The German Mittelstand carries the economy by every structural measure, and it is losing the one capability that decides whether it keeps doing so. Innovation capacity is concentrating in a shrinking number of companies while the rest hold their position on business models built for a different economy.
Figures on economic output published by the Federal Ministry for Economic Affairs and Climate Action (BMWK) at the start of 2022 set out the structural weight:
- 99% of all German companies are Mittelstand companies.
- 33% of total revenue in Germany is generated by Mittelstand companies.
- 55% of all jobs in Germany are created by Mittelstand companies.
- 80% of all apprentices in Germany are employed at Mittelstand companies.
That position cannot be taken for granted looking forward. Megatrends such as digitalisation, technological innovation, and climate- and resource-conscious economic activity require new thinking to preserve the structures that have grown over time.
This article is based on a white paper developed in cooperation with New Mittelstand.
1. What are the greatest challenges facing the Mittelstand?
The global economy is in the middle of a long-term transformation. In numerous areas, this is giving rise to far-reaching, fundamental changes to the current state of affairs, which will inevitably be replaced over the medium to long term by a new target state. Given the globalised economic structure, this transformation will sooner or later also reach the often family-run, tradition-grown companies of the German Mittelstand. Many mid-sized companies must already today face the following challenges:
- Shortage of skilled workers. Due to the demographic shift in the German population, the BMWI expects the shortage of skilled workers to increase. Already today, almost half of all occupational categories are confronted with a shortage of skilled workers. More than 50% of German companies see the shortage of skilled workers as an entrepreneurial risk.
- Business succession. According to a projection by the Institut für Mittelstandsforschung in Bonn, around 150,000 German companies face succession decisions at the level of company and executive management in the period from 2018 to 2022.
- Technological change. Studies conducted on behalf of the BMWI estimate the additional growth potential of Industry 4.0 and the associated automation and transformation processes at between 200 and 425 billion euros by 2025.
- Digitalisation. The trend toward greater digitalisation and interconnectivity affects both products and services as well as the associated work, production, and communication processes. Current studies show, however, that mid-sized companies have catching up to do in these areas compared to large corporations.
- Innovation capacity. The globalised economic structure and the associated acceleration of change require not only adaptability but also innovation capacity in the future, in order to endure as a full member of the market over the long term.
In this article and the joint paper with New Mittelstand, approaches to addressing these challenges are presented, approaches with which the transformation of the established German Mittelstand structure toward a future-proof model can succeed.
2. Is Mittelstand innovation capacity actually declining?
According to research by the Kreditanstalt für Wiederaufbau (KfW), the German Mittelstand faces a paradox in its innovation capacity.
Few Mittelstand companies with a future-proof innovation strategy
Comparing the share of innovative Mittelstand companies in Germany against expenditure on research and development shows a scissors-shaped gap between the two curves. The reading in the KfW research is that both the activity and the money behind it sit with a shrinking group of companies.
The threat is to the companies outside that group
Overall, the innovation capacity of Mittelstand companies is at its lowest point in the past 15 years. With ever-shorter technology cycles and the pressure to innovate that comes with them, the question in some industries is whether the future viability of the German Mittelstand is under sustained threat. The digitalisation of value chains is the most acute of those problems.
3. Is digitalisation really about technology?
The term "digitalisation" is often used to describe only technological change in terms of corporate organisation. This assumption, however, falls far short of the mark, since the process behind the term encompasses not only technological transformation but also changes in corporate culture and the associated mindset.
Digital change requires comprehensive transformation
In order to meet the new demands of digital change, a radical transformation of corporate organisation across several levels is often necessary.
- Uncertainty and mode of development: The previous certainty of path-dependent development must give way to the uncertainty of disruptive, flexible development.
- Planability: The previous planability along well-known paths gives way to flexible development possibilities that require different planning horizons.
- Dynamics: While fixed structures and processes were characterised by low dynamism, short product life cycles and fast-moving innovation and transformation sequences require very high and accelerated dynamism in terms of corporate organisation.
- Innovation and iteration cycles: The duration of the underlying innovation and iteration cycles is difficult to estimate for the entrepreneurial activity of the future. Innovation strategies must be adapted accordingly.
- Decisive resources: While capital and means of production were previously the primary drivers of entrepreneurial success, this will increasingly depend in the future on direct customer contact and the underlying communication platform.
- Perspective on industries: A sector-focused fixation on the status quo will in the future be replaced by business models that are structured and positioned across industries.
- Company boundaries: Stable company boundaries that are difficult to penetrate are increasingly being replaced by flexible and transparent structures in the form of alliances, cooperations, and joint ventures.
- Spatial organisation: Company activities at a central, physically material location are increasingly giving way to decentralised, immaterial marketplaces in virtual space.
- Leadership: Instead of hierarchically structured leadership models, future-proof business models call for collaborative leadership in which multiple actors from different areas work together on an equal footing.
- Decisions: While today decisions still emerge from lengthy, purpose-built processes and are underpinned by a large volume of data and facts, the decision-makers of the future must respond quickly to current developments and continuously question the decisions made and adapt them in line with the respective development dynamics.
- Collaboration: Whereas in the past in-house solutions were preferred and collaboration with external partners took place only when necessary, in the future only a cooperative fundamental attitude across industries will lead to lasting corporate success.
3 topics decisive for the future viability of Mittelstand companies
The transition from traditional Mittelstand business models to digital economic activity turns on three areas:
- Customer centricity
- Innovation climate
- Business model
These three areas and their realignment along the priorities outlined are decisive for the future viability of Mittelstand companies. The radical transformation of corporate organisation that goes with it should happen proactively inside the companies themselves, so that they shape the change rather than react to it.
4. Is digitalisation really the greatest challenge?
For Mittelstand companies in Germany to be equipped for the challenges of tomorrow's economy over the long term, digital transformation is arguably merely the step toward the status quo of the current economic order, which is often summarised under the term Internet Economy.
Internet Economy is the status quo of the present
Since the early 1990s, the economic system known as the Internet Economy has begun to replace the previously prevailing structure of the Industrial Economy, which was still predominantly oriented toward meeting basic needs and, building on that, toward creating material prosperity.
With the Internet Economy, social needs were also increasingly incorporated into economic thinking and action. Innovations in the areas of digitalisation and information and communication technology in particular drove the interconnectivity between people, companies, data, and processes significantly forward. Interconnectedness is therefore the central pivot of this dynamic of change.
Purpose Economy as a concept for the future
Although the process of digital interconnectedness is far from complete, the next cultural shift is already beginning to take shape. One that will in all likelihood trigger further processes of change in the economic order: the Purpose Economy. The current global problems of our time, and in particular the advancing environmental and climate change as well as increasing resource scarcity, are gradually giving rise to a new generation of consumers who will evaluate and assess the products and services of the future primarily according to the criteria of "meaning" and "sustainability."
In addition to digital transformation, the German Mittelstand must therefore also engage with corresponding innovation strategies that make products and services interesting and attractive for future generations of customers under this aspect.
5. What can the Mittelstand learn from start-ups?
The success of Mittelstand companies is frequently founded on structures and processes that have grown over the long term, resulting in quality advantages over larger competitors. The fast-moving nature of products and services introduced by the Internet Economy, and the dynamics of the underlying business processes, tend to favour smaller and more flexible company structures in the form of start-ups.
New Mittelstand: a synthesis of start-ups and the Mittelstand
For the German Mittelstand to be able to take on and successfully manage the challenges of a Purpose Economy in the future, aspects of traditional Mittelstand culture must be supplemented and extended by the dynamic entrepreneurial approaches of start-ups. This approach, referred to as the New Mittelstand, combines the strengths of both types of company and thereby creates the conditions for a future-proof and authentic corporate structure.
New Mittelstand as a future-proof concept
The concept of the New Mittelstand holds potential in many respects for positioning Mittelstand companies in a future-oriented way:
- Lasting success is made possible through the combination of long-term orientation with dynamic growth.
- Evolutionary optimisation paired with technological change leads to multi-horizon innovations and the opening up of new sales markets.
- Alongside focused expertise in specific areas, innovations in new markets ensure durable diversity of products and services.
- Scalable profitability and the use of venture capital create opportunities to ensure a continuous, contemporaneous transformation of companies.
- Regional responsibility and the opening up of new markets go hand in hand and in the best case lead to a win-win situation.
- Cross-generational continuity combined with visionary, self-confident opportunism offers potential for future-oriented cooperations and collaborations.
- Family-based structures and long-established expert knowledge, combined with an entrepreneurial spirit and a performance-oriented business approach, ensure balanced value generation.
The concept brought together in the New Mittelstand thus opens up for mid-sized companies a flexible innovation strategy that can be implemented with the help of a transformative leadership culture.
6. How can a transformation to New Mittelstand be implemented?
For Mittelstand companies in Germany to successfully complete a transformation to the New Mittelstand, both short- and long-term innovations are required that ultimately come together to form one approach. The right balance must be found between:
- Product development and improvement of the value chain
- Expansion and improvement of the market position as well as increasing customer value
Both factors must be taken into account in a coordinated manner across three different levels.
Optimising the profitability of the core business
The first step on the path to the New Mittelstand is the optimisation of the profitability of the core business. A decisive factor in being able to implement this successfully over the long term is making adequate use of the opportunities offered by digitalisation. Numerous studies show that German Mittelstand companies have catching up to do in this area. Starting points include, among others:
- Use of new digital software solutions
- Introduction of Industry 4.0 applications in the production process
- Standardised eBusiness processes
- Digital interconnectivity along the value and supply chains
Digitalisation and interconnectivity form the foundation for a future-proof, scalable business model that, in a next step, also enables expansion toward an innovation strategy to develop new products and open up previously untapped sales markets.
Generating growth with new products, services, and markets
Once the organisational structure and processes of the core business have been placed on a future-proof foundation through digitalisation and intelligent interconnectivity, the successive expansion of business activity can take place. Two measures are particularly required for this:
- Continuous investments in research and development
- Corresponding further training and development of human capital
Through the development of new products and services and the opening up of new markets, companies of the German Mittelstand will gradually become less dependent on their core business. Should a sustained decline in revenue occur there in the future due to innovation or changes in needs and demand, companies pursuing the New Mittelstand approach will find it easier to compensate for this through the successive expansion of their business activity into other sales markets.
Creating new markets and solutions
A third step toward the New Mittelstand is the proactive creation of new sales markets and solutions. With the help of a far-reaching innovation strategy, a scalable business model, and an efficient organisational structure, Mittelstand companies can deliver new product and service solutions or even create entirely new sales markets.
7. What are the concrete steps in implementing the transformation?
A key challenge for Mittelstand companies that wish to participate in economic activity as part of the New Mittelstand in the future will be the implementation of a dual innovation strategy.
Evolutionary approaches grown over decades in the German Mittelstand
One element of the dual innovation strategy is the evolutionary mindset that has grown and been cultivated in Mittelstand companies over decades:
- Understand the origin - analysis of the current situation
- Envision the future - projection of the target situation
- Plan - design of a transformation strategy
- Transform - implementation and execution
Evolutionary approaches follow a structured process and fixed guidelines.
Revolutionary approaches typical of start-ups and young technology companies
As the second element of a dual innovation strategy, revolutionary approaches are used. Approaches characteristic above all of the fast and flexible development processes of start-ups and young technology companies:
- Inspire - create visions for the products and markets of the future
- Experiment - realise visions through research and development
- Build structure - introduce new products and services
- Scale - create demand and sales markets
Revolutionary approaches align their strategies with the potential consumer needs of the future.
Combining both approaches paves the way to the New Mittelstand
The combination of the two innovation streams presented allows Mittelstand companies to engage already today with the radically innovative topics of tomorrow. From the best of both worlds emerge:
- Lasting growth - a balanced mix of organically grown structures and the opening up of new markets with exponential growth
- Quality - social responsibility through environmentally, climate-, and resource-conscious processes combined with revenue-generating quantity and scaling
- Customer success - alongside the goals of customer satisfaction and customer loyalty, the acquisition of new customers also plays a decisive role
- Awareness - both brand trust in the familiar and product acceptance for the new are taken into account
When both innovation streams are combined and implemented with the help of a corresponding innovation strategy, Mittelstand companies as part of the New Mittelstand can look to the future with confidence.
8. What the transformation looks like in an established company
A case study shows how the New Mittelstand concept works in practice. The focus is the transformation from hardware-driven to data-based business models in the automotive industry.
The starting situation: a hardware core business with a 5 to 10 year horizon
Following the merger of several family-run companies, high staff turnover occurs at the leadership level. There is consensus that far-reaching changes in the Automotive Aftermarket area, for example e-mobility and the sharing economy, are necessary. The risk is recognised that a hardware-driven core business could become irrelevant within the next 5 to 10 years. Numerous challenges in the quality area of the core business demand future-proof solutions.
The approach: a parallel organisation and a dedicated budget
The development of a future-oriented overall strategy is the top priority. Both the repositioning in the market and the focus on "Sustainable Value" in the data area are among the most important aspects of the transformation process. Feasibility checks using hackathons are carried out. A dedicated investment budget for the New Mittelstand transformation is approved. A parallel organisational structure for building the new business model is implemented.
The first year: Digital Board, agile processes, one pilot
The new corporate culture is communicated. A Digital Board that takes over the management of the new business model is introduced. The core competency from the existing business is supplemented by the recruiting of new talent. The organisation is restructured with agile processes and the support of OKR and KPI systems. A pilot project based on the new data-driven business model is carried out.
What the transformation is expected to deliver
The new tech culture is implemented step by step. Areas newly created through innovation are intended to generate significant revenue shares in the future. The continuous growth of the core business is secured through implemented shared services. Innovation capacity is strengthened through newly introduced processes and methods.
Where a New Mittelstand transformation is decided
Four conditions separate the transformations that hold from the ones that stall. Mittelstand companies have to analyse and reflect on the current business model honestly, recognise the necessity of change, find the courage for radical transformation where it is needed, and then drive the transformation process through. A transformative leadership culture is necessary and not sufficient: the workforce has to be involved early and convinced that the company's competitiveness depends on it.
9. How do you get started?
A good starting point for Mittelstand companies beginning the transformation to a New Mittelstand company is the creation of a transformation map. With it, the concept underlying the transformation can be presented in a structured and clear manner, thereby simplifying the high complexity of the issue. The transformation encompasses several areas that interact with and influence each other.
Culture and brand
This area of the transformation map addresses the fundamental questions that concern the future company as a whole, including among others:
- What meaning, value, or "purpose" should the company represent?
- What values and visions should the company stand for?
The answers defined in this area form the foundation for the remaining areas.
Customer needs
This area defines on one hand the current customer base and the respective expectations and needs. Beyond that, the customer of the future is also envisioned and their requirements of the company are projected.
Organisation and leadership
This part of the transformation map examines the organisational and leadership structure of the company. The focus is in particular on the current strengths and weaknesses and what changes must be made in order to implement the New Mittelstand mindset in the corporate structure.
Market developments
With regard to the company's positioning in the sales markets of the future, the following questions must be answered, among others:
- What are the currently dominant trends and which key trends will shape the future?
- How are venture capital-backed start-ups positioning themselves in the market?
- What tendencies and developments are markets showing at a global level?
Technology and design
This area deals primarily with technological change and the associated human changes. Of particular relevance is the potential influence on the company's business model.
Strategy
For a New Mittelstand transformation to succeed, a structured strategy is necessary. Both the prioritisation and weighting of individual implementation steps and the subdivision into short-term and long-term sub-goals are useful in this context.
Business Model
The current business model is clearly defined in this sub-area. In addition, alternative paths toward the business model of the future are developed and set out in writing.
Two questions worth answering before the first workstream starts
Which parts of the current revenue would survive if the core product became a commodity in five years, and who inside the company owns the answer? And of the areas on the transformation map, which one is currently receiving budget without a named owner? Those two answers usually locate the real starting point better than the map does.
Innovation strategy for the Mittelstand: the questions we get asked most
What is an innovation strategy?
An innovation strategy sets out which innovations a company will pursue, in which markets, on what time horizon, and with which resources. It covers both the incremental improvement of the existing business and the development of new products, services, and markets. Without that split made explicit, innovation budgets default to the incremental half.
What is the New Mittelstand?
The New Mittelstand combines the strengths of traditional Mittelstand companies, long-term orientation, focused expertise, and regional responsibility, with the working methods of start-ups: fast iteration, scalable business models, and access to venture capital. It is a response to the fact that the fast-moving nature of the Internet Economy favours smaller and more flexible structures.
What is a dual innovation strategy?
A dual innovation strategy runs two innovation streams at the same time. The evolutionary stream follows a structured sequence: understand the origin, envision the future, plan, transform. The revolutionary stream works the way start-ups do: inspire, experiment, build structure, scale. The evolutionary stream protects today's earnings, the revolutionary stream builds the markets of the next decade.
What is a transformation map?
A transformation map lays out the areas a New Mittelstand transformation has to cover and how they interact: culture and brand, customer needs, organisation and leadership, market developments, technology and design, strategy, and the business model. Its purpose is to make the dependencies visible, so that no area gets budget while a dependency it relies on stays unaddressed.
