As Germany’s Business Model Wobbles, Firms Reassess Reliance on China

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Amid the ruins of a city ravaged by World War II, Karl Haeusgen’s grandfather invented a hydraulic pump he was so proud of that he founded a company to sell it. Back then, there were no revenue projections or five-year growth strategies. The plan was survival: “It was just about grabbing chances,” Mr. Haeusgen said.

Seven decades and three generations later the family business, Hawe Hydraulics, ships some 2,500 parts around the globe. Instead of scrambling for sales, though, Mr. Haeusgen must parse the geopolitics of an ever more polarized world.

“A third of my business, if not more, depends on how Biden and Xi get along,” he said. “I sometimes wish I ran a restaurant and didn’t have to care about global politics.”

With China and North America as Hawe’s biggest trade partners, Mr. Haeusgen doesn’t have that luxury. As tensions between Beijing and the West rise, Hawe officials are working to hedge the company’s dependence on the huge Chinese market.

Long a linchpin of Chinese trade in Europe, Germany is increasingly caught in the diplomatic tussle between the world’s two largest economies — wooed by China but urged by Washington to move further away from Beijing, even as Treasury Secretary Janet Yellin arrives in China on Thursday for talks seeking common economic ground.

How Hawe and other midsize German companies navigate these new global forces will be critical to the country’s future prosperity. Though Germany’s 20th century success as the economic powerhouse of Europe is often seen through its biggest brands — like Volkswagen, Mercedes and Siemens — it is small and medium enterprises that are the backbone of its economy.

These companies, known in German as the “Mittelstand,” are struggling to create a model for the future, as the country’s socioeconomic order begins to falter under the weight of stalled modernization and ruptures in global politics.

Some executives like Mr. Haeusgen are embracing transformation, testing new strategies and markets. Other businesses, however, are wary of abandoning a model that for decades enabled Germany to thrive but defied change.

The tensions are felt even on Hawe’s factory floor.

“I just can’t see it. What’s the alternative to China?” said Holger Rebbe, a floor manager.

Hawe’s handling of international affairs is not just a concern for its 2,700 employees. The economies of some German towns depend on it.

In Kaufbeuren, a brightly painted Bavarian town nestled below the Alps, Hawe is a top employer. In the tiny village of Sachsenkam, 60 miles to the west, Hawe provides 250 jobs — the next largest employer is the local brewery, with a staff of 17.

“It’s like we were successful for too long,” said Stefan Bosse, the mayor of Kaufbeuren, who is keen to attract other businesses to diversify the employers his town relies on. “Now, gradually, we see: ‘Uh oh — this is not a given. This can also be endangered.’”

The archetypal Mittelstand company is based in a rural German town, making a piece of equipment few have heard of, but that is crucial for goods worldwide — like a screw needed for every airplane or passenger car.

These companies provide the majority of Germany’s economic output, according to some studies. They employ 60 percent of its workers, and make up 99 percent of its private sector — a higher percentage than in any industrialized nation in the world.

“The German business model, particularly Mittelstand, is being extremely good at doing one thing: Slowly but steadily perfecting one product,” said Mathias Bianchi, spokesman for the German Mittelstand Association. “Because that worked so well for years, they had no need to adapt to changes. But now, they need to adjust to the new economic reality.”

Even as the tech revolution and climate change added strain in recent decades, Germany’s model plodded profitably along.

But the pillars it relied on to do that — cheap Russian natural gas and the Chinese market — are collapsing.

Moscow’s invasion of Ukraine forced Germany to wean itself off the gas that provided its industry with cheap power. China’s drive toward self-reliance means a market that once seemed an unending source of growth is not only less assured, but a rival.

Staking out a socioeconomic transformation for the country, pledged by Chancellor Olaf Scholz’s coalition government, has become a source of national anxiety.

Like its population, Germany’s business owners and entrepreneurs are aging — the average Mittelstand association member is 55.

Some are resistant to adapting to new technologies and cling to a loyalty-based system that created lifetime employees — and customers. (Hawe’s very first client in 1949, a forklift producer, still buys from it today.)

The government, too, has a poor record in shedding outdated practices — like its labyrinth, paperwork-based bureaucracy. In 2017, it vowed by 2022 to digitalize its 575 most used services, like company registrations. A year past that deadline, said Mr. Bianchi, only 22 percent of those services are online.

Such failures makes businesses wary of transformation plans the government says will be costly now, but will make Germany a diversified, digitized and climate neutral economy.

“Our companies don’t see it at the moment,” Mr. Bianchi said.

A survey of Mittelstand companies released Tuesday by the analytics firm Kantar showed a sobering statistic: Over half the companies polled did not want to expand in Germany, and a quarter were considering relocating.

Even among companies like Hawe, the pace of geopolitical shifts have been eye-opening.

The day after Vladimir V. Putin’s forces invaded Ukraine, Hawe decided to halt operations in Russia. It was an easy decision. Russia was not a major market.

Still, Mr. Haeusgen said, the move felt like a shock: “This was something that had never happened before — that, as the consequence of a political event, we closed down an operation.”

On the Hawe factory floor, the anxieties it sparked still linger.

Marita Riesner, inspecting parts, said her heating costs spiked to 740 euros ($803) a month from 120 euros ($130). She and her neighbors are growing vegetable gardens to ease the pain of inflation as the country dips into recession.

“I was a very positive thinker before,” she said. “But these days, I’m sweating it. It seems a lot is going wrong.”

Should geopolitical events disrupt business with China, Mr. Haeusgen said, the consequences could eliminate more than half of Hawe’s jobs in Kaufbeuren. Currently, he said, 20 percent of Hawe’s business comes from China.

Some business groups raised alarm in recent years over Germany’s vast exposure to China — before the risks were taken seriously by former chancellor Angela Merkel’s government, which had heavily encouraged German-Chinese trade.

Today, some policymakers privately worry that an event like a Chinese attack on Taiwan would be an inescapable disaster for Germany’s economy. The government is now pushing “de-risking” by finding alternatives to trade with China.

Berlin plans to release a new strategy paper this month to outline how it will go forward with its relationship with China. It is expected to take into account pressure from Washington, Germany’s security guarantor, to move away from China.

But major brands like Volkswagen and BASF insist that China, as the world’s second-largest economy, is too important a market to give up. Such German-based multinationals are responsible for a 20 percent rise in foreign direct investment in China this year.

German officials say their strategy will maintain ties to China, but will counterbalance that by strengthening relationships with other nations, like India or Vietnam.

The Mittelstand is doing the same: Hawe is investing heavily in India, where it plans to build a new plant, and other companies are looking to North America.

In Kaufbeuren, Hawe’s department head, Markus Schuster, says diversification brings new challenges.

“It used to be that we made a majority of sales with three customers from China,” he said. “Now we have many, many smaller customers scattered all over the globe.”

Instead of making a few parts at a huge scale, as cheaply as possible, Hawe must make a wide variety of parts for an array of customers, as quickly as possible.

That means finding cost cuts, while developing automatization systems to allow flexible production, he said. He pointed to a team of robots engaged in an intricate dance, drilling and polishing metal parts.

Mr. Haeusgen believes that trade with China will remain a cornerstone of Germany’s economy. And he will keep traveling to China with other Mittelstand leaders for talks to resolve business differences and repair ties.

The new socioeconomic model for Germany may be less about erecting pillars than managing an ever more intricate, international juggling act.

“Being able to live with and manage uncertainty and to handle complexity becomes, in my opinion, a core strength ,” Mr. Haeusgen said. “The way my grandpa did it won’t work today.”

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