Canada’s innovation approach is failing to support scale-up tech firms: study

Canada’s suite of innovation policies and funding fails to adequately support scaling tech companies and prevents potential high-growth firms from becoming large enterprises, according to a study by Canadian policy researchers.

Previous research shows Canada’s innovation policy over the past three decades has been unable to shift the country’s economy out of a “low innovation equilibrium,” said the study. Despite favourable conditions for startup companies, relatively few Canadian firms reach scale-up or high-growth status.

“The failure to provide adequate support for Canadian firms to scale suggests a disconnect in the national innovation system between the policy supports provided by successive governments and the needs of the high-technology community and scale-up firms specifically,” the study said.

“If we want to begin to solve all these dilemmas – low R&D spending, low productivity, not enough tech exports – we have to support the scale-up firms,” study co-author David Wolfe (photo at right) told Research Money.

When it comes to policy supports for innovation, “particularly the direct spending programs, have to be become more targeted and more focused on scale-up firms,” said Wolfe, professor of political science at the University of Toronto and co-director of the Innovation Policy Lab at the Munk School of Global Affairs and Public Policy.

The study, funded by Mitacs, was authored by Steven Denney (then a post-doc with Wolfe, now at the University of Vienna), Travis Southin at Carleton University’s School of Public Policy and Administration, and Wolfe. It was published last year in the journal Science and Public Policy.

Research on potential impediments to reaching scale-up status in Canada – including by the federal Advisory Council on Economic Growth in its 2017 report– shows that inadequate incentive structure, weak government support, and misalignment of support to scaling up objectives hinders firms’ performance, according to the study.

Canada’s Economic Strategy Tables in 2018 specifically called for targeted support to help scale medium-sized firms towards globally competitive enterprises, the study’s authors noted.

The 2017 Innovation and Skills plan aimed to double Canada’s high-growth firms from 14,000 to 28,000 by 2025. However, the latest data from Statistics Canada indicate that Canada is not on track to meet this goal, recording only 10,700 high-growth businesses by revenue in 2020, their study said.

Scale-up companies comprise less than one per cent to eight per cent of firms in Canada (depending on the definition) with about eight to nine per cent coming from the tech sector, according to a slide presentation by the study’s authors. Scale-ups achieve higher employment levels and pay higher wages than smaller firms, have higher average productivity growth, are up to 10 times more likely to export, and are up to eight times more likely to conduct R&D.

 The researchers’ study draws on more than 100 interviews with Canadian technology firms from July 2015 to February 2020, supplemented by additional consultations with innovation ecosystem actors and relevant stakeholders. The core empirical analysis relies on 71 interviews conducted with the CEOs of Canadian tech scale-ups.

Their study found that scale-up entrepreneurs prefer a more active role by government in the form of demand-side, direct and targeted innovation instruments, including procurement.

Numerous cases illustrate the effect of strategically targeted policy to secure a competitive advantage in high-tech industry sectors, such as Japan in consumer and microelectronics, China with digital technologies, Israel in software, and Taiwan with semiconductor manufacturing, the study said. “Most countries deploy policy mixes that combine a range of direct and indirect, but in the majority, the emphasis tends towards direct spending programs.”

Canada and several other countries, such as France, are outliers with a policy mix skewed towards using tax policy instruments instead of direct-to-firm grants, the study said.

Specifically, the federal government’s Scientific Research & Experimental Development (SR&ED) tax credit – which now amounts to about $4 billion a year – has constituted between 74 and 90 per cent of total spending on support for business R&D each year since 2000, according to the study.

Cross-national data from the Organisation for Economic Co-operation and Development on business enterprise expenditure on R&D (BERD) shows that Canada spends far less – as a proportion of GDP – on direct funding of BERD and significantly more on indirect tax support.

Challenging for small-economy countries to adopt targeted innovation policies

Canada is a relatively small, export-oriented country with a comparatively strong startup ecosystem, the study said. However, Canada’s innovation performance reveals lacklustre results in terms of narrowing the gap with competitor countries, including BERD, firm-level productivity, investments in digital technology, exports and patenting.

Small economies have a limited domestic market, which hinders tech firms’ growth opportunities and demand for users of their technologies. In addition, the increasing technological complexity of most market segments puts firms in small domestic economies, especially small and medium-sized enterprises (SMEs), at a particular disadvantage, the study said. “The challenge of competing in global markets requires greater human resources with experience operating at scale plus access to the capital needed to grow.”

The Canadian economy is disproportionately comprised of SMEs. Canada’s relative lack of domestic technology anchor firms, particularly since the collapse or decline of its two flagship firms – Nortel and Research in Motion – stands in contrast to some small, open economies, such as the Netherlands, Finland, and Sweden, which are home to many multinational enterprises, the study said.

 “The structural dependence on technology imports from foreign multinational enterprises has been described as a barrier to innovation, making the country a buyer of technology, not a creator or competitor,” the researchers noted.

The comparative literature on the politics of innovation policy suggests that it is politically challenging for developed, small countries to adopt targeted innovation policies that focus resources on emerging niches of comparative technological advantage, their study said.

Instead, small, slow-growth economies like Canada’s often prioritize macroeconomic “framework” policies due to interest group pressure from traditional industries and large multinationals, a lack of policy coordination, and structural resistance from key policymakers. In such economies, established firms and industries have generally supported and benefited from so-called “neutral” policies, rather than explicitly selective policies.

One study cited by the researchers found that the outcome in small, slow-growth countries is a “tug-of-war in innovation policy between large firms and SMEs,” producing an innovation policy mix defined by “fragmentation, debate, and a lack of consensus.”

Canada’s funding programs to support innovation “are still divided, they’re still scattered,” Wolfe said. Firms still say they have trouble figuring out which ones they should be applying for, and that it’s much too time consuming to do all the applications for the different programs, he said. “It all needs a major overhaul.”

Barriers to scale-up growth include “laissez-faire” innovation policy mix

In 2019, between seven and 11 per cent (depending on the definition of scale-ups) of all scale-ups in Canada received business innovation and growth support from government, according to the policy researchers’ data. The most commonly leveraged programs by scale-ups were the National Research Council’s Industrial Research Assistance Program, and the Trade Commissioner Service.

Scale-ups received nearly twice as much support from the SR&ED tax credit program compared with government business innovation and growth support (BIGS) programs. More innovative scale-ups (exporters, R&D spenders or patenting firms) received more federal support than other scale-ups.

BIGs support is associated with faster growth and higher rates of subsequent scaling periods, the researchers’ data showed. More than half of scale-up recipients received support from BIGS programs only after scaling for 10-plus years. Between 55 to 60 per cent of the value of BIGS support went to these mature scale-ups.

In the study, scale-up firms identified Canada’s small internal market, lack of patient, non-dilutive capital, limited size of the domestic market, and “comparatively laissez-faire innovation policy mix” as barriers to their growth and expansion. 

“Overall, our interviews show that scale-up entrepreneurs display a clear set of policy preferences for innovation policy instruments – they strongly favour a more targeted innovation policy mix that employs direct grants and demand-side procurement,” the researchers said.

Thirty-nine per cent of the entrepreneurs interviewed expressed a preference for direct grants over tax credits, making this the most popular preference for one instrument over another. Interviewees regularly cited the need for direct-to-firm instruments like grants and loans.

More targeted approach needed to support Canadian champions

Of the entrepreneurs who maintained that Canada’s current policy mix was too neutral, most criticized the R&D tax credits, followed by a concern that grants and procurement were not focused sufficiently on supporting scale-up firms. Several expressed a need to emulate other countries’ more targeted approaches to supporting scale-ups or high-growth firms.

Interviewees noted that Canada’s neutral approach of spreading support across all sectors and firm types ignores structural barriers to scaling up, such as the power imbalance with foreign multinational firms in oligopolistic technology markets.

One entrepreneur argued that Canada needs to be “quite selective as to the areas where they want to try and position Canadian champions [because] we don’t have the ability to take our limited capital and spread it across a large war front.”

This same entrepreneur articulated another commonly heard complaint that Canada lacks the capacity at the national level to identify and support promising firms. “It’s not that hard to pick winners . . . each one of those successful countries’ governments are informed by a Technology Advisory Board or a technology court,” the entrepreneur said.

Interviewees contrasted this with Canada, saying: “There is no established systematic way to engage with business, and especially technology businesses, to actually get their opinion on what’s working and what isn’t working and picking the winners out of that.”

Wolfe, however, argued that “Governments don’t have to pick winners. Winners pick governments.”

Policymakers don’t have to figure out what the criteria are for firms that should be targeted for support, he said. These firms “will demonstrate that they’re worthy of support by crossing over the scale-up threshold,” based on the widely used definitions of scale-ups cited in the study.

Scale-ups are defined as those companies that have 20 per cent or greater year-on-year growth in revenue over three years (or an average of at least 20 per cent year-on-year growth in employment for three consecutive years), and $2 million or higher in revenue at the end of the measurement year.

“Once they’ve crossed the scale-up threshold, these are firms with usually a 10-year proven track record of growing,” Wolfe said. “They tend to out-perform on all the criteria we think are important – R&D, productivity, exports. These are the firms we should be targeting with support to keep them growing.”

One of the interviewees’ most stated preferences for new or improved policy instruments was for the Canadian government to assume a more active role in employing demand-side instruments, such as procurement, in a targeted fashion to act as a “market-maker” in support of scale-up firms in strategic technology sectors.

Procurement was frequently cited as a missed opportunity to enable Canadian firms to overcome pressures for early exit by using the government as a reference customer, bolstering their credibility in export markets and their ability to retain equity in future financing rounds.

Innovative Solutions Canada, for instance, was identified as “a good step in the right direction” but strongly criticized as too small-scale, not fast enough, and not coordinated enough with significant industry players.

When it comes to research and development, Canadian business enterprise expenditures on R&D (BERD) amount to $23.9 billion, or 0.93 per cent, while the average BERD for OECD countries is more than double at 1.99 per cent, the researchers noted. Citing data from David Watters, founder and strategic advisor at Ottawa-based Global Advantage Consulting Group, the study’s authors point out that to meet the OECD average, Canadian businesses’ R&D expenditures must increase to $51.2 billion ($27.2 billion higher per year).

According to Watters’s data, because of the relative size of Canada’s domestic market, exporting firms would also need to increase exports by more than 80 per cent from $936 billion in 2022 to $1,713 billion annually to generate sufficient revenues to fund the targeted R&D spending level.

“An R&D and a tech strategy has to be an export strategy and it has to be an export strategy focused on scale-up firms,” Wolfe said. “You can’t be a successful scale-up in Canada and be limited to the Canadian domestic market. You can only successfully scale by expanding into international markets.”

The study’s authors argued that government must take a “firm-centric approach” when it comes to innovation policies and funding support, and recognize the value of understanding the unique needs of scale-up enterprises. “A failure to align the interests of these key stakeholders could potentially hinder the growth and competitiveness of the high-technology sector,” they said.

Wolfe pointed out that Canada’s productivity levels relative to the U.S. are declining. Canada also lags in expenditures on technology – especially software – and is far behind the U.S. in the pace of technology adoption. Without a change in how government supports scale-up firms, he said, “we’re just going to continue on the path we’re on.”

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