Germany Fights Back

You couldn't find a more contented spot than the rolling hills and vineyards around Schweinfurt, a placid town of 55,000 some 30 miles from the former East German border. And for factory workers at FAG Kugelfischer, the world's third-largest ball-bearing maker and the town's largest employer, life has always been good. Well-polished Mercedes sit in the driveways of tidy homes. Come annual vacation time, employees head for six weeks of sunbathing in Spain.

But in January, prosperity came to an end. Battered by Asian price-cutting and shocked by mounting losses in eastern Germany, executives told a stunned gathering of workers that half their factories would have to be sold or shuttered to keep the 110-year-old company alive. Since then, it has axed 2,700 employees. Thousands more now face a similar fate. "Everyone has to fear for their livelihood," says Susanne Kretzer, whose mother and both grandparents worked at Kugelfischer and who lost her own job in the first round of cuts. Kretzer's husband, a machinist, is terrified his job will go next. If it does, the Kretzers could lose their home.

STUNNED. It wasn't supposed to happen this way. The fall of the Berlin Wall and the reunification of Germany were going to create a $2 trillion dream economy whose skilled workers and world-class manufacturers would make it the envy of the world. But instead of newfound riches, Germans woke up to find themselves straining under high interest rates, brutal global competition, labor strife, and a recession that's putting all of Europe into a blue funk. No longer the economic-miracle nation, "Germany's suitability as a location for business and industry is being questioned," laments Daimler Benz Chief Executive Edzard Reuter. "German companies have lost their international lead."

Now, Germany Inc. is fighting back. Stunned by its economic comeuppance, Germany is finally getting serious about restructuring in a way that Japan did after the yen shock of the 1980s. And this isn't just a knee-jerk reaction to an economic downswing. From mighty Daimler to the thousands of tiny Mittelstand companies that form the backbone of the economy, something far more profound is unfolding. Says IBM Deutschland CEO Hans-Olaf Henkel: "There's a revolution under way."

Indeed, German manufacturers are in the midst of the biggest upheaval since the country was rebuilt from the ashes of World War II. What they are trying to avoid is a lengthy industrial decline that would spell big trouble for the entire world. Even mired in recession (charts, page 50), Germany remains the fulcrum of Europe. With currency turmoil and political tensions already threatening the European Community's unity plans, the EC desperately needs a strong and expanding German economy to make its free-trade efforts pay off. The economies of the former Soviet bloc also need Germany as a source of investment and a market. America has a big stake, too, since it sells Germany $30 billion worth of goods and services a year.

Most experts believe the Germans will pull it off. They point to such enduring German strengths as a highly trained and literate work force, an efficient national infrastructure, and years of export savvy. But success is hardly guaranteed, and many Germans will pay a painful price as they struggle to catch up to their global rivals. As the recession bites deeper, corporate restructurings are severely straining the social contract among business, labor, and government that has underpinned four decades of postwar growth. Germany's highly unionized, well-paid workers now are being told to shoulder huge layoffs and accede to stagnant or even lower living standards. No longer can workers count on short 35-hour weeks, lengthy vacations, or comfortable sinecures. "You used to join Siemens for life," notes Claude Courteaux, Paris-based senior vice-president with General Electric Co.'s Medical Systems Div. "Now, there can be no more promises."

As that realization spreads, tensions are mounting. With unemployment expected to rise past 9%, jobs are growing scarce and violence against foreigners is on the rise. So is labor strife: Across eastern Germany, for example, some 70,000 metalworkers walked out in May seeking a 26% wage increase to bring eastern salaries closer to western levels.

But the broad outlines of a new social contract are appearing. Despite the eastern labor stress, union leaders are now hinting that they would be willing to trade wage moderation and greater job flexibility for a stake in German corporate profits. And in coming months, Chancellor Helmut Kohl is expected to slash government spending, cut business taxes, spur deregulation, and privatize the state phone monopoly DBP Telekom.

SEA CHANGE. But the politicians are not the driving force behind Germany's economic revolution. Corporate Germany itself is the No.1 actor. Manufacturers have shed 500,000 workers since early 1992, as they have sought to ease the sting of Germany's $25.21-an-hour production costs (charts). They are also going global with a vengeance. Germans are opening plants in eastern Europe, China, and South Carolina to tap into cheaper labor, serve faster-growing markets from local bases, and concentrate domestic efforts on high-technology goods. The move abroad may undermine Germany's reputation for producing top-quality items. But manufacturers are undeterred.

Labor flexibility is only part of the equation. Management ranks are being flattened to speed decision-making. And executives, engineers, and factory workers alike are rethinking the entire way they design, produce, and market everything from cars to environmental cleanup gear. That's leading managers into a sea change. For the first time, they're being governed by what the market wants instead of what engineers think consumers need.

Why are the Germans being shocked so suddenly? Part of the reason is that the reunification binge concealed the need for the structural changes required to respond to the U.S., Japan, and even France. With domestic demand booming, competitive retooling was hardly a priority. But now that recession has sunk in, there is little escape from the imperative to become competitive. Much of that effort is centered around the four big industries--autos, machinery and machine tools, electrical engineering, and chemicals--that account for 60% of Germany's $425 billion-a-year export trade. At the forefront of competition from Asia, the U.S., and eastern Europe, they now are the acid test for Germany's makeover.

Carmakers and their suppliers alone account for nearly $1 of every $5 in German exports. With 1.6 million workers, they're also the nation's biggest employer. But now, with everyone from Toyota to Peugeot to General Motors eating their lunch, German auto makers are embarking on radical shock therapy to restore their edge. Take Volkswagen. To CEO Ferdinand Piech, the company is in a "crisis." No wonder: The highest-cost big-volume car producer in Europe, it made 3.5 million vehicles last year, yet it couldn't earn a pfennig. So Piech is getting tough. Since taking over on Jan. 1, he has cut VW's plant spending in half, to $3.8 billion, and is slashing its work force by 36,000, or 14%. He is also orchestrating a savage campaign to shrink VW's $33 billion annual supply bill.

PROFIT SKID. This spring, Piech won away General Motors Corp. purchasing czar Jose Ignacio Lopez de Arriortua with a rumored $20 million package. At GM, Lopez won acclaim--and plenty of fear--for browbeating parts makers into reducing prices. Now, he's demanding VW's supplier corps cut prices as much as 50%. In so doing, estimates Bank Julius Baer analyst Carmen Domenech, Lopez may be able to save $4.8 billion a year.

Mercedes-Benz is also moving. The whipping that the Japanese have delivered to German luxury-car makers was particularly humbling to its CEO, Helmut Werner. Last year, as Mercedes' profits skidded 45%, execs were stunned to discover that their production costs were 35% higher than Japan's. In response, Werner declared his cars "overengineered" and ordered up a new line that more consumers can afford. One answer will appear in showrooms later this year: an amenity-packed "C-class" sedan that will cost about the same as the less-well-equipped 190-series model it replaces. And close on the heels of BMW's move to build an assembly line in Spartanburg, S.C., Mercedes is preparing to open its first U.S. auto plant to build sport utility vehicles.

The auto producers' battle to remain competitive is having a profound effect on the Mittelstand, which generates half of Germany's GDP. Facing the end of fat contracts, these smaller companies are devising new methods so they, too, can survive. That's the story at Allgaier-Werke, an auto-tool maker 25 miles from Stuttgart. Forced to slash its prices as much as 30%, it has switched to "concurrent engineering" involving teamwork with BMW and other customers. That allows Allgaier to suggest changes as cars are being designed. One such change permitted BMW to cut from eight to three the number of steps it needs to stamp fenders.

"IRON GRIP." If regaining competitiveness in autos is vital to Germany's present, electronics will be the key to its future. Realizing that, Siemens, Bosch, and Daimler's AEG unit--the big three of electrical equipment and electronics--are rushing to retake lost markets and conquer new ones. The Germans are investing billions in chip technology. But instead of building basic low-margin chips, they are focusing on highly profitable complex systems built around application-specific chips. Those include such products as antilock-brake systems and airbags. Last year, for example, AEG opened a $2 billion microelectronics joint venture with Deutsche Aerospace. "We have to keep an iron grip on the intelligent part of a car," says AEG chief Ernst G. St ockl.

The strategy plays to Germans' adroitness in engineering complex systems. But to win in new markets, they will have to do more. Just ask giant Siemens, whose bureaucracy was renowned for hamstringing innovation and making the customer the last priority. When private competition to DBP Telekom was allowed in 1992, Siemens was thrust into competition against L.M. Ericsson and Motorola Inc. as phone users clamored for sleeker--and cheaper--digital units. To keep its customers, Siemens had to engineer a digital phone selling for $1,150, an eighth of its predecessor's price.

Next time around, Siemens may be first out of the gate. Since 1989, it has flattened management and created hundreds of profit centers. Siemens' private communications group cut product-development time by 30% last year and is now gunning for 40%. In Toulouse, France, it has halved production time for electronic motor controls. A leaner Siemens is also winning big orders in Asia, a key market growing at 10% a year. In 1994, it will start producing 300,000 mobile phones a year in Shanghai.

The sales surge is making rivals take notice. Siemens recently snatched a Greek order for submarine telecommunications cable away from Alcatel by undercutting the French company's bid by 20%. "They're responding quickly in the market, which is not business-as-usual," says Alcatel Cable Chairman Claude Bovis. "Siemens has become closer to the customer--and more efficient."

Electronics makers also are ditching the old tradition of producing from start to finish in Germany. To save money, AEG started making cases for high-voltage power-plant transformers in Poland, Greece, and Turkey last year instead of in Germany. So now, a truck leaves Istanbul every month headed for Berlin, carrying one enormous steel casing for AEG's top-of-the-line, 400-ton transformer. Once the casing hits Berlin, German workers install the high-priced electronic circuits that make the unit work.

As Germany's electronics giants reprogram themselves, metals producers and other old-line industries are going high-tech in search of business. Hit hard by collapsing steel orders, for example, Thyssen CEO Heinz Kriwet is jumping into mobile phones. A Thyssen-led consortium including BellSouth Enterprises Inc. is spending $4.4 billion to build Germany's third mobile-phone network. The network will create 8,000 new jobs and may garner annual revenues of $1.2 billion by the decade's end.

BIG SHIFT. Then there's Metallgesellschaft (MG), Europe's largest nonferrous metals company. In five years, CEO Heinz Schimmelbusch has spent $1.6 billion to buy recycling, pollution-control, and decontamination companies. MG is now one of the largest environmental-services groups in Europe, with sales of $3 billion. Laws requiring waste recycling play into Schimmelbusch's green strategy. MG is the only company in the world with the technology to recycle highly toxic aluminum-slag waste.

To usher in this new era and help manufacturers compete in new industries as well as old, labor and government leaders are working together. They are moving to chip away at the restrictive work rules and lavish benefits that middle-income Germans have come to regard as their birthright. If those are to be contained, unions will have to settle for as much as a decade of wage stagnation. That may lead to the first big shift in labor-management relations in years. Despite fiery rhetoric during the eastern German walkout, metalworkers' chief Franz Steink uhler may trade more job flexibility and less generous wage hikes for government aid to emerging industries and a share of employers' earnings for his 3.4 million members.

It's too late for organized labor in America to consider such a trade-off, but the different position of unions in Germany means that leaders such as Steink uhler have a unique interest in making sure Germany regains its competitiveness. In no other industrialized country is labor so involved in corporate governance. Workers control up to a third of the seats of big companies' supervisory boards, giving them a major say on everything from the selection of CEOs to restructurings and layoffs. Steink uhler, for instance, is deputy chairman of VW. As such, he helped select the two men--CEO Piech and Lopez--who are now savaging the auto maker's payroll. But questions over his role in an alleged insider-trading scandal may diminish his power. Steinkuhler, who is also a Daimler Benz board member, admitted earning $38,000 trading shares in a Daimler company. He denies any impropriety.

Germany's economic turmoil is breeding a distinctively German-style effort to come to grips with an economic crisis the nation never expected. But it's one Germans must confront with sudden intensity. They are being asked to make huge competitive strides of a sort that the U.S. and Japan are making. The success of this catch-up depends on nothing less than reawakening the German spirit that rebuilt the country after World War II.

The risk is that years of prosperity mean German business, labor, and government won't be willing to make the sacrifices that have made the German economic model work. But as each day passes, evidence is mounting that the Germans will agree to adjust the underpinnings of their system to preserve their prosperity.

      The new German model will:
      Rely more heavily on cheaper manufacturing bases; more goods will be made 
      outside Germany
      Demand much greater flexibility with labor costs, work rules, and social 
      requirements at home--in effect creating a new social pact
      Concentrate on delivering what consumers want, not on making expensive, 
      overengineered products
      Move into newer, higher-value-added technologies
      Depend on a much more deregulated and privatized economy with more 
      opportunities for private enterprise
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