Amazon's War On Germany's $18 Billion Patriarch

Mar 5 2014, 9:21am CST | by

Amazon's War On Germany's $18 Billion Patriarch
Photo Credit: Forbes Business

Michael Otto’s family has been as omnipresent in German postwar retail as Wal-Mart, Sears and Target have in the U.S. So what does this 70-year-old patriarch of this $18 billion clan most want to talk about? A factory in Bangladesh.

With gusto he describes how he and Nobel Peace Prize-winner Muhammad Yunus hatched a plan to build a humane clothing factory, where all profits would go back into the community for schools and hospitals. At best, the Otto Group would recoup its initial investment. Immediately they faced red tape. Electricity would take five years. Officials wanted bribes. Otto refused to base a social business on a corrupt footing and walked away. “It’s unbelievable,” says Otto, pounding on his wooden desk in his corner office in Hamburg, Germany. “You would think the government must be happy somebody is building such a company and leaving the money in the country.”

And then the man with the crown of white hair and piercing blue eyes stops, composes himself and apologizes for banging on the table: “It is extremely seldom that I bang on the table, because I think it must be possible to solve problems in a very human and civilized way.”

Human and civilized. That’s the Otto Group, which encompasses 123 companies (including America’s Crate & Barrel) across 20 countries and expects revenue for the fiscal year ending in February to top $16.4 billion. Germans covet jobs with the firm. Its workers have never led a strike against the company, which instructs its managers not to work weekends or holidays. “The increase in burnouts is a problem because people are always on and they are always reacting,” says Otto. “It is so important to relax.”

For six decades such values have served the Otto family well. Today you can almost hear Jeff Bezos’ famous braying laugh emanating from Seattle. The Otto way of doing business is up against the age of Amazon, in which scale, brashness and speed rule. Otto thought he had digital retailing figured out: No entity sold more clothes online last year, and the Otto Group also operates the world’s largest mail-order retail operation. But last year, for the first time, Amazon’s sales in Germany ($10.5 billion) eclipsed Otto’s ($9 billion). And the trend lines are far uglier: The Otto Group’s sales are up 17% in Germany since the recession, while Amazon’s have doubled since 2010.

It’s worth noting that charges of poor work conditions led Amazon workers in its German distribution centers to strike last year. Which has set up something of a test: Can a family-owned retail giant run by a paternalistic billionaire compete with the efficiency-obsessed behemoths born of the cut-throat Internet?

The rise of the Otto clan mirrors that of Germany after the Second World War. Michael’s parents, Werner and Eva, resettled from Berlin to what was euphemistically called West Prussia after the Nazis conquered Poland. Michael was born in Kulm an der Weichsel, a town the Poles call Chełmno. Before he was 2 the settlers had to flee back to Germany ahead of the encroaching Soviet army.

Surviving a 400-mile trek by horse cart, with occasional strafing from British bombers, the Ottos eventually settled in the Hamburg area but were by then separated. Michael lived with his mother, who struggled to make ends meet. He remembers going to bed hungry on many nights. On weekends he would visit his father, who attempted to launch a series of businesses, including a halting effort at making wooden shoes. In 1949 Werner tried something new, pasting pictures of 28 pairs of regular shoes into a 14-page catalog, and writing out the prices by hand. He duplicated the catalog 300 times and handed them out to other Hamburgers. Orders started coming in, and propelled by Germany’s “economic miracle” in the 1950s, the company he called Otto grew into a leading German catalog business. By 1967 the company was distributing more than a million catalogs with 748 pages.

In the 1970s, when postal strikes and higher rates threatened operations, Otto started doing its own deliveries. Today its logistics company, Hermes, grosses $1.5 billion and competes fiercely with Deutsche Post DHL in parcel delivery. Its $690 million distribution center in Haldensleben, in formerly Communist East Germany, is one of Europe’s largest warehouses, holding up to $1.4 billion worth of merchandise at peak times. About 40% of its revenue comes from delivering for non-Otto Group companies–including Amazon.

In 1965 Werner set up a separate commercial real estate business, ECE Projektmanagement, that’s now Europe’s biggest developer of American-style shopping malls and is today run by Michael’s younger half-brother Alexander. (That business, which accounts for two-thirds of the family’s net worth, ultimately insulates the Ottos’ fortune from the whims of retail.)

Michael Otto joined the family’s catalog business in 1971 at age 28. Though the family had become successful, he remained a product of his hardscrabble roots. He paid for his own college education by starting a real estate business, which gave him street smarts to go with his eventual doctorate in economics. He’s still that way: He buys his suits off the rack, and while he has a direct line to German Chancellor Angela Merkel, helped Christo win permission to wrap the Reichstag in silver fabric and has a species of lemur named after him, he remains the prototypical northern German merchant, steeped in modesty and dignity. His favorite hobbies: gardening and traveling off the beaten path (he recently returned from a ten-day camping trip in Kazakhstan). “I have a good understanding how it is to be poor,” he says. “I sometimes cannot understand how people who became successful seem to be a different person.”

Otto’s tenure at CEO, which began in 1981, came with one main priority: diversify internationally. By 1987 Otto had become the world’s largest mail-order company, expanding into Spain, Italy, Britain and other markets. In the U.S. it has placed its bets on Chicago’s Crate & Barrel after an initial foray buying the Spiegel catalog ended in bankruptcy. In 1998 Otto bought 81% of Crate & Barrel from its founders, Gordon and Carole Segal. The year before, the company had sales north of $400 million. Now annual sales are above $1.4 billion. Otto bought the remaining shares in 2011.

The fall of the Berlin Wall in 1989 boosted sales into Eastern Europe. Russia was a top priority, where Otto is the leading mail-order company with revenue of $750 million in 2013, up 12.3% from the year before.

Otto embraced technology early: In the mid-1990s, he teamed with Time Warner in an experiment in interactive television in Orlando, Fla. It failed, epically so, but it opened his eyes to the potential of the Internet. “The biggest mistake is not to make decisions or not to develop new concepts,” he says.

Otto went online in 1995–the same year as Amazon and earlier than many German competitors. Today online sales are 60% of Otto Group’s total; another 30% come from its 1,800 different catalogs and the rest from its 400 physical stores. Before stepping into the chairman role in 2007, Otto nurtured dozens of new brands, such as myToys, which was started 15 years ago in Berlin’s multicultural Kreuzberg district. Its of?fices have Ping-Pong tables and big open spaces, Silicon Valley-style. It’s Germany’s biggest online toy store and operates in Europe and Russia, and has 13 stores. Sales were an estimated $535 million last fiscal year, up from $384 million in the prior year.

But Otto now faces competition that plays by different rules. Amazon is famously ambivalent about showcasing profit margins–last year its average operating margin on worldwide sales was 0.9%. Otto’s was 6% in its 2013 fiscal year. Otto invests regularly in digital, but Amazon plows almost all of its profits into building big new pillars such as Kindle and the Web Services cloud operations./>/>

And it’s not just the U.S. behemoth that he has to worry about. A German upstart, Zalando, has flanked Otto on his home turf. The shoe-and-apparel site, which posted sales of $2.47 billion in 2013, up 57% from a year earlier, is winning over customers with its low prices, generous return policy and edgy ads. Michael Otto was offered shares in Zalando but turned them down. The startup raised money in September at an estimated valuation of $5 billion, more than our estimate for the worth of the Otto Group itself. (Zalando continues to lose money, however, in pursuit of growth.)

“We are not the coolest and hippest company to the 16-year-olds living in Berlin,” shrugs Otto Group CEO Hans-Otto Schrader, who took over day-to-day operations in 2007. “[Zalando's] story is not profit but growth.” But others see missed opportunity. “Zalando should have come out of the Otto Group,” says Kai Hudetz, head of the Institute for Research in Retailing in Cologne. “It is not so clear that if you look forward the next five to ten years that they will still be the second-largest e-commerce company in the world.” Even Otto allies are worried. “[Zalando is] a great example of speed and execution,” says Oliver Lederle, founder of myToys. “Otto has to take care.”

A few years ago an Otto board member led the way in buying an Italian wholesaler whose fortunes plummeted after the 2008 recession, costing the Otto Group tens of millions. “I made a mistake. I bought the wrong company,” the executive told Michael Otto. “I’ve lost millions of euros of your personal money.”

“I’m a very successful entrepreneur. I’ve had failure as well,” Otto responded. “The last thing I would do is fire someone because they had a failure.”

That’s a telling story because it’s Otto’s only chance to stave off competitors: If he will refuse to chase Amazon in muscle or efficiency, his only chance is to out-manage and out-think. People yell and burn out at Amazon; at Otto, less often.

The Otto Group currently has hundreds of millions of dollars in early-stage venture investments. (It was an early investor in Groupon, and sold its stake at a profit.) It funded an online tire vendor called Tirendo, expanded into digital wallet payments through a product it calls Yapital and has bet big on Brazil; China, Mexico and India could be next.

Crate & Barrel CEO Sascha Bopp recalls launching a $5 million TV ad campaign in 2012 that showed only a white screen with two words connected by an ampersand and changing until they land on “Crate & Barrel.” No furniture, no home accessories, no smiling families using the company’s products. Just words.

“[Otto] personally didn’t understand it, told me so and wished me good luck,” Bopp says. Crate & Barrel could not show any measurable impact from the ad, but Bopp continues to enjoy full support from headquarters. Bopp contrasts his experience with former Apple executive Ron Johnson’s troubled and brief tenure as CEO at J.C. Penney: “He tried something, he made mistakes. I try things, I make mistakes. The difference is one is owned by the Otto Group, the other is public.”

The future of the Otto Group–in person and action–comes with a code name, Project Collins. A showy fashion site, run by Benjamin Otto, Michael’s 38-year-old son, it’s scheduled to go live later this year.

The Otto Group is loath to reveal much, and Benjamin Otto declined to comment. But its website says the goal is “to change the online fashion market in Germany and beyond Germany’s borders a bit and make it more attractive and exciting for young people.” In an interview online, Benjamin said, “We are not going to reinvent the e-commerce wheel, but we will build it differently.”

“This can and will become a very important company of our group,” says Michael Otto, who is well aware of the dynastic implications. “If my son finally will be successful and enthusiastic further on, then, of course, he can make the next step to the executive board of the group and perhaps one day CEO. But I don’t put pressure on him. He must decide, and we must see step-by-step.”

For all the innovation, though, the Otto culture won’t change. Benjamin has expressed distaste for the “no holds barred” Amazon approach to work and recently founded the Burn Out Prevention Center in Hamburg, which runs seminars on stress reduction and holistic health.

Benjamin can rest assured about one thing: Dad will be around to help. Michael Otto still shows up to work every day–many Mondays he even joins the company volleyball match–and he expects to do so for a long time. His father, Werner, the company’s founder, lived until 102.

Source: Forbes Business

 
 

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