Why Europe’s largest economy resists new industrial revolution
Fewer than 20% of Germany's Mittelstand - small and medium-sized manufacturers - have heard of Industry 4.0, Angela Merkel's "fourth industrial revolution" launched in 2011, according to a study by ZEW. The Mittelstand make up two-thirds of Germany's $4tn economy and have been warned that if they don't embrace digital technology they risk being overtaken by Asia and the US. Critics, however, have blamed the German government for not investing more in digital infrastructure.

BERLIN — For as long as anyone can remember, German manufacturing has been the envy of Europe. From automobile engines to airplane fuselages, nothing says quality like “Made in Germany.”

To keep it that way, Chancellor Angela Merkel has been pushing Germany’s big companies, as well as the legions of small and medium-sized machinery and toolmakers that form the backbone of German industry, to embrace a sphere outside of their comfort zone: the internet.

“We have reached a critical moment, a point where the digital agenda is fusing with industrial production,” Merkel said this April at the Hanover Messe, the world’s largest industrial fair.

The European Commission estimates the coming revolution could boost the European Union’s gross domestic product by €110 billion annually over the next five years, breathing new life into sectors that account for 2 million businesses, 33 million jobs and around 60 percent of European economic growth. Yet that assumes the region will succeed in adopting to the changing environment — a big if.

“This period will determine the future strength of the world’s leading industrial centers. We have yet to win this battle,” Merkel warned in Hanover.

The fear in Germany is that the auto industry is about to reach a similar tipping point as digital advances lower the barriers to entry into the car industry.

So far, most German companies haven’t even taken up the fight. More worrying for Berlin: Many aren’t even aware there is one.

Merkel’s government began championing what it calls the fourth industrial revolution under the banner “Industrie 4.0” in 2011. As devices, transport, and other machinery increasingly collect data and communicate with one another, the government is encouraging its vaunted Mittelstand, as the country’s small- to medium-sized manufacturers are known, to adapt.

Those companies account for about two-thirds of Germany’s nearly $4 trillion economy, the world’s fourth largest. Yet less than 20 percent of German companies have ever heard of Industry 4.0, much less taken steps to implement it, according to a recent survey of 4,500 firms by the Mannheim-based ZEW. A similar percentage of German companies use cloud computing.

“Despite persistent demands by politicians and industry associations to invest in Industry 4.0 to avoid losing the advantages domestic industry still enjoys in many areas … actual investments and plans are modest and limited to a small number of companies,” the study, the most extensive of its kind, concluded.

The analysis found wide disparities between sectors. While nearly half of companies in tech and telecommunications were familiar with Industry 4.0, just a quarter of those involved in the metalworking industry were.

Risk of being overtaken

For better or worse, most German manufacturing is rooted in 19th-century technology. Over decades, industrial companies (including scores of smaller, lesser-known names) have perfected the manufacturing process.

German companies generally consider their work to be done once a product leaves the factory. But in the world of Industry 4.0, also called the industrial internet, that’s just the beginning. A matrix of internet-enabled sensors will soon link factories with customers and suppliers to optimize production and service.

If German manufacturers don’t embrace the digital shift, economists and politicians warn, they might be quickly overtaken by U.S. and Asian competitors. Germany’s export economy — and by extension Europe’s — would take a big hit.

In terms of convincing companies to invest in new technologies themselves, there may not be much politicians like Merkel can do aside from raising the alarm.

The outlook is even more worrying outside Europe’s biggest economy, especially in the EU’s southern half. Countries plagued by economic stagnation in recent years, such as Spain and Italy, risk slipping even further behind other parts of the world if they fail to invest in the new technologies. For countries on Europe’s periphery with little industry, including laggards Greece and Portugal, it may already be too late.

“Some countries have still a lot of things to do and they are not so advanced,” said Peter Scherrer, the deputy director of the European Trade Union Confederation. “For the countries with less manufacturing industry, the countries with lesser economic performance, we see a problem where we have well-developed countries advancing much faster than countries who would need more help.”

Nevertheless, the fourth industrial revolution in Europe will rise or fall in Germany. Germany depends more on manufacturing than any other developed economy. Industry accounts for about 22 percent of German GDP, compared to just 12 percent in the U.S.

A recent report by consulting firm Roland Berger and the German Federation of Industries concluded that failure to adapt to the new digital landscape could cost the country’s industry €220 billion by 2025.

The German government has taken fire for not doing more to improve the country’s broadband infrastructure, a key requirement for Industry 4.0. In a recent ranking by the European Commission of countries’ progress on digitization, Germany finished ninth.

In terms of convincing companies to invest in new technologies themselves, there may not be much politicians like Merkel can do aside from raising the alarm.

“At the end of the day, it’s up to business to take this challenge on,” said an adviser to the economy ministry on the digital transformation.

One look at Germany’s benchmark stock index, the DAX, explains the challenge. Just one tech company, software giant SAP, founded in 1972, is among the 30 bluechips.

Though German companies largely missed out on the digital revolution, they continued to thrive by churning out the old economy products for which they’re famous. What worries Merkel is that even that bastion of German industry is now also under threat.

“We have to execute quickly, otherwise those who are already leading in digital will snatch the industrial production from us,” she warned at last year’s World Economic Forum.

Resistance to change

In some respects, German industry is a victim of its own success. Following a deep correction after the financial crisis in 2008, German industry powered back on the strength of demand from China and other emerging markets. The German economy has grown every year since, even as much of Europe struggled. Unemployment is at its lowest level in a generation and wages are rising.

In short, the German economy is doing so well that many companies wonder why they need to change.

German companies generally consider their work to be done once a product leaves the factory. But in the world of Industry 4.0, that’s just the beginning.

“Most companies aren’t doing that badly,” said Jörg Ohnemus, one of the authors of the ZEW study. “It could be that they don’t see a necessity to change.”

Resistance to change is baked into many Germans’ DNA. A country that has experienced no shortage of turmoil over the past century, Germans crave nothing more than stability. Merkel likes to cite Victor Hugo’s famous quote about seeing the future as an opportunity. The more common reaction, however, is fear. Companies worry about investing in new technologies that won’t pay off.

Employees fear Industry 4.0 could cost them their jobs as manufacturing becomes more streamlined.

“Upheaval has always led to fear and worry. That’s normal,” said Sascha Stowasser, director of the Institute for Applied Labor Studies in Düsseldorf. “Maybe now there’s a particular fear due to the speed of the change.”

German angst isn’t the only thing holding back Europe’s economic motor. Another factor is the law. Uncertainty over how regulations like Germany’s famously stringent data protection laws (which have made it difficult for companies engaged in the sharing economy, such as Airbnb or Uber, to operate in the country) will be applied in the world of Industry 4.0 is also slowing adoption.

“Our legal system needs a digital update,” said Ulrich Grillo, president of the German Federation of Industries. “The law can’t be allowed to fall behind technical advances or to create avoidable costs which will impair the competitiveness of our companies.”

Though German engineers pioneered many of industry’s innovations they have been slow to embrace more recent trends at the heart of Industry 4.0 technologies.

Consider the car industry. The advent of self-driving cars, now only in the initial testing phase in Germany, necessitates the collection of a flood of information about the location, destination, and speed of a vehicle. But that’s just the kind of data collection that makes many Germans squeamish. A recent headline above an article on a self-driving car in Germany’s best-selling Bild newspaper captured that fear: “This car knows everything about you!”

The question of whether such concerns hamper innovation is particularly crucial in the auto sector, the pride of Germany. The auto industry accounts for as much as one quarter of the German economy by some estimates that factor in the long tail of suppliers and services connected to it.

Blinded by success

Though German engineers pioneered many of industry’s innovations, from the diesel motor to the spark plug, they have been slow to embrace more recent trends at the heart of Industry 4.0 technologies such as the electric, self-driving car.

They may yet catch up. With government support, the industry has built a testing area for self-driving cars on the Autobahn and has more planned. Whether such steps are more about PR than a true commitment is unclear. What worries some policy makers in Germany is that the industry has been blinded by its long success. They point to the recent diesel scandal that ensnared Volkswagen as a consequence of the industry’s arrogance. When it comes to developing electric cars and other new technologies, the auto companies’ first step is to ask the government for subsidies, officials say.

“We have to execute quickly, otherwise those who are already leading in digital will snatch the industrial production from us” — German Chancellor Angela Merkel

That kind of hubris, they warn, is what got Finland’s Nokia into trouble. Once the world’s dominant handset maker, the company didn’t take the challenge posed by Apple and its iPhone seriously. After all, Apple had never even made mobile phones. Nokia helped invent them. Within a few years, Nokia found itself on the brink of collapse and was broken up.

The fear in Germany is that the auto industry is about to reach a similar tipping point as digital advances lower the barriers to entry into the car industry. While a Google or Apple self-driving car may have been unthinkable just a few years ago, it could soon become reality. The fine-tuned, gas-powered engines Germany’s auto industry spent the better part of a century refining could quickly become obsolete, replaced by the electric internet car.

For now, such an outcome is still unthinkable to most Germans. Ask a German auto executive about Tesla, the trendy electric car maker, and the response is likely to be a roll of the eyes. Then, he (almost all German car execs are men) will remind you how much money Tesla loses on every car it sells.

ZEW’s Ohnemus cautions politicians against overdramatizing the problem. Like all new technologies, the adoption of digital industrial tools will come gradually, he said.

“To speak of a total revolution all of a sudden is an exaggeration,” he said.“That politicians recognize the need for action and have promoted the issue is positive, but it’s not going to happen from one day to the next.”