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By Christopher Alessi and Chase Gummer 

AMBERG, Germany--The next front in Germany's effort to keep up with the digital revolution lies in a factory in this sleepy industrial town.

At stake isn't what the Siemens AG plant produces--in this case, automated machines to be used in other industrial factories--but how its 1,000 manufacturing units communicate through the Web.

As a result, most units in this 100,000-plus square-foot factory are able to fetch and assemble components without further human input.

The Amberg plant is an early-stage example of a concerted effort by the German government, companies, universities and research institutions to develop fully automated, Internet-based "smart" factories.

Such factories would make products fully customizable while on the shop floor: An incomplete product on the assembly line would tell "the machine itself what services it needs" and the final product would immediately be put together, said Wolfgang Wahlster, a co-chairman of Industrie 4.0, as the collective project is known.

The initiative seeks to help German industrial manufacturing--the backbone of Europe's largest economy--keep its competitive edge against the labor-cost advantages of developing countries and a resurgence in U.S. manufacturing.

Underpinning the effort is the Internet of Things, where the Web meets real-world equipment. Google Inc. made a big push on the consumer front this year with its $3.2 billion purchase of Nest Labs Inc., which makes thermostats that can be remotely controlled by smartphones and other connected devices.

Full-fledged smart manufacturing is still in the pilot phase. But the German Research Center for Artificial Intelligence has worked with German industrial companies to engineer some of the most advanced demonstrations in the field.

At the center's pilot smart factory in Kaiserslautern, chemicals giant BASF SE produced fully customized shampoos and liquid soaps. As a test order was placed online, radio identification tags attached to empty soap bottles on an assembly line simultaneously communicated to production machines what kind of soap, fragrance, bottle cap color, and labeling it required. Each bottle had the potential to be entirely different from the one next to it on the conveyor belt.

The experiment relied on a wireless network through which the machines and products did all the talking, with the only human input coming from the person placing the sample order.

Siemens's Amberg facility shows what is possible in an operational factory at this point. The plant, which builds automated machines for the factories of German industrial companies like BASF, Bayer AG, Daimler AG and BMW AG--and many of their rivals abroad--has been digitizing gradually for 25 years. Today it is about 75% on autopilot, with 1,150 employees mostly operating computers and monitoring the production process.

Designing a self-operating intelligent manufacturing system over an Internet network could still be a decade away. "We have the building blocks," said Siemens board member Siegfried Russwurm.

Besides Amberg, other German factories on the road to intelligent manufacturing include one operated by electronic motors producer Wittenstein AG, and Robert Bosch GmbH's nascent adaptive assembly line for hydraulic equipment, set to be operational in Homburg this fall.

Germany's foray into the industrial Internet comes amid widespread unease here about U.S. domination of the Internet. Google currently handles 95% of all German Internet searches, according to online statistics portal Statista, and its pervasiveness could pose a challenge for German industrial companies trying to harness the Internet to adopt a more service-oriented business model.

Günther Schuh, a member of the National Academy of Science and Engineering, which helped launch Industrie 4.0, said he has noted "genuine concern in German industry about the monopoly position of companies like Amazon or Google" because they control the interface between consumers and companies.

Google could potentially use its dominant position as a search engine to push its own products and services, while expanding beyond simply providing email, word processing and cloud computing software. For example, the tech company is in the early stages of producing technology for a self-driving car.

Amazon hasn't just stuck to online retailing, but has moved into consumer electronics with its tablet device Kindle Fire and its Fire Phone smartphone.

German Chancellor Angela Merkel has warned that German companies need to do more to stay competitive in the digital economy, while German economics minister Sigmar Gabriel sees dangers in allowing American companies like Google to dominate the so-called Internet data business.

"The big data necessary for Industrie 4.0 to work isn't being collected by German companies, but by four big firms in Silicon Valley. That's our worry," Mr. Gabriel said at a public debate with Google Chairman Eric Schmidt earlier this month.

German executives appear less worried.

Peter Herweck, chief executive of Siemens's division handling motorized equipment, said he doesn't see Google's Internet dominance as a threat to Siemens's digital-manufacturing efforts. "Maybe they can become a partner," he said, by someday helping engineers find tools or parts needing repair inside factories.

"When it comes to the connected world, one needs more than just software" for smart manufacturing, said Werner Struth, a Bosch board member. "One needs products one can touch."

German companies have been at the cutting edge of production technology for years--and now they are getting government help to stay on top.

Industrie 4.0 is the kind of public-private program Germany does well. The government doesn't pick winners through subsidies, but is giving EUR200 million ($253 million) for research to create new technologies and networking opportunities for companies to develop common standards--harnessing a vast system of public research institutes that help companies carry out research and development.

In the U.S., the Obama administration is trying to emulate that research network, having earmarked over $2.2 billion in 2013 for a nationwide manufacturing initiative.

Concurrently, U.S. industrial and tech giants including General Electric Co., AT&T Inc., Cisco Systems Inc., Intel Corp., and International Business Machines Corp. have joined forces in March to create the Industrial Internet Consortium. Like Industrie 4.0, the nonprofit consortium seeks to create a framework for companies and university researchers to establish standards and best practices for industrial applications of the Internet.

Write to Christopher Alessi at christopher.alessi@wsj.com and Chase Gummer at Chase.Gummer@wsj.com