Taking stock: How the “German Mittelstand” weathers the COVID-19 pandemic

8 min readDec 27, 2020

Disrupted logistics & operations, declining profits, pressure to dip into savings; how can the German SME sector rebound?

When the COVID-19 crisis became evident in Europe, Germany put strict measures in place beginning mid-March, including store lockdowns. These weeks of lockdown have had a tremendous effect on the German Mittelstand, the businesses segment which accounts for 58% of employment in the country and 34% of national revenues¹.

The lockdown has significantly disrupted operations. >50% of surveyed enterprise leaders by McKinsey (2020) stated their enterprises were still not fully back to business (41% only partially back to business and 15% not back at all). 17% needed to put the business on hold due to the crisis, while 27% had no need to shut down the business. ¹

Even for the businesses that were able to avoid a nationwide shutdown in production, the crisis has significantly strained their revenues, profits, and resources. More than 50% of surveyed enterprises expect a decline in turnover for the current quarter, 10% expect the decline to exceed 50%.

Businesses that largely depend on global supply chains, such as retail, automotive, electronics, mechanical and plant engineering are being hit hardest. The recent KfW SME Panel (2020) delves deeper into the root causes: Manufacturing is closely intertwined with international supply chains². Outside Europe, restrictive measures such as border closures remain in place due to high infection rates. Retail businesses and construction firms have also reported more problems with their sales (17 and 15 vs. 9%) and procurement (21 and 16 vs. 9%). The loss of employees is more problematic for manufacturers than for the remaining SMEs (13 vs. 9%). This is likely because the production of goods offers fewer opportunities to work from home. The same also applies to retail businesses (12 vs. 9%).²

Out of all the possible effects of COVID-19, depressed demand is the main problem businesses face, as was already the case in April and June. In September, some 1.9m SMEs — that’s more than one in two SMEs — were still grappling with losses in turnover. The expected declines add up to around 12% of the previous year’s turnovers — €545 bn. ³

The high losses in turnover put pressure on companies’ liquidity. Many SMEs can no longer replenish their reserves, ultimately having not enough cash to meet ongoing payment obligations, facing insolvency. However, the liquidity situation has eased slightly in the past months. Only 5% of all SMEs would have liquidity reserves for one or two weeks before they would be forced to suspend or give up their business activity. 12% would have liquidity for up to 4 weeks and a further 23% for up to 2 months. This is mainly due to the fact that SME took advantage of generous state aid programs (e.g options to defer the payment of commercial rents, social security contributions and taxes). According to study by CreditReform (2020), 33% accepted state allowances. On average 27% implemented short-term labor measures (furlough), with the highest figures in SME’s manufacturing sector (47%).⁴

One thing is for sure the positive trend in equity ratios (ER) is unlikely to continue in 2020. I reported on record level ER of 31.8% in 2019 in my previous article. The expected losses are eating into businesses’ equity buffers. SMEs had to take up loans in the course of the crisis in order to bridge liquidity shortfalls, leading to a rise in the ratio of debt to equity. A solid ER still allows most firms to be resilient to crises and absorb losses in their balance sheets for a longer period of time in the current situation. ⁵ Still, 1 in 5 SME had to dip into its savings. ⁶

Many enterprises are likely to be under high pressure to reduce costs. This also has consequences for employment, with 16% of SMEs planning to reduce their workforce in 2020. Overall, the workforce in the SME sector might fall by around -3.3%. That would result in a loss of >1.1m jobs. ²

I want to stress 5 key measures as identified by McKinsey to getthe German Mittelstand back on track: ¹

1. Rethink customer engagement

9 out of ten companies took ad hoc action to support business continuity with short-term measures, e.g. short-term labor (STL) and reducing both administration costs and indirect spending. Enterprises with a negative perspective on their economic futures tend to be more rigorous in reducing direct costs and optimizing their cash flows.

A different picture emerges when looking at actions taken to stabilize or increase revenue. A key measure that highlights revenue-positive Mittelstand enterprises is the increase in customer contact:

Mittelstand enterprises that intensified customer contact to show customer commitment and care have the best revenue outlooks. Distilleries started producing disinfectants, car manufacturers started developing a new filter for the interior of the car, and fashion labels introduced style guides that helped customers online.

2. Close the digital gap & Launch new digital businesses

The need for social distancing will increase the use of robots and automation tools. Robots will be used to perform roles workers cannot do at home and help maintain a high level of business continuity.

The extraordinary constraints and imperatives drive the need for complete digital transformations in weeks rather than months or years.

The dilemma: Although the immediate crisis is increasing the pressure to digitalize, it is also pausing ongoing digital projects.

The more progressively enterprises interpret their digital projects, the better their own revenue forecasts. 68% of growing enterprises are building new digital businesses, only 39% of those experiencing stagnation or decline are doing the same. They are formulating new solutions to both help resolve the crisis and re-imagine their industries in the aftermath. They iterate rapidly and work in an agile fashion rather than engaging in lengthy planning processes. Interestingly, Mittelstand enterprises with more dismal revenue reports tend to be more inward-focused with their digital efforts concentrating mainly on internal process automation.

3. Tackle supply chain risks

COVID-19 has exposed the global trade and supply networks of the German Mittelstand. 73% state they are or have experienced supply-chain issues. 43% of these enterprises are committed to acting and plan on modifying their supply chains.

A large shift in the supply network and local demand in Germany is ahead of us. With enterprises bringing suppliers closer, several core competences could be brought back to Europe to reduce both the supply chains’ and enterprises’ vulnerability to global disruptions.

Enterprises need to evaluate the potential increase in costs of a more local supply chain, driven by higher production costs, a more saturated labor market, and higher wages. This will result in a mix of global and local supply chain solutions that finds the right balance between higher costs and reduced risks.

4. Rethink competition by joining ecosystems

With the arrival of digital platforms comes a shift in enterprises’ understanding of the nature of competition:

We are moving towards more cooperative ecosystems, where players across all parts of a particular sector pool their profound customer understanding and relationships, establish industry-specific networks, and highly complementary value chains to create true value add for their end customers.

In the past, large retail and technology giants have already been using their digital expertise to enter distant markets and became a threat to adjacent B2B sectors (e.g. after-sales or services within the manufacturing industry). No B2B enterprise can rival the software and IT prowess of a technology giant (think Microsoft, Apple). However, as part of a system that includes other market players — ones who serve a similar customer base and whose offers are complementary — enterprises can fend off the new wave of tech competition .

81% agree that joining a new or existing ecosystem would be highly beneficial for them — and 51% are expected to do so. The German Mittelstand sees 3 key specific advantages of participating in ecosystems:

new value through partnerships
increased international competitiveness of the German Mittelstand as a ‘collective ecosystem’
better customer experience

All parties must rethink their approach and view their sector and its players in a completely new light: Other players are no longer just competitors in product distribution, but partners in value creation.

5. Consolidate beyond optimizing costs

In the first wave of the pandemic, firms tried to stabilize their businesses. The second wave could lead to an increase of mergers and acquisitions, as “hidden champions” tended to increase their equity ratio in the last years. See my previous article on popular financing strategies in the SME sector. Enterprises may look to take over direct competitors to combine their strengths and streamline their costs. 60% of enterprise leaders are either planning or have begun acquiring competitors. One out of 4 enterprises is already dealing with consolidation measures (strategic alliances, mergers, cooperation, purchase of critical intellectual property)

Research has shown that 80% of an enterprise’s growth is driven by market growth in the industry segments where it competes and 20% by revenue gained through mergers and acquisitions. M&As can also be a way of regaining relevance for enterprises that fell behind in digitization.