The Future of German Competitiveness

What Disruptive Innovation Is — and Why It Matters to the German Economy

Bernard Kümmerli, Senior Partner at Innosight

Christoph Brand, International Advisor at Goldman Sachs

In order to develop an understanding of how Germany can best meet the competitive challenges it faces, language is important. The word disruption is bandied about quite a bit these days, to describe everything from the incredible impact of the Covid-19 pandemic to a great, new idea.

When Innosight talks about disruption, we are referring to a very specific concept: disruptive innovation. Innosight founder and Harvard Business School Professor Clayton Christensen pioneered this notion, describing disruptive innovation as that process that enables a smaller, less well-resourced company to successfully challenge established incumbent businesses.

These disruptors do not necessarily offer a better product or service than the incumbent organizations. Rather, as most incumbents spend their time improving their products and services for their most demanding customers and end up overshooting their mainstream customers’ needs, the disruptive entrants are able to offer simpler, less costly alternatives or go after an entirely untapped set of customers. Over time, the quality of these new offerings improves and eventually appeals to the majority of all mainstream customers. That spells trouble for incumbent organizations, who often only recognize these threats once they are overtaking them.

As Christoph Brand summarized: “Clayton Christensen said the disruptors come along and they ambush you from behind. And they come along with products that are good enough. In fact, they have a slightly worse performance. They essentially have three characteristics. They’re convenient, they’re affordable, and they’re accessible.”

Disruption does not always come in the form of a startup. Incumbent organizations can disrupt as well —and even disrupt themselves if necessary. In the PC market, for example, as computers were getting thinner, lighter, more powerful, and faster every year — incremental innovation at work — Apple introduced the disruptive iPhone and the iPad.

“Disruption doesn’t just lead to a destruction of the incumbent core business, but it offers new options for growth and to create value,” said Brand. This puts incumbents in a tough position, which Professor Christensen famously called the “innovator’s dilemma.”

“Incumbents in established markets, through sustainable innovation, tend to win with their products. But as new entrants come with disruption, they nearly always win as well,” said Bernard Kümmerli, Senior Partner at Innosight. “So, the question is, how do you deal with this dilemma as an incumbent? On the one hand, you need to develop your own core business further, but parallel to that, you have to think about how your sector could be disrupted.” Future-proof organizations must recognize the threats that could wipe out their existing businesses and then organize disruption in their own organizations — all while improving their core business. Success requires not one or the other, but both.

It’s a simple concept in theory but challenging in reality. “The top management do everything right in their core business: they focus on customer and improve the product,” Kümmerli explained. “But they have to disrupt themselves. They have to create their own competition in-house. And very few do that.” One company that has done that — and done it well —is Apple. Their market capitalization was $8 billion in 2000, $63 billion in 2010, and is $347 billion today. That’s bigger than the entire German stock exchange; in fact, Apple’s two most disruptive products amount to 70% of the German stock exchange. Meanwhile, the market capitalization of German companies in the Global 2000 has fallen 11% since 2008, and German companies’ percentage share of revenues in the global 2000 has plummeted by nearly a third over the same period.

The German economy does not exist in a vacuum. It lives on its exports. But it needs growth to maintain prosperity and finance innovation for the future.

Navigating Disruption: An Appreciation of Clay Christensen

Patrick Viguerie, Managing Partner at Innosight

For an economy to grow, either its labor supply or productivity must increase. Often, it’s both. “Germany has been a productivity story,” said Patrick Viguerie, Senior Partner at Innosight, “the export champion of the world.”

However, Germany cannot risk resting on these laurels.

A key indicator of the amount of disruption taking place in the global economy, Innosight’s analysis of companies on the S&P 500 index shows that longevity is declining. Since 1980, the average lifespan of a company on the S&P 500 has been cut nearly in half from 35 years to 18 years. Innosight’s analysis indicates that half of the companies in the S&P 500 will be gone by the end of this decade.

The German economy specifically faces the twin risks of significant disruption and growth constraints. Its key sectors (like automotive) are in the midst of incredible disruption while Germany’s exposure to the fastest-growing new economic sectors is limited.

Business as usual won’t sustain German industry long term. “No one has ever beaten disruption just by trying to do what they currently do better,” Viguerie said. If we look to Professor Christensen, he found that what causes great companies to fail is not that they are bad companies or badly led. On the contrary, he found that they were good companies well-led. They were acutely focused on meeting the needs of their customers. However, by pursuing incremental innovation and driving greater performance over time, they missed the disruption underneath them.

“Disruption is not new,” Viguerie said. “We think about it as a technology phenomenon, but many markets and businesses have been disrupted over the history of commerce.” The clipper ships, able to travel at ever faster speeds with additional sails, were disrupted by the steamship. This long history of disruption informed Professor Christensen’s theories of disruptive innovation and growth. Three concepts, rooted in his research and Innosight’s work, can provide some direction as Germany faces the future.

1. Traditional approaches to strategic planning fail when dealing with disruptive growth. “Disruption is different,” said Viguerie. “It’s not a linear extrapolation of the present.” It demands a future-back approach: envisioning the future (and future disruptions), defining a future-oriented strategy, and then walking that back to today. Rather than pushing an existing business model forward, leaders connect the dots back from the future to inform tangible initiatives to pursue today to enable transformative growth.
2. Navigating disruption requires a “dual transformation approach.” As Bernard Kümmerli explained, organizations must transform their core business while also building the new. And they must cross-leverage their key capabilities to achieve both. “Dual transformation is super powerful because it enables you to create the space in your head to do two things at once,” Viguerie said. “It is the mechanism that enables an organization to escape the innovator’s dilemma.”
3. Granularity focuses transformation efforts on high-impact opportunities. Value is created at the granular level in business. Therefore, granularity is necessary to focus resources, energy, and attention on things that really matter and to sharpen insights and decision-making.

Germany’s Innovation Framework and Infrastructure

Dr. Levin Holle, Chief Financial Officer at Deutsche Bahn AG

Dr. Joachim Lang, Director General and Board Member at BDI

Andreas Mundt, President at Bundeskartellamt

Christoph Brand, International Advisor at Goldman Sachs

In looking at Germany, we find an economy with a strong history of performance as well as a country considering significant challenges ahead in its future. “Before COVID, many companies had their best year ever,” said Dr. Joachim Lang, Director General and Board Member at BDI (The Bundesverband der Deutschen Industrie, or Federation of German Industries).

German companies today face significant pressures (and opportunities) in the areas of digitization and sustainability.

As Germany’s leaders seek to bolster the country’s strengths and rethink its models to deal with current and future upheavals, having the right infrastructure and innovation frameworks in place is important.

The German government has created ambitious goals in the areas of climate change and energy (for 2030 and 2045) that will require significant rethinking of federal bureaucracy if the country’s companies are to meet them. “Over the next eight years, depending on the sector, we will have to save between four and eight times more carbon than we did in the last 30 years,” said Lang. “I’m not saying it’s not possible, but this gives you a sense of the scope of the challenge.”

At the same time, there is the ongoing work of digitalization, an effort long ago dubbed “Industry 4.0” in Germany. “Many of the business models that we’re talking about here [depend on] having an infrastructure that works,” Brand said. “A digital business model without a good digital infrastructure isn’t really going to work, and infrastructure issues can actually become massive disadvantages.” While the private sector has made some great strides, some worry that public sector complexity and red tape could slow that progress. “We’ve got Industry 4.0, but we have a sort of Public Administration 1.0,” Lang said. “And we’ve got to close that gap.”

“When companies become more and more digital, then we need a digitized government as well,” said Andreas Mundt, President of the Bundeskartellamt (Germany’s national competition authority). “The public sector is actually permanently adopting new digital solutions.” Mundt pointed to the advanced data forensics and analytical tools used to screen for price-fixing or in areas such as merger control.

However, there are challenges in implementing digital tools: “Just imagine, we would upload business secrets which we have requested from companies to an unsecure private cloud. I don’t think the companies would like that, and as a public authority, we cannot do that,” said Mundt, who suggested that a government cloud could offer data sovereignty and the secure infrastructure the public sector needs to better support transformation. Germany is already driving the development and implementation of a so-called “federal cloud” (“Bundescloud”), a central and secure platform for the federal administration. “We have to think digital,” Mundt said.

The speakers concurred that — In the race to disrupt or be disrupted — sustainability, digitalization, and streamlined bureaucracy must coalesce.

Dr. Levin Holle, Chief Financial Officer at German railway operator Deutsche Bahn AG, said moving more transport to green railroads demands technological innovation, digitalization, and accelerated public planning processes. “The common denominator here is that we need to have dramatic changes of the framework conditions — I think we all agree on that — in order to make disruption possible,” Holle said.

2020 German Transformation Champions

Bernard Kümmerli, Senior Partner at Innosight

In the private sector, Germany has a number of transformational growth champions: those companies that have moved into entirely new business models or markets while also strengthening their core. Innosight identified eight such leading firms that have mastered dual transformation and repositioned their core business to create significant new growth.

These transformation champions delivered much stronger financial results over a five-year period than their counterparts in Germany, reporting an average revenue compound annual growth rate of 13.3% (compared to 4.8% for other companies) and annualized total shareholder return of 34.8% (compared to 12.7% among other companies). Looking at what those innovation and growth leaders do differently can be informative for German leaders.

The three most important lessons these companies have to impart are:

1. Transform preemptively. Dual transformation must begin before the house is on fire. Once companies face significant challenges, they tend to pull back on their investments in innovation. Growth champions commit while the core business is in good shape.
2. Be clear on goals. German growth champions have a well-defined growth vision. They clearly articulate a “north star” and the transformation’s purpose.
3. Maintain focus. Growth champions don’t just throw some ideas over a wall and hope that an accelerator or business incubator makes them happen. They identify and align on a select number of attractive growth areas and apply extreme discipline to pursuing them.

When asked to consider the hardest challenges a leader will face when driving dual transformation, Berlin Summit attendees ranked the courage to choose before the platform burns as the most difficult.

Reflections on Transformational Leadership

Dr. Axel Kaufmann, Spokesman of Executive Board and Chief Financial & Operations Officer at Nemetschek Group

Bernard Kümmerli, Senior Partner at Innosight

Nemetschek Group is one of Germany’s growth champions that Innosight identified, with almost half of its sales generated by new areas. The maker of software for architects, engineers, construction, and building management has a commitment to disruptive innovation that dates back to its launch in 1963. Nemetschek’s founder was determined to improve the inefficient and manual way that architects planned buildings. “He was really farsighted,” said Dr. Axel Kaufmann, Chief Financial & Operations Officer and Spokesman for the Executive Board at Nemetschek Group. “He said, ‘The way we build today — in Germany and in the world — cannot be the solution. There are many things that interfere with the process. It’s very inefficient. It’s too manual.”

In the decades since, without necessarily having a name for it, the company has taken a jobs-to-be-done approach to disrupting not only architecture, but also engineering, construction, and most recently building management.

The jobs-to-be-done framework asks not what new products or services does a customer want to buy, but rather what job is a customer hiring a product or service to do. It’s a mindset that broadens the possibilities and encourages disruptive innovation. “The job-to-be-done, making our customers work more efficient so they can provide better results for their customers, is in all of our projects,” Dr. Kaufmann said. “And that’s how we grew from a little architect and engineers’ shop to a global software company.” Nemetschek Group’s vision is to digitize the entire value chain, and its growth strategy is built around that crystal clear aim. Someday it may create solutions for building renovation or dismantling. Company leaders don’t think in distinct ways about strengthening core operations and moving into new business models or markets. “I think our motto has always been to do both,” Kaufmann said.

Transformative Innovation to Own the Future

Rafael Laguna de la Vera, Director at SPRIND

Chris Boos, CEO at Arago

Dr. Stefan Breit, Executive Director, Technology at Miele & Cie. KG

Professor Dietmar Harhoff, Director at Max Planck Institute

It’s clear that transformative innovation is critical to growth and longevity. One of the challenges is connecting those who are working in deep research and development with real-world applications and “jobs to be done” in a more effective way.

Rafael Laguna de la Vera, Director at SPRIND (“German Agency for Disruptive Innovation”), wants to use the power of the public administration to not only promote innovation, but also bring together the best minds from science and business to create new solutions. “Basic research is the foundation for the innovations and inventions that we promote,” Laguna de la Vera said. “But then we have to create a supportive environment — in terms of financing, networking, and space — to enable innovators to take the risks necessary to develop new, useful solutions.”

Balancing a focus on core strengths with a vision for the new can be difficult for any organization. It is especially so for a 122-old company like Miele & Cie KG. The German manufacturer of high-end domestic appliances and commercial equipment built its reputation on product performance and durability. “Having that as a starting point to walk towards something new is a bit of a challenge,” said Dr. Stefan Breit, Miele’s Executive Director, Technology.

To jump-start disruptive innovation, Miele Venture Capital, together with its external partners, looks at some 1,000 startups per year. Miele then usually starts with acquiring minority shares in the most promising companies with a focus on deep technological expertise aligned with the company’s growth strategy. Its New Growth Factory business group has been experimenting and piloting products in a number of new areas such as at-home vertical farming, new outdoor grilling technologies, and digital cooking services.

The manufacturer also has a huge stream of digital transformation occurring throughout the company as well as an ongoing focus on sustainability initiatives. “If I had one wish,” Breit said. “it would be determining how to connect those two mega topics.”

For Chris Boos, CEO at Arago, a provider of AI-enabled end-to-end process automation, one of the hurdles to transformative innovation is legacy thinking. Most leaders today are products of industrialization; productivity and economies of scale were the growth drivers. That’s not the case with technological capabilities like AI, which can have an exponential impact. New mindsets are required.

The biggest impediment, however, is the way R&D Is explored and funded in the private sector, according to Boos. Large companies must be more willing to invest in disruptive innovation that has a much longer investment horizon — 30 to 50 years— to achieve true technical transformation. “At the moment there’s investment with a horizon of three to seven years,” Boos said, “and we’re never going to get any technical transformation going that way.”

Availability of emerging and important skillsets is also critical, said Professor Dietmar Harhoff, Director at Max Planck Institute. “In German industry, we find ourselves in the middle of an important transformation, and it’s not enough just to say, ‘Okay, we’re going to hire AI minds,’” Professor Harhoff said.” We’ve got thousands of developers who are coming from engineering, and they have to be retrained. We need lifelong learning. We have to teach new skills to everyone.” This is not just a challenge, but an opportunity for Germany, added Harhoff. The country’s engineering heritage can provide an advantage in embracing an AI-enabled, data-driven future.

Disruptive Business Models and What Capital Markets Pay For

Steven Strongin, Senior Advisor at Goldman Sachs

Looking at how innovation has evolved over the last thirty years provides important insight to German leaders regarding what the marketplace will reward in the future. One of the most fundamental shifts that have occurred in the last 100 years — and certainly the biggest since the development of the production line — has been the replacement of products with services as the defining unit of business value, according to Steven Strongin, Senior Advisor at Goldman Sachs.

Historically, innovation was largely a corporate venture within a vertical chain. A company “created a great car or a great camera with their own particular expertise combined with a great deal of cooperation with other members in that vertical value chain,” Strongin explained. Today, companies work in ever greater partnership but across different vertical chains (or ecosystems) and demand even greater specialization.

“If you look at most firms today, they actually do fewer things than they used to, even if they offer more services, because they’re using other people to provide those bits and pieces,” said Strongin. Consider how car manufacturers ceded control of their own navigation systems in favor of integrating with smartphone map apps. “The control of the vertical has declined, but your ability to reach customers and layer on other systems has massively improved,” Strongin said.

This shift was manifestly evident in the early days of the Covid-19 pandemic. “I can still remember sitting in meetings where we were pondering with great focus the degree to which we could allow people to work from home,” Strongin recalled. Within Goldman Sachs pre- Covid, it was estimated at one point that, at most, 60% of the research department might be able to work from home while just five or ten percent of the trading department could work remotely. “As it turned out, we found we could reach 99.9% in both places, but we did so but using non-Goldman technology,” Strongin said.

This is what we see in market capitalization today: the market values narrowness and discipline. Large financial services companies bemoan the fact that fintech upstarts with very little cash may be valued higher than their much larger firms for the same enterprise. But the reason for that is a logical one. A large company can spend — and ultimately waste — much more money chasing a bad idea. A small startup is going to take its shot and either win or shut down. That requires much more discipline and is worth more than, say, a COO spending billions of dollars trying to prove that he’s right,” says Strongin. Companies want a thousand shots to get something right, Strongin explained, and that’s where they are most at odds with the marketplace.

Ultimately, the marketplace is designed to reward that focus and discipline and discourage organizations from continuing to go down the road of supposed innovation in situations where the company is failing to ask the right questions to start. “The market wants you to try,” said Strongin. “But if it doesn’t work, they want you to move on to something else.” The marketplace is taking a portfolio approach to innovation, and the winners in the everything-as-a-service economy will be those new approaches and technologies with the broadest applicability. Understanding how to navigate disruption will be instrumental in helping Germany’s leaders not only preserve the country’s hard-won prosperity and social stability but also best position the national economy for the future. Innosight’s decades of research, along with a look at what Germany’s own transformation leaders are doing differently, offers some clear instruction on paths forward for the country’s private and public sector leaders.

Conclusions

A dynamic marketplace demands (and rewards) change. As the German economy faces the risk of significant disruption, it is important to remember that no one has ever beaten disruption just by trying to do what they currently do better. Attendees overwhelmingly agree that Germany needs to better handle disruption and the innovator’s dilemma in order to create the next wave of prosperity. It’s simple in theory but challenging in practice: companies must disrupt themselves.

A jobs-to-be-done lens is needed to fuel innovation. Customers don’t buy products, Professor Christensen argued, they hire them to do a job. The German American economist and Harvard Business School professor Ted Levitt famously said: “Customers don’t want to buy a quarter-inch drill, they want a quarter-inch hole!” Thinking this way enables a more transcendent view of what customers really care about. The jobs to be done don’t tend to change much over time, but the solutions do.

To beat disruption, sustainability, digitalization, and a streamlined bureaucracy must coalesce. Germany must not only bolster its historic strengths, but create new foundations for the future to make Industry 4.0 a reality

Dual transformation drives long-term value. Incumbent firms can leverage their core capabilities — acquired knowledge, experience, and competitive advantage — as a basis for creating something new. Those who harness their strengths in this way are able to improve and bolster their core businesses while enabling disruptive innovation and growth.

Having the right innovation system in place is important. The basis for innovation has changed significantly. Historically, innovation was largely a corporate venture within a vertical chain. Today, companies must work in ever greater partnership across ecosystems. As products shift to services and value chains disaggregate to create more direct-to-consumer possibilities, companies need to adopt new approaches to innovation, such as incubators and partnering across verticals, to win the marketplace.

Next Steps

The 2021 summit is the first in a series of senior peer-to-peer events and thought leadership that will explore how disruptive innovation and other management lenses can help to guide the German economy toward continued prosperity. Christoph Brand and Bernard Kümmerli thank the speakers and participants for making this first summit so successful and look forward to convening future summits and continuing the conversation with business, academic, and policy leaders. Explore more resources and request an invitation to join the next event at: https://www.innosight.com/insight/the-future-of-german-competitiveness/