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03/27/2017 11:44 AM

Left Behind

Germany's Race to Catch Up in the Startup World

By , Armin Mahler and

Although it is a business powerhouse, Germany's economy is dominated by pre-internet companies. Now the country is realizing that if it wants to remain strong, it needs to create the next Google -- and reinvent the way its entrepreneurs work.

Nikolai Ensslen and Andrija Feher aren't much for false modesty. When the two students decided to start a company, they knew that they wanted it to be big -- really big. "The sky is the limit," says Ensslen today, seven years later.

And there's still room to grow. They recently moved their company, Synapticon, and its 45 employees to new headquarters in a nondescript building in Schönaich outside Stuttgart. There, they develop intelligent control systems for robots. Their goal, Ensslen and Feher say, is to make "Synapticon inside" as self-evident for robotics as "Intel inside" is for computers.

Are these delusions of grandeur? Or is this precisely the entrepreneurial spirit Germany urgently needs?

A long time ago, Robert Bosch and Gottlieb Daimler founded companies in the Schönaich region that still shape the country and its people. University students in Stuttgart often aspire to safe jobs at Daimler or Bosch or with one of the many "hidden champions," the small and medium-sized machine-building companies that dominate the world market in their particular niches. But what you won't find here are new world market leaders. And yet they are urgently needed.

"We Germans were once very good at starting companies, but that was 150 years ago," says 33-year-old Ensslen. The country is "underdeveloped when it comes to software," adds Feher, his partner, noting that Germany's success came at the wrong time, and that success makes you complacent.

Dietmar Harhoff agrees, though he doesn't believe that this passion for founding companies disappeared so long ago. "We forgot the willingness and ability to be independent sometime after the Grundig-Nixdorf generation," says Harhoff, director of the Max-Planck Institute for Innovation and Competition in Munich. He is referring to Germany's postwar economic miracle, a period that produced Max Grundig, who founded a successful electronics company, and computer pioneer Heinz Nixdorf.

Although the German economy remains strong, it is living off the success of its past. Its strength lies in its constant ability to improve products and technologies, to build the best cars and the best machines. For a long time, this has allowed it to conceal the fact that it lacks a fundamental trait: innovative strength, or the ability to create entirely new things, new technologies, new products and new business models.

Innovations rarely emerge from large corporations with hierarchical structures, where everyone plays it safe. Innovations require space -- and courage. That's why they thrive most in young companies which have little to lose but everything to gain, and in regions that offer them the right ecosystem to encourage their growth -- along with a lot of capital.

In the United States, giants like Apple and Microsoft came into being in the 1970s, and Google, Facebook and Amazon, companies that are now among the world's largest and most valuable businesses, emerged around the turn of the millennium. They have an astounding combined value of €2.5 trillion ($2.7 trillion), far more than the total value of all publicly traded companies in Germany.

The DAX, the stock index of Germany's 30 most important companies, consists mainly of corporations founded before World War II or even World War I -- giants like Bayer, Siemens, Daimler and Allianz. Software manufacturer SAP is the only German company from the new industrial age that is a global leader.

This does not bode well for the future of the German economy. Data-driven internet companies threaten the country's traditional business models, but Germany has hardly any players in promising high-tech industries.

"In the last few decades, we have simply missed out on all major technology trends," says investor Frank Thelen. "Search engines, mobile internet, online video, social media -- it's all in American hands. It's time we finally created something in Germany again that has worldwide relevance."

Thelen, known to viewers as a juror in the German version of the TV show "The Lion's Den," a sort of casting show for startup entrepreneurs, is a pioneer of the German startup scene. He has had a hand in companies that have become spectacular successes and in one spectacular bankruptcy. He is currently pinning his greatest hopes on a young Bavarian company, Lilium Aviation, which is developing an electric air taxi that can take off vertically. "At first we thought they were crazy," says Thelen, who is 41. "But the startup team is incredibly strong, and my technology expert has told me: It will fly."

No one knows if Synapticon will capture the market in robotics, or if Lilium Aviation will fundamentally change aviation, but what's important is that they are trying, and that other young entrepreneurs in the country are also taking bold steps. Unless it experiences a new era of creative business innovation, Germany will lose its role as an important industrialized nation.

There has been some undeniable progress in recent years. According to estimates by the German Startup Association -- which is headquartered in Berlin -- about 6,000 startups, young companies that pursue an innovative business model and grow quickly, have emerged. Berlin is a natural choice for startups, and not just because it is the country's political capital: Young entrepreneurs have become an important economic and image factor for the city. An interesting startup community has also taken shape elsewhere in the country, especially in Munich. Regardless where in Germany, however, the scene is dominated by men, with women heading only 14 percent of startups.

The question will be whether all of this is enough, and what else needs to be done so that the German economy can truly rejuvenate itself from the bottom up.

Berlin: Startup Hotspot

The Factory in Berlin has become an important symbol for the capital's startup scene, the network of young Internet companies and investors that has developed in the city in recent years. There is, of course, a ping-pong table in the Factory, along with open coffee kitchen and a quiet room for midday naps. The walls are exposed brick, the chairs are by designer Charles Eames, and the young people sitting on them wear headphones and use MacBooks. In visual terms, the Factory is a cliché.

The building, located along the former border strip between East and West Berlin, was once a brewery. In 2011, a group of real estate developers began converting it into a campus for digital businesses. Companies like Soundcloud and Twitter rented space on the upper floors. The ground floor consists of a co-working space, a work area and gathering space for freelancers, startup founders and other members.

More and more companies in the "old economy" are seeking contact with startups, and the Factory addresses this demand. It enables established companies to become members, like in a club, and in return, they gain access to the campus, its events and its network. Deutsche Bank is a member, and so is automotive supplier Schaeffler. Factory Managing Director Udo Schloemer turns down any other inquiries, he says. "Sometimes managers call us and ask: Can I come and take a look? That's not an option. We are not a zoo." The point, he says, is that corporations interact with startups as equals.

"Everyone wants to make it big in Berlin," says 34-year-old Jan Beckers. He came to Berlin from the western German city of Münster in 2008 after completing a business degree with a clear goal in mind: "I wanted to be an Internet entrepreneur." At the time, he says, the community consisted of "no more than a hundred people," many of whom came to Berlin because it was the middle of the financial crisis, and they couldn't find jobs in consulting or investment banking. StudiVZ, a social network, was the star of this young community -- though it failed soon afterwards, beaten out by Facebook. Those years marked the beginnings of the Berlin ecosystem.

Since then, Beckers has developed about two dozen startups. He's what they call a serial entrepreneur. FinLeap, Becker's current project, incubates several ideas simultaneously, including an app that would make insurance brokers redundant, and a digital asset management system.

Because the business models are so complex, FinLeap is deliberately searching for experienced executives for its top jobs, says Beckers. He recently recruited a former board member from Arvato, a subsidiary of publishing house Bertelsmann. "You can't build a bank with someone fresh out of WHU," says Beckers.

Many graduates of WHU, an acronym for the private Otto Beisheim School of Management, are milling about in Berlin, partly because of Oliver Samwer. The entrepreneur systematically recruits graduates of his alma mater for junior positions at his publically traded company, Rocket Internet -- a startup factory that creates large numbers of new companies, mostly based on the business models of others.

The startup community has given a boost to the Berlin economy, which doesn't have much of an industrial base to rely upon. According to calculations by the Berlin Investment Bank, the digital economy contributed about eight percent to the city's GDP in 2016, more than the construction sector and almost as much as the industrial sector. About 77,000 people are employed full-time in Berlin's digital sector.

Zalando, Market Leader

A significant portion of them, about 5,000 people, work at one of online retailer Zalando's Berlin locations. Thirty-three-year-old Robert Gentz, a member of the company's management board, is sitting on the fourth floor of company headquarters, not far from the line that divides the Friedrichshain and Kreuzberg neighborhoods. He and his two fellow board members still work at a desk in an open-plan office. The building is surrounded by the construction for a 5,000-person Zalando campus that is scheduled for completion in the coming months.

Founded in 2008 by Gentz and fellow student David Schneider, Zalando has grown precipitously. The simple idea of selling shoes on the Internet has turned into a company with annual sales of €3.6 billion and solid profits.

Zalando has been listed on the MDax, the second league in the German stock market landscape, since 2015 and is currently worth more than Lufthansa. It is possible that Zalando will graduate to the blue-chip German Stock Index, or DAX, in the foreseeable future. If it did, it would be the first DAX company with its headquarters in Berlin -- and the first from the Internet era.

To continue growing and prevail against global competitors like Amazon, Gentz wants to transform Zalando from an online retailer into a technology platform to which various business models can be attached. In addition to selling items from its own warehouses, the company also has goods delivered directly by fashion labels and stores. A few weeks ago, Zalando acquired a Munich-based chain of athletic shoe stores. "The European fashion market is worth €400 billion in annual sales," says Gentz, "and we don't even have one percent of that."

Gentz says he has never been in cashing out by selling his shares and getting out of the company -- an approach he criticizes among many young entrepreneurs who try their luck in Berlin. "You still frequently hear people say: The main reason I want to establish a startup is to sell it. A company is not a short-term project. You have to love it, in good times and bad."

Yaron Valler is concerned about the Berlin ecosystem, however, and not just for the reason Gentz cites. The Israeli claims that it has lost its balance and is "dominated almost exclusively by businesspeople." From his office on Friedrichstraße, Valler manages Target Global, a venture capital fund worth more than $300 million. "A healthy startup community needs both," says Valler, "business ideas that shine because of excellent execution, and technological innovations."

Many startups in the capital still operate online shops or marketplaces, relatively simple business models that take a lot of capital to succeed. This could be a watershed year for many of them -- but it hasn't gotten off to a good start. In January, online auction house Auctionata declared bankruptcy. The stock price of the Samwers' Rocket Internet plunged in late February, after Kinnevik, a Swedish investment firm, sold half its shares. "Things will get difficult in Berlin," predicts Valler.

This makes it all the more important that a startup community develop elsewhere in Germany. Interesting approaches are generally found in places where universities, high-tech founders and industrial companies work together,

Startups Beyond Berlin

If you take the Munich U6 subway line to its last stop at Garching Forschungszentrum, you'll emerge into a world that seems far away from Berlin's chic Factory space. Walk past a number of buildings at the Technical University of Munich (TUM) and you'll reach modern headquarters of UnternehmerTUM. The institute, which is associated with the university, is intended to provide young entrepreneurs with support from the moment they found their companies to when they go public.

UnternehmerTUM, partly funded by major BMW shareholder Susanne Klatten, sees itself as a startup of sorts: fast-growing and innovative. Everything is expected to triple in the next few years, from the number of startups receiving funding to the amount of money invested and the number of employees. Its most ambitious project is an innovation center in the middle of the city, twice as big as the one in Garching today. Beginning in 2020, startups and established companies will begin working together at the new innovation center to find solutions for the "smart city," the networked city of tomorrow.

Today, UnternehmerTUM's 170 employees not only address the entrepreneurial qualifications of students, but also consult with traditional companies, known in the startup community as "corporates." A third business unit invests venture capital in the young companies.

Finally, there is the center's so-called "Makerspace." According to its advertising, Makerspace is "Germany's largest publicly accessible high-tech prototype workshop," ideal for current and future startup founders. Unlike many of their counterparts in Berlin, most of the entrepreneurs in Munich are working on products linking hardware and software.

UnternehmerTUM has already produced a number of important startups. One is Tado, which makes intelligent thermostats connected to smartphones. Another is Konux, which manufactures intelligent sensors that now monitor track switches at Deutsche Bahn.

UnternehmerTUM also provided startup consulting to Celonis. Business information specialist Bastian Nominacher, 32, met his co-founders, Alexander Rinke, 27, and Martin Klenk, 30, at the Technical University of Munich. They were attending a seminar when they discovered by coincidence that every business process leaves behind a technological footprint which can be used to reconstruct the path of the process and examine weaknesses. Celonis now has 120 employees, up from 60 in the middle of last year, and it expects to grow to 1,000 by 2020. Then Celonis, Germany's fastest-growing startup, plans to go public in the United States. Its goal is to become a unicorn, a term the Americans use for startups when they reach a valuation of $1 billion.

"Founder culture doesn't just happen; you have to cultivate it," says UnternehmerTUM Managing Director Helmut Schönenberger. "So why don't we have 10 UnternehmerTUMs?"

Perhaps because billionaires willing to fund a project like this don't grow on trees, but especially because few universities promote entrepreneurial spirit among their students as much as they do in Munich -- or in Karlsruhe, where the first computer science department was created in 1972.

Matthias Hornberger, 56, came to Karlsruhe in 1999, during the "new economy" boom, also known as the dotcom bubble. A banker by trade, he managed the IPO of Web.de, a local email provider, and became wealthy when the company was sold to United Internet a few years later. Today Hornberger invests in internet companies and promotes the local startup community.

Of course Karlsruhe is not a "cool hotspot like Berlin," Hornberger says, but the local startups generally "have more technical depth." According to Hornberger, the Karlsruhe startup community benefits from its proximity of small and medium-sized industrial companies. This is why the city is home to so many so-called business-to-business companies -- startups whose business model targets business customers instead of consumers.

According to a recent report commissioned by the federal government and written by the Expert Committee on Research and Innovation headed by Max Planck Institute director Harhoff, the number of these "knowledge-based business startups" is still too small. The report identifies a "dormant potential for founding companies, which ought to be utilized more effectively." In addition to professional competencies, the report adds, "a multidisciplinary founding spirit must be created at universities, so that independence is perceived as a realistic option."

Corporates Look to the Startup World

Many "corporates" have now discovered startups' potential for the German business world, as well as for their own survival. Many say that the German economy has lost out in the first round of digitalization, with the U.S. companies in Silicon Valley clearly and unstoppably in the lead, but the goal now is to take advantage of the opportunities presented by the second round, and this, says innovation expert Harhoff, "we cannot do without startups."

This is why Gisbert Rühl, 58, has launched his own startup. He became CEO of the 110-year-old steel distributor Klöckner & Co in 2009. Since then, he has had to let go more than 3,000 people, a quarter of the workforce. Although he knew this couldn't continue, his attempt to change the company from within was a failure. "We noticed that we, as a 'corporate,' are too slow," says Rühl. He went to Berlin, where he rented a table for two people at the Beta Haus, another co-working community. It marked the beginning of klöckner.i. Today its 40 employees, most from the startup community, are developing a digital trade platform for steel.

Rühl, with his carefully parted gray hair, suit, tie and white pocket square, looks like an alien among the young Berliners working alongside him. He doesn't like to dress like the other CEOs who explore the Berlin startup scene in casual outfits, appearing in public wearing jeans and sneakers. Yet hardly any other manager in Germany is as adept at using the startup culture for his company. Rühl is confident of victory. "We are a leader in the industry, and no American is further along."

Almost all big companies now cooperate with startups, and many have participated in founding new companies, but they don't always find what they are looking for in Germany. BMW board member Peter Schwarzenbauer, 57, travels several times a year from Munich to Silicon Valley and China. The most exciting young companies today can be found in Beijing, Shanghai and the southern Chinese city of Shenzhen, he says. "The speed is impressive. You can have a prototype built within 24 hours there."

The startup scene in Israel is even more successful, as evidenced by Intel's spectacular €15 billion purchase of Mobileye, which specializes in camera and sensor technology. Mobileye works with many large automakers, including BMW, whose business models will fundamentally be changed by digitalization. In industrialized nations, fewer and fewer people want to own their own car, and the internal combustion engine is beginning to seem like a dinosaur.

That's why BMW wants to transform itself from a pure automaker into a provider of mobility services. In doing so, the company is counting on the support of startups. BMW has established a fund that is expected to invest €500 million in young tech companies within 10 years. So far it has invested in an app that can be used to reserve parking spaces in advance.

It isn't as if no one at BMW would have come up with the idea of digitalizing the search for a parking space, says Schwarzenbauer. Technologically speaking, he explains, startups are rarely miles ahead of the auto industry, but their way of thinking is critical. "The scene thrives on the belief that everything is possible. I am convinced that this boundless optimism releases an incredible amount of energy," says Schwarzenbauer. A company like BMW, which has been wired for decades to build the most flawless cars possible, cancertainly learn something from this mentality, he explains -- for instance, that mistakes are part of groundbreaking innovation. "Startups act as an accelerator," says Schwarzenbauer. "They even show innovation leaders like us that a large company can become more flexible and implement things faster."

Many students now feel the same way. The best of them "no longer want to work for McKinsey. They want to start businesses," says Harhoff. "Something is happening here."

Five-and-a-half years ago, Celonis founder Nominacher was the only member of his class at the Technical University of Munich who did not apply for a job with an established company. Today, he says, every other graduate either works for a startup or has founded his or her own company.

Closing the Financial Gap

The creation of a founders' mentality requires role models like Celonis. It also requires an environment like Berlin or Munich, where startups can thrive. But the one thing that is needed most of all to ensure that the startups eventually become large companies is money.

"The entrepreneurial potential exists in Germany, and so does the technological basis, of course," says Hendrik Brandis, founder and partner at Earlybird, a venture capital company. "What's missing is something else: Investors willing to take risks by funding startups with major prospects for growth."

Earlybird was launched in the "new economy" of the late 1990s. At the time, investors were eager to fund the next EM.TV or Intershop, two companies who were then worth billions on the Neuer Markt, or New Market, a segment of Deutsche Börse, a marketplace organizer for shares and securities, for young high-tech companies. But many of these companies disappeared just as quickly, and with them went the Neuer Markt and most of the venture capital funds. The trauma still has an impact today.

"Based on the strength of the German economy, one in four Googles should come from Germany. But that isn't the case," says Mr. Brandis. "There is 10 times as much venture capital available in the United States, as a percentage of economic output, as in Germany." In 2016, €1.7 billion in venture capital went to German startups, compared to the more than €60 billion being invested in startups in the United States.

In the founding phase, it is still relatively easy for startups to find investors. There are so-called business angels, small venture capital funds, development banks and, finally, the High-Tech Gründerfonds, or High-Tech Founders Fund. For more than a decade, the German government and private investors have used this fund to promote companies. It has already invested €576 million in 468 startups.

But things become more difficult in the growth phase, when startups need a lot of capital to achieve critical size and gain market share. During this phase, individual investors need to contribute €5-10 million each.

Why does this gap exist? In the United States, two-thirds of venture capital comes from foundations and pension funds. In Germany, however, these two sources of capital play almost no role, partly because the pension system is dominated by the government. There are also legal restrictions, and insurance companies need to hedge risky investments on their own books with a lot of equity capital, which makes venture capital unattractive.

"Either the government or companies can close the existing gap," says Earlybird partner Brandis. There has been some movement among potential investors. At the national level, the coalition government of the center-right Christian Democratic Union (CDU) and the center-left Social Democratic Party (SPD) want to significantly expand the KfW Banking Group's promotion of startups. KfW, Germany's government investment bank, already played a critical role at High-Tech Gründerfonds, which it now wants to expand. A new fund to finance growth, the Tech Growth Fund, is in the works. But there is still disagreement over how best to structure the fund.

The market for private startup investments is also picking up steam. Brandis believes that companies like Daimler will increasingly invest in independent venture capital funds, so that they will be there when the next unicorn takes shape in their field of business. Together with a few large German corporations, his venture capital company is thinking about a new fund that would invest in more mature technology companies.

The nine-figure sum envisioned for the fund would be invested in companies from a wide range of industries, like fintech (financial technology), Industrie 4.0 (automation and data exchange in manufacturing) and cybersecurity, which have already proven that their business model works, and now want to grow. As investors in the fund, companies would gain insights into and contact with the world of digital startups. The venture capital company would receive capital, which is especially scarce in Germany and Europe for growth companies, Brandis explains.

The next step for the unicorns of tomorrow would be to go public -- otherwise many German startups would likely continue to be bought up by American competitors. This is where Deutsche Börse, which owns the Frankfurt Stock Exchange, is engaged in a new effort, less than a decade and a half after the end of the Neuer Markt. The new market segment, called "Scale," is intended to introduce young companies to the global capital market.

Progress is being made, and not just in venture capital. Despite its weaknesses, Berlin could become Europe's startup capital and university graduates all over Germany are getting enthusiastic about starting companies again. Many have the confidence to think big.

The one thing that still needs to change is the fear of failure. According to an estimate by the German Startup Association, half of all startups do not survive the first five years. A bankruptcy is seen as a blemish in Germany, whereas the Americans have practically turned it into a cult. In America, those who fall are not stigmatized. Instead, they stand up and start all over again.

Carlos Borges had to declare insolvency in January. The native Brazilian founded Hamburg-based triprebel in 2013. The startup developed a digital travel assistant that searched for the best deals for its customers. If a better deal turned up somewhere on the web before the beginning of the trip, the old posting was deleted and replaced with a new one.

The idea was well-received, at least in the media and among experts. But there weren't many customers and recruiting new ones proved to be far too expensive. Insolvency became unavoidable.

Borges says he is "relatively relaxed." He is working with the insolvency administrator to find a buyer for the product. "We have not failed," he says. "There are new possibilities, even for employees." He has learned a lot, he says, about digital transformation and how to make do with few resources, "experiences that are priceless." And now, as an employee, he wants to bring them into a new project.

And then launch another startup.

Translated from the English by Christopher Sultan

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