Industry 4.0

The Mittelstand's Digital Problem

industry 4.0, mittelstand, germany digitization, digitalization
The future of industry is digital, but many German companies aren't quite prepared for it. Source: dpa/Ole Spata

Germany prides itself on being a global leader in engineering. In particular, its small- and medium-sized business sector, known as the Mittelstand, thrives on supplying factories around the world with specialized machinery that is often the best in the world. But the Mittelstand is at risk of being left behind in the fourth industrial revolution, dubbed Industry 4.0, according to a study prepared for one of our sister publications. The Mittelstand, and Germany’s industrial future, which seems so bright, could instead be at risk.

The previous three revolutions were, respectively, driven by steam power, mass production and information technology. This fourth industrial revolution is borne of digitization: It will lead to intelligent factories that run themselves, and products that communicate with the machines that are making them. The German government predicts that by 2025, production lines crowded with workers or machines all performing the same tasks to make uniform products will be a thing of the past. Instead, robots using a variety of tools will be able to forge, drill, polish and lacquer components into a variety of designs, steered by bar codes or radio-emitting chips that are embedded in the materials. That will permit the mass production of customized goods, with customers able to order red-and-green dotted cars if they like, with custom-molded seats, and pick it up days later at little or no extra cost.

But the study, conducted by consultancy McKinsey for our sister publication WirtschaftsWoche, shows that the majority of Mittelstand firms are in an anxious wait-and-see mode rather than making the technological leap to intelligent factories that run themselves. “Many Mittelstand firms are looking at the digital revolution without doing anything about it and are thereby endangering their business model and their strength,” said Niko Mohr, a digitization expert at McKinsey in Düsseldorf.

The survey of German companies with annual revenue between €100 million and €2 billion ($116 million to $2.3 billion) showed that only 10.5 percent of them are exhausting their digital potential. The percentage is even lower, 10 percent, for the overall German economy, which includes thousands of small businesses that are even more technophobic than the Mittelstand. Only a few German blue-chips, such as Siemens, are up to speed in their digitization. The European average is 12 percent.

The study also shows the Mittelstand lagging far behind the US, with its internet giants such as Google, Apple and Facebook. McKinsey believes the IT and telecoms sector in the US is using 100 percent of its digital potential. Its analysis measured companies’ spending on IT and the level of digitization in their internal processes, in their interaction with customers and in their jobs. For an international comparison, McKinsey used the overall corporate sector in other countries as its benchmark because medium-sized businesses don’t play as big a role.

America’s internet industry, of course, grew up in the past few decades unencumbered by old corporate structures. Germany’s Mittelstand consists of family-owned businesses that have grown over many decades or even centuries. That’s one reason why many are struggling to keep up with the pace of change.

mittelstand germany smes digitization, digitalization

If the Mittelstand digitized, however, it could create value of €127 billion by 2025, McKinsey estimated. Companies could increase their revenues by tens of billions of euros, especially in IT, communications, metalworking, electrical engineering, wholesale and export trade.

Entrepreneurs like Jürgen Mangelberger are still a rare breed in Germany. It took him less than two decades to turn his eight-man electrical-engineering firm with a handful of customers into a global supplier of energy controlling systems in restaurants and stores, and he did so by spotting the potential of digitization.

In the late 1990s, Mr. Mangelberger figured out how to use the internet to check his customers’ lighting systems remotely and quickly. He now employs more than 70 technicians. From Sydney to New York to London, restaurant chains and supermarkets are running their freezers, air conditioners and cash registers with technology developed in the tiny Bavarian town of Roth.

“I had to offer more to convince the managers of Starbucks and McDonald’s to do business with a small Mittelstand company like us,” Mr. Mangelberger said. “I had to take a risk.”

But while almost two-thirds of Mittelstand companies believe digitization is relevant for their future success, and about half claim to be pursuing a digital strategy, many of them still don’t realize how big the upheaval will be, Mr. Mohr said. “Classic business models are changing fundamentally, and whole industries are redefining themselves,” he said.

Family-owned company Voith shows the challenges confronting a classic engineering company. Voith, which makes paper-processing machinery, water turbines and power-train technology, has shed 2,500 jobs in the last four years because demand for paper is falling.

CEO Hubert Lienhard responded by creating a new digital-solutions unit with 1,500 employees to harness the data created by the machinery business. Four months ago, he set up the Internet portal merQbiz to bring together paper factories and waste-paper merchants in the same way that Uber connects drivers with passengers and booking.com finds hotel rooms for travelers.

“The managers should be asking themselves: What would a business look like if one were to build it today from scratch?”

Robert Neurohr, a partner at Hamburg-based firm Infront Consulting

Within just a few weeks of starting, the unit had arranged the sale of 3,000 tons of waste paper, which Voith earns a commission on, like auction site eBay. Mr. Lienhard plans to invest more than €50 million in merQbiz by the end of 2020.

Maybe Mr. Lienhard should be risking the bigger step of jettisoning the stagnating paper machinery business altogether. “The companies often don’t think radically enough,” said Robert Neurohr, a partner at Hamburg-based firm Infront Consulting. “The managers should be asking themselves: What would a business look like if one were to build it today from scratch?”

The pressure to change is increasing. In Germany, 62 to 77 percent of the working time of low-skilled workers and 46 percent of those of workers with mid-level qualifications can be automated, wrote Cornelius Baur, who heads the German office of McKinsey, in an op-ed in Handelsblatt. For workers with the highest qualifications, the figure is only 18 percent. “This does not mean that these jobs would be completely eliminated, but the working world will change dramatically,” he wrote.

voith digitization mittelstand
Many manufacturing jobs may be done by robots in the future. Source: dpa/Stefan Puchner

The German government identified “Industrie 4.0” as one its economic priorities following the September 2013 election and has pledged hundreds of millions of euros to research projects underway across the country.

Industry 4.0 in that sense is the manufacturing aspect of an older concept, the Internet of Things. It describes the ability of every device, from your refrigerator to your pacemaker and your navigation system, to talk to each other. German firms are now anxious that they will lose out to American ones in defining the standards that will regulate how things will communicate with one another.

Ultimately, progress can only be achieved internationally. In a clear rejection of American protectionism under President Donald Trump, Germany’s Plattform Industrie 4.0 panel of industry groups, government representatives, trade unions and scientists has joined forces with its counterparts in France and Italy to develop common systems and put Europe at the forefront of change.

“These firms need particular support and also need to change their thinking even if everything doesn't immediately work perfectly.”

Klaus Mittelbach, head of Germany's Electrical Industry Association

“Digitization involves an international linking-up of technical systems and processes,” German deputy economics minister Matthias Machnig told Handelsblatt. “For that you need cross-border cooperation, especially in questions of technical cooperation.”

Bernd Leukert, the chairman of the Plattform Industrie 4.0 steering committee, said Germany has no desire to create an exclusive club. “We’re aiming for a growing European network. With this strong voice we will be able to engage in much more intensive cooperation with partners or networks” in the US, he said. Japan, Korea, China and Australia are showing strong interest in joining this cooperation.

Asked if the cooperation with France and Italy was aimed at sending a message to the US that Europe was setting up a counterweight in the race to develop new systems, Mr. Leukert said: “No, but it’s a clear message by Europe regarding openness, fair competition and market transparency. At present there are some signals from the US government about wanting to fence oneself off a little. That would have grave consequences for the software sector and the products it makes. One basic tenet of Industrie 4.0 is networking and striving for an international framework of conditions. Companies and governments must enter into international cooperation, which is why European initiatives will always be in communication with initiatives in the US.”

“The companies that act now will shape future markets and outpace the others — by a factor of up to 10,” said Heinrich Arnold, the head of Detecom, Deutsche Telekom’s in-house consultancy. He said he remained upbeat about Germany’s prospects. “It’s looking good. People have faith in us, we’re doing something and have a good base.”

The much-lauded Mittelstand, meanwhile, will need government help to ready itself for the upheaval, industry leaders say. “The will is there, but they lack the strength and sometimes the financial resources,” said Klaus Mittelbach, head of Germany’s Electrical Industry Association. “These firms need particular support and also need to change their thinking even if everything doesn’t immediately work perfectly. Such a change in corporate culture only happens slowly.”

Handelsblatt and WirtschaftsWoche staff contributed to this report. To contact the editor: kluth@handelsblatt.com

We hope you enjoyed this free article.

Subscribe today and get full access to market-moving news in Europe's leading economy.