The Mittelstand man

For decades Fiducia has been helping German companies to do business in China. With a client roster of some of the key manufacturers from the Mittelstand, the Greater China-based advisory firm has unique insights into German executives’ sentiment on China. Here Stefan Kracht, the second-generation owner of the family firm, talks to WiC about how his clients are reacting to the Sino-US trade war and changing business conditions in China.

You had a major conference with your Mittelstand clients in Munich recently. What is the mood across Germany Inc about China’s economic prospects?

I have a number of recent reference points on this topic. Our Mittelstandstag event in Munich is one. The second is the Asia-Pacific Conference in Jakarta which had nearly a thousand participants – mostly from German companies – and included board members from giant firms such as Siemens, Thyssen Krupp, and Bosch. The third is the event I’m attending now: the Guangdong-European German Investment Conference. There were around 500 attendees this morning including the China chief executives of German firms.

We had close to 80 companies at our Munich event, all of which have operations in China, and their outlook was surprisingly upbeat. I should add that no one who is doing badly generally comes to such events, and those who do come tend to be pretty happy about how well their business is doing in China. For instance, one of the German firms that attended had a record year in global terms, largely thanks to a 70% jump in its China sales in 2017.

I would categorise how companies are doing based on the industry they are in, their size, and the period in which they first came to China.

Mittelstand firms that came to China 20 years ago and have a large installed base are generally doing well. In the automotive sector, for instance, they followed their customers and prospered with the growth of companies like VW and BMW in China. Later on they kept expanding by making sales to the Chinese car firms. One of our clients has done very well selling lubricants and now makes around Rmb3 billion ($431.97 million) in China – roughly 15% of its global sales. They have been in China for ages and continue to fire on all cylinders.

The other category I’d mention are medium-sized companies who have come to China more recently, in the last three to five years.

They are also doing well, but are in the growing pains stage. Much of what they were told five years ago doesn’t hold true anymore – for example, in regard to costs. It’s a bit of a changed game.

Then there’s the smallest group: German companies that are much smaller and very new to China. There I am a bit more pessimistic because the barriers to entry are higher and the investment costs are proportionately bigger.

Business opportunities are not so obvious for these newcomers. The golden period was 10 years ago, just after the stimulus.

For the majority of our established clients, the last decade in China has been good and the current challenges are not having a significant impact on their numbers.

If you ask me how many clients are thinking of shutting down their businesses in China I would say none in our roster. But anecdotally I do know of German companies that have left or are planning to leave.

So at these events there weren’t major concerns about a slowing China? The firms you spoke to still have rising revenues?

The view was certainly more positive than we expected. But in certain sectors German managers are being more conservative in their 2019 planning. Their biggest challenge is to manage expectations back in Germany where their head offices have got used to 20% sales growth in China after a series of record years. I don’t see that happening across a variety of industries anymore, especially not in the automotive sector – unless the government changes regulations or injects stimulus. I would say most of our installed base of clients is formulating low double-digit Chinese growth targets for 2019.

Moving away from the industrial companies, what other sectors have good prospects?

Mittelstand players are also excelling in the medical equipment sector. If you visit any top class hospital in China, you’ll see a lot of hardware from Germany. But this sector faces some special challenges. Nearly all of them sell into China but do not manufacture here. Even though they have been encouraged to do so under Made in China 2025, and even though China accounts for a growing share of their global sales, they are very reticent about doing so. They’re too worried about sacrificing their intellectual property. One client who makes nearly 30% of its global revenues in China still refuses to produce here for this reason.

Companies in the medical and food sectors are also finding it tougher from an ‘ease of doing business’ point of view. They’re facing a variety of regulatory and bureaucratic hurdles. For instance, there simply aren’t enough people around to do the testing needed to get the approvals quickly, meaning that registration processes can take up to two years.

But generally I am positive about this sector. Similar to machinery and automation, this is stuff that China needs, and domestic production is not yet up to the standards of foreign technology.

Did your clients attend the Import Expo (CIIE) earlier this month in Shanghai?

About 170 German companies participated at the CIIE under the guidance of the Association of German Chambers of Industry and Commerce. That’s a small number compared to the thousands that are invested in China. Because the CIIE was an import fair, I would also have expected the number of German exhibitors to be much bigger.

But the expo was not promoted very aggressively in Germany over the past six months. Even now it’s not getting much press coverage – unlike the Hong Kong-Zhuhai-Macau Bridge which was all over the news in Germany, as a testament to Chinese infrastructure development and the future of Hong Kong.

Nor did the import fair get much high-profile support from the German government. Our economy minister went to the Asia-Pacific Conference in Jakarta but not to the Shanghai expo.

My clients who did go pointed out that it was held in the oldest of three convention centres in Shanghai and the logistics of getting there were a nightmare because of the location and the high levels of security.

Will the fair meaningfully increase German exports to China?

No. There weren’t enough companies attending and not enough marketing was done in Germany. It wasn’t on the radar. I was in Shanghai the week before and the only reason we were talking about it was because of the blue skies – a board member at a large client pointed out it was because President Xi Jinping was coming to the CIIE.

Some senior executives have indicated that foreign firms are no longer as welcome in China as they were 20 years ago. Is that a feeling your clients express too?

It depends who you speak with. The older generation of German entrepreneurs had a very romantic idea of Germans in China: we’ve come as friends, we’ll become partners, it’s a win-win, and so on. Many of them now feel that the honeymoon period is over and they’re leaving China. But it’s not always because they feel that the business environment has become less welcoming. I know a general manager who quit his position because he refused to use WeChat and as a result was rendered immobile and non-functioning; he couldn’t communicate or even pay for things.

Most of the foreign friends I made while working in Shanghai in the 1990s have left China. Some were put off by a lot more controls, some by pollution, others by the ‘new nationalism’. There’s a bunch of factors. But the new generation of managers at German firms have adapted well and have taken a more practical view on the new China. Localisation is happening and it’s a good thing. But a lot of younger bosses who don’t know the pre-WeChat time find it more challenging to manage the head office back in Europe.

What they do see are two main threats. The earlier threat was posed by private sector firms that were often created by managers from German firms who quit to take on their previous employers. The second is more recent and relates to Made in China 2025. This is competition from local companies that enjoy state support or have become state-invested though debt-to-equity swaps. I hear from clients that these types of local competitor are underbidding them in tenders not just by 20-30% but by 90%. They are sometimes selling below raw material costs, which can only mean they are being financed to grab market share.

But you have to look at it by industry. In high-tech areas such as semiconductors, 3D printing and automation – where China is not competitive yet – foreign companies are being increasingly encouraged to localise. It’s reaching a squeezing point because head office is resisting localisation based on IP concerns. For instance, one local manager wanted to qualify the company as a ‘high and new technology enterprise’ to get a preferential rate of corporate income tax, but it was vetoed by the board in Germany because they didn’t want to localise any more IP.

So one of the highest ranking concerns of German clients is this trade-off between protecting intellectual property and localising more manufacturing?

Absolutely. The old fear of being copied in China and having no way to legally resolve the case still persists. This concern was voiced at this year’s Mittelstandstag event more strongly than ever. The most-asked question last year was ‘how do I get my dividends out of China’? Now it has shifted to: ‘we don’t know what to put into China because we are worried about data security, and whether there will be a level playing field when fighting an IP infringement case against a local competitor’.

I still think it’s more an issue of perception. I have seen as many successful cases in terms of the IP lawyers we deal with as I have scary stories. But in the German press it is always the scary stories that our clients read.

What about the situation with the US and the trade row?

Many clients are worried about the Sino-US trade war escalating, but there is no sense of urgency. They’re taking a “wait and see” approach.

A few clients are already suffering the impact of new tariffs, especially those producing machinery in China for export to America. But not many of our mostly European clients who export from China are heavily exposed to the American market.

One client that produces components has actually benefited from the softening of the renminbi. Its products don’t currently face tariffs so it has enjoyed a short-term export boost. However, it is worried about tariffs hitting its product group in the medium term.

For German companies selling to China, most of the concerns are more long-term than immediate. They fear the impact that an extended trade conflict could have on China’s economy and consumer confidence.

Are the Chinese still keen to buy German companies?

Among all of our Mittelstand clients I don’t think there is a single one that hasn’t been approached by a prospective buyer from China. In most cases these are opaque approaches, often through frontmen and with unclear financing. An example would be a family-owned company that makes switches. Three men showed up saying they worked with a Chinese state fund, offering to acquire their technology for a lot of money. But if you know anything about Germans, you’ll know that you’ll get nowhere by approaching the owners of an old family business and putting a bunch of cash on the table. If anything, you’ll annoy them and burn that bridge.

So yes there have been many approaches but very few examples of sellers – just a handful. These are usually firms that were private equity owned; not family-owned. An example is Romaco, which does packaging for pharma. It was sold to the biggest Chinese competitor. Had it still been family-owned, this probably wouldn’t have happened.

The German government recognises the danger, in terms of competitiveness, if many of its industrial Mittelstand companies are sold. So it has come up with an industrial plan that roughly translates as ‘shoulder-to-shoulder’ to create more cooperation in Germany Inc and discourage Mittelstand firms from selling to Chinese buyers.

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