Geo-Economics and Politics

Scale matters more than ever for European competitiveness. Here's why

European firms are lagging on scale and performance.

European firms are lagging on scale and performance. Image: Getty Images/iStockphoto.

Sven Smit
Senior Partner, McKinsey & Company
Jan Mischke
Partner, McKinsey Global Institute
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  • As we enter a new geo-economic era, Europe's competitiveness is under pressure.
  • New research highlights the need for bold action if European firms are to compete globally.
  • Scaling up across Europe, in areas such as R&D, will help companies increase their competitiveness.

Enrico Letta’s report on the single market, presented to the European Council recently, comes at a time when Europe is wrestling with competitiveness in a new geo-economic era. How important is market scale for competitiveness?

Recent McKinsey Global Institute (MGI) research suggests that bold action is needed for Europe’s firms to compete in the world – and acting on European scale is more important and more urgent than in the past.

MGI found that large European firms with more than $1 billion in revenue have fallen behind their US counterparts. They collectively invest $400 billion a year less. They spend only half the share of revenue on R&D. They grow one-third more slowly. And they generate 4 percentage points lower returns on capital.

That relative underperformance could even deepen in these turbulent times. Europe has long thrived on the back of its highly effective industrial model, but the supply of affordable energy to Europe was disrupted, geopolitical tensions challenge global supply chains, and technology disruption is accelerating and reshaping competitive dynamics even in Europe’s stronghold industries. For example, look at how traditional automaking is being reinvented with electric vehicles.

Why does scale matter?

Scale matters more for competitiveness than in the past, putting Europe in a difficult spot. In a growing number of sector and technologies, there are winner-take-most advantages. Consider, for instance, the fact that five US tech giants invested $200 billion in R&D in 2023 – more than half the entire R&D spending, public and private, in the EU. This accounts for almost all the R&D spending gap between Europe and the United States. Amid a fragmented and complex European market, Europe’s large firms have one-third less revenue than US firms on a sector-by-sector basis. And in many areas of new technology, European firms haven’t managed to scale up at all. In fact, in 10 critical technologies of the future, Europe leads on just two.

Reform of the single market is thus welcome. In a spring 2023 survey by the European Round Table for Industry, 84% of CEOs said competitiveness was weakening and 56% cited a “complex and/or incoherent regulatory environment.” Europe’s startups face the complexity of doing business across borders earlier in their journey than, say, their US counterparts. Indeed, about 70% of European unicorns have established a global or partly global geographic footprint to reach unicorn status, compared with 50% of US unicorns.

But can reform happen quickly enough? Given the multiple geo-economic shifts undermining competitiveness, Europe needs reform in months or years, not decades. In a recent report, MGI explored the merits of establishing a "28th regime" of common, simplified business rules into which companies for whom scale is critical could opt into that would run alongside the 27 EU member states as a pan-European regulatory entity. This kind of pro-investment regulatory framework could cover areas such as product market regulation, supervisory authorities, employment rules (including professional qualifications), corporate tax and VAT, and more.

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Such a regime could be most acceptable if constrained to where it matters most: high-growth firms, often in the technology arena in areas such as generative AI (GenAI) , quantum computing, and next-generation clean and biotech, but also businesses operating cross-border in more traditional but competitively exposed industries. A common regime may also remove an important barrier to cross-border consolidation and mergers and acquisitions.

How can industrial policy support businesses?

Removing barriers may not be enough, however. Industrial policy, more in vogue in recent times, could play a role too in supporting infant industries and sectors. If Europe did choose an industrial policy route, it would need to do so on its own terms, but with a similar scale and simplicity as other global regions to be attractive for businesses. For instance, Europe could contemplate pooling public procurement in defence, healthcare, and energy at the European level – and allocate a significant share of it to pre-commercial innovation procurement including AI-based solutions.

This could add much needed heft in critical innovation areas – and attract European talent to work on European issues. In 2023, Europe invested $1.7 billion in GenAI, compared with $23 billion in the US (venture capital and private equity). The EU’s scheme to support innovation of the European cloud is funded to the tune of €1.2 billion but consider that Amazon Web Services invests more than $30 billion—every year.

Europe’s companies, in turn, would also need to commit to investing in their continent’s competitive edge, collaborating where it makes sense. The idea floated recently by Renault boss Luca De Meo of a collective European response to competition in particular on electric vehicles—and setting up an Airbus for the automotive industry—is just one sign that Europe’s business leaders are thinking in these terms. Corporate Europe cannot be a bystander.

MGI has estimated that about €500 billion to €1 trillion of value added could be at stake annually by 2030 if competitiveness challenges are left unresolved. This is three to six times the incremental annual investment needed to achieve net-zero. Revitalizing the single market is an important element of what needs to be done.

Europe has much to be proud of. It is a world leader on sustainability and inclusion, and has highly successful companies in almost every sector. The prize to go for now is making Europe’s competitiveness fit for the coming era, which will help preserve and amplify those attributes.

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