Germany's hidden champions: The Mittelstand's lessons for Indian SMEs

The “Made in Germany” label was first introduced in 1887—not by Germany, but by Great Britain. Why? It was a way of flagging “inferior” German-made goods on the market so that consumers didn’t mistake them for British goods.

Today, when you see “Made in Germany,” it has a different effect. It makes a product instantly more attractive, desirable, even aspirational. It brings to mind ideas about German precision and engineering, and images of sleek luxury automobiles gliding along the Autobahn. We’ve clearly come a long way since 1887. Today, ‘made in Germany’ is a brand unto itself.

German industry has earned this reputation by offering the world high-quality products that often require sophisticated engineering. And while it’s tempting to attribute this solely to the giant German corporations—recognizable names like Daimler, BMW AG, and Bosch—it’s not the whole picture. In reality, a huge part of cultivating this image was played by the Mittelstand.

If you’re wondering what that is, it’s the German word for the many small and medium businesses that form the backbone of the country’s economy. They may not be household names, but these companies are commonly referred to as “hidden champions” because, despite their relative obscurity to laypeople, they’re often global leaders in their sectors. They’ve been the envy of the business world for decades, with business leaders visiting from across the globe to learn how they can replicate this success at home.

At Zoho, we’re particularly excited to delve into this subject because of how the Mittelstand’s values and philosophy align closely with our own. Let’s look at some of the traits that define these companies.

Locally rooted, globally connected

When you take a closer look at German businesses, you start to realize that they’re often headquartered in surprisingly obscure places. For example, Adidas and Volkswagen are headquartered in Herzogenaurach and Wolfsburg, respectively, whereas fashion giant Hugo Boss and software titan SAP are both based out of Metzingen, an hour’s drive away from second-tier city Stuttgart. This decentralization is true of the Mittelstand too, and it contrasts with other countries, where industry is concentrated in or around key cities.

For example, founded in 1795, Mittelstand company Meyer Werft GmbH is a world market leader in building cruise ships but remains headquartered in Papenburg, with a population of 35,000. According to a DZ Bank report, it has “enabled the company’s management to develop its staff over the long term.” Located in a town of 8,000 people, Weisser Spulenkörper has been a global market-leading company in the production of precision plastics.

But it’s not just that they’re located in small towns; Mittelstand companies are deeply embedded in these communities. They have a shared history and identity with their respective regions, which they take pride in—an umbilical connection to their place of origin, such that the local community and the business nourish each other in a symbiotic way.

The fact that a Mittelstand company is usually a family business also means that the family’s reputation is tied to the reputation of the organization among the community. This means that nobody is eager to pollute the neighborhood lake in order to save on waste disposal costs. Their sense of social responsibility is not diffused and outsourced to mercenary-like executives. Mittelstand entrepreneurs have more skin in the game, and everyone benefits as a result. They even play a proactive role in investing in their communities in the form of social and cultural initiatives.

This model provides a contrast to the mega-city-focused approach that much of Western capitalism follows. Not only does it help in driving down youth unemployment, but also sows the seeds of prosperity in non-urban centers. It’s no surprise, then, that rural regions accounted for half of Germany’s $4.5 trillion GDP in 2022.

But how does this benefit businesses? Deep ties with the local region mean that these firms have access to many valuable resources. Connections are formed over decades and strengthened with customers, suppliers, research centers, schools and universities, governments, banks, and local chambers of commerce. From talent to research and financing, everything is easier to attract.

Vocational education and talent development

Thanks to the connections mentioned above, companies are able to gain intellectual capital from research centers and labor from schools and universities in their respective regions.

Vocational training and apprenticeship are common facets of education in Germany. Prominently displayed on the Weisser Spulenkörper website, for instance, is a banner asking for applications to start one’s professional education at the company. With opportunities for hands-on learning on the job, students pass out of educational institutions with a certain level of technical skill and knowledge, ready to be absorbed by their local businesses.

As employers to their local communities, owners don’t view employees as expendable resources. They live in the same communities as their employees, forming deep ties with their workforce. They ensure that workers have careers with fulfilling growth paths.

Training and L&D (learning and development) initiatives are supremely important in these firms, especially given the niche and specialized nature of many of the products and services in question. Mittelstand founders tend to be technically minded and highly appreciative of their employees’ deep expertise and skill sets. They strive to keep attrition rates low.

Thanks to flat hierarchical structures, employees are also involved in decision-making in these firms. It’s a best-of-both-worlds scenario: ideas and feedback flow freely toward leadership, informing key decisions, but at the same time, leadership has complete control and can act on ideas without hesitation.

Narrow niches, global ambitions, and customer focus 

Mittelstand firms don’t just supply products to customers. They gain deep knowledge of their requirements and collaborate closely with customers, building solutions to solve their challenges. This culture of constant customization serves as a wellspring of innovation for Mittelstand companies, keeping their R&D prowess and capabilities sharp. When a customer’s needs are too technically demanding, it becomes an opportunity for learning rather than an obstacle. This trait serves the companies well, especially when most of them are highly specialized and operate in extremely niche spaces, often in B2B segments.

This niche focus means they can be leaders in their domains, with the consequent efficiencies and expertise adding up to lend them insurmountable advantages over time. Investment requirements are also kept in check by having a narrow focus.

Despite being SMEs, German firms often have an international presence, as going global is a natural way to unlock growth avenues beyond the home market. While high prices could be a deterrent, the firms more than make up for it through superior quality, innovation, reliability, and service.

Together, the customer focus and global presence create a positive feedback loop for these companies in the long run. Their presence abroad helps them better understand and cater to their international clients and become true global leaders in their respective segments, as many of them are.

Resisting the “growth at any cost” philosophy

Mittelstand companies tend to be privately owned, family-run companies that are self-financed. This gives their leadership the space to operate freely, with longer windows to make decisions that bear fruit over time, going against the “growth at any cost” approach to business that dominates the modern business world.

This is helped by the fact that, in German business culture, shunning external capital is not an oddity, like it is in the US. Founders can happily steer away from the dangers of short-termism in the absence of external pressures from investors, VCs, and shareholders. They don’t have to let financial metrics take the steering wheel or sacrifice their long-term vision for temporary gains. They value sustainability, and founders find it important to pass on the organization to future generations.

This conservative streak serves to steady the organizational ship in dangerous economic waters. Even during economic upturns, Mittelstand firms choose to play safe where others would exhibit extreme confidence. Naturally, it takes restraint and conviction to do so, and often, it involves making decisions that will feel like sacrifices at the time. However, when the tide eventually shifts, these sacrifices are repeatedly proven to be the right decisions.

If any doubts remain about how investors can influence companies, consider this excerpt: “...loading a public firm with debt was a useful device to stop managers frittering away shareholders’ cash. The leveraged buy-out boom of the 1980s was predicated on the idea of debt as a tool to focus the minds of managers. Private-equity firms employ this trick.” - The Economist, November 2020, “Double trouble”

While it talks about keeping managers focused, it hides the fact that this short-termism often means hurting and sacrificing a company’s long-term vision. Mittelstand firms are far less saddled by debt compared to funded companies. Instead, what Mittelstand companies have plenty of is patient capital—funds that are accumulated over decades and offer a competitive advantage in the long run.

While playing the long game, Mittelstand firms are also simultaneously better equipped for rapid decision-making and swift responses to developments in the market. After all, private ownership means entrepreneurs don’t have to answer to other parties. And, importantly, when decisions don’t pay off, it doesn’t lead to leadership turnover. This means that there can be consistency and continuity in the vision and direction of the company.

At Zoho, being bootstrapped for over two decades, we’re quite familiar with the benefits of the self-financed approach.

Building success 

It’s important to mention a caveat here: The successes and failures of a country’s businesses are not always down to the individual businesses themselves but also depend on state policy frameworks that nurture or hinder them and the business ecosystems and culture of which they are a part.

German manufacturing has benefited from conducive policies to become an export superpower—but it has also suffered in areas like digitalization due to policy oversight. In the case of digital payments, German SMEs lag severely behind their Indian counterparts despite their industrial might. That being said, there’s still plenty to learn from the Mittelstand.

By delivering quality consistently and being the best in their fields, Mittelstand firms showcase the power of patience and long-term thinking. They also demonstrate that you don’t have to be massive corporations to be global leaders and makers of top-quality products.

Whether it’s being conservative regarding debt and ownership or ambitious regarding R&D, innovation, and growth, businesses worldwide would do well to take a page or two out of the German playbook. Their sense of responsibility to local communities and employees is worthy of emulation. Most importantly, the Mittelstand story teaches us that the idea of growth and development doesn’t have to be anchored to one conventional narrative.