Hidden Champions of the 21st Century Success—Strategies of unknown mid-sized world market leaders

Date October 21, 2011
Speaker Prof. Dr. Dres. h.c. Hermann SIMON(Chairman, Simon-Kucher & Partners)
Commentator OTA Takehiko(Director, Regional Economic Development Department, Organization for Small & Medium Enterprises and Regional Innovation, JAPAN)
Moderator YOSHIDA Yasuhiko(Director, International Coordination and Public Relations, RIETI)


Hermann SIMON's PhotoHermann SIMON

Why are Germans always one of the leaders in exporting? This cannot be explained as merely the influence of large corporations. Germany only has half the number of global corporations as Japan, but German exports are almost twice as high as Japanese exports (1.8 times higher for the years 2008-2010), and while large companies conduct the majority of exporting in Japan, Germany has a powerful mid-sized sector that is the main driver of its economy. Germany's strength in exporting can be accredited to its ambitious mid-sized companies, or more specifically, what is referred to as "Hidden Champions."

Hidden Champions are companies that are world leaders in their respective markets, with revenues below $4 billion. They are usually unknown to the public. The smallest Fortune 500 Company is about three times larger than the biggest Hidden Champion.

This topic has attracted worldwide attention because countries are increasingly recognizing that they cannot build their futures in the global market with large corporations alone. 88% of all countries have no entry in the Fortune Global 500. Countries need strong mid-sized companies. South Korea, for instance, has started an initiative to create 300-500 Hidden Champions in the next 10 years. Of course, the current structure of South Korea is similar to Japan, with big successful corporations and a weak mid-sized segment, so this is a very ambitious project.

In the case of Germany, Hidden Champions have created one million new jobs in 10 years, achieved growth of 10% per year, and today are four times larger than they were in 1995. Additionally, more than 200 new billionaire (US$) companies have emerged from former Hidden Champions.

Why are these companies so successful? How do they differ from large firms? There are a number of lessons that Hidden Champions teach us.

Lesson one is that success begins with ambitious goals. The Hidden Champions of the 21st century strive for growth and market leadership. This is the fuel that drives them forward. One does not stumble into world market leadership—one needs ambition from the beginning.

Focus and depth are the essential elements of the strategies of these companies. An example is Winterhalter, a dishwasher company that changed its focus from broad to deep in order to become the market leader in its field. In this case, instead of serving all segments of the commercial dishwasher market, it decided to deepen their focus and concentrate on hotels and restaurants and providing better products and customer service. As a result, all of the big players such as McDonald's and Burger King use its cleaning equipment. It found that the needs of hotels and restaurants are more or less similar around the world, whereas the needs of hotels and hospitals are very different, and adopted them to its company's policies.

This case shows the importance of deep value chains for Hidden Champions. While the hottest fashion of the last 20 years has been outsourcing, these champions do not outsource any of their core competencies, and often even make their own machines. They refrain from outsourcing their products to maintain a high quality standard and go deeper into the value chain where they create unique processes and technologies, which are then used to create a superior end product. Superiority can only be created internally because what you buy on the market is also accessible to your competitors. If you create it internally and keep it for yourself, there is a better chance that your product will beat all others. Products are created by strictly following the quality standard guidelines that are defined by the company itself.

Lesson two is that only focus and depth lead to success as a world class company. The Hidden Champions focus on narrow markets and are deep rather than broad. They tend to do things themselves and refrain from outsourcing core competencies. Globalization is the second pillar of their strategy. If you go with accelerating globalization, here is no limit to growth. However, this takes time because it requires that you go directly to your customers and markets. Few of the products of Hidden Champions are like the Apple iPad or Google which are global from the time they hit the market. Instead, they build their global presence through their own subsidiaries and establish direct relationships with their customers rather than delegating this to trading houses, intermediaries, or distributors.

Lesson three is that the Hidden Champions combine specialization in products and know-how with global selling and marketing. Globalization is a growth booster for them. They serve the target markets through their own subsidiaries. They heavily invest into the markets of the future. The biggest difference between the Japanese Hidden Champions and others is their lack of international presence.

One does not become the market leader by imitation but by innovation, which starts with spending on R&D. The Hidden Champions spend 6.0% on R&D, while the Global Top 1000 spend only 3.6% and normal firms just 3.0%. While large corporations have six patents per 1,000 employees, Hidden Champions have 31 patents per 1,000 employees. This makes the cost per patent for large corporations $3.717 million, while it is only $0.725 million for Hidden Champions.

Lesson four is that Hidden Champions are successful because they are in a phase of massive innovation. The effectiveness of their R&D activities beats that of large companies by a factor of five. Their innovation processes are fundamentally different. Their innovations are driven by a balance of technology and consumer needs.

The biggest strength of the Hidden Champions is their closeness to customers—the customers drive these companies into performing better. Quality is more important than price to most customers, and the companies aim to meet this demand. Five times as many employees (25-50%) have regular customer contact compared to large companies (5-10%).

The Hidden Champion's strategy is not price-driven but value-driven. This means that their prices are usually 10-15% higher than the market average. The key elements in value-based pricing are understanding a product's value, quantifying the value in terms of price, and, finally, observing the product line and competitive situation.

The most important competitive advantages of the Hidden Champions are product quality and service directly relating to customers. Additionally, as a result of the importance of systems integration, advice for products has become essential. These advantages are different from attributes that are integrated in products which you can reverse engineer and imitate. These advantages are rooted in the heads of the employees or the capacity of your organization to manage complexity.

Lesson five is that closeness to customers is vital. It is the greatest strength of the Hidden Champions—even more important than technology. Their strategies are value-oriented not price-oriented. The Hidden Champions hold strong competitive positions. Advice and systems integration are new advantages which create higher barriers to entry and limit the competition.

With regard to ownership and financing, most of the Hidden Champions are family-owned. This does not mean that they are necessarily family-managed, and there is a trend toward hired managers. In the past, few Hidden Champions were publicly listed, but the percentage has gone up in recent years. Private equity is a new phenomenon with about 10% currently owned by private equity investors.

Key financial indicators of Hidden Champions include a 13.6% return on capital employed (ROCE) and an equity ratio of 41.9%. In particular, their high equity ratio helped them survive the recent financial crisis, despite being affected by the overall market decline.

Lesson six is that Hidden Champions are very solidly financed. Their ownership is long-term oriented, and capital markets do not play a big role. Rather, the Hidden Champions rely on self-financing and are conservative in financial matters.

Lesson seven is that the Hidden Champions have "more work than heads" and have a culture of high performance. This is the best productivity driver for companies. They focus on high qualification and low turnover. The foundation for this is the German vocational training system—one pillar of German competitiveness. The combination of practice and theory creates highly qualified workers. Global competition is increasingly concerned about qualifications and less about cost.

Once you train highly skilled employees, it is important to retain them, and Hidden Champions maintain extremely low turnover rates with strong company loyalty. The Hidden Champions instill a sense of mission and identity into their employees. For leadership, while it is authoritarian in principle, they promote employee participation and are flexible in the details of implementation. More often than in large companies, CEOs come into power while young, and more women are in top positions. In addition, the clear identification and continuity of leaders are the foundations for long-term success.

If one breaks up the workings of Hidden Champions into three different circles, then the core is leadership with ambitious goals, while the middle circle consists of innovation, depth, and high performing employees. Finally, regarding the outer circle, the important concepts are focusing on a narrow market, closeness to customers, clear competitive advantages, and conducting business with a global orientation.

In conclusion, the Hidden Champions of the 21st century go in their own ways more decisively and successfully than ever. They do most things differently from the teaching of management gurus, modern management fads, and large corporations. Maybe this is the most important lesson.


OTA Takehiko

When I was working in Germany, I read an article about Professor Simon's book in The Financial Times and wrote back to Japan on what I had learned, which was that the current robust German economy is led by exports—especially those of small- and mid-sized companies. According to the article in The Financial Times, those companies were quietly located in rural areas without the spotlight of the mass media but at the same time operated globally. Looking at the shrinking domestic market, the presence of small companies was felt throughout the world as these companies created access to world markets from their rural areas. Professor Simon called those companies Hidden Champions.

Germany and Japan have many things in common. Both are export-led manufacturing economies with non-English native speakers. There are more than 1,200 Hidden Champions within Germany. If Germany can foster these companies, so can we. Japan should learn from these German Hidden Champions about how to run its small- and mid-sized companies.

In Germany, I visited one of these companies that Professor Simon spoke about, and his lessons were true. In particular, I noticed strong leadership and that the company was upheld by two main pillars of strategy that valued specialization with a global focus and a strong relationship with the end customer. They were also regularly in contact with their top five consumers in order to capture their companies' needs and guide their innovation.

Professor Simon's book, Hidden Champions of the 21st Century, has been translated into more than 20 languages. It will appear in Japanese in February 2012. There is much to learn from Europe, especially Germany, and we need to look carefully at the European/German case studies.

Questions and Answers

OTA Takehiko: One question, as I said before, is that if Germany can, so can we. However, in reality, the globalization of Japanese small and mid-sized companies is still insufficient. What is the main difference between Japanese and German Hidden Champions? My observation is that the key to German Hidden Champions' success is direct selling, but most Japanese small and mid-sized companies are selling globally only through intermediaries or big companies—not directly to the global markets—so can you be more specific in this regard?

Hermann SIMON
If you had just asked me the question on what is the main difference, I would have said global presence. This is the same as what you just said—direct sales and contact with the customers. Closeness to customers cannot be established if you have intermediaries in between, and you need to be in direct contact with them. Additionally, since most of the products of the Hidden Champions are quite complex, you need highly competent people in sales and installation services. Companies must establish their own subsidiaries to control service. Complex products need highly qualified people, which must be done on your own. Distributors are rarely able to do that.

That is the biggest difference between mid-sized German and Japanese companies. The differences are not in the products or the technical competencies but in the way they are sold. Therefore, Japanese companies must become international. It will take time, and it requires a certain cultural foundation as well as language capabilities—but the potential is there.

Q: Mr. Ota, you mentioned closeness to the markets, but this certainly requires international personnel within the company. What is the willingness of Japanese companies to internationalize, especially with regards to mid-sized companies?

OTA Takehiko

I have always wondered how German Hidden Champions secured those highly qualified people, especially Hidden Champions from the rural areas. I think it is much harder to get that kind of skilled labor in Japan. There is the possibility here for local small- and mid-sized companies to hire international workers and adopt a culture of internationalization, but I think it will take a little bit of time.

Hermann SIMON
This is the most difficult problem in globalization—people. It is also very difficult for German mid-sized companies. Usually, when they start, they either send the people they already have abroad or they try to hire people who speak German. However, if you are in the United States or Japan, there are very few people who speak German. Therefore, a big step for German companies was to establish English as a corporate language. I think this is also very important for Japanese companies, and they should at least demand that the younger generations speak English.

However, we also see that many of the German Hidden Champions in the founding generation did not speak English, but they had the courage to go abroad. It is also a matter of courage in addition to language capabilities. A company must have the ambition to become international and overcome the hurdles that stand in the way.

Role models play a very important role. We find that many small cities have three or four Hidden Champions because upon seeing the example of others, many companies sprung up out of even the most unlikely of places. It would be beneficial to METI to make some of these mid-sized Japanese entrepreneurs better known so that other people can use them as role models.

Q: For Hidden Champions, capital markets do not play a big role so what is the force that makes these companies' management efficient? Second question, in terms of exports, some say that German companies are benefitting from the euro, a united currency that links the country with weaker nations; do you have any comments on this? If the currency appreciated 20% or 30%, would these Hidden Champions still be able to continue to export?

Hermann SIMON
Let me start with the second question. Indeed the introduction of the euro has helped German companies in exporting to other European countries. Before the euro was introduced, every couple of years, southern European countries devalued their currencies, which made international sales difficult for German companies. Now that the exchange rate is fixed through the euro, this kind of devaluation is no longer possible. However, this is also one of the causes of the problems that these countries are currently facing. One of the reasons that Germany is so competitive is that the government made dramatic cuts to the real labor costs, and companies thus became much more competitive. So while the euro has favored Germany in exporting, it is not the only factor which has contributed to its performance.

On the first question, have we thought of systematic factors that guarantee the quality of management? Traditionally, banks have played an important role in providing credit to these companies and acted as supervisors. Managers are more often engineers than businesspeople, and there are no U.S.-style business schools in Germany. You also touched on the succession problem, which is the most difficult one for family companies. These champions have a presence in 50 countries and have complex R&D structures, which makes it difficult to find successors within the families. That is why the percentage of family companies run by non-family members is increasing.

I would also like to make a comment on the effect of the euro and the exchange rates because this question comes up very often in economic discussions. I am convinced that although this has an effect, it is heavily overestimated. The Japanese GDP is 50% bigger than Germany's, but German exports are 50% higher. This has been true for over a decade, so I think the fundamental effect of the euro in recent years is heavily overestimated.

Hermann SIMON
Japan is farther away from some of the markets, and in a more sophisticated analysis this would be included, but why doesn't Japan export more? The internal competencies are sufficient to generate exports of $10,000 per capita in Japan, and that would mean one million more sophisticated jobs in Japan. Mr. Ota says that we can. The only thing that this required is to go out into the world. The current yen exchange rate makes it a little more difficult than it would have been three years ago. However, that will be corrected with the natural volatility of the exchange rate. Likewise, there are serious problems in Europe, but I do not expect the euro to go under. So why not make $10,000 per capita exports as Japan's goal for the next 10 years? These things are structurally determined and do not change in a short period due to short-term exchange rate volatility.

Q: All of the factors that you described were defined by strong leaders, but you mentioned that there are no business schools in Germany, so how is strong leadership formed? My second question is about globalization; is there a certain degree of internationalization required for these companies, and what are the other factors that allow a company to be successful?

Hermann SIMON
First of all, you are absolutely right—the key to these successes are the leaders at the helm of these companies. However, there is no uniform-type of leader, and there is no systematic way of developing leaders in Germany. They emerge rather than being developed, which is very different from the United States where so many leaders come from elite business schools.

On the second point, building up capacity abroad helps employment in Germany. There are few companies where domestic employment is going down while foreign employment is going up—both go up. Hidden Champions still make core components in Germany and have a division of labor with foreign countries. The German people have also learned that these developments go in sync and that you need to develop both the domestic and foreign sectors. It is important to teach your people that both the domestic and foreign markets are necessary to be successful in the world market.

Additionally, mental or cultural globalization is very important as the foundation for internationalization. At my company, we do not hire anyone without international experience. It is critical to prepare young people for the globalized world of the future.

Q: Do you have any advice for Japanese companies that produce intermediary goods in becoming Hidden Champions?

Hermann SIMON
In Germany, two-thirds of Hidden Champions deal in intermediary goods. Globalization actually tends to be easier for intermediary goods, because there are less customers to be reached. However, it is also easy for Japanese companies to live without becoming global by establishing links with large domestic companies. Overall, if a company has a good intermediary product that is globally competitive, it is easier to globalize.

*This summary was compiled by RIETI Editorial staff.