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Innovation Canada: A Call to Action
Special Report on Procurement

The Case for the Use of Procurement to Stimulate Business Innovation

The use of federal government procurement to support business innovation is an important and timely question for a number of reasons.

  • From an opportunity perspective, federal procurement spending has been growing in recent years and will continue to grow into the future, based largely on significant defencerelated equipment purchases. In 2009, federal procurement amounted to about $27 billion or 2 percent of gross domestic product, up substantially from an average of $22 billion annually in the 1999–2008 period. During that same period, Department of National Defence (DND) procurement averaged about 30 percent of the total, but rose to 46 percent in 2009–10 and will be sustained at a high proportion of the total by planned expenditures over the next several decades.
  • From a policy perspective, procurement is the major demand-pull instrument available to governments to stimulate business innovation relative to the vast array of supply-push instruments and, as such, dollar-for-dollar, provides potentially more valuable, marketdriven support to individual companies.
  • From a program perspective, procurement has the potential to be tailored toward highgrowth firms, mainly SMEs, or to particular emerging technologies, such as green tech, information and communication technologies (ICTs) or to specific sectors like defence and aerospace, as a complement to supply-side programs. The federal government has been increasingly active in the field in recent years by fine-tuning existing programs and by experimenting with new ones.
  • From a financial perspective, "smart procurement" policies and practices, based on life cycle costs and benefits, can result in superior outcomes for given levels of expenditure, while enhancing Canadian innovation, productivity and growth.

At the same time, there are a number of important caveats to bear in mind with respect to opportunities for greater or better use of procurement as an innovation policy instrument.

  • The practical scope for the use of procurement to stimulate innovation is only a fraction of the total annual expenditure. Some of the top categories in federal procurement include real property (7.6 percent), travel (5.5 percent), advisory services (3.6 percent) — areas not particularly ripe for technological innovation. Most science-based departments and agencies represent a small proportion of the total value of federal contracts, leaving DND at 46.4 percent and Public Works and Government Services Canada (PWGSC) at 24.1 percent as the common service agencies to take the lead on any significant initiatives.
  • The long-standing federal procurement policy, led by the Treasury Board and implemented by PWGSC, has as its central tenet "value for money," which is criticized by industry as more often than not being "lowest price through competition among qualified bidders." This practice is aided by a culture within government that favours off-the-shelf, known-technology products and is further reinforced by renewed pressures to reduce costs in response to the current federal budget deficit. Notwithstanding these industry views, government officials state that, for complex procurements such as sophisticated military equipment, technical merit is often more heavily weighted than price.
  • Federal procurement is also constrained by international trade agreements — Agreement on Government Procurement under the World Trade Organization (WTO); the North American Free Trade Agreement (NAFTA) — that require bidding to be open to foreign suppliers for most goods and services above various contract thresholds, with relatively few exceptions regarding entities or product categories. The main exceptions relate to defence and security procurement and to set-asides for small businesses. Canada has not invoked small business set-asides but has a specific exemption related to Aboriginal businesses.
  • The Agreement on Internal Trade (AIT) requires non-discriminatory treatment among jurisdictions in Canada and affects mainly procurement by the provinces and territories, which account for 86 percent of total procurement, or six times that of the federal government. The federal government is constrained by the AIT from directing procurement to a specific province or territory. Like international agreements, the AIT contains a national security exception.
  • As a practical matter, even where possible to derogate from obligations for open, competitive bidding, there is always the question of what premium the government is paying for the perceived benefits of more restricted procurement. This is often very difficult to measure, but it raises the question of whether an amount equivalent to the premium could have been spent more costeffectively through a different program instrument.
  • A central tenet of economic and business literature is that intense competition among suppliers, combined with demanding customers, drives business innovation. The Report of the Expert Panel on Business Innovation (Council of Canadian Academies 2009, Innovation and Business Strategy: Why Canada Falls Short, p. 109 [available online at: http://scienceadvice.ca/uploads/eng/assessments and publications and newsreleases/inno/(2009-06-11) innovation report.pdf]) devoted a whole chapter to the role of competition, noting that "competition is one of the most potent incentives for innovation." Indeed, the underlying premise behind the procurement provisions of international and domestic trade agreements is that, like other forms of trade liberalization, open competition for government purchases spurs business productivity and provides economic benefits to all participating jurisdictions.

In light of these considerations, why would governments want to restrict competition in their purchases of goods and services, particularly in a small economy such as Canada's where domestic competition is naturally limited in many product areas? The answer is that government has a huge, ongoing need for an array of goods and services in a broad range of innovative activities. Canadian SMEs can potentially meet these requirements but may need to be nurtured by government until they reach a point of scale and sophistication at which they can compete without special assistance.

Such support has traditionally been made available to SMEs through various supply-push programs. Procurement has the advantage of impacting more directly on business innovation as a demand-pull instrument. The benefits to business of the use of procurement as an instrument of choice are generally as follows.

  • Governments can be demanding and sophisticated customers for innovative solutions to their needs.
  • At the same time, because of the potential for broader spillover effects, governments are prepared to provide a support element in their initial purchases of innovative products, thereby reducing commercialization risks to firms.
  • Such purchases and the prospects for followon sales facilitate equity and debt financing for firms.
  • Firms supplying governments as lead users can more effectively market those products to private sector customers domestically and abroad.
  • Successful initial purchases are key to ongoing public and private sector procurement and the building of critical mass for production economies and future growth.

All governments, within international rules, have used procurement to support domestic industry, and indeed many have exploited flexibility in their trade obligations much more than Canada. Based on this international experience, there is therefore scope for the greater use of procurement of innovative goods and services to support Canadian industry. Indeed, the federal government's increased use of procurement as a policy instrument will help "level the playing field" with international competition in both domestic and foreign markets.