The Hannover Messe, the world’s largest industrial fair, is normally an occasion for German industry to celebrate its world-beating engineering prowess.

But this year Ulrich Grillo, head of the BDI German industry association, warned an audience at the fair that German business faced a stark new challenge. “The global players are reordering the digital economy and Germany is losing touch with the global elite. We must do something to close this competitive gap with the US,” he said at the fair in April.

Although Germany accounts for almost 6 per cent of annual global information technology (IT) revenues, the country has struggled to create new global players since SAP, the business software company, was founded more than 40 years ago.

Now, as its high-tech machinery and automobiles — the foundation of German success — become increasingly mediated by software and communication technologies, the worry is that the IT deficit could become Germany’s Achilles heel.

Factory automation equipment is set to become more deeply networked. Cars are already highly sophisticated mobile computers and they are becoming increasingly autonomous and connected. If German businesses do not build the so-called “Internet of things”, others will.

“Digitisation goes across the board, across all sectors, which makes it necessary to strengthen the position of computer science and related fields,” says Dietmar Harhoff, chairman of the commission of Experts for Research and Innovation. “I wouldn’t claim it is a doomsday scenario, but is it a risk to German industry? Absolutely.”

German companies do not need reminding of the danger posed to incumbent hardware makers by paradigm shifts in technology. Siemens was once a major player in telecommunications, for example, but overlooked the rise of internet-based telephony and was eventually obliged to exit the business altogether.

Now, Google is building an operating system for self-driving cars and has made a succession of acquisitions in robotics and home energy management.

Although its exact intentions remain unclear, Google’s algorithms seem set to disrupt the status quo in automobiles, automation and electrification - all areas where Germany traditionally excels.

“The software aspect is definitely something that German companies need to think about... Software is like the brain — machines and cars are like the bodies — if you control the brain the other stuff becomes a little more interchangeable,” says Konstantin Guericke, co-founder of LinkedIn and now a partner at Earlybird, the venture capital group.

The German government, which last month unveiled a new “digital agenda”, hopes young German software coders can help reinforce Germany’s IT capability.

But although Berlin is emerging as a start-up hub and incubator Rocket Internet is poised for a multi-billion euro IPO, the city still lags behind far behind Silicon Valley in terms of innovation.

In part this reflects a lack of available venture capital funding. It also stems from a past reliance on imitating successful US app and software start-ups rather than building on the country’s strength in engineering and systems.

“It’s great that Berlin has a buzz... but if you take the current GDP contribution of the start-up companies it’s basically still irrelevant,” says Dirk Kanngiesser, co-founder of the German Silicon Valley Accelerator. “German industry has thrived on incremental innovation... [But] Germans are very poor when it comes to testing unfinished products early in the market,” he adds.

German business culture is less tolerant of risk-taking and failure, compared with the US, and its bureaucracy can also be a hurdle, says German-born Florian Leibert, a former senior engineer at Twitter and Airbnb. “It took less time to create a company in the US than it did for us to open a bank account in Germany for our business. In Germany there are also criminal implications for companies that go into bankruptcy.”

As a result some German computer scientists are choosing to emigrate, either to do research at US universities, found a start-up or to help established Silicon Valley companies challenge Germany in robotics, autonomous systems and machine learning. Sebastian Thrun, once a student at the University of Bonn, helped build Google’s self-driving car technology, for example.

“There is a substantial brain drain,” says Wolfram Burgard, head of the research lab for autonomous intelligent systems at the University of Freiburg, who once worked with Thrun and also supervised Christian Plagemann, now the head of physical interaction research at Google.

“Google is absorbing many people [in autonomous driving]... There is a substantial attraction for good people from Germany to go [to Silicon Valley]... It’s hard for German companies to compete.”

A German investment banker concurs: “The internet of things — that’s something that could be developed in Germany. But rather than becoming a section head at German engineering company, these guys go off to California, where they get paid more money.”

Germany’s real innovation hub lies in southern Germany where its carmakers, suppliers and engineering companies are concentrated. Here companies are taking action to further bolster their software and IT capability.

Developing services that build on the data generated by Siemens’ turbines, electrification and factory automation equipment is a major plank of strategy for Joe Kaeser, chief executive. Siemens has made a succession of software acquisitions in recent years and now has some 17,500 software engineers. Big rival General Electric is also investing heavily in this area.

Kaeser says he respects but is not afraid of Google. This is because Siemens has access to the machinery that its customers have purchased and installed and therefore has the opportunity to provide data-related services.

Bosch, the technology conglomerate whose products range from coffee machines, dishwashers and power tools to fuel-injection and ebike systems, has also expanded its software division and like Siemens it can access new innovations via a venture capital arm. Its micro-electromechanical sensors — the building blocks of the internet of things — are contained in half the world’s smartphones.

Volkmar Denner, Bosch’s chief executive says: “It’s still not been decided who will play the most important part in the Internet of things: IT companies or companies that truly understand the objects themselves.

“What’s essential here is to have expertise in physical objects. And we are currently seeing that IT companies are in fact struggling to get to grips with the world of objects. It’s no easy task to reliably manufacture good, high-quality objects.”

Although Google has claimed the lion-share of media fuss over its development of self-driving cars, Daimler, Bosch and Continental are among German companies already bringing autonomous functionality to market-ready products.

For example, the latest incarnation of the Mercedes-Benz S-Class has a significant degree of autonomous driving capability. The car has systems that, in a slow-moving traffic jam, in effect enable the vehicle to drive by itself.

“German carmakers must be careful that business is not snatched out of their hands. However, they have seen the risk and are defending themselves intensively,” says Ferdinand Dudenhoeffer automotive research director at Center of Automotive Research at the University of Duisburg-Essen.

“Understanding mechanical and electronic systems remains important and here the incumbent carmakers clearly have the advantage.”