Following the end of World War II, France and Germany made dramatic strides in narrowing the labor productivity gap with the US Then that trend suddenly changed. This MGI report uncovers the reasons why and what France and Germany can do about it.
Reaching higher productivity growth is vital to France and Germany's future standard of living. Fortunately, it is fully within their grasp. European sector experience indicates clearly that the key is business and technology innovations made possible by appropriate regulation that spurs high competitive intensity at the sector level.
France and Germany's labor productivity had been closing the gap with the US for almost 50 years following World War II. However, that trend reversed itself in the 1990s when US productivity grew at a faster rate and the gap with Germany and France started to widen again.
Looking for Answers, Sector by Sector
Given an aging population in both countries, future living standards depend on high productivity growth. To provide a better understanding of the true drivers of, and barriers to, higher productivity growth, we performed an extensive, in-depth analysis of the labor productivity performance of six sectors in France, Germany, and the US The sectors we examined were: Telecommunications, Retail banking, Automotive, Road freight, Retail trade, and Utilities.
Courting Competition and Smart Regulation
What we learned is that business and technology innovations play a critical role in raising productivity across the entire economy. France and Germany have the potential to reach higher productivity growth again if smart regulation and the resulting competitive pressures force businesses to adopt and leverage innovations. Both policy makers and business leaders have a part to play.
The Responsibility of Policy Makers
Policy makers are responsible for improving regulatory conditions to create a healthy competitive environment in all sectors. They have already begun to dismantle some regulatory barriers (with great positive impact on sector productivity), but many opportunities remain. Policy makers also need to ensure that the regulatory changes lead to economic and employment growth. They also need to facilitate the redeployment of displaced workers and foster an environment in which innovative sectors can grow.
The Responsibility of Business Leaders
Business leaders, for their part, need to take into account all aspects of productivity improvement. Their key lever to improve productivity—and thus maintain profitability—is the development and diffusion of innovative products, services, and processes. In some industries, they will also need to find more efficient economies of scale through further consolidation. A broad perspective on productivity will also put them in a position to recognize and exploit further improvement opportunities along the entire value chain: either in the form of vertical collaboration or through horizontal specialization.
While most other sectors lag, telecommunications services has given a big boost to productivity in Germany and France. Germany has led the way in fixed-line services while France holds the advantage in mobile services labor productivity, where regulation has stifled growth in the US.
German Fixed-Line Surge
Liberalization and privatization, resulting in intensified competition and increased shareholder pressure, have been the key factors in a German surge in fixed-line productivity.
Deutsche Telekom responded to these changes by cutting call tariffs, shedding excess labor, and developing new services. With fewer workers handling more calls, productivity jumped significantly. The tremendous development of ISDN lines, boosted by a pioneering marketing approach, also helped.
French Mobile Leadership
Meanwhile, France set its sights on the mobile industry, with remarkable success. In 2000, France had a 43 percentage point labor productivity advantage over Germany and stood at more than twice that of the US.
While penetration rates for mobile phones were similar in Germany and France over the 1990s, the French used their phones far more: 62 minutes/month in Germany versus 120 minutes/month in France in 2000. There are many reasons, including differences in pricing complexity as well as cultural differences in mobile consumer behavior.
France also outpaces the US where a regional licensing approach led to the fragmentation of the industry. Small operators in America cannot reap the economies of scale in the same way as their counterparts in the European countries.
Closing the Gaps
All three countries can improve their productivity performance: France must make further operational improvements in fixed-line services; the US mobile services market needs to consolidate; and players in the German mobile market need to find ways to further stimulate demand.
Retail banking sector
Despite improved labor productivity in retail banking from 1994 to 2000, France and Germany are still behind the US. Among other solutions, higher consolidation in Germany and an improved payment mix in France will help the nations boost their productivity and get more out of IT investments.
While a range of improvements are necessary to revitalize German and French retail banks, four areas represent the highest priorities:
Information Technology Adoption
IT has already made significant inroads into banking in France and Germany, accounting for more than 10 percent of nationwide IT spending. IT-based innovations accounted for 1.9 percent of annual productivity growth, as back-office automation and the introduction of remote channels (e.g. call centers) improved efficiency. But there is significant room for further improvement. IT systems are not taking advantage of economies of scale triggered by consolidation, and insufficient levels of standardization mean that systems are complex and inefficient.
Mixing Up the Payments
In France, where the government mandates free checks, there is little incentive for the consumer to move away from paper for transactions. But processing paper checks is labor intensive and, therefore, less productive than an automated, paperless system. A relaxation of regulations won't be enough though. French banks will have to come together to convince customers to use modern payment methods instead of checks.
For a variety of reasons, including higher affluence, the stock market hype, and the increasing requirements for personal retirement plans in France and Germany, customers are more active in managing their accounts. That resulting bank activity accounted for more than two percent of annual productivity growth in both France and Germany from 1994 to 2000. However, despite this growth in activity, French and German customers are still well behind their US counterparts, who not only have more banking products to choose from, but also take advantage of them. French and German banks need to expand their product offerings.
Competition from direct banking and a drop in deposits led to a drastic erosion of profits for French and German banks from the beginning of the 1990s. Lower margins can be addressed in part by consolidation where the benefits of scale are substantial. Germany particularly, with a large proportion of small banks, can reap significant rewards through consolidation. The catch is that the consolidation process can be slow.
Under threat of declining sales and stagnating vehicle markets at home and abroad, in the early part of the decade French auto makers focused on improving productivity while German companies concentrated on product portfolio expansion. Both countries, however, still lag behind the Japan and the US.
Assault from Abroad
In the early 1990s, French and German auto manufacturers were under major assault, particularly from the Japanese. Relaxed EU import limitations and far higher Japanese productivity sent a stern message to local manufacturers: improve productivity or risk losing market share in vehicle markets at home and abroad. Responding to the threat, France and Germany followed distinctly different approaches to shoring up their industries.
France Gets Lean
France made up ground by shedding inefficiencies. French companies adopted lean manufacturing techniques—such as eliminating superfluous administrative tasks—improved procurement, and simplified auto designs. In slashing costs, however, French auto makers did not sacrifice quality. Manufacturers actually developed even more advanced safety and comfort features.
In this way, French companies managed to improve processes and product quality at the same time. The result: labor productivity in the French automotive industry grew annually at an impressive 15 percent from 1996 to 1999, outstripping the Germans.
Germany Goes for Quality
German auto makers, with markets growing in the US and at home in the early '90s, felt themselves in a more comfortable position and took a less radical approach to the Japanese threat than their French counterparts. The Germans chose to focus on their strength: product quality. Hoping to build an attractive product portfolio, manufacturers introduced new models for the mass and niche markets.
But innovations came at the cost of productivity. German companies outsourced R&D and part of production, increasing process complexity and leading to a ballooning of the labor force. Overall, the German automotive industry increased its labor force between 1996 to 1999 by 110,000—in stark contrast to France, which reduced its labor force by 20,000 over the same period.
Finding the Balance
Successfully weighing the needs of standardization against the needs of the customer is the key to improving productivity. But the industry needs incentives, and the government can provide them in two ways: removing barriers to competition, such as import tariffs, or reducing its ownership in the industry. With those protections gone, the national industries will have all the incentive they need to improve productivity as soon as possible.
Road freight sector
French and German road freight companies saw impressive growth in the 1990s through deregulation and the birth of a single European market. But recent competitive trends threaten the road freight industry, and companies must improve operations using information technology and continue the wave of consolidation.
Slow Information Technology Adoption
Deregulation and the increased demand for cross-border deliveries in a common European market drove productivity in French and German road freight the '80s and '90s. More competition led to consolidation, increased truck sizes, and improved processes.
IT investment, meanwhile, was more limited. Companies invested in network optimization and back-office automation, but these improvements accounted for only about 1.0 percent CAGR growth. French and German companies also worked to increase information visibility (i.e., tracking loads and capacities within the network) and to integrate IT systems from acquired companies. Productivity benefits from these steps are expected only in the next decade.
US has Technology and Time Advantage
Despite France and Germany's efforts—and successes in—narrowing the productivity gap with the US, their road freight industries still lag 20 percent behind. More than half of the difference in productivity levels between the two European countries and the US is due to the latter's more intensive use of IT. The US industry is more advanced in its use of IT to improve efficiency.
Much of the advantage that American companies can claim is based on timing. Deregulation in France and Germany took place during the 1990s, while the US passed through this stage in the 1980s. After US companies went through a post-regulation wave of consolidation, they used IT to optimize their networks and to improve capacity utilization a full decade ahead of their European counterparts.
Challenge to Freight Companies
French and German road freight companies are at a crossroads. Falling prices have cut margins, consolidation has only just started, and lower-wage Eastern European companies are waiting in the wings to join the European single market. To continue diminishing the gap with the US, France and Germany will have to follow the US example.
Retail trade sector
US efficiency in retail trade gives it only a slim lead over France, though the lead over Germany is larger. To catch up or overtake the US, retailers in France and Germany need to increase their deployment of lean management processes through better use of information technology and greater integration with suppliers.
Zoning Laws Favor French
Retail trade is one of France's strengths. The food distribution subsector in particular drives French retail efficiency. This segment is 19 percent more efficient than its US counterpart and 34 percentage points more so than in Germany.
France's big productivity advantage in this segment is due to a favorable regulatory environment. Strict zoning rules in France have effectively limited the opening of new, large outlets and the expansion of existing stores. As a result, French food stores handle approximately double the output of similar-sized stores in the other two countries. At the same time, however, this regulation slowed down the modernization of store formats. Consequently, retailing started to lose ground in terms of labor productivity in the 1990s.
US Pushes Ahead
However, if all the effects of external factors, such as regulation, are removed from the equation, the US reasserts its labor productivity advantage in food retailing—5 percent over France and 15 percent over Germany. US retailers push productivity through innovation - frequently using IT—in merchandise management, supply chain management, and store operations.
To find these efficiencies, US retailers aren't afraid to invest. In 1999, US retailers spent 8 percent of their gross margin on IT improvements. France and Germany were well behind at just 6.3 and 6 percent investment levels respectively.
Collaborating to Get Ahead
To exploit the productivity potential of IT, French and German retailers need to work on their collaboration approach with suppliers. Better IT integration requires a certain level of cooperation, for example, sharing demand forecasts with suppliers. This allows suppliers to optimize their production schedule.
These integration benefits can only be reaped, however, if the right IT applications are in place, such as point-of-sale data collection on individual products, data warehouses, forecasting tools, and a common platform for sharing information.
Energy deregulation has resulted in impressive 5 percent productivity growth rates in the US and UK Germany has posted similar numbers recently. France's protected market, however, is relatively stagnant.
France Falling Behind
At the beginning of the 1990s, France was in a dominant position. Labor productivity figures placed them 6 percent ahead of the US and a commanding 30 percent ahead of the Germans. By the end of the decade, that lead had been wiped out. When adjusted for the capacity mix, France is now 20 percent behind both its counterparts. In choosing protectionism over deregulation, productivity for France's utilities has suffered.
Germany's Energetic Growth
Facing deregulation at the end of the '90s, Germany's labor productivity growth in energy sectors was lock-step with America's. In electricity generation, for example, competition increased and both countries posted impressive gains of more than 5 percent. Germany started later in the deregulation cycle than the US, so its strong growth is in a position to continue.
UK Pushing Ahead
In labor productivity, all leaders took a back seat to UK utilities. Britain charged into deregulation, introducing free choice of energy providers, unbundled generation and distribution, and regulated network access and prices. These regulatory changes forced companies to quickly improve efficiency to maintain profitability. Labor productivity in generation grew by seven percent; in distribution, it grew by 7.8 percent.
Having lost a decade, France has the opportunity to make the most significant leaps ahead. Successes in Germany, the US, and the UK show that responsible deregulation could put France on the road to productivity leadership again.
Germany, meanwhile, also has some challenges to overcome to maintain its impressive track record. Network regulations especially need to create a level playing field for the different providers and put pressure on network operators to improve productivity. Responsible handling of these challenges could mean long-term sustainable productivity growth for Germany.