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Digital society May 18, 2021

Digitalization can still become a success story for Germany

woman sitting at desk working on laptop with digital graphics surrounding her
Germany and digitalization. If you look at the relevant international comparisons and the evidence to date, not only in the coronavirus pandemic, the verdict is initially simple and depressing: It is not a success story.

This verdict relates to a variety of different aspects, which, depending on one's perspective, can include the faltering broadband expansion, the lack of digitalization in public administration and especially in schools, the lack of data for evaluating essential political decisions, especially in times of crisis, or the insufficient options to work remotely. All these facets are important and need to move ahead much more quickly, but possibly none of them is currently the most important aspect for future economic prosperity for Germany.

Market capitalization in international comparison

This is because, alongside these developments, there is an ongoing and comprehensive shift in the corporate world toward digital business models, which can be seen particularly clearly in the market capitalization of companies in various countries. Table 1 shows the market capitalization of the top ten companies worldwide and the corresponding information for the three German companies in the top 100.

 

                                       table

 

This market capitalization is a particularly suitable benchmark for their future competitiveness, as it measures the expected future cash flows that market participants believe these companies can and will generate. A development has been perpetuated over the last few years that can be summarized as follows:

  • First, the companies with the highest market capitalization worldwide are almost exclusively digital platform companies such as Apple and Amazon.
  • Second, most of these companies originate in the US and increasingly in China, but none of them comes from Europe.
  • Thirdly, the particularly successful companies, such as Apple or Microsoft, currently have a higher market capitalization than all 30 companies assembled in Germany’s leading index, the DAX. In other words, a single company is more valuable than the crown jewels of the German economy combined.

Now, one could object to various points. For one thing, share prices change all the time. Therefore, the current state of affairs does not have to last, and the current dominance of platform companies could evaporate just as quickly as it emerged. However, developments just since the pandemic began have not interrupted or reversed pre-existing trends but have actually accelerated them. Amazon alone hired 500,000 new workers last year. The profits and share prices of this and other platform companies have once again risen significantly. Their market power has increased, while discussions about vacancies and the desolation of city centers are gaining in intensity, especially in Germany.

One could also argue that the market capitalization of companies in Germany traditionally has not been particularly high by international standards. One reason for this is that that Germany’s economic fortunes depend on family businesses to a greater extent than in other countries. These family businesses, which, in their pure form, are not listed on the stock exchange, contribute greatly to economic prosperity without this being reflected in Germany’s general market capitalization.

But this argument does not carry very far either. One does not have to do much analysis to conclude that even a possible broader stock market listing of these companies would not lead to a significant change in the international balance of power. On the contrary, there is evidence that companies in Germany can only match the highly profitable international platform companies in terms of profitability in individual cases.

Market leadership in the future

The market capitalization dominance of US and Chinese platform companies is not the end of the bad news for Europe, however. Table 2 shows that despite promising examples of success, Europe also lags well behind the US and China when it comes to the so-called unicorns, i.e., startups with a valuation of at least one billion dollars.

 

                                       pie chart

 

It is not only the current market leaders, but also aspiring market leaders, who are currently not based in Europe and Germany.

What are the consequences of this development? The central question in this context is where value creation will take place in the future. Let’s take the case of car production. If the parts of value creation that will be particularly lucrative in the future, such as software development, are of a different kind than those that have been used in the past and are also more important than precise and efficient production, then there is a risk that this value creation could also take place in other economic regions of the world. The effects of such a development would be far-reaching and have implications for the German labor market as well as for the state’s ability to collect taxes from employees and companies – and thus for its long-term ability to act.

The dominance and business success of international platform companies mean that these companies have significant and increasing financial resources. They can use these to drive research and development in potential new business areas and thus extend their existing competitive advantage to other future-oriented fields. If these efforts within the company do not result in the hoped-for success, then they can also buy up other companies around the world. In extreme cases, this could even lead to these platform companies acquiring possible future competitors at an earlier stage of their development and integrating them into their own company, thus prohibiting the acquired companies from being able to develop into genuine competitors. In sum, what is at stake is nothing less than the future viability of an important part of the German economy and economic prosperity in Germany.

Nevertheless, there are also encouraging signs. The last few weeks in particular have shown that the German automotive industry has comprehensively accepted the strategic challenges and that the capital markets are beginning to appreciate this fact. Companies like BMW, Daimler, and Volkswagen have become darlings of the stock market and are fighting tooth and nail against the loss of their international pre-eminence. Where initially there was concern about rapid adaptability compared to new competitors, confidence in seamless and customarily efficient implementation in mass scaling and production is slowly and increasingly prevailing.

The next great technological leap

The encouraging example of the automotive industry can be taken more broadly. While German companies are clearly lagging behind in the online platforms between companies and consumers (B2C) described above, the race in platforms between companies and companies (B2B) is anything but decided. On the contrary, it can be argued that this race is only now really getting going. Now that all sorts of consumer products – from books to shoes, from food to travel – have been transferred from physical to online sales, enabling massive growth for the corresponding providers, the next generation of startups will have to take another step in technological development to be similarly successful. Here, too, the transformation is in full swing.

This opens up the possibility that the next great technological leap will be found in a field other than digitalization. The current coronavirus pandemic is a particularly valuable example in this context. After all, hardly anyone would have expected vaccines to be available so quickly at the beginning of the pandemic. Presumably, the expectation would have been even lower that Europe and Germany would be at the forefront here, especially with the modern mRNA vaccines. These offer a great opportunity to permanently establish a promising future technology in Germany with potential applications in many other areas.

Requirements for startups

It is not advisable to despair in the face of the dominance of the international platform companies. The glimmers of hope described above highlight a number of aspects that are necessary to maintain and expand the future competitiveness of German companies. The recent upswing in the German automotive industry is due to massive efforts in research and development, as is the innovative strength in the development of new vaccines. Financial flows within companies have been redirected to the development of new products. Additional funding has been raised through private means, and the state has supported this process both ideally and financially, especially in the case of vaccines. The state and companies would therefore be well advised to work together to further increase spending on research and development.

In an international comparison, Germany still lags behind in terms of the amount of venture capital available for start-ups relative to its gross domestic product. The examples of BioNTech and CureVac impressively demonstrate what private capital can achieve in this form. The state must create the conditions here to attract even more private capital into innovative financing, be it through the appropriate regulatory framework conditions for institutional investors, the comprehensive empowerment of long-term capital in foundations, or a better integration of fundamental research and its commercial application.

Perhaps, it is precisely the pandemic and the systemic weaknesses it has highlighted that are going to foster a new awakening in Germany and Europe. The chances for a success story are better than previously feared if companies and the state draw the right conclusions from the experience and implement them consistently. Success is not a foregone conclusion, but many important elements such as inventiveness and intelligent capital are in place. Smart economic policy should intelligently combine these elements and give Germany the chance to experience a new upswing in the coming decade, following the long-lasting upswing in the wake of the financial crisis in 2008 and 2009.

 

Originally published in German by Makronom on April 26, 2021. Republished with permission.

 

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