A Lesson in the German Model Economy
By ROBERT P. WUJTOWICZ, Managing Director, InterOcean Advisors LLC and DR. CARSTEN LEHMANN, Managing Director, Lampe Corporate Finance GmbH
Much has been written of late about the loss of manufacturing jobs in the United States. Statistics show that the U.S. has lost over an estimated 3.0 million manufacturing jobs since 2000. Politicians, pundits, and businessmen attribute the loss to several factors: a flight to low-wage countries, unfair trade policies by foreign governments, stricter U.S. environment regulations, and lack of clear-cut policies in the U.S. to support and enhance manufacturing. Suggestions to improve the situation in the U.S. have included tax incentives, government support for R&D, increased valuation of the Chinese yuan, looser environmental policies, and “Buy America” initiatives.
But manufacturing in at least one country – faced with the same global competitive issues as the U.S. – appears to be thriving. Germany’s trade and current account balances are positive, and demand for its products is strong. The IMF estimates that Germany will have an account surplus of 5.5% of GDP in 2010, close to China’s 6.2%. Its unemployment rate is at a 20-year low, reflecting efforts to address the economic challenges that plagued the country after reunification. Today, German manufacturers are reporting labor shortages.
Some of this success can be attributed to a reduction in real wages from 2000-2008, while real wages grew in other developed countries. In addition, the German economy benefitted from a material increase in both temporary and part-time employment which resulted in a more flexible workforce. However, Germany sustained strength in the manufacturing sector despite (or possibly because of) a high national savings rate and without significant monetary or fiscal stimulus.
This article seeks to identify characteristics of German manufacturers that could enhance U.S. initiatives to create a more successful manufacturing-based economy – especially in a soft consumption and higher savings rate environment where monetary and fiscal stimuli have been exhausted. We reviewed several analyses of the German business model to try to establish the basis of its success. One of these studies was particularly compelling. In 2007, Bernd Venohr and Klaus Meyer analyzed the long-term performance of successful, medium-size German companies identified by Hermann Simon 15 years earlier. They found that the “German Model” is predicated on several key factors:
- Strong customer service.
- Flat organizational structures.
- Professional management.
- Operational excellence.
These factors were shared by many of these companies.
Specialization: These German companies concentrate their resources on niche market segments in an effort to dominate them worldwide. These manufacturers aggressively pursue emerging markets. Their target segments are well-defined, and their products are focused on meeting the needs of those segments. Breadth of one’s product line is not a priority.
Innovation: Continued improvement in products and processes is critical. These companies commit significant resources to research and development. They tend to focus on traditional manufacturing sectors (e.g., industrial machinery and components, medical instruments, and automotive parts) where technological breakthroughs are rare. Thus, even incremental innovation creates important positive product differentiation.
Strong Customer Service: These German manufacturers are very close to their customers - especially their top customers. They are intimately aware of their customers’ needs and have a robust after-sales service orientation. They tend to sell on value and not price. As such, their goods appear to be less price-sensitive than those manufactured in other developed countries.
Flat Organizational Structure: Management behavior is typically predicated on flat hierarchies and informal channels of communication, which reflect the personal styles of the businesses’ owners. This leads to a high degree of mutual trust and loyalty between management and employees. These companies possess strong corporate cultures coupled with excellent employee identification with their employers. In addition, their leaders possess strong characters and have long tenures with their companies.
Professional Management: Family-owned German firms are more likely to employ outside professional managers in leadership positions than firms in the U.S., the U.K. and France. According to research by Venohr and Meyer, approximately 60% of family-owned companies in Germany hired outside professional managers. In the U.S., the U.K., and France only 30%, 23%, and 31%, respectively, hired outside professionals.
Operational Excellence: Most of these companies employ state-of-the-art lean manufacturing practices. They strive for operational effectiveness, continuously assimilating, attaining and extending best practices. They pursue aggressive cost management, including selective off-shoring of lower valued-added activities. Target setting and performance management is critical. These companies rely heavily on their own strengths. They do not rely on strategic alliances, and few are involved in large acquisitions and other risky game-changing strategic moves. They also prefer to minimize the use of outside financing to capitalize their businesses.
In addition, these companies are supported by an educational system that produces a skilled manufacturing workforce. Germany has a vocational training system that parallels its university system. As such, it has a lower percentage of university students than its developed country peers. Many occupations require vocational training, and these vocational students are taught by expert worker instructors. Employers place a major emphasis on apprenticeships for skilled positions.
Former U.S. Commerce Secretary Carlos Gutierrez noted that the U.S. has tended to retain the manufacturing of items that are complex to produce – especially in high-tech industries such as medical devices, aerospace, and pharmaceuticals. These industries require continuous research and development and demand specialized skills and training. It appears that German manufacturers have applied this same commitment to continuous improvement to a much broader array of products and industries.
By applying the same principles, U.S. manufacturers can identify business opportunities that will allow them to compete globally. The adoption of the focus and business practices of their German counterparts could help drive a sustainable advantage. With innovation as the historical mainstay of the US economy from its inception, a reinvigorated U.S. manufacturing sector is a realistic and attainable objective – given time and commitment.
About InterOcean: InterOcean Advisors LLC, based in Chicago, Illinois is a boutique investment bank serving the manufacturing sector.
About Lampe: Lampe Corporate Finance GmbH, based in Frankfurt Germany, is the investment banking subsidiary of the German private bank Bankhaus Lampe.