The digital transformation of the German Mittelstand

Companies are turning more and more into smart factories with an increasing interconnection between humans, machines and processes. Products and services as well as overall competitiveness can be enhanced by using digital technologies. Which phase of this development have German small and medium-sized enterprises (SMEs), known in Germany as the Mittelstand, now reached?

The rapid development of information and communication technologies and the resulting spread of digital value-added activities have gathered enormous momentum in recent years – on a global level and particularly in Germany. This trend, referred to as digital evolution or the fourth industrial revolution (Industry 4.0), is something not only large companies but also the SMEs of the Mittelstand have to face.

Press coverage and studies frequently imply that the Mittelstand has already missed digitisation.

Press coverage and studies on the topic frequently imply that the Mittelstand has already missed digitisation or has at least constantly put off implementing specific measures. But is this a fair evaluation of the traditional Mittelstand businesses that are often referred to as the engine of the German economy?

It is certainly true that the Mittelstand attaches great importance to digitisation, in particular to the fact that it is a major driver for competitiveness. Most SMEs are aware that topics such as big data, the Internet of Things and cloud computing are more than just IT projects, and that digitisation is not an end in itself. This also means that setting the target to increase a company’s degree of digitisation only makes sense if this goal is also anchored in the company’s overall strategic orientation – and not merely driven from the bottom up, for example by the IT department.

Most SMEs are aware that topics such as big data, the Internet of Things and cloud computing are more than just IT projects.

However, many SMEs need support in assessing which trends are just a fad and which developments offer real chances and actual benefits for the business. On the one hand, expectations of digitised processes are high: simplification of workflows, sales growth, innovation of products and services as well as the development of new markets. On the other hand, SMEs in particular are afraid of bad investments because in contrast to large enterprises, they have limited financial resources. Also, the digitisation process is often impeded by concerns about data security. This applies particularly to exporting companies, which – unlike companies solely active on the domestic market – are more likely to be exposed to IT security issues, such as cyber espionage or data theft, due to their stronger international integration. Furthermore, SMEs aspire to find the right balance between the growing pressure for innovation and the desire to adhere to their business tradition, and to establish the necessary knowhow for their employees at the same time. The technological changes should be in line with the business culture and the entrepreneurial instinct.

Nevertheless, at this point it is necessary to move away from trying to find the right overall assessment of increasing digitisation and understand that the Mittelstand is already an integral part of the digital transformation. For the sake of a structured approach and in order to survive in the long run, it is therefore essential that every business asks the right questions, including the following considerations:

1. Are we in a position to offer our customers comprehensive solutions and applications or do we need to adjust our business model with regard to digitisation?
2. Does our business bear untapped potential to create added value? Could an analysis of the data generated in the business (big data) enable product and process optimisation, the development of new products or the improvement of brand awareness?
3. Could ‘disruptive technologies’ render our business a target for market entrants and start-ups?
4. Do we have an efficient security system to protect our products and services?

These questions mainly show that competitiveness is determined by fast market adaptation, that many industries are facing fierce competition and that digital transformation has become a competitive factor on an international level as well. In most cases, SMEs cannot find the answers by themselves.

In this context, collaboration with different partners holds the greatest potential, since Mittelstand businesses generally form inter-company value chains with close connections between businesses, clients and suppliers. In fact, in SMEs horizontal collaboration between sales and procurement is where the greatest progress has been made. This may also be due to the fact that the digitisation of the production process is seen to consume more time and resources.

Nevertheless, networking with external partners still offers a lot of untapped potential, especially when taking into account the limited staffing and financial resources in some cases. Apart from the above-mentioned collaborations with clients and suppliers, businesses from the same industry sectors should be taken into consideration – or even sector-unrelated partners such as IT providers, research institutes or start-ups, which are not part of a business’s value chain. In many specialised areas, it is recommended that businesses supplement their business know-how with external expertise in order to deal with tasks such as data privacy, IT security, appropriate contractual documentation and intellectual property – and to track the success of digital transformation.

Digitisation has proved to be one of the most important drivers for transactions.

Partnerships and collaborations are not the only means of reaching this goal. Both internationally and in Germany, since 2014 digitisation has proved to be one of the most important drivers for transactions involving technology companies. Recent record transaction volumes were not only generated by a few global mega-mergers; in 2015, the number of transactions worldwide, with Germany as one of the main markets, was already higher before the end of the year than at the end of the New Economy Era (2000). All forecasts indicate a continuous increase in M&A activities, with growing involvement of the Mittelstand. Many SMEs are increasingly looking for acquisition opportunities in order to enter new markets, to face the challenges of digitisation and to become ‘more ready’ for the digital transformation.