German companies stay positive about growth and M&A belies disruptive pressures

German executives are surprisingly confident in their growth and M&A objectives, despite a series of endemic disruptive pressures.

According to the latest edition of the EY Global Capital Confidence Barometer, 96% of German executives see the local economy as improving. We find this level of positive sentiment striking given the strategic and disruptive pressures so many German companies face — adaptation, digitization, automation, saturated markets and talent shortages, to name a few.

These pressures are here to stay and they’re pushing many sectors into crises unlike anything they’ve seen in the past. Usually, these types of pressures would result in a decline in business volume. So far, this hasn’t been the case, largely because financing remains affordable and there is still easy access to capital. We surmise that because volumes haven’t dropped, many companies still believe they are on solid footing. In fact, 82% say they are expecting revenue growth rates of between 6% and 15% in the coming year.

Money may be cheap for a while, but companies unwilling to reshape their organizations now may soon find themselves on the road to obsolescence.

German executives take a multi-pronged approach to building resilience

From the financial crisis of 2008 until recently, business models remained undisrupted. This gave companies the opportunity to focus on reducing costs and improving efficiencies. However, in the frenzy of cost-cutting to achieve growth and margin objectives, they failed to consider the long-term sustainability of their business models — until now. Given that 35% of German executives say the biggest external threat they see to the growth of their business is an economic slowdown, companies are beginning to realize they need to adapt at a far more fundamental level to survive. Cost-cutting alone is no longer enough.

There are several ways German companies are looking to build resilience to protect against the challenges ahead, including:

• Cost cutting. Understanding that cost-cutting forms only one piece of a bigger puzzle, nearly half (48%) of German executives say their focus over the next 12 months to build resilience into their company’s profitability and cash flow will concentrate on reducing overheads and administrative costs.
• Technology enablement. German companies also are taking significant steps to leverage technology, automation and artificial intelligence (AI) for improved performance. One hundred percent of German executives surveyed say that their company is planning significant investments in technology in the coming year. They expect their predominant focus for technology enablement will be on creating new products and services (23%), improving internal efficiencies (21%) and reducing risks (20%).
• M&A. German executives see dealmaking as playing a principal role in building resilience, with a record-breaking 72% saying they’ll actively pursue M&A in the next 12 months — well above the 43% Capital Confidence Barometer average since 2010. More than four out of five German executives also anticipate they’ll close more deals in the coming year than they did in the previous year. Seventy percent say that technological innovation is the key external trend influencing their deal strategy; 23% say it’s their main strategic driver for dealmaking. However, we expect German executives will proceed judiciously with any M&A deal, particularly since an overwhelming majority acknowledge that the valuation gap is the highest since the global financial crisis and is certainly higher than it was 12 months ago. Moreover, 88% of German executives recognize that traditional valuation methodologies make it difficult to determine the correct value for digital companies and innovative startups.
  

A more proactive approach to portfolio management will improve opportunities for more fundamental portfolio reshaping

The one area where German companies seem to be lagging their global peers is in the frequency of their portfolio reviews. Globally, for the first time, more companies are reviewing their portfolios every quarter or more frequently than at any time in the past. Certainly, more German companies are accelerating their portfolio reviews. However, 30% (versus 22% globally) say they still only review their portfolios annually.

A more sporadic approach to portfolio assessment may leave German companies flat-footed when the downturn occurs and access to capital dries up. More active portfolio reshaping can help German executives to more proactively identify areas of potential underperformance or emerging growth opportunities ahead of their competitors.

Three actions German executives can take today to prepare for the future

As German companies navigate today’s uncertainty and prepare for the challenges appearing on the horizon, there are three actions they may want to consider:

1. Acknowledge where the company stands. This is much more difficult than it sounds, as evidenced by the number of German companies that see the economy improving, even as they face a host of disruptive pressures that they’ve overcome to date mostly by taking advantage of cheap credit and refinancing terms. German companies would do well to step back and take a hard look at where they stand. How robust is the company’s business model? If interest rates increased and access to capital dried up, how solid would the business be?
2. Get the timing right. Timing, as they say, is everything. German companies want to be prepared for the future, but there is such a thing as being too prepared. If a company fundamentally restructures too early, it may waste money. On the other hand, if it waits too long, the company won’t be prepared and it may end up with its competitors leapfrogging ahead.
   
3. Invest in a robust integration strategy — and execute upon it. When asked what they see as the biggest risk when executing a transaction, 25% of German executives cite integration of operations and people. Getting integration right has never been more important. This is especially true when it comes to an organization’s people. In an environment where talent is already scarce and the competition for high-quality people is fierce, integration efforts need to center on retaining both the talent that comes with the acquisition, as well as the people the organization already has.
   

German companies face a triple whammy of disruptive pressures: adaptation shock, innovation and digitization, and the inevitability of a volume downswing. So far, they’ve been able to buy time with refinancing. But they are still left with all of the actions they should have taken earlier.

German companies that act now, by continuing to build resilience, while accelerating portfolio reviews to capture opportunities for restructuring, can reshape results for better performance in an uncertain environment.