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New perspectives on the innovation gap

Canadian governments give generously with tax incentives and subsidies for business R&D, but businesses aren’t doing that much R&D in Canada. What are we doing wrong?

BY JOHN LORINC | JAN 12 2011

When Stephen Harper’s Conservative government announced this fall that they intend to review Ottawa’s $7 billion annual outlay on business research and development, many public policy watchers braced for a reprise of a debate that’s almost as old as Canada itself. Why does a country so blessed with natural resources find it so difficult to innovate and improve the productivity of its workforce? While we don’t intend to preempt the findings of the expert panel, University Affairs decided to speak to researchers at some of Canada’s business schools for their perspectives on what might be causing Canada’s innovation gap.

Whenever this perennial question crops up, many critics reflexively point an accusing finger at foreign-owned multinationals that buy up Canadian firms and move their R&D operations out of the country. Others recall the loss of a grim parade of technology stars – Mitel, Newbridge, JDS Uniphase and now Nortel, all gone. And could Research in Motion, with Apple hot on its heels, be the next victim?

In its ninth report on the state of Ontario’s competitiveness, the task force headed by Roger Martin, dean of the University of Toronto’s Joseph L. Rotman School of Management, argues that low productivity in the country’s manufacturing heartland has led to low prosperity, revealing an “innovation gap.” Professor Martin writes that public policy is more concerned with science-driven inventions that, while very important to society, won’t necessarily lead to products and services that consumers want – and thus products and services that could improve Ontario’s innovation capabilities.

The TD Bank’s economics shop recently offered another take on the debate by examining the role of small and medium-sized enterprises in budging the innovation agenda. Citing a 2003 Statistics Canada survey, the bank noted that Canadian SMEs in the past have rated R&D far down on the list of sources of innovation, well behind factors such as customers, management and suppliers. But the mindset appears to have shifted, the TD study concluded. The most successful SMEs “are those that pursue increased R&D, strive to innovate, and invest in new technologies. And the data show that many Canadian small and medium-size businesses do exactly that. Indeed, many SMEs are more productive than large firms.” The issues, in other words, are more nuanced than previously thought.

Canadians don’t like taking risks

For many years, William Polushin has taught a core international business undergraduate course at McGill University’s Desautels Faculty of Management. Each year Mr. Polushin (who’s also founding director of the Desautels program for international competitiveness, trade and innovation) polls his students about their attitudes towards entrepreneurship and innovation by asking whether they see themselves as the next Bill Gates – in other words, as individuals who will come up with an innovation that could be a game-changer. Year after year, the response rate is consistent: only about 10 percent say they see themselves in this kind of role. By comparison, at a recent conference on North American competitiveness in Mexico City, he asked the students in the audience to raise their hands if they saw themselves running their own businesses in the future. “Well over half put up their hands,” he says.

The results of his straw polls tell a story. Canada has not been especially successful at fostering an innovation mindset among successive generations of business grads and entrepreneurs. Mr. Polushin says, “We don’t have a strong risk orientation in our own country.” Most of his students aspire to work in large companies, even though the supply of Canadian-based multinationals continues to shrink due to consolidation. The result, he says, is that much R&D and innovation activity occurs elsewhere.

In the past, the problem may have had something to do with a contradiction in Canadian tax policy: the federal government offered generous tax credits for private-sector R&D activity, and it simultaneously imposed high corporate-income tax rates. But, with recent cuts to corporate taxes, “we’ve solved that problem,” observes James Milway, executive director of the Institute for Competitiveness and Prosperity, an independent task force funded by Ontario. So, he adds, “the tax excuse goes away.”

The broader question, in Mr. Polushin’s view, is whether Canadians see themselves as wealth creators. “Do we have the appropriate systems in place to create an innovative economy? Are we creating the appropriate conditions that can turn R&D into something [that is] valued and has sustainable economic benefit?”

Competition can be an important prod. But while Canadian firms compete increasingly in a global market, national R&D investment lags behind that of our trading partners. Canadians grappling with the R&D issue frequently look to emulate the United States, with its long history of technological innovation, capital market clout and postsecondary research. But Mr. Polushin observes that the comparisons may not be instructive because of the huge size difference of the two countries.

Rather, countries like Finland offer clues about how to build an innovation culture within the confines of a small, resource-based economy. After the fall of Communism in the Soviet Union, he says, Finland had to grapple with the collapse of a key economic partner. The country looked at the interface between government, industry and the university sector and developed a successful innovation strategy that brought together all three pillars. Canada’s federated system and overlapping responsibilities for tasks like economic development and higher education militate against the creation of a common vision, he suggests. “We’re too fragmented relative to some of our international peers.”

How do you teach innovation?

When Patrick Draper thinks about building an innovation culture, he considers small- and medium-sized enterprises and the way they approach core business functions. In every viable company, says the president of the Toronto Region Research Alliance, there are departments for human resources, operations, sales and so on. The list includes information technology, of course. A generation ago, many companies didn’t have IT departments; today, they’re standard. And yet, despite the near universal adoption of IT systems by SMEs in Canada, research and development remains an optional element for many of these firms, even with federal research grants and tax incentives to invest in R&D.

“From an individual company’s standpoint, R&D and innovation isn’t an ingrained function within the operation of a business,” observes Mr. Draper, whose organization looks to attract research-oriented firms to the Greater Toronto Area.

By contrast, he cites the example of research-focused firms like the Dutch giant Royal Philips Electronics, where the innovation culture “is bred in the bone.” The company’s growth strategy is to invest heavily in design research to drive new product development.  At Google, individual employees are encouraged to use company time to pursue their own interests, says Mr. Draper. “That mandate permeates the whole company.”

In a bid to alter the innovation culture at the firm level, the Toronto-area regional alliance plans to launch this spring a research and development “academy” targeting SMEs. It aims to fill a gap that isn’t covered by many business school programs by teaching new product development. Participants will be entrepreneurs who are interested in innovation and need to learn how to manage the risks inherent in the process. Mr. Draper says the alliance wants to offer the program to 500 companies a year.

Supply and demand of knowledge-workers

In recent years, thinkers like Richard Florida, the U of T urban geographer and economist, have devoted much scholarly effort to investigating whether regions with dense social concentrations of creative, highly educated people will produce a kind of critical mass of innovative ideas. That was the driving idea behind Toronto’s MARS Centre, an incubator for biotech and biomedical upstarts, and similar projects in other parts of North America. In Waterloo, Ontario, a cluster of high-tech firms has sprung up around the University of Waterloo, including powerhouses like Research in Motion and OpenText (whose president heads the government-appointed panel on business R&D). Human capital is what draws businesses and recruiters to places like Waterloo – as RIM’s founder and co-chair Mike Lazaridis likes to say, the university turns out as many smart graduates as inventions.

Waterloo is clearly benefitting from the cluster effect. But the cluster idea hasn’t worked out as many had hoped. Innovation experts say it’s impossible to create a cluster by fiat. Clusters often evolve around innovation-driven firms that eventually grow big and spin off other startups – Waterloo’s RIM, Ottawa’s Nortel labs, or Palo Alto’s Hewlett Packard all had this effect. “There’s no way of predicting those,” says Stewart Thornhill, executive director of the Pierre L. Morrissette Institute for Entrepreneurship at the Richard Ivey School of Business at the University of Western Ontario.

As it turns out, many Western governments have grappled with the cluster model and how to put policy into practice. Indeed, many are starting to look not just at the supply of smart graduates and researchers, but also the demand for these people. The question then becomes: how should governments support companies that want to do research with universities, instead of just pushing universities to market their research?

Better bang for your buck

Another challenge for Canadian entrepreneurs is the struggle to find venture capital. While there’s sufficient private equity in Canada for the most sophisticated large-scale projects, there isn’t enough capital to finance small ventures. The best-funded venture capitalization pools are U.S.-based.

A new approach to upstart development – the so-called “lean start-up” – emerged two years ago from Stanford University in California. It may point to ways of fostering an innovation culture that’s well suited to the digital economy. Entrepreneurs who use the lean start-up approach rely on open-source software, agile development techniques designed to cut costs, and very rapid iteration of product or service prototypes in response to customer feedback. In effect, lean start-up firms rely less on venture capital for research activity than on a rapid trial-and-error approach to beta-testing as a means of honing in on a commercially viable product.

Dan Debow, co-founder of Rypple, a Toronto software and coaching firm, is an advocate of the lean start-up model. He sees it as an example of a new innovation dynamic in emerging sectors that doesn’t require massive capital outlays.

Over the last decade, Ottawa has expanded both the funding and the number of programs designed to support collaboration between university researchers and businesses and to bring inventions to market. The purpose of the federal R&D review is to assess and improve the many programs – by some counts, more than 200 – that were designed to do just that.

The review begins with the premise that Canada isn’t getting enough bang for its buck when it comes to the return on its investment in R&D. “While governments in Canada have provided world-leading support for private sector R&D,” said Minister of State for Science and Technology Gary Goodyear in announcing the review, “this has not resulted in the desired increases in business R&D, productivity or prosperity for Canadians.”

In early December, a three-day conference called Innovation 2010 took place in Ottawa, with more than 700 attendees from industry, government and universities. Bruce Good, a vice-president with Rx&D, the association representing Canada’s research-based pharmaceutical companies, told his audience that the federal R&D review is the single most important activity for the future of innovation in Canada. And, with an aging population, the imperative to improve productivity is becoming ever more important. As many of the participants agreed, the forthcoming R&D review may be Canada’s last and best chance to fix a problem we’ve known about for years.

The March issue of University Affairs will follow up this theme with a story about MITACS, a successful example of university-industry collaboration in the Networks of Centres of Excellence program.

Meet the Expert Panel

Chairing the Research and Development Review Expert Panel is Thomas Jenkins, executive chair and chief strategy officer of Open Text Corp., Canada’s largest independent software firm.

The other members are Bev Dahlby, a University of Alberta economist; Arvind Gupta, University of British Columbia computer scientist as well as chief executive and scientific director of the MITACS Network of Centres of Excellence; Monique Leroux, chief executive officer of the Desjardins Group; David Naylor, president of the University of Toronto; and Nobina Robinson, chief executive of Polytechnics Canada.

The group has a mandate to review the following:

  • Ottawa’s $7 billion investment in business R&D, including tax incentive policies such as the Scientific Research and Experimental Development program;
  • direct or sector-specific support mechanisms, such as the Industrial Research Assistance Program and Strategic Aerospace and Defence Initiative;
  • programs that support business R&D through various granting councils, departments, agencies and centres of excellence geared at commercializing innovation.

In late December, the expert panel released a consultation paper and began what it called a national dialogue “on what’s working and what’s not, and, most importantly, about the opportunities [Canadians] see for Canada to do better in the future.”

Or is it the way we measure …

Although he’s based at the epicentre of Ottawa’s policy machinery, veteran Statistics Canada economist John Baldwin has a message that runs sharply counter to much of the conventional wisdom that emanates from the capital’s think tanks. “There’s an awful lot of innovation taking place,” says Dr. Baldwin, director of StatsCan’s economic analysis division. The problem is that Canadian policy doesn’t recognize it as such.

Dr. Baldwin argues that R&D is a capital investment, just like machinery. Companies that import this kind of activity are furthering the cause of Canadian productivity in precisely the same way as firms that purchase sophisticated manufacturing equipment from off-shore suppliers.

But the way the Canadian government measures R&D activity routinely excludes the on-the-job, engineering-driven innovation that also produces real productivity gains, he says. Why? Politicians and policymakers place a higher value on research labs populated by white-coated scientists than on the real-world problem solving that routinely takes place on factory floors, mine sites and drilling platforms.

Dr. Baldwin learned this lesson years ago during a conversation with the president of a small but fleet-footed steel manufacturer. The executive told Dr. Baldwin that the company doesn’t spend a cent on R&D; instead it puts a lot of capital into engineered improvements to the production process. The result: the sort of productivity improvements governments crave.

He names several drilling techniques that Canadian oil and gas exploration firms have developed in shale gas extraction – innovations that have had a “huge impact on the price we pay for energy.” These engineering activities also yield lasting knowledge that disperses through the economy. “But we don’t count that as part of the innovation this country makes,” says Dr. Baldwin.

PUBLISHED BY
John Lorinc
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