Despite the economic downturn, Germany’s small and medium-sized enterprises (Mittelstand) are becoming more digital, albeit at a slow pace, according to a study by KfW. While companies invested more money in digitalisation projects in 2023, these investments still lag far behind capital expenditures on machinery, equipment, and similar assets. Larger SMEs with 50 or more employees are leading the way in digital investments. Factors holding back digitalisation include underestimated strategic importance, limited financing options, a lack of digital skills, a backlog in digital infrastructure, and challenges related to data security and privacy.

According to the findings of the KfW SME Panel, the share of SMEs with completed digitalisation projects rose for the second time in a row between 2021 and 2023 to reach 35%. That was five percentage points more than in the years 2017 to 2019, before the outbreak of the pandemic, and two percentage points more than between 2020 and 2022. Thus, 1.3 million of the 3.84 million SMEs in Germany have recently completed digitalisation projects – 100,000 more than in the previous survey.

In spite of the difficult economic environment, companies have been pressing ahead with digital investment.„Businesses typically take digitalisation steps in economically favourable times. Thus, the current increase departs from the pattern of behaviour otherwise observed and is remarkable“, commented Dr Volker Zimmermann, digitalisation expert at KfW Research.

“Many businesses obviously see a great need for digitalisation measures irrespective of the cyclical situation, for example because they expect permanent shifts in demand towards digital offerings and sales channels", he added.

In 2023, small and medium-sized enterprises in Germany spent 31.9 billion euros on digitalisation projects. In nominal terms, that was 2.6 billion euros more than in the previous year, or 1.0 billion euros more after adjusting for price increases. It was also a significant increase on the pre-pandemic year 2019. But SMEs’ digitalisation expenditure still lags far behind their investment in fixed assets. In 2023, investment expenditure amounted to 250 billion euros, which means that SMEs spent nearly eight times as much on traditional investments than on digitalisation.

On average, SMEs spent 25,000 euros on their digitalisation projects in 2023. That was 23% more than before the outbreak of the pandemic. And there was a wide divide. Small businesses on average spent 8,000 euros, while large firms spent 216,000 euros. That means large SMEs on average spent almost 27 times more on digitalisation than small businesses. This span was „just“ 17-fold before the pandemic, for example in the years 2019 and 2016. „In the past years, large SMEs succeeded in continuously widening their lead in digitalisation. Unless they significantly increase their digitalisation activities, small businesses run the risk of being left behind in digitalisation“, said Dr Zimmermann.

Despite an increase in digital spending across all company sizes, larger businesses have accounted for a growing share of total investment. This trend has been observed since the study began eight years ago. Large SMEs, which make up only 2% of the sector, currently account for 12.9 billion euros, or 41% of digitalization expenditures. In contrast, small businesses – comprising 81% of SMEs – collectively spent 4 billion euros on digitalization.

To accelerate digitalisation, KfW identifies several key areas for action. To address the lack of digital skills, more young people should be encouraged to pursue computer science degrees, and dropout rates should be reduced to ease the IT labor shortage. Additionally, IT education should be strengthened in schools and integrated into vocational and higher education curricula.

To alleviate financing constraints, KfW suggests offering targeted financial incentives for digital projects. These should align with the maturity level of digital technologies. Specific proposals include tax incentives for research and development (R&D), better integration of R&D and digitalization funding, and improved access to equity-like financing instruments.

The KfW SME Panel tracks projects related to the initial or improved use of digital technologies in internal processes, products, customer and supplier interactions, as well as initiatives to develop digital skills.

A similar picture emerges from a digitalization survey conducted by the German Chambers of Industry and Commerce (DIHK) among more than 5,000 businesses from various industries. „Digitalisation in Germany is progressing too slowly“, says Volker Treier, a member of the DIHK executive board. „We are missing too many opportunities, and there is a lack of innovative technologies.“ The survey indicates that digitalisation is seen less as a driver of innovation and more as a tool for managing day-to-day challenges. Of the businesses surveyed, 66% cited increased efficiency in work processes as their main motivation for digitalisation, 65% aimed to reduce costs, and 63% sought quality improvements.

The biggest challenges reported were a lack of time (60%), excessive complexity (54%), and high costs (42%). Around one-third of respondents also pointed to security risks, shortages of IT professionals, insufficient digital skills, and legal uncertainties. Furthermore, the slow expansion of broadband networks remains a concern: only 73% of businesses said that their current access to high-speed internet meets their needs.