Why R&D Spending is Good for Canadian Business

By Charles McMillan

The global economy has become a knowledge business. Globally, governments invest more than $1.7 trillion annually on research and development, primarily on the ‘r’ side, or long-term mission research, as distinct from the ‘d’ side, development, that takes the form of product and process innovation found in private firms. What does this mean for Canada?

High technology is a loose term in the business press, but in general, refers to firms that are primarily knowledge-based – the key assets are not embodied in physical assets like machinery, buildings, or raw materials, but in knowledge or intellectual capital. The competitive advantage is in people’s brains, algorithms in group work (problem-solving), and patents and copyright materials. Software, biotechnology, media, and electronics are often cited as proto-type knowledge firms, but there are many others, from fast fashion to medical imaging, and composite materials as a substitute from aluminum or copper.

Scarcely a week goes by without discussions decrying Canada’s innovation gap. What is missing is a clear eye on the changes taking place globally, and what they imply for Canada.

Canada’s Science Ecosystem

There is good news and bad on Canada’s science infrastructure and ecosystem. The good news is that a blue-ribbon panel, headed by Dr. David Naylor, President of the University of Toronto, has completed a comprehensive and far reaching analysis. The report, entitled Investing in Canada’s Future: Strengthening the Foundations of Canadian Research, undertook comparative benchmarking with peer countries, including those with smaller populations like Canada. The bad news and core conclusion is stark: Canada’s federal research ecosystem, despite many strengths, is weakly coordinated, inconsistently evaluated, and lacks consistent oversight.

What does Canada’s science ecosystem look like? Over time, successive governments have added funding to new agencies and programs, yet there is wide variation in the level of annual funding, regional or national coverage, and range of disciplines. As the Panel study notes,

It is hard to imagine another developed nation that would allow more than 40 years to pass before undertaking an integrated and integrative review of functions that have such clear-cut national importance and involve billions of dollars each year. This unfortunate vacuum may explain why the landscape we have been exploring embodies and supports tremendous professionalism and accomplishment, but also features a proliferation of small agencies and one-off investments in research facilities and programs. Moreover, notwithstanding some fine collaboration on varied fronts, many examples of inconsistencies and poor coordination are clearly visible across the four pillar agencies.

After widespread consultations, including with the business community, the panel made numerous recommendations. The current external advisory body, the Science, Technology and Innovation Council, has no independent reporting authority and a constrained disciplinary mandate. The appointment of a new Chief Science Advisor, a central part of a related bundle of recommendation, by an Act of Parliament, would give voice for “an independent National Advisory Council on Research and Innovation”, which would … advise on evaluations for all programming in both the research and innovation spheres, including proposals for new agreements with external entities and renewals of extant agreements, …. a four-year phase-in involving base increases averaging 9% each year… New spending would be balanced across investigator-led research operating grants (the highest priority); enhanced personnel supports for researchers and trainees at different career stages; targeted spending on infrastructure-related start-up (small equipment) and operating costs (Big Science facilities); and enhancement of the environment for science and scholarship by improved coverage of the institutional costs of research.

The cumulative base increase would move annual spending from approximately $3.5 billion to $4.8 billion. The steady-state increase in base funding by the end of four years is small, amounting to 0.4% of the federal budget. By comparison with peer countries, with targets exceeding 3.5% of GNP, the Panel’s recommendations keep Canada in the global game. More emphasis should be placed for “independent, investigator-led research by frontline scientists and scholars” and less to priority-driven and partnership-oriented research. In all, and more vitally, the Panel correctly believes that these commitments produce “the very highest-yield investments in Canada’s future”.

Canada’s Knowledge Sector

Research and development (R&D), the major driver of the knowledge-economies, is based on total R&D/GNP spending for countries, and on R&D/total sales for corporations. Countries with strong economic performance have industries that create the pull for technological innovation. Industry creates the demand for R&D by providing funding, and conducts a majority of the R&D often in concert with universities, and capitalizes on the outputs via intellectual property. The ratio of industry-applied R&D is at least twice that of universities and governments combined. Private sector R&D spending as a percent of the total ranges from a high of 77.9% in Japan, 76.2% in Korea, 72.3% in China, 71.9% in Germany, 64.2% in Russia, 63.2% in France to 56.1% in Canada. Canadian corporate R&D spending, about C$15 billion, has not increased in ten years.

For Canadian firms, whether meas¬ured by domestic patents, by scientists and engineers in the labour force, or by sectors with a positive trade balance, science-based innovation remains weak.

Despite having a rich tradition of invention and discovery, and a record of leading firms in many sectors, where Canadian private firms rank last in company-funded R&D. The danger is that Canada will be caught in the middle, between the growth sectors represented by high-technology trade, and the low-cost sectors increasingly dominated by Asia, where skilled labour and engineering applications are key to competitive success.

While foreign ownership plays a role in reducing Canadian R&D spending, it is as much a symptom as a cause, because other factors are at work. Canada has an anemic record in apply-ing existing technologies. For six advanced manufacturing technologies — computer-aided design, NC-CNC machines, program controllers, inter-company links, LAN for technical data, and LAN for factory use —Canadian usage is significantly less than US firms, and the gap is greatest among small firms, i.e., fewer than 500 employees. Other barriers include aging plant and equipment, and too little appreciation of the enabling impacts of investing and using IT.

Of the leading Canadian firms in the Top 100 Fortune 500 companies, seven of the eleven largest are in the financial sector. To be fair, firms like Spotify, SNC, RIM, IBM Canada and Open Text have mobilized a cluster of knowledge workers, suppliers, and customers. For a country so well endowed with natural resources, Canada has few global leaders in agribusiness, dairy, or food production. Firms like Saputo, McCains, or FPI are large by domestic standards, but small relative to global players. In some sectors like pulp and paper, management practices have centered on turning cut trees at sawmills into logs, boards, and plywood, and shipping outputs to the US market or Asia, or upgrading the timber to low grade products like newsprint. (In 1991, 50 of Canada’s 67 pulp and paper plants were built in 1941 or before.) Ironically, Canada’s record in scientific research by researchers stands up well by international criteria, and the recommendations of the Naylor Report can reinforce that competitive edge.

In science-based sectors like medicine and biotechnology, advanced materials, and IT and electronics, progress requires long term horizons, critical mass of researchers, and the desire to move the technological frontier forward. According to Statistics Canada’s first-ever Survey of Intellectual Property Commercialization, Canada’s 12 largest universities account for 77% of invention reports, 68% of new patent applications, and 74% of active licenses. In short, Canada needs to improve the two sides of the innovation game – strong linkages between publicly-funded support for science-based research, outlined in the Naylor Report, and business-university linkages for idea commercialization. In this game, to quote from a technology corporate leader, 3M, research is the transformation of money into knowledge, while innovation is the transformation of ideas/knowledge into money.

In this non-linear world, corporate strategists need to focus on being first to market, where scaling fast is vital, and a mindset to pursue relentlessly improved production innovation to optimize financial returns. All firms now face the paradox of long lifecycles to meet the ‘r’ side of R&D but very short time frames to meet the ‘d’ side of product innovation. Getting two frameworks right is central to Canada’s success. The recommendations of the Naylor panel and their report, Investing in Canada’s Future, put the country’s mission research program on a greatly improved footing, involving long term funding for quality research. The second framework now needs to be stepped up – the corporate-university nexus to focus on the ‘d’ side of R&D, where product commercialization, vastly increasing the rate of new start-up firms, better access to venture capital, and changes to protocols governing university intellectual property would be starting benchmarks.

In this sense, science-based innovation has become a never-ending match of wits, much like a game of contract bridge, with three identifiable variables. The first, akin to classical economics, is the lay of the cards. The players can only play the cards in their hand — i.e. governments and firms are at the mercy of uncontrolled market forces and national resource endowments. The second variable in the bridge anal¬ogy is how players play their cards. Here, strategy, cunning and guile all play a role (surrogates for international trade policy, political pressure groups and management competences and capabilities). But that relates to the third: how the competition plays the game. Implementation the Naylor Panel’s recommendation shows the opportunity to win is also Canada’s to lose.

Charles McMillan is Professor of Strategic Management, Schulich School of Business at York University. charlesmcmillansgi@gmail.com