THE PROBLEM WITH SOLID ENGINEERING

ELVIS PRESLEY, Buddy Holly, Frank Sinatra, David Bowie and Celine Dion are among those who have crooned and cried into Neumann microphones, insisting that no others can so faithfully capture their voices. It is a powerful endorsement for a product that is, unsurprisingly, made in Germany. Neumann, like the companies behind many of Germany´s highly regarded brands, has regained its old confidence and is expanding again. This is good news for corporate Germany, long regarded as the locomotive of the European Union. But just as these firms pull out of the station their passengers are being left behind. Unfortunately for Germany, its export champions have become uncoupled from much of the domestic economy.

Saddled with some of the highest labour and tax costs in Europe, German companies compete at the top end of the market by devising excellent technical solutions, supplying reliable goods and building long-lasting relationships with their customers. But the very qualities that enable this--over-engineering, obsession with detail and an extreme emphasis on safety and durability--come at a price: expensive products built to last. These do not bring much repeat business and tend not to spin off many new firms to create additional jobs. Fast-moving mass-consumer markets, ruled by the simplification of products, pushy marketing and dramatic innovation, are much more of an entrepreneurial free-for-all.

Germany´s problem is renewal. It has few obvious successors to the industrial behemoths: carmakers DaimlerChrysler and Volkswagen, chemical giants BASF and Bayer, and Siemens, a conglomerate. These are powerful companies, but they are trapped in industries that face growing competition from younger, more vigorous firms in Asia. Smaller German companies, the famous MITTELSTAND, face difficulties of their own. Their founders are often reluctant to pass on ownership of their firms or to change direction. Most are dedicated to improving their products rather than taking risks with new ones.

Much of this risk aversion can be traced back to Germany´s post-war economic miracle, the WIRTSCHAFTSWUNDER. Most MITTELSTAND companies sprang up in the absence of competition with capital provided by the Marshall Plan. Being an entrepreneur in Germany these days is not so easy. The red tape involved in starting a new company, the cost of hiring and firing in a protected labour market, and the stigma that is still attached to those who go into business and fail, complete the picture. In Germany too few companies are being born. Even the successful exporters are increasingly using imported materials or outsourcing much of their production. What is made in Germany is often the work of only a few highly skilled people engaged in an inexorable pursuit of quality and precision.

Neumann is a classic example. Inside its microphones is a capsule containing a diaphragm that vibrates near-perfectly when converting sound-waves into electric impulses. It is designed to withstand the decibels of the loudest rock band or even the noise of a Formula 1 racing car. The capsules are made in ultra-clean conditions--a speck of dust could ruin the effect. The average one will last 22 years before it needs repair, says Wolfgang Fraissinet, president of marketing and sales at Neumann´s base in Berlin.

Neumann was sold by its family owners in 1991 to Sennheiser, another traditional microphone producer. Its best microphones can cost more than EURO5,000 ($6,450). Yet the company is not insulated from the fast-moving digital world. It is investing EURO1.4m to develop digital microphones. "Someone will do it, so we decided it should be us," says Mr Fraissinet. Like its analogue predecessors, these are aimed at the top of the market and an early model was used to record the soundtrack for the film epic "The Lord of the Rings".

Companies such as Neumann are Germany´s "hidden champions", according to Hermann Simon, a former professor at Mainz University and now a consultant. He calculates there are more than 500 of these sometimes less well-known firms doing their bit to help Germany´s exports. Many are small and still family owned, but have won themselves a niche in the global marketplace and defend it by constantly reinvesting in high-end innovation and placing a supreme emphasis on quality.

Another champion is C. Bechstein, a piano-maker, which shows just how far German companies will go in order to maintain quality. "We give the instruments a soul," says Klaus Schulze, a master piano technician and large shareholder in the company which he runs. Each Bechstein grand piano takes up to 500 man-hours to build over the course of a year. Some aficionados believe the result is a softer, more intimate sound than an American Steinway or a Japanese Yamaha.

Bechstein is broadening its product range. It bought Zimmermann, an East German producer, in 1992 and now makes a range of pianos to less demanding standards in the Czech Republic, America, Indonesia and China (in a joint venture with Samick of South Korea). But its finest instruments are made in Germany. The company insists on the absolute calm and stability of its factory in Seifhennersdorf, near the Czech Republic. "We thought of locating production in Berlin or Leipzig, but there would have been too much to distract the workers," says Mr Schulze.

Even a company selling humble screws and hand tools goes to extraordinary lengths to keep up standards. Wurth´s power drills may be made in China or the Czech Republic, but they are branded with the Wurth label only when they have passed the company´s rigid quality controls. They can then carry its guarantee. Nine out of ten of Wurth´s 2.8m customers are professional craftsmen. The company also operates in the do-it-yourself end of the market, but with different brands: Meister and Connex.

Wurth is a trading company that directly manufactures only 5% of what it sells. Only 60% of its goods are made by German companies, and only 25% of its profits come from Germany. It has tripled its turnover in the last ten years, to EURO6.9 billion. The company´s strategy is to buy up firms at home and abroad and instil its own standards of quality. It now owns 355 firms in 81 countries. To improve its logistics, the company is now automating its vast warehouses at Kunzelsau, which means there will be less work for unskilled people in the region.

Because of inflexibility in the labour market and high labour costs, German companies do much of their labour-intensive production abroad, keeping the capital-intensive operations at home. This has led some to argue that the increasing globalisation of German firms is costing jobs. Hans-Werner Sinn, the head of Ifo, a Munich-based research institute, has published a book called "The Bazaar Economy", which explores the dislocation of Germany´s export champions from the rest of the country. The share of imported inputs to German goods destined for export increased from 30% to 39% between 1995 and 2002.

Although German companies still pay their workers at home a good wage, that is little consolation to the unskilled who see their jobs migrating abroad. Mr Sinn recognises that companies must build factories where they are most efficient--in Slovakia, say, rather than Germany. But for the economy as a whole, he calls it a "second-best solution". He believes a more flexible labour market, which might provide more employment at home, would be a better solution. Only then would demand in Germany begin to rise to match the booming demand for German exports (see chart), which has persisted even while the rest of the economy is in the dumps.

Other economists are less alarmed by the idea of Germany as a turntable for exporting goods. Mr Sinn is not looking at the whole cake, which is getting bigger, says Klaus Brenke of DIW, a Berlin research institute. Although the share of inputs from abroad has risen, the total volume of goods exported has risen faster, he adds.

Yet the world´s biggest exporting nation is not creating jobs for the unskilled. Germany´s unemployed include a high proportion of long-term job-seekers. More than 40% have been looking for jobs for a year or more, according to the latest figures published by the Federal Labour Office. Almost 27% of all unemployed people have no qualifications and around a quarter are 50 years old or more. Solutions tried so far by successive governments have not worked: they have tended to set perverse incentives, such as tempting some workers to switch to subsidised jobs and school leavers to quit the parental home for subsidised housing.

Germany´s export champions rightly do not see that as their problem. Manfred Wennemer, the boss of Continental, a big tyre-maker, recently took some political flak when he decided to close a plant at Stocken near Hanover, the company´s heartland. The closure, now due at the end of 2007--a year later than was first planned--will affect 320 workers. "My duty is to my 80,000 workers worldwide," says Mr Wennemer. He also believes that if wages were set by the market, Germany´s unskilled labour pool would be more competitive.

That would still not prevent the migration of labour-intensive production to central Europe, China and other parts of Asia. Western Europeans are not likely to accept wages of a dollar or so an hour. Continental, for example, employs 1,000 workers at a plant making tyre sensors in China, whereas production of the same sensors in Ingolstadt in Bavaria is fully automated. The only difference is a slightly higher failure rate of two parts-per-million in China, compared with 0.8 in Germany. The pursuit of perfectionism is costly, but not always necessary. But if you are making machine tools and other devices which will be used by companies wanting a near-zero tolerance of failure, then dedicated precision is required and that reinforces the legend of made in Germany.

RISK AVERSION

Whether hidden or not, Germany´s export champions have their limitations. They solve problems brilliantly. German inventors also register plenty of patents, but usually this is within parameters set by others. An historical problem is the German public´s aversion to risk in scientific experiments, such as testing genetic or biological products, or extending nuclear technology. "That kind of research would really have suited us," says Mr Wennemer of Continental.

In the 19th and early 20th centuries Germany was the pharmacy for the world. Now there is only a handful of small pharmaceutical firms left. In March, however, Bayer and Schering agreed on a merger that might provide a German contender able to compete with the world leaders. The anti-capitalist movement has a lot to answer for, says Peter May, a professor at INTES, an academy for family-owned firms in Bad Godesberg. He blames it for engendering a "fear of the future and resistance to new branches of research". While the Anglo-Saxons developed a dynamic version of capitalism, "We had Karl Marx," he says.

Although technical education at many German universities is excellent, and local companies make good use of it, there is a need to spend more to extend the scope of research and development, say economists and businessmen. There is also a need to improve education on a more basic level to reduce the number of unskilled school leavers who do nothing more than join the ranks of the unemployed.

The companies under most pressure in Germany are the automotive suppliers. Ever since Ignazio Lopez, a General Motors purchasing manager, made a name for himself squeezing suppliers at Opel in the early 1990s before moving on to Volkswagen to do the same thing, the parts suppliers have been caught in a constant battle of cost against quality. Continental was quicker than most to see the need to cut costs. It has also been clever at forming partnerships with diverse manufacturers, tailoring components for vehicle "platforms" (a shared chassis) and developing new technologies. Continental recently joined Volkswagen, Porsche and ZF Friedrichshafen, a chassis specialist, to help develop hybrid diesel/electric vehicles. Such close relationships with business customers suit the company well.

THE EXCEPTION

The same sort of relationships also suit SAP, which is based in Walldorf, Baden-Wurttemberg, and is arguably one of the German firms with the strongest position to compete in growing world markets. But SAP is something of an exception because it was started in 1972 by a group of rebels from IBM. It is now the world´s biggest supplier of business software, although Oracle and Microsoft are snapping at its heels.

SAP is firmly rooted in Walldorf, where some 90% of its staff are German, but the company is thoroughly international. It has operations in America, Japan and the rest of Europe. Its German aptitude for problem-solving, complex engineering and precision shines through. "We don´t oversell, we deliver, we thrive on peer relationships," says Henning Kagermann, SAP´s chief executive.

Can Germany´s big companies and its ranks of champions drive the economy through to the next century? The industrial sector relies heavily on the automotive industry (3.7% of GDP), chemicals (2.2%), mechanical engineering (3.3%) and electrical engineering (3.2%). Even if you argue, as does a recent study by the Boston Consulting Group together with Siemens and Deutsche Telekom, that information and communications technology make up a bigger proportion of German industrial output (6%) than do the traditional industries, that is a bit misleading. The calculation includes fixed-line telephony and the IT components of traditional industries.

Germany´s economic future is still heavily dependent on the health of the auto industry, although that industry is becoming increasingly wedded to electronics and computer science. But there is no guarantee that car firms, however smart they have become at cost-cutting, outsourcing and upgrading their technology, can survive as engines of German economic growth.

SAP alone could not replace them. Nor, probably, could the production of more sophisticated chemicals. What is lacking are links between the research done in universities and the small entrepreneurial start-ups that have been the secret of so much development in Britain, America and elsewhere. The big companies work well with the universities. SAP draws liberally on expertise from the local citadels of learning: Mannheim, Karlsruhe and Saarbrucken. Last November Continental launched a research consortium led by the university of Darmstadt to promote "global engineering excellence".

Certain industry "clusters" have developed in the state of Baden-Wurttemberg, which may one day replace the automotive clusters around Stuttgart, Munich and Leipzig, and the old smokestack cauldron of the Ruhr. Germany is also home to two leading international logistics companies: Deutsche Post (which owns DHL and now Exel) and Deutsche Bahn. German firms are among the best in wind-farm technology and solar panels. But that may not be enough when almost 5m people are unemployed and the service sector is developing slowly.

In Britain in the mid-1980s unemployment was equally high. The slow remedy over a decade was the creation of many service industries. But Germany is still struggling to find a policy mix that might inspire the same level of enterprise. Germany´s regional and federal politicians rightly see education and integration of the non-German population as a priority. Without that, the numbers of unemployed will only grow.

That calls for greater entrepreneurial spirit and a willingness to acknowledge that business failure is as much part of a thriving entrepreneurial culture as is business success. At a conference on entrepreneurship in Bavaria earlier this month, the notion of a prize for entrepreneurs who have failed in business and have bounced back--a sort of "phoenix" prize--was discussed only half in jest. Even the most outward-looking of Germany´s export champions would get a boost if the country´s economy grew faster. Professor Sinn believes Germany needs to change course if it is to avoid a total annihilation of labour-intensive industries. The enormous export surplus is damaging, he argues, and to some extent self-defeating. Companies that ignore the home market and concentrate on intermediate goods rather than consumer ones are also missing opportunities.

Puma and Adidas, two rival sportswear manufacturers from the same Bavarian village of Herzogenaurach, show that some German firms can compete in big consumer markets. Puma shifted its production abroad more than a decade ago, retaining design and marketing at home. Adidas recently bought America´s Reebok in a bid to rival Nike, the world´s leading sports brand. Hugo Boss, a fashion house based in Baden-Wurttemberg, has also built a global consumer brand.

But these are exceptions to the German stereotype. An optimist might advise more patience as companies in Germany´s traditional industries will run their course and spin-offs and start-ups will eventually take their place--with or without a change in public policy. But Germany´s policymakers could make a difference sooner if they dared to be inventive.