Hermann Simon Offers A New View Of the Economy

We have been seduced by the interests of the financial sector to view the economy as a structure dominated by a few big businesses. The latest acronymic expression of this bias is MAMAA: Meta, Amazon, Microsoft, Apple, and Alphabet are the five stocks (and therefore, in the minds of stock traders) the five companies that matter.

Most of us, as more casual observers of the corporate landscape, might add other big companies we know about, like ExxonMobil and Boeing and General Motors and LVMH, and Walmart. But the mental model is the same: it’s the big companies that matter. They generate the bulk of the important revenues, they provide jobs, and they advance innovation. They are the subject of all the attention, analysis, and scrutiny the traders can bring to bear, and that attention is transmitted and amplified through the business media and academia.

There’s another, better way, to think about the economy: as a complex interconnected and collaborative network of companies, contracts, and service agreements, embracing manufacturing, component supply chains, service systems, distribution, technology enablement, and research projects. Companies and people and buildings and server farms and lines of code are nodes in this network, and information flows in multiple directions at variable speed between and across nodes, spreading to all points. 

In this economy, there are millions of firms, of all sizes from single contractors or single entrepreneurs to the biggest of the big, and every intermediate size. The point is not to count and number the nodes but to assess the interaction and interconnectivity, and enhance and accelerate those interactions as the ultimate source of growth and innovation. 

And, of course, even the largest companies are not monoliths. Within them, there are divisions and subsidiaries, projects and teams, pursuing new value through new forms of interaction, even if the stock traders monetize these efforts for investors by trading a single stock. The single stock bears no resemblance to operational reality.

Many of the firms below the level of the S&P 500 or the DAX or the EuroStoxx 50 are virtually invisible. Most people wouldn’t recognize their names or know what they produce or know if they are growing or declining. Hermann Simon has made it his life’s work to identify and understand this layer of the economy. He calls the firms that comprise this layer “Hidden Champions”.  They are concealed behind a curtain of inconspicuousness, invisibility, and, in some cases, deliberate secrecy. He names companies like Baader, 3B Scientific, Hoganas, Hamamatsu Photonics, Petzl, Molex, and many more. They are typified by outstanding success: relative to, say, the average S&P 500 firm: higher margins, higher levels of reinvestment in R&D, high return on that investment, high equity and low debt, better customer relationships, and longer employee retention, as well as higher levels of revenue per employee. 

These firms are very much the engine of the economy, even though they are not the names on the tip of the tongues of the stock traders. Hermann Simon cites some drivers of their success, based on his decades of research and data gathering. 

• His first driver is subjective: willpower and setting ambitious goals. Inspirational leaders encourage employees to be the best and become world leaders.
• High performance by a motivated team requires rigorous selection and intolerance against shirking and anyone who does not pull their weight. 
• Tight focus on narrow markets combined with great depth in the value chain and high levels of vertical integration. Identifying a narrow market allows for uniqueness and depth results in control over that uniqueness.
• Decentralization – smaller business units and high autonomy for individuals and teams.
• Innovation: the Hidden Champions integrate customer understanding and technical knowledge as equal driving forces. They have more patents per employee than the large companies and can obtain a patent with one-fifth of the expenditure of the big companies,
• Closeness to the customer, which creates a competitive advantage through relationships. Top customers drive the Hidden Champions’ performance.

These are the kinds of metrics we should be elevating in our assessment of the health of the economy, rather than earnings per share and total market capitalization.

Many of the Hidden Champion companies are what is often called, somewhat dismissively,  B2B. They make components and supply services to the big names, making their visible end results possible, while remaining invisible themselves. For example, Hermann Simon, based in Germany, likes to ask audiences how many suppliers Apple has in Germany. The audience estimates typically range between zero and 20. The true number is 767! These include the German-Swiss software LSTM (Long Short Term Memory) developed by Professor Jürgen Schmidhuber, which is behind Apple’s Siri system and installed on more than 3 billion smartphones. The optical system from Zeiss shortens the distance on chips from 193 to 13 nanometres and thus extends Moore’s law by at least ten years. With its help, 56 billion transistors can be placed on the surface of a fingertip. These and many more Hidden champions make the iPhone possible.

These companies are the nodes and flows in the network of the economy. 

It’s a better way to think than to focus on MAMAA.