On world market leaders, specialists and the assumption of a dormant reserve in Germany’s Mittelstand

One assumption recurs with remarkable regularity in Germany’s economic policy debate: the Mittelstand, the country’s small and medium-sized, often family-owned companies, is said to possess an intact capacity that is merely being held back. Free it from bureaucracy, high taxes and expensive energy, the argument goes, and it will get the economy moving again. This expectation is often underpinned by pointing to Germany’s many „world market leaders“, which are taken as proof of a substance that is only waiting to be released. On closer inspection, both parts of this narrative hold up only to a limited extent.

The tailwind that was booked as a policy success

The idea of a reserve that can be called upon draws heavily on memories of the years following Agenda 2010, the reform package of the Schröder government that from 2003 onwards restructured above all the labour market and the social security systems. The reforms were followed by an upswing, and the causality seemed obvious. What is overlooked is that this upswing coincided with China’s investment boom. China was building factories, infrastructure and a middle class at great speed, and it demanded precisely what the German Mittelstand produced: machine tools, plant, components, vehicles. A considerable part of the recovery was an external tailwind that was credited to policy after the fact.

That tailwind has turned. In many segments that formed the backbone of the industrial Mittelstand, China has moved from customer to competitor, in mechanical engineering as well as among automotive suppliers or in medical technology. No German tax or regulatory reform can reverse this shift. Other developments also contradict the image of a dormant strength: numerous owners will search in vain for a successor in the coming years, research and development is increasingly being relocated abroad, and the shortage of skilled workers is demographic in origin. Competence that has migrated or been lost with a closed company does not automatically return when conditions improve. The substance is not dormant; it is eroding.

This is not to say that framework conditions are irrelevant. Bureaucratic costs, lengthy approval procedures and high energy prices hit smaller companies disproportionately, because they lack the legal and regulatory departments that large corporations maintain. Better policy can slow losses and make restructuring easier. It is a necessary condition for renewed growth in the Mittelstand, but not a sufficient one.

A title one awards oneself

The term „world market leader“ itself is particularly revealing. In Germany it owes much to the management consultant Hermann Simon, who in his book „Hidden Champions“ described little-known mid-sized companies that rank among the top three in their market worldwide or first on their continent. By his count, Germany accounts for a far disproportionate share of these companies, and that figure has become a fixed part of how the country describes itself as a business location.

The problem lies in how the market is defined. A market share is always relative to the definition of the market, and in practice that definition is made by the company itself. The more narrowly the market is drawn, the easier it becomes to claim leadership within it. A company that defines its market as labelling machines for returnable glass bottles in the beverage industry can be world market leader with modest revenue. Many of the lists in circulation are moreover based on self-reporting. The title is therefore also a marketing instrument, used with equal enthusiasm by companies, chambers of commerce and regions.

Viewed soberly, most of these companies are specialists who sell their products all over the world. That is a respectable achievement, but nothing more and nothing less. The term „world market leader“, by contrast, suggests a market power that exists only in the rarest of cases.

Few buyers, a low ceiling

A world market consisting of only a handful of suppliers and a handful of buyers is hardly a yardstick for leadership. A supplier serving sixty per cent of a market with five customers does not dominate that market. As a rule, it is a dependent supplier. Economists call this a monopsony or, with several buyers, an oligopsony: a market with few purchasers, in which bargaining power lies with the buyers. Every automotive supplier knows this situation from the annual price negotiations with the carmakers.

There is also a growth ceiling. A company cannot grow larger within its niche than the niche itself. Even a high share of a small market yields only limited revenue, and the scope for growing beyond that market is often small, because the company’s competence lies precisely in its specialisation. This explains why a large number of world market leaders carries less economic weight than the number suggests, and why it offers no guarantee against stagnation.

The rare exception of the bottleneck

There are cases in which the term is justified. They arise where a specialist occupies a bottleneck in a critical value chain. The best-known examples are Zeiss SMT and Trumpf, which supply optics and laser sources for the EUV lithography systems of the Dutch manufacturer ASML. This exposure technology, which uses extreme ultraviolet light, is a prerequisite for producing the most advanced semiconductors. The market for these components is tiny, yet without them leading-edge chip production would grind to a halt. The power of these companies stems not from the size of their market but from their irreplaceability.

Such constellations, however, are the rare exception. And even they are less robust than they appear. For one thing, their position is often derivative: Zeiss and Trumpf owe their importance to the monopoly of their customer ASML, not to an independent market position of their own. For another, bottlenecks erode as soon as they become visible. When Japan restricted exports of hydrogen fluoride, photoresists and fluorinated polyimide to South Korea in 2019, these inputs for semiconductor manufacturing were regarded as classic bottlenecks. South Korea responded by building up its own capacity and considerably reduced its dependence on hydrogen fluoride within a few years. A bottleneck that is used as leverage, or merely recognised as a risk, creates the incentive to circumvent it at the same time.

The protection that rested on others‘ lack of interest

For the great majority of specialists, something else applies. They compete on quality, reliability and service in markets that a determined competitor with sufficient time and capital can enter. Their lead is an experience advantage, not a structural one. Experience advantages can be caught up with; the only open question is how quickly.

For a long time these companies were protected by a circumstance that never rested on their own strength: a narrow niche was too small for large competitors to make entry worthwhile. This protection is losing its effect. Chinese suppliers, tasked with state backing to reduce import dependencies in a targeted way, do not primarily calculate the return on an individual niche. What matters to them is that a gap in the domestic supply chain is closed. With that, the barrier on which many specialists had tacitly relied falls away.

What follows from the distinction

The number of world market leaders is therefore a poor indicator of the Mittelstand’s resilience. It would be more revealing to distinguish three cases: the specialist with worldwide sales, the supplier dependent on a few large customers, and the holder of a genuine bottleneck position. Only the last case comes close to justifying what the title promises, and it is considerably rarer than the lists suggest.

The thesis that the German Mittelstand is less a held-back reserve than a collection of experience advantages that can be caught up with is provisional, but it has consequences for economic policy. Anyone who relies on the mere release of a supposedly existing strength underestimates how much of it can no longer be called upon under changed conditions. The more fruitful question is which part of the Mittelstand remains viable under these conditions and what it needs in order to restructure. A software company, a specialist machine builder with worldwide sales and a supplier of combustion engine components have hardly any needs in common. The collective term „Mittelstand“ obscures these differences just as the title „world market leader“ obscures the limits of specialisation.

Ralf Keuper