Notes on Germany in the Entrepreneurial Age
Notes on Germany in the Entrepreneurial Age
European Straits | Work in Progress
Hi, it’s Nicolas from The Family. This Work in Progress edition discusses startups in Germany, building upon my Is Germany Nearing the Abyss? newsletter sent earlier this week.
This is an edition of my newsletter European Straits accessible only to paid subscribers. And regarding that, the next iteration for this publication will be about establishing a direct link between the main (free) edition published every Wednesday and the Friday Reads that follows two days later. The former will set the stage on a given topic, while the latter will get into the details by discussing tech-related frameworks and data.
I devised this plan following the many replies to this past Wednesday’s issue, Is Germany Nearing the Abyss? That edition provides a broad historical and cultural framework to better understand Germany today. But it didn’t dig into the details when it comes to German tech. So let’s focus on those here 👇
1/ There’s all this talk about Germany being specialized in exporting manufactured goods. But we can still pose the question: Are Germans really that good at manufacturing? I’d say yes and no.
First of all, manufacturing alone does explain why Germany has been doing so well over the past decades. As I wrote back in October in Does Manufacturing Matter?
Standardized parts and scientific management were the two keys that helped unlock unprecedented productivity gains from the early 20th century onward. Thanks to these, assembly lines emerged as the segment of the productive economy generating superior increasing returns to scale: the larger those assembly lines were, the more productive they became (up to a certain point, of course).
We tried to apply this recipe of mass production to every sector, but it really was in manufacturing that this mode of production thrived. As a result, manufacturing created an economic surplus that could then be redistributed (through the market, taxes, and regulations) to the rest of society. And even if most people were ignorant about the microeconomic details, we as a society collectively felt how important those factories were to our well-being.
2/ Excellence in manufacturing cannot be implemented in a day, however. There’s a path dependency in these matters that relates to several factors: ability to deploy capital, engineering skills, appropriate training of the workforce, etc. The more you excelled at manufacturing in the past, the more you’ll excel at manufacturing in the future. And on that front, Germany has three competitive advantages:
One is that the Germans were among the first to manage operating standardized tasks at a very large scale. As written by David Graeber, “in the late 19th century, the German postal service was considered one of the great wonders of the modern world. Its efficiency was so legendary that it casts a kind of terrible shadow across the 20th century. Many of the greatest achievements of what we now call “high modernism” were inspired by the German post office.”
Another is the excellence of the German university system. We French people know about it because the superior education of the German elites was deemed the reason why the French military was severely beaten by the Germans in Sedan during the Franco-Prussian War of 1870. (A defeat that prompted entrepreneur Emile Boutmy to found my alma mater, Sciences Po, in 1872 so as to train a new French elite and catch up on Germany.)
Finally, there’s Germany’s unique ability to train factory workers and make them as productive as possible. It’s all about culture, really. As written by Tamar Jacoby in The Atlantic back in 2014, both “the employer and the employee still respect practical work. German firms don’t view dual training as something for struggling students or at-risk youth.” It’s not a question of corporate social responsibility; rather, it’s because employers need the talent.
3/ All this being said, I liked this article by Giulia Pines of the BBC. As someone who frequently visits Germany, I couldn’t agree more:
German efficiency is a myth, with roots in religion, nationalism, enlightenment thought and a few major wars. It may have reached its pinnacle in the 20th Century, but since then it’s survived as a useful stand-in for everything that confuses the world about Germans – that in spite of a war that decimated them, a wall that divided them, a currency designed to weaken them and a financial crisis that could have ended them, they still seem to come out on top...
[Yet] In making a myth of the Germans, we make a myth of ourselves....Perhaps no-one knows this better than non-German Germans; those who have settled here from elsewhere and encountered stringent rules and unending bureaucracy in daily life, even as public works like Berlin’s airport languish.
4/ Beyond the myth of German efficiency, however, there’s something more: the world-famous Mittelstand—something that Ludwig Erhard, the founding father of the German Wirtschaftswunder, described as “an ethos and a fundamental disposition of how one acts and behaves in society”. Indeed, the Mittelstand’s origins can be found in how the German economy was rebuilt by that same Erhard following World War II. As I wrote three years ago in Germany’s Problem With Tech,
The origins of the German economic advantage date back to 1948, when then-finance minister Ludwig Erhard decided to bail out German business assets while wiping out paper money for private savers…Erhard's fateful move contributed to much of German industry still being owned by families rather than outside investors. It inspired a unique corporate culture in which, as once remarked by legendary hedge fund manager Julian Robertson, German managers “couldn’t care less about return on equity".
The legacy of the German Mittelstand is double-edged:
On the one hand, it has long made the German economy resilient to the ups and downs brought about by financialization. When what matters is the long-term interest of a few families rather than the short-term gains that can be derived from financial shenanigans, businesses can constantly reposition so as to account for how the economy is changing.
On the other hand, we tech people can immediately guess just how conservative business leaders can become when facing a paradigm shift. To quote Marc Andreessen’s Why Software Is Eating the World, relying on the Mittelstand sounds incompatible with “Silicon Valley-style entrepreneurial technology companies invading and overturning established industry structures”.
5/ At the risk of repeating myself, this, I think, is the dilemma making it so difficult for Germany to shift to the Entrepreneurial Age:
First, German added value is all about exports (cars, chemical products, machine tools), which require operational effectiveness and differentiation. Second, cost competitiveness is achieved thanks to a combination of strong antitrust policy (which brings prices down), monetary stability, and low wages. And third, such ongoing pressure would be unbearable for the German workforce if it were not for the incredible level of corporatism in every part of the economy.
Corporatism doesn’t prevent innovation if long-term focus inspires radical repositioning, like Bertelsmann achieved in the music industry (under the brand Bertelsmann Music Group, or BMG):
Contrary to what the old BMG used to be, the new BMG’s business (which dates back to 2008) is not to sell records but rather to manage rights on behalf of artists, performers and producers who ultimately hold the industry’s essential assets, works and digital masters.
To achieve this radical repositioning up the music industry’s value chain, BMG didn’t even try the incremental route. Rather, the conglomerate divested its old record company (by selling it to Sony, thus giving birth to Sony-BMG) and then reinvested the proceeds, alongside KKR, into acquiring publishing rights further up in the value chain.
This is an amazing strategic prowess that I often describe in detail when speaking to corporate executives. However, Bertelsmann, which in many respects is still representative of the “ethos” that is the German Mittelstand, was able to make such radical decisions because as a conglomerate it doesn’t depend on one business line alone. Many other German businesses don’t have that luxury!
6/ This is why, like many other countries, Germany’s future depends on tech entrepreneurs coming together as an entrepreneurial community. That community’s mission is to build the first generation of successful tech companies, usually against all odds, and then foster the formation of an ecosystem (a set of resources and good practices that lifts every future entrepreneur up). As I wrote in Forbes in 2018,
Europe has many problems when it comes to building successful tech companies. But one of the most vexing is the lack of those older giants that are so critical to the health of an ecosystem. That first generation didn’t grow during the dotcom bubble because few European entrepreneurs had an empire-building mindset back then. Then Europe grew complacent because the bursting of the bubble made us believe that ubiquitous computing and networks were only a fad. It was only following the financial crisis that a generation of more ambitious European entrepreneurs entered the stage. But it was already too late: building tech giants was already a discipline best mastered in the US and China.
Germany, alas, has many problems when it comes to building a thriving startup ecosystem to take over from its beloved industrial Mittelstand. Let’s discuss the key resources first and then the nascent entrepreneurial community in Germany.
7/ Many years ago, I laid out in a (long) blog post what I think is required to build a healthy entrepreneurial ecosystem. It’s a long and tortuous path, but you have a higher probability of success if you secure three key resources from the beginning. Here they are, with my assessment of the German situation for each:
Talent. Considering its background and history, Germany has a lot of technical talent, but it’s quite polarized. Talented engineers either work for German industrial giants (or within the Mittelstand) that play by the rules, or for crypto organizations that explicitly want to overthrow the existing order. It’s difficult for the many startups in between to attract that talent. Plus, talent is spread around several local ecosystems rather than being concentrated in one.
Capital. There’s certainly a lot of capital to be invested in Germany, but the German business world’s traditional reliance on long-term relationships with their bankers makes it difficult to introduce the idea that you should raise money from venture capitalists, that acquiring those funds might be dilutive (shocker!), and that your investors have a high probability of losing everything. Israel once had the same problem, and they had to build bridges with Silicon Valley to solve it, via the widely praised Yozma program. No such program exists in Germany.
Rebelliousness. Are German rebellious? Definitely not. And if they are, it’s to the point of rejecting the very idea of making money out of a business. Let’s be clear: this “German fondness for rules” is simply incompatible with success in the Entrepreneurial Age.
8/ Now, if a country doesn’t have all the ingredients needed to succeed, that doesn’t mean it’s doomed to lose. You can still count on the first generation of entrepreneurs to wage the battle and attract the necessary resources by beating the odds, making their case and ultimately paying it forward to the next generations. But is there even a first generation of successful German tech companies?
An oft-quoted champion is SAP. It’s a company I don’t know particularly well, but I’m skeptical for at least two reasons. One is that SAP operates an enterprise business, not a consumer-facing one (more on that below). The other is that, judging from all the large organizations that have deployed SAP products and lost money because of it, I’m not even sure SAP fits a key criteria of what being a tech company is about: delivering an exceptional user experience at scale.
The other German tech company on which many are willing to bet is Rocket Internet (which, I should mention, is an investor in my firm The Family through Global Founders Capital). I find that the world doesn’t know that much about Rocket Internet, which makes me think it’d be a good idea to write an “11 Notes” post one of these days. I like what I’ve seen so far; yet it’s still falling short:
Reading Kai-Fu Lee’s AI Superpowers has convinced me that there’s quite a lot of value in starting by copying others—which has been Rocket Internet’s strategy all along. What’s lacking in Germany, however, is the ruthless competition that marks the Chinese economy and eventually forces one-time imitators to become actual innovators. Again, corporatism stands in the way.
Rocket Internet has been a pioneer in exploring new frontiers by launching businesses on emerging markets. As I’ve written in the past, I think there’s real potential there for European entrepreneurs. But so much of the know-how has been lost along the way. Look for the articles, the blogs, the newsletters, the books that document the whole effort—you simply won’t find them. That means Rocket Internet might be without a legacy as an ecosystem builder (the jury’s still out).
9/ Beyond that first generation of ecosystem builders, I must say from our own experience at The Family that it’s extremely difficult to build tech startups in Germany. There are three problems:
One is the lack of density due to the decentralized nature of the German economy. Have a look at this great article by Robin Dechant of Point Nine about the fact that German tech people are spread between Berlin, Munich, Hamburg, and many other cities: “While Germany is a powerhouse for research and technology with its scientists and engineers, it’s incredibly challenging to connect all these people and to build bridges.”
Another problem is that nothing in the German business environment has been tailored for the Entrepreneurial Age. Corporate law is a nightmare. Providing equity to employees is a nightmare. Do anything that vaguely resembles moving fast and breaking things, and you’ll receive a cease-and-desist within days. The environment just doesn’t support how business should be done as we shift to a new paradigm.
The third problem is that you don’t build a tech ecosystem by focusing only on the upper links in the value chain. Because the Entrepreneurial Age is all about computing and networks, the pace is set by companies that serve numerous consumers down the stream and then force a radical upgrade on the rest of the value chain up the stream. This is what’s been happening in China with Alibaba and Tencent, as well as with every US tech giant. Despite the many opportunities that still exist in industries such as financial services, mobility, and healthcare, I still don’t see the equivalent in Europe, let alone in Germany.
10/ In conclusion, let’s take a step back and look at the broader German picture:
The situation is dire. Germans aren’t having enough babies. They’re closing the borders to immigrants. They depend on exporting manufactured goods in a world that’s more fragmented by the day. And the shift to the electric car could destroy hundreds of thousands of industrial jobs in their beloved Mittelstand.
On the bright side, there are massive investments being made by the government to foster the growth of renewable energy. Those who know their history, particularly of venture capital, know this could trigger the rise of a successful startup ecosystem in that industry. And who knows what will come out of the COVID-19 crisis when it comes to healthcare and biotech?
Since all the ingredients are there, and even a potential first generation of successful tech companies (even if they aren’t quite up to par), maybe a miracle can happen and Germany can beat the odds, realizing it can embrace a new paradigm and become the cradle for those pan-European tech giants that we’ve all been waiting for?
As always, please don’t hesitate to reach out if you want to pursue this discussion or if you’d like me to dig deeper into one of the questions above 🤗
On tech entrepreneurship in Germany
Shortage of later stage venture capital in Germany: more acute due to Corona crisis (Dealroom, March 2020)
Berlin is crap and no-one is talking about it (Torben Friehe, Sifted, March 2020)
Germany — we have a structural problem and we need to solve it together (Robin Dechant, Medium, January 2020)
Germany’s tech scene lacks lure of stock options (Tobias Buck, The Financial Times, December 2019)
Where are all the German deep tech startups? (Pitchbook, April 2019)
3 Myths from the Berlin Tech Ecosystem (my former colleague Hugo Amsellem, The Family, November 2018)
Berlin, the cryptocurrency capital (Andrew Bulkeley, Handelsblatt, January 2018)
Germany’s Problem With Tech (me, European Straits, November 2017)
Berlin's tech scene - The freaks are coming (The Economist, September 2016)
A Letter to German Entrepreneurs (Neil Rimer, Index Ventures, October 2013)
On the paradigm shift in Germany
Germany’s spending finally. But how green is it? (Claire Jones, FT Alphaville, January 2020)
Electric Cars Threaten the Heart of Germany’s Economy (Jack Ewing, The New York Times, December 2019)
Germany’s Cities Aren’t Ready for the Future (Leonid Bershidsky, Bloomberg, November 2019)
Dynamism, Innovation, and Germany’s Future (Edmund S. Phelps, Project Syndicate, November 2019)
How Technology Grows (a Restatement of Definite Optimism) (Dan Wang, July 2018)
Germany’s Shift to Green Power Stalls, Despite Huge Investments (Stanley Reed, The New York Times, October 2017)
Germany's industry - Does Deutschland do digital? (The Economist, November 2015)
The strangeness of Berlin (Dan Wang, May 2015)
On Germany’s export-led model
Weaponizing the Economy (Daniela Schwarzer, Berlin Policy Journal, January 2020)
Strong Firms, Weak Banks: The Financial Consequences of Germany’s Export-Led Growth Model (Benjamin Braun and Richard Deeg, Journal of German Politics, December 2019). Also see this thread.
Germany Can Reduce Its External Surplus (Dalia Marin, Project Syndicate, November 2019)
Germany is damaging the European economy. The answer? Raise German wages (Maximilian Krahé and David Adler, The Guardian, November 2019)
Three Countries That Prospered in the ’10s Are in Trouble (Noah Smith, Bloomberg, October 2019)
Exportweltmeister: The Low Returns on Germany's Capital Exports (Franziska Huennekes, Moritz Schularick, Christoph Trebesch, CEPR Discussion Paper (abstract), August 2019)
I Think They Get It Now, Part Drei: Germany (Peter Zeihan, Zeihan on Geopolitics, June 2018)
Germany: What Happens Next? (Claus Offe, Social Europe, October 2017)
Germany's Working Poor (Olivier Cyran, The Nation, September 2017)
German resurgence: It wasn't the Hartz reforms (Christian Dustmann, Bernd Fitzenberger, Uta Schӧnberg, Alexandra Spitz-Oener, VOX | CEPR Policy Portal, February 2014)
On the German economy in general
The plight of Germany's female workers & all the reasons why it could change (Laetitia Vitaud, Laetitia@Work, January 2020)
Germany’s Government Still Has an Allergy to Investing (Guntram Wolff, Bloomberg, May 2018)
The secret to Germany’s happiness and success: Its values are the opposite of Silicon Valley’s (Rebecca Schuman, Quartz, September 2017)
Why people think Germans are so efficient (Giulia Pines, BBC, September 2017)
The good and bad in Germany’s economic model are strongly linked (The Economist, July 2017)
German macroeconomics: The long shadow of Walter Eucken (Peter Bofingen, VOX | CEPR Policy Portal, June 2016)
Germany’s bizarre version of capitalism—where bosses and workers actually cooperate—is winning (Matt Phillips, Quartz, August 2015)
Why Germany Is So Much Better at Training Its Workers (Tamar Jacoby, The Atlantic, October 2014)
Most Germans don’t buy their homes, they rent. Here’s why (Matt Phillips, Quartz, January 2014)
German banks: This is tomorrow calling (The Economist, October 2002)
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From Normandy, France 🇫🇷
Nicolas
