Family Business Par Excellence – The Story of the German Mittelstand by Nadine Kammerlander
As mentioned above, the goal of this Insight is to both provide a description of the German Mittelstand – which are family businesses par excellence – and to provide a prescriptive model for how others might emulate the success story of the German Mittelstand. The article will cover 6 strategies for making the most out of limited resources. When these 6 strategies work together, and mutually reinforce each other, they become particularly strong – to such a degree that firms with resource disadvantages often may manage to outcompete larger firms, with vastly larger resources. Thus, this Insight is about how family business can make the most out of the resources it has in order to compete successfully, even on a larger scale, internationally.
Before we commence this article, I wish to say a few words about myself. I am Nadine Kammerlander, professor at WHU – Otto Beisheim School of Management and leader of the university’s family business institute. This is a summary of a research article which I co-authored, “Innovation with Limited Resources: Management Lessons from the German Mittelstand”, published in the Journal of Product Innovation Management (2017; co-authored by Alfredo de Massis, David Audretsch, and Lorraine Uhlaner). As mentioned in the introductory sentences above, the Mittelstand is the German word for small and medium sized firms that are family owned. These businesses have typically 50-500 employees. They are controlled by one family and are very often also managed by the controlling family. Furthermore, they are international in orientation, and finally, they identify themselves as a Mittelstand firms. (In other words, not all German SMEs fit the label Mittelstand.) I have worked much of my professional life with Mittelstand firms, both working for Mittelstand firms, and researching these firms. In this insight you will find many of my conclusions from these years of research. The hope of my fellow researchers and myself is that our findings can prove useful for other family owned firms, and for their owners. We believe that both Mittelstand and non-German firms can improve performance over time by implementing specific strategies that many firms before them have proven to be successful.
First, however, a few more words about the Mittelstand “Wirschaftswunder”. The Mittelstand in Germany comprises a larger portion of the German economy than what family owned SMEs do in other countries. The same is true in terms of percent of BNP, export, and patents. Family owned Mittelstand firms stand for 30% of all revenues of German firms, and 40% of all exports from German firms. It is thus a fair starting point to say that both the German economy has done well the last 30 years, as has the Mittelstand. If this is a fair starting point, it is also valid to study what can explain the Mittelstand´s relative success, both in Germany and internationally.
**What characterizes them?**
Mittelstand firms are family owned firms, where the owners are also often the managers of the firms. As owner/managers, the identification with the firm is very high, and very often leads to extraordinary efforts in developing the business. Owners, management and employees often share common values and an extreme quality focus. Together, owners/management/employees are able to overcome resource constraints and limitations – particularly financial limitations, but also often limitations from being located in more peripheral areas – in order to compete on a national and even global level. Often reluctant to bring in external capital, Mittelstand firms also many times face a paucity of human resource talent, in particular if located in smaller towns and cities. Still, since Mittelstand firms are largely very successful and geographically dispersed, it is obvious that they are able to compensate for their lack of resources, among other things by sharing common values, by having a strong identification with the firm, and by the special efforts put in by the owner/management as well as by employees. Finding better ways of deploying and combining existing resources, the Mittelstand firm leverages its resources to compete, and gain competitive advantage, both relative to SMEs in other countries, as well as to larger multinationals. This is the German Mittelstand.
**Six Mittelstand Strategies**
Through our findings, we have identified six salient and mutually dependent strategies that help explain the German Mittelstand success – the strategy and structure that enables them to overcome limitations, and compete globally:
**1) Niche Focus and Customer Collaboration:**
Laser-like niche focus and avoidance of diversification allows Mittelstand firms to innovate persistently and stay ahead of potential competitors despite resource limitations.
The niche focus allows them to closely collaborate with their existing customers, a source of innovation!
For instance, 37% of employees in Mittelstand firms have direct contact with customers compared with only 7% in major German corporations (p.6). Ultimately, the niche focus and customer collaboration of Mittelstand firms, with its resulting innovative products, is reflected in Germany´s nr. 1 ranking as the market leader across many industry sectors globally.
R&D: **The innovation investment intensity of Mittelstand firms is twice as high as non-Mittelstand German companies, and far higher than the EU average.** This high R&D focus leads both to incremental innovations, as well as the ability for the Mittelstand to re-invent itself over time.
**2) Globalization Strategy:**
The Mittelstand´s laser-like niche strategy allows these firms to expand and seek out opportunities globally.
One finds amazingly strong data for the Mittelstand’s international success, despite the relatively higher German labor costs compared to those of Asian competitors. It seems that the Mittelstand is able to compensate higher costs through product and process innovation, highly reliable delivery times, service orientation, customer knowledge, and product quality and attractiveness (p.6).
When internationalizing, the Mittelstand often sets up its own subsidiaries rather than creating JVs or trading partnerships. A higher degree of control is deemed important, and the data suggests that this facet of the international strategy works. (Our data shows that Mittelstand firms are in general more open to international expansion compared to family firms/owner-managed SMEs in other countries, p.7)
**3) Preference for Self-Financing:**
On average, Mittelstand firms do not wish to seek out external capital. Their owners prefer a more conservative approach, namely, to finance through self-financing. This financial strategy provides a larger possibility to pursue a strategy of the firm´s own choosing. The data shows that German Mittelstand firms make more use of internal funds in than similar companies in the EU (p.7). The desire is to maintain control and to reduce the risk associated with financial leverage from external banks and institutions. The family´s personal wealth is often used to fund R&D and internationalization. Because of the desire to maintain control of the firm across generations, there is often an unwillingness to dilute ownership, and also an unwillingness to increase debt levels. The penchant for self-financing or organic growth, leads to a conservative attitude towards growth in general. Mittelstand firms may sacrifice growth opportunities in the short term, particularly during periods of economic boom, compared to more leveraged firms that grow through acquisitions. However, the fiscal conservatism gives the same Mittelstand firms a greater financial stability and continued independence in times of crisis!
Thus, the penchant for self-financing gives Mittelstand firms a greater freedom to pursue their own strategies. Yet the fiscal conservatism forces them to remain focused and true to their niche. Conservatism means lesser growth in times of economic upturn, but perhaps a greater stability and robustness in more challenging times.
**4) Long-term Mindset:**
“Aside from the autonomy in pursuing their focused globalization strategy, another implication of the Mittelstand´s preference for internal financing is the ability to employ a long-term perspective.” p.8.
The desire for continued control across generations often leads to the development of companies characterized by inter-generational entrepreneurship.
The tendency for pursuing inter-generational entrepreneurship is reinforced and made more feasible by the longer tenure of the CEO in the firm, compared with CEOs of larger German corporations. Mittelstand managers often seek to build a legacy, more than a career.
A recent survey of board members and C-Suite executives report that 79% report pressure to demonstrate strong financial performance in just two years or under, while 73% say that they would have preferred to use a longer time horizon. Mittelstand firms are largely exempt from such pressure and thus endowed with the privilege of having a longer term mindset. This longer term orientation helps these managers, in turn, to pursue strategies that may not pay off in the short term, but that greatly pay off in the longer term – one example could be continual product and process innovation.
In sum, limited financial resources are compensated by patience, allowing Mittelstand to invest with more “stamina”, which in turn leads to different – often superior – innovations and valuable competitive advantages.
Lastly, the longer term mindset also has the consequence that Mittelstand more often include ethical and sustainability goals in their strategies. (“Anständig” is a word that is often used, financially and ethically, responsible and proper). Can you imagine what this means for employee pride, and identification with the firm!
**5) Superior Employee Relations:**
The aforementioned longer-term orientation enables Mittelstand family businesses to build long-term relationships with employees, which in turn help these firms to overcome what might otherwise be viewed as human capital resource constraints to innovation (especially in rural or small-town areas). Employee relations in Mittelstand firms are characterized by enhanced training, high involvement in decision making and a flat hierarchy! The German Mittelstand has the lowest employee turnover rate in the world. Conversely, five of Germany´s neighbors (Belgium, Denmark, Luxemburg, the Netherlands and Switzerland!) were among the top ten in employee turnover (p.9).
Job retention is an indicator of job satisfaction and, over the long term, allows for the preservation of the needed tacit knowledge associated with a firm’s ability to innovate! (p.9)
“Wertschätzung” is a word often used. It means to hold in high esteem; it means more than keeping the job, celebrations and Christmas parties. It means that the management and owners truly value the employees.
Thus, superior employee relations are a means for overcoming resource constraints – also for overcoming the limitations of the owners themselves! – by building competitive advantage through teamwork, and long term collaboration.
In sum, Mittelstand firms foster a sense of community, even “pseudo-family”. When there is such an overlapping of values, identity and culture smaller firms will be faster to seize opportunities, be more able to commercialize, and to implement innovations despite more limited resources than those faced by much larger global companies.
**6) Community Embeddedness:**
Remaining in the same community over time – even over generations – provides the opportunity to develop and maintain a loyal employee base, and further strengthens the superior employee relations.
Staying in one place also allows for strong partnerships with local research centers and universities. Such partnerships very often assist in R&D efforts or lead to increasing the talent pool that the firms can access.
Lastly, the long-lasting connection between the Mittelstand and the local banking system is very important. As in many countries, the local “Sparkasse” has a dual focus. One is to be profitable, but the other is to give back to the local community in terms of helping to create jobs in particular. This dual focus and long-term orientation seems dovetailed to the Mittelstand´s size and financing needs. While perhaps not willing to finance acquisitions and foreign growth, they often will finance local employment with advantageous terms, and with more leniency in times of trouble. Again, stronger bank relations lead to fewer bankruptcies in times of recession and higher chances for long-term success.
The power of the Mittelstand approach takes full effect only when all six traits operate in an integrated fashion. In such cases, the six strategies mutually reinforce each other, and act to create a positive cycle.
To be more precise, a long-term mindset supports developing superior employee relationships and community embeddedness, which mitigates the effects of limited resources, enhancing the firm’s ability to self-finance and which again reinforces and fosters a long-term mindset. By keeping the product focus narrow, thus deepening the understanding of the product and the cooperation with the customer, a Mittelstand firm can achieve an innovation position of global market leadership even with limited resources.
When all six strategies work together, Mittelstand firms become family firms par excellence and pillars of the community.
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