Germany Enters The New Economy

How hot high tech could keep the country growing

It was a dorm room startup in the mold of Dell Computer Corp. Chums since age 13, Jurgen Peter and Sascha Hancke launched a computer services company 15 years ago while still in college. Now, with sales of $90 million and 280 employees, hancke & peter IT Service is booming: On Jan. 25, the two pals raised $22 million to make acquisitions and double staffing over the next three years. It would be a classic American success story--except that it happened in Aachen, Germany, a town of 251,000 near the Belgian border that is rapidly becoming a hotbed of entrepreneurial activity.

Therein lies the grand paradox of the German economy. The old Germany is struggling as consumer spending sags and as weaker players get splattered by the Asian and Latin American crises. Those problems have led Morgan Stanley Dean Witter to scale back its estimates for German economic growth this year to just 1.3%, the weakest showing among the 11 nations in the Continent's new euro zone. Yet even as many mature German companies continue to sputter and cut jobs, there is huge vitality in so-called "new economy" industries, from biotechnology to software. Says Simon E. Moroney, CEO of 1992 Munich biotech startup MorphoSys: "Germany is moving toward much more of an American model: dynamic, high turnover, fast growth. It's a very exciting time because we're just starting off down that road."

Indeed, Germany seems to be splitting into a two-tier economy. In manufacturing, where Germany is more heavily exposed than any other country, the trend is clear. Companies like DaimlerChrysler, Volkswagen, Continental, Bayer, and Mannesmann have been remarkably adept at restructuring and remaining competitive. Productivity is soaring as manufacturing unit-labor costs dropped 10% over the last two years, while J.P. Morgan figures that the country's trade surplus in 1998 was a powerful $80 billion. Even though exports are lagging this year, J.P. Morgan still expects Germany to boast a $75 billion trade surplus for 1999.

But there's also a manufacturing underclass that hasn't profited from streamlining or by tapping hot markets across Europe and in the U.S. Meanwhile, high wages and rigid labor rules have kept even highfliers from adding workers--the main reason German unemployment is still distressingly high at 10.8%. This year, Germany's manufacturing laggards will also be vulnerable to soaring costs if labor unions succeed in winning high pay hikes. That's why the surge in "new economy" service and data-based companies is so important for Social Democrat Gerhard Schroder's newly elected government. New jobs in telecoms, computers, media, software, and entertainment may make up for employment losses elsewhere--especially if the economy slows.

LABOR DROUGHTS. That shift in job creation is most evident in telecommunications, where deregulation sparked several hundred startups last year. Onetime monopoly Deutsche Telekom shed 11,500 jobs, or 6% of its total, but the German telecom sector still created 40,000 new jobs last year. Amazingly, labor shortages are even cropping up. Viag Interkom, an upstart rival to Deutsche Telekom, more than doubled its head count to 3,500 last year. It's having so much trouble finding the 100 technicians it needs to hire each month this year that it's running want ads and hiring headhunters in Britain to fill the gap. "The British market was privatized 12 years ago, so there are a lot of experts there," explains a spokeswoman.

Powered by deregulation and new technology, the job boom is spreading from Aachen to places like Munich and Cologne, where scores of biotech start-ups are springing up. In Walldorf, software giant SAP boosted its German workforce by 2,064, or 37%, last year.

Another driving force is the red-hot Neuer Markt, the German growth-company stock exchange. The Neuer Markt shrugged off the world economic crisis, rising 170% last year. The vast majority of Germany's 70 initial public offerings during the year were on this exchange, driving its market capitalization to $46 billion. Up to 100 IPOs are expected this year from companies in telecom, Internet services, entertainment, media, and biotech. "There are new industries developing like the ones in the U.S.," says Josef Nagel, head of primary markets for Deutsche Borse, the company that runs the Frankfurt stock exchange. "Everything that's sexy, high growth."

Biotech is a case in point. Pressure from environmentalists had nearly wiped out German biotech by the early 1990s. But a federal program started under ex-Chancellor Helmut Kohl forged a comeback by pumping grant money into promising biotech centers such as Cologne, Dusseldorf, Munich, and Heidelberg (see BW--Jan. 25). Loads of venture capital soon followed, and the head count of biotech companies in Germany skyrocketed from only a handful in 1990 to close to 500, estimates Schitag Ernst & Young. "When we started up, this was a desert," comments Moroney, whose MorphoSys employs 61 people, 22 of them PhDs. "Now, looking out my window, I can count 30 other biotech companies, and I'm probably underestimating."

Germany's anemic service sector is also getting a boost. Deregulation has opened up broadcasting since the late '80s, for instance, and now many of the hottest companies on the Neuer Markt are in music and entertainment. On Feb. 3, for instance, a Bavarian film company called CineMedia Film AG raised $120 million in an IPO. Perhaps the hottest company in Germany right now is EMTV & Merchandising AG, a Munich producer and syndicator of children's programming that had sales of just $15.5 million in 1997. It has done a flurry of deals, including a recent joint venture with Kirch Group in which it paid $300 million for half of Kirch's children's programming unit. JUNIOR.TV, over which EMTV has management control, has a library of 20,000 cartoon and other half-hour program segments. How could little EMTV finance the deal? Its share price rose 3,400% in a little over a year and its market cap is now an astonishing $4 billion. Leanly managed, it's not a huge employer, but it has doubled its workforce to 130 in two years.

OLD DOG, NEW TRICK. Can all this new dynamism ever offset the structural weaknesses in Germany's economy? University of Maastricht Professor Luc Soete argues that European countries are at a disadvantage in growth industries compared with the U.S. because language problems, lack of common pension and medical plans, and other labor rigidities make it difficult to lure the best and brightest from around Europe.

And in Germany's case, union wage demands this year will keep the pressure on traditional industries. But even here pessimists could be in for a surprise as old-line companies find new ways to manufacture cost-effectively. For instance, Hanover tiremaker Continental has held its German employment in the ultracompetitive tire biz steady at about 20,000 by boosting sales in profitable niches such as high-performance snow tires. "Part of my job is to defend our high-cost labor here--if I can," says CEO Hubertus von Grunberg.

If unions and employers can agree on reasonable pay raises, von Grunberg is convinced he'll be able to keep his job rolls steady in Germany--even if he doesn't increase them. Otherwise, he admits, "I'll have to reconsider" the strategy. As Germany's exports slow, the big question will be how much its globally competitive giants, along with its tech and service companies, will be able to create jobs and spur growth.