms of

growth, we need to take a brief look at Germany’s economic history. For the sake of simplicity,

and because the mention of earlier periods would be largely irrelevant, we will start with

Germany’s situation during the Great Depression. Germany was hit particular hard during the

interwar years that followed what is now referred to as World War I. They were affected by the

Great Depression, as most European countries were, but they were also landed with the

responsibility of paying off the multitude of war reparations that had been imposed on them by

the Treaty of Versailles. It was into this period of economic stagnation that the Nazi Party

stepped in, bringing with them a quick return to Germany’s former economic prosperity.

Unemployment declined significantly, the incredible amount of inflation experienced just years

earlier was curbed, and many businesses were finally able to pick up the pieces. All of this came

about because of Germany’s transformation into that of a Centrally Administered Economy

(Watkins n.d.).

After World War II ended, it became increasingly obvious that a strong border was

developing that would eventually separate Germany into two separate nations and, accordingly,

two separate economies. For the first few years after the war, the allied forces kept many of the

unsustainable economic policies of the Nazi regime in place, but they soon realized that they had

yet another potential economic disaster on the horizon in the form of explosive inflation. In

1948, in order to avoid such a disaster, the newly forming Federal Republic of Germany

instituted a series of sweeping financial reform, not the least of which was a bold currency

reform that would go on to help keep German post-war inflation in check (Watkins n.d.). In the

decades to follow, Germany, along with the rest of Europe, saw steady and significant growth in

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GDP and technological prowess. Between 1950 and 1973, the per capita GDP in Germany more

than tripled, after adjustment for inflation (Judt 2006). By the late 1980’s and early 1990’s,

however, Germany’s growth began to slow significantly, and the country entered a period of

economic stagnation that earned them the phrase “the sick man of Europe” (Venohr and Meyer

2007). Then, something changed for the German economy, allowing a specific type of company

to flourish and prosper, bringing Germany out of its “sick man” status and into the forefront of

the world economy - globalization. Because Germany is a country that emphasizes exporting,

globalization increased the market size, which led to an increase in exports. Globalization proved

to be a tremendous asset to companies that fell under the definition of “Mittelstand,” a uniquely

German term describing small and medium sized companies that focus on producing highly

differentiated products.

A. UNEMPLOYMENT BEFORE, DURING, AND AFTER THE GREAT RECESSION

One of the most commonly observed elements during any period of extreme growth or

decline is that of unemployment. Figure 1 shows five of the world’s top economies and how their

unemployment rate has changed during the 2000s.

Figure 1: Unemployment Rates of Five Top Economies From 2000 to 2009

Source: Bureau of Labor Statistics, 2010.

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It should be noted that, although Germany’s unemployment peaked around 2005, it then sharply

declined and leveled off during the most recent recession. That sharp peak can mainly be

explained by particularly cold winters that caused many construction workers to be laid off and a

significant change in the definition by which Germany defined the “unemployed” (Dougherty

2005). One of the reasons that Germany was able to maintain a level unemployment rate was

because of the number of barriers that German law has in place to prevent companies from easily

laying off workers. Indeed, most German companies found it easier to simply reduce employee

hours and then increase them later on, when the economic outlook was less bleak, rather than lay

off workers, have to pay out the mandated unemployment benefits, and then go through the

lengthy process of rehiring workers a few years later (Ydstie 2010). This process, known by the

Germans as Kurzarbeit (short-time work), saved an estimated 200,000 jobs (Employment

Outlook 2010 - How Does GERMANY Compare? n.d.).

B. GDP BEFORE, DURING, AND AFTER THE GREAT RECESSION

Another important aspect of any period of economic turmoil is the GDP growth and

contraction itself. It is helpful to look at the trends in unemployment and GDP simultaneously to

have a deeper understanding of the actual economic situation (see Figure 2).

Figure 2: Germany GDP Growth Rate

Source: Trading Economics, 2010.

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The years in which Germany was particularly hurt by the recession is clear; between mid-2008

and mid-2009, Germany’s economy was contracting instead of growing. This can be attributed to

the loss of trade overseas, which was particularly hard on an export-driven economy like

Germany’s. This period of GDP decline did not affect the unemployment rates during the same

time frame (see Figure 1) due to the practice of Kurzarbeit, mentioned above, which causes

much more underemployment than unemployment.

C. GERMANY COMPARED TO OTHER COUNTRIES

In order to understand Germany in the context of its neighbors, we will now look at a pair

of graphs that show how Germany compares to the rest of Europe. Figure 3 refers back to

Germany’s trade dominance, which was mentioned earlier.

Figure 3: Europe’s Unbalanced Economy

Source: Eurostat. Europe’s Unbalanced Economy, 2010.

Germany has been able to maintain a significant lead with its trade surplus, not only among its

neighbors in Europe, but also worldwide. Germany is second only to China in trade surpluses

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worldwide (International Trade Statistics 2010 n.d.), despite the decrease in international demand

of its companies’ products.

Figure 4 shows how Germany’s GDP growth compares to that of its European neighbors.

Figure 4: European economies’ GDP

Source: Eurostat. Germany Leading the Way – Europe’s Economy Following an Upward Trend, 2010.

Based on the information represented in Figure 4, Germany is second only to Lithuania in terms

of GDP growth for the second quarter of 2010. It is necessary to note that their percentage

change from the previous year is higher than any of the other countries represented, meaning that

Germany is quickly picking up steam. The recent economic strength of Germany, as exemplified

in these two charts, is so strong that Germany no longer deserves the title of "sick man of

Europe.” The remainder of this paper is a review of the "Mittelstand," a group of companies who

are largely responsible for Germany's current economic strength.

III. THE MITTELSTAND COMPANIES

Mittelstand is a German term that translates to “middle-sized.” It is used to describe a

unique business model that has surfaced in Germany within the past few decades. These

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companies are small to medium in size, they are usually family-owned, and they have a narrow

focus with a global orientation.2 Although these characteristics may describe businesses in other

countries, the German politics and philosophies allow them to prosper. Small and medium sized

companies (employ less than 500 people) describe 99% of all German companies (Meyer and

Venohr 2007). Furthermore, a small or medium sized company employs 70% of the German

population (Kirchfeld and Randow 2010). Even though they have been in existence since the

middle of the 20th

century, they gained global notoriety from the works of Hermann Simon, a

German economist and professor. He published Hidden Champions of the 21st Century, a book in

which he elaborates on the details of the Mittelstand. It was also around this time that the

Mittelstand rose to its dominant position. According to Simon, the Mittelstand is a small to

medium-sized business that dominates its world market as the leading company, operates

business to business, and has a niche product (Simon 1996).

Those companies in the Mittelstand that are described as a “hidden champion” are

relatively unknown, yet are a dominating force in the German economy. These businesses are

considered to be “hidden” because they operate in a business-to-business manner, meaning they

are unknown to the average consumer and are not common household names. Ninety percent of

the Mittelstand “shun the limelight” and strictly operate business-to-business. Additionally,

seventy percent of all of the Mittelstand organizations are headquartered or located in rural areas

instead of in large, metropolitan cities (Schumpeter 2010). Although it can be difficult to compel

potential employees to move to small, rural towns, the German culture helps overcome this feat

2 The term “Mittelstand” refers to a broad range of companies with these characteristics. The

companies defined as “hidden champions” are an elite group of companies within the Mittelstand

who occupy the number one or number two spot in the global niche market, do not generate

more than €800 million a year, and have low public visibility (Meyer and Venohr 2007).

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with their apprenticeship program. The apprentices begin as early as 11th

and 12th

grade and

become highly specialized in the field.

In order to further define and further understand the Mittelstand, it is helpful to view the

business model with respect to three interdependent functions: governance, operational

effectiveness and strategy.

IV. GOVERNANCE

The authoritative system of the Mittelstand is distinctive because the majority of them are

privately owned yet have outside professional management. The private ownership and

professional management combination is known as “enlightened family capitalism” (Meyer and

Venohr 2007). Normally in family-owned businesses, those who own the company also lead the

company. However, the blend of the familial and professional qualities enables the Mittelstand to

have an unusually successful approach to business by encompassing the positive aspects of both

managerial styles. The owners have an emotional attachment to the company and tend to strive

for survival instead of profit maximization. Because less than 500 people are employed, the work

environment is more familial and the employees interact as if they were “extended family”

instead of coworkers (Schumpeter 2010). Moreover, the structure of the organization is a flat

hierarchy, which strengthens the idea of a family and nurtures open communication amongst the

employees and owners. The familial feature of the governing structure indicates that the

Mittelstand is focused on long-term survival, relentless customer service, and conservative

business decisions. External management contributes in a way that promotes more risk,

innovation, and professional leadership. As an overall result, enlightened family capitalism

proves that “family control ensures long-term investment horizon and balanced stakeholder

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philosophy [as well as] state-of-the-art management practices contributed by professional

managers” (Meyer and Venohr 2007).

The governing structure of the Mittelstand is under constant criticism from outsiders.

They are said to be too conservative and too small to play such a considerable role in the global

markets (Schumpeter 2010). However, these very characteristics have helped to lead them to a

quick recovery after the recession. The “extended family” feel combined with the savvy business

sense pushes these companies to make conservative, yet well-informed business decisions.

V. OPERATIONAL EFFECTIVENESS

These companies have more than an understanding of world-class key processes. This is

best exemplified in their superior commitment to quality and customer service. “Do one thing

and do it well” is a maxim that drives the Mittelstand companies. They have a differentiated

product and are determined to make sure it is of the best quality. Many companies claim to have

superior customer support, yet few live up to the claim with the sort of vigor and emphasis

exemplified by the Mittelstand and their elite “hidden champions.” They excel in managing the

“value chain” by spending approximately twice as much time with their customers as large firms

in Germany do (Venohr and Meyer 2007).

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Figure 5: Percent of German World Market Leaders with Wholly-Owned Subsidiaries

Source: Venohr, Bernd. The Power of Uncommon Common Sense Management Principles – The Secret Recipe of

German Mittelstand Companies – Lessons for Large and Small Companies, 2010.

The “hidden champions” typically accomplish this with wholly-owned subsidiaries placed

strategically throughout the world in proximity to their largest customer-base (Meyer and Venohr

2007). (see Figure 5). Globalization has increased the market for the hidden champions and

allowed them to see lower transportation and communication costs.

The CEO of one of the Mittelstand companies is quoted as asserting that they know their

customers intimately and that many of their employees have flown to China more than 100

times. They “categorically reject” sales agents despite the small size of their firm and prefer to

handle the job themselves (Meyer and Venohr 2007). This dedication to quality and customer

loyalty solidifies a loyal customer base that will pay a little more for the product because they

know it is of the highest quality.

VI. STRATEGY

Operational excellence is obviously a key trait of the Mittelstand companies. However, it

is really part of the larger picture in terms of the firm’s strategy. As stated above, a majority of

the firms are privately owned, and as a result, there is no pressure from the shareholders for sort-

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term gains. Instead, the Mittelstand companies are able to focus on pleasing stakeholders and

emphasize the long-term. The Mittelstand is composed of many “hidden champions” who excel

at producing a highly specialized and differentiated product (usually in the manufacturing

industry). A niche market is more risky than a highly diversified company, yet the Mittelstand

companies have succeeded because of their reliance on technology and innovation as a key

aspect of the strategy. The Mittelstand model calls for a higher than average infusion of monies

into Research and Development. On average, the 1,000 largest research and development

spenders in the world spend 2.2% of sales on R&D, while the Mittelstand companies almost

double this percentage spending 5% of sales on R&D (Meyer and Venohr 2007). With less

diversification than many large companies, they are able to allocate all of the R&D resources to

the improvement of one product. This allows for constant incremental innovations and

improvements.

VII. MARKET STRUCTURE

This commitment to continuous improvement reduces the threat of substitutes and new

entrants due to the high barriers of entry created by differentiation. Michael Porter, an expert on

company strategy, identifies five forces that contribute to the sustainability of a company,

including threat of substitutes, buyer and supplier power, intensity of rivalry, and barriers to

entry (Porter 1998). Because the Mittelstand operates in a niche market with a highly specialized

product, the barriers to entry are very high, allowing for very few substitutes and less rivalry for

the major companies. In consideration of the continuum of market structures (McGuigan, Moyer

and Harris 2008), we would see many of them as having a market structure along the lines of a

monopolistic competition because of a few key factors: (1) It is easier to enter these markets

although effective entry is still difficult, (2) There is more than one dominant firm and there are

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many less threatening rivals, (3) The firms produce highly differentiated products and perform in

niche markets. Figures 6 and 7 help analyze monopolistically competitive firms.

Figure 6: Monopolistic Competition, Long Run Figure 7: Monopolistic Competition Short Run

Source: EconomicsOnline.com. Monopolistic Competition, 2010.

In a monopolistically competitive market, demand is relatively elastic and substitution is

somewhat possible. In the short run, if the price is set where marginal revenues are equal to

marginal costs, the firm is making a profit. However, because the barriers to entry are not set as

high as in a monopoly, other firms will enter and will drive the price down. In the long run,

monopolistically competitive industries will earn only a normal profit where P= ATC. Again, the

Mittelstand companies have a long run mindset, and are mostly concerned with the survival of

the company.

While the majority of the Mittelstand are monopolistically competitive, the “hidden

champions” sector function in a monopoly or, at least, a monopoly-like market structure because

of their strong control on a niche market. The strongest “hidden champions” hold absolute

product differentiation whereas the rest of the firms that fall under the Mittelstand category may

have high product differentiation, but it is not absolute. In addition, the monopolistic nature of

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these companies (Meyer and Venohr 2007) insures that they will continue to shy away from

quantity (over quality) since their marginal revenue would diminish as they increased their

quantity of output (see Figure 8). In a monopoly, a firm will set the price for the product where

marginal revenue is equal to marginal cost. The market demand is the same as the firm’s own

demand curve since there are no substitutes. This is how the “hidden champions” prosper and

dominate in their niche market.

Figure 8: Profits for Monopolistic Firms

Source: EconomicsOnline.com. Monopolistic Competition 2010.

Again, the firms use technology as their saving grace, allowing them to constantly innovate and

stay ahead of the rest of the marketing in order to maintain the top position in the industry.

VIII. POTENTIAL PROBLEMS

The Mittelstand model is not flawless. Demand is affected by many factors, such as price,

tastes and preferences, income, substitutes and complements. If the demand for the product

decreases because of obsolescence, the firm will have to diversify which can be very costly. The

firms may also feel pressure to outsource because of lower labor costs, which would eliminate

the familial atmosphere that is one of the key factors in the model. Because this model is now

becoming more defined and distinct, it will be interesting to see if more companies decide to

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imitate this model, adding more competition for the Mittelstand companies. For the firms in

monopolistic competition, as others enter the market, the supply curve shifts outward, decreasing

the price of the product. In turn, the firms will have less money to spend on R&D, which could

have a detrimental effect on the future and success of the product. Additionally, because the firm

is constantly innovating, the level of inventory could increase due to the incremental changes.

The cost of holding the inventory and the cost of producing in excess could be damaging to the

firm. The size of the firm is also something to consider. It needs to be small enough to maintain

the familial atmosphere and feel less pressure to become public, yet large enough to obtain

enough resources to allocate to R&D in order to stay ahead of the potential competition.

IX. CONCLUSION

The Mittelstand model is comprised of concepts that seem to be common sense for any

company. They are value leaders who are committed to customer satisfaction and producing high

quality products. They are niche market leaders who give their undivided attention to one

product to ensure its success. They operate as an extended family and are more concerned with

the long-term survival of the company as opposed to profit maximization in the short run.

Constant innovation, strong relationships with employees as well as customers, long-term

orientation, and a commitment to one global niche market seem like qualities that many firms

could adopt. It is the synergy of all of these qualities along with the German philosophy,

economy, and politics that enable such great success in a time when other countries are

struggling to maintain their footing. The Mittelstand have been hiding in the background for too

long, and although they are not used to the limelight, it is time that they earn the recognition they

deserve.

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