The danger of economic disruption in Germany

Ben Shaw explains that German companies are by no means immune to disruption in the long term and should address innovation before it is too late.
February 11, 2021
6 Minutes
Ben Shaw
Associate Partner

“Watch out, Germany, disruption is coming.”

While numerous companies in America are experiencing highs, things are going downhill in Germany, even before the pandemic: Galeria Karstadt Kaufhof files for insolvency, the DAX company Continental announces job cuts and unleashes a chain of redundancies in the automotive industry. Other business models that solve the same customer need, profit: Amazon instead of Galeria, Tesla instead of BMW, MAN, or Continental.

What looks like mere coincidence had already been predicted many times by numerous economists and academics. Best known is the disruption theory of Harvard professor Christensen published, among others, in his work “The Innovators Dilemma” in 1995. The commercialization of disruptive technologies gives more people access to the labor market and allows efficiencies that benefit everyone in the long run. Christensen even dares to claim that disruptive innovations, among which he counts, for example, the PC, the Internet and the Android and iOS app stores, are the greatest driver of economic growth.

Even the German company examples mentioned are by no means immune to disruption in the long term. Quite the contrary! The static image of a large corporation is in fact anything but static in the market economy. Competitors from all sides test new solutions, products and concepts for customer benefit and try to prove themselves in this way. Generally, the customer gains from this process; the large corporation only benefits if it initiates the disruption itself. And the large companies in the USA do this much more than the DAX corporations.

Amazon is the prime example: the eCommerce giant already has more than 40 business models on the market, including both acquired companies such as the organic food market WholeFoods, the movie database IMDB and the streaming service Twitch, as well as companies founded in-house such as Prime Video, Alexa or the world’s largest cloud provider AWS (Amazon Web Services). This strategy has proven itself over a long period of time: the more diversified the revenue sources of a corporation, that is, the more different business models under the hood, the more durable and valuable the company. Amazon still hasn’t paid a dividend, signaling that they still believe they can invest the money they generate better than their shareholders.

But Amazon, too, is guided by a build and buy strategy, admitting that many of the new innovations come from so-called new entrants, startups that Amazon acquires.

The last two decades prove a privatized downsizing of innovation through digitization – a shift to the venture capital scene. In the past, before the year 2000, many innovations that led to disruption came from public-private partnerships, universities, or even existing large corporations. Now the best incentives are being created in the venture capital world. It is not the so vaunted hidden champions, whether in Germany or the U.S., it is venture capital funded startups that are shaking up the market and sooner or later displacing the big companies.

Venture capitalists are taking over

The DACH region lacks both. There are hardly any growth companies that prove themselves by diversifying different business models (German Amazons), nor are there many startup founders. The 2010s marked the historic low for startups in Germany. And even though the number of VCs (venture capital investors) is increasing, the most successful among them, such as Earlybird or Picus Capital, started investing abroad some time ago, as there are not enough investable targets in this country.

20 years after his underestimated forecast, Clayton Christensen talked about his thesis at Google. He had not thought that disruption would come so quickly. He counted Google as the disruptive innovation that gave the big advertising companies a run for their money; Apple, through product diversification, as the disruptor of Blackberry and Nokia. Uber and Airbnb would bring disruption to cab and hotel chains. He said he knew of no examples of truly disruptive innovation from Germany that was also being exported abroad.

Christensen worried, pointing to Japan; a stagnant economy where innovation had been unlearned. The large companies there are focusing on maximum operational efficiency and are thus being outmaneuvered by the new players from the USA or China. Japan has an “entrepreneurship vacuum” – the willingness to start a new company is lower than in any other OECD country.

This is precisely the phase Germany is in. The signs of disruption are already there and the examples within Germany of responses to them are lacking, whether from corporations or startups. Sooner or later, this could become a problem.

Innovation strategies of large corporations like BMW, Allianz, or Daimler are reminiscent of late Roman decadence; there would be no reason for concern. “Keep it up” is the official mantra here, usually followed by “There is nothing BMW can’t do itself”, while internally various so-called innovation initiatives are used, such as the incubator or accelerator model, which has yet to prove itself in more than a decade of its use by large corporations.

One would expect DAX corporations to also focus more on Build & Buy: Penta, Germany’s first mobile bank for SMEs, is still in the hands of VCs and founders, although Deutsche Bank, for example, could have taken it over long ago; quite the opposite. Deutsche Bank even accepts that its Chief Digital Officer leaves the bank as yet another disgruntled employee. Next stop: new CEO of Penta.

What has become popular in the context of innovation initiatives, including BMW’s “Startup Garage,” is instead the venture client model, a new kind of procurement in which you work with young startups instead of software houses like SAP. While it’s certainly true that Tractable.AI, a British AI startup, delivers better, use-case-tailored models for motor insurance claims processing than SAP, for example, in the long run, this doesn’t protect an ERGO against disruption, but again only increases operational efficiency. The innovation initiatives that many of the large corporations are striving for are therefore not aimed at their own business models of the future, but rather serve as a marketing ploy – discredited as “innovation theatre” by those startups that expect too much from the large corporations in terms of collaboration. Yet it is precisely the startups whose time should not be wasted by the large corporations. The Japanese entrepreneurship vacuum exists here in the DACH region, too.

In Germany, the land of German Angst, where being a civil servant or embarking on a career with a large company still represents the ultimate social status for many, hardly anyone wants to take risks. Whereas in 2004 it was still almost 3 percent of the workforce, in 2018 founders accounted for only 1 percent – self-employed included. In the U.S., the figure is 30 percent.

There are many examples of missed opportunities

The fact that Germans prefer to retreat into their shells rather than shake up the market is also evident from the social platforms that people here browse day in and day out. Especially from the German market, where distrust of Facebook has been spreading for years, one would expect a counter to the social network. Instead, Germany is the place where the exclusive app Clubhouse has experienced the fastest growth since its founding. But the permanent sound platform was built in the USA. Every minute spent on Clubhouse increases the value of a U.S.-based company, which also currently generates jobs only there.

Social networks like Clubhouse are not solely responsible for the disruption of traditional, linear media. ARD and ZDF are also being replaced by Prime Video and Netflix. This was foreseeable before Netflix’s German market entry in 2014; YouTube started streaming in HDTV in 2009. Netflix left a head start to a potential German player not only with the rather late market entry – after all, the company was founded in 1997 – but also with the rather late German first production: Dark, 2017. While the average viewing time on classic TV is dramatically declining, every second German household now has Netflix – and the trend is rising.

Not only for the American streaming company but also for Russia’s Tinkoff Bank, it was probably obvious that there are opportunities in the German market that have not been fully exploited. So last year they founded Vivid Money, a startup that is now worth 100 million euros with 40 million euros invested.

What happens if it continues like this?

All these success stories of innovations coming from outside Germany and even Europe entail macroeconomic consequences, starting with tax sources. First, adoption within Germany of a new business model does not necessarily lead to tax revenues, or even any revenues in this country, see the example of Clubhouse. Even if such corporations settle in Germany sooner or later, there is most likely a tax loss compared to purely national players due to the many tax tricks that have been used for decades, whether at Starbucks or Apple.

On the other hand, disruption affects the federal budget in the long term due to the lack of revenues from existing large companies. There is hardly any other industry where it is so easy to see what is on the horizon as the automotive industry, which, depending on the calculation with all suppliers and logistics companies, is responsible for 5 – 15 percent of the gross domestic product and one-third of the foreign trade surplus. A large fiscal forfeit increases the budget deficit.

Christensen’s suggestion to take a look at Japan, however, not only shows that a much higher national debt can occur – Japan had a national debt that was more than twice the national economic output within two decades – but also increased unemployment and a growth stop.

So to ensure that future generations can continue to afford more in Germany than their parents and grandparents before them, the right impetus must be given now. In Berlin, we should arm ourselves to introduce an economic policy that does not try to prevent disruption, but recognizes that it will come, but ideally from German companies.

The foreign trade surplus of the future will not come from large carmakers profiting from generations-old standing. It will come from digital business models, whether from a startup or a new division of an existing corporation.

Ben Shaw
Associate Partner

Interested in how our team can help you?

Get in touch with our partners to learn more
Thank you! A member from our team will be in touch soon.
Oops! Something went wrong while submitting the form.