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Innovation Canada: A Call to Action
Special Report on Procurement

Selective International Practices

The use of procurement to stimulate innovation has been a long-standing practice in other countries, particularly the US with its enormous defence expenditures. The US has also led the way internationally with respect to promoting small business with vigorous programs, including procurement set-asides.

Small Business Procurement

The quintessential small business program is the US Small Business Innovation and Research Program (SBIR), now almost 30 years old. A legislative mandate requires federal agencies that contract out more than $100 million annually in R&D for technologies to set-aside 2.5 percent for small businesses. This translates into annual expenditures of $2–3 billion, with the Department of Defense and National Institutes of Health as the largest users.

SBIR also has a sister program, Small Business Technology Transfer (STTR), now 20 years old, which applies a 0.3-percent set-aside by agencies with over $1 billion in extramural R&D budgets for small business R&D partnerships with academic institutions. The programs provide fully funded contracts for phase 1 proof-of-principle studies ($150 000 for SBIR over six months and $100 000 for STTR over one year), and for phase 2 R&D work ($1 million for SBIR and $750 000 for STTR, both over two years). The programs do not fund phase 3 commercialization, which is financed through conventional sources (i.e., equity, debt and retained earnings).

SBIR–STTR implementation varies widely in practice among US federal agencies. For some, like the National Institutes of Health, they are mainly a source of R&D funding. For others, like Defense and Energy, they can become the actual first-user procurement of products developed with SBIR funding should the research be successful.

Other countries, such as the UK, Sweden, the Netherlands, Finland, Japan and the Republic of Korea, have adopted SBIR-type programs. In the case of the UK, building on a 2008 white paper that required departments to develop innovation procurement plans, in 2010 the government set a goal of 25 percent of procurement going to SMEs, followed by a series of measures to enhance transparency and access by SMEs (especially ICT procurement).

Perhaps the most important tool, however, is the Small Business Research Initiative (SBRI) originally launched in 2001. Like SBIR, the program provides fully funded development contracts between SMEs and government departments, but on a voluntary basis, not mandatory as in the US. The value of contracts in the case of SBRI was the equivalent of about $50 million in 2009.

Defence and Security Procurement

Most countries face a considerable challenge in developing their defence industry. In the past two decades, globalization and the end of the cold war gave way to important consolidations in the international defence sector. The defence industry is now concentrated in the US and major economies of Europe, with affiliates of large suppliers established in smaller markets such as Canada and Australia. It is more difficult than ever for small economies to develop a defence industry base in a globalized defence industry dominated by a few very large defence companies. For many countries, a solution has been to integrate into the global supply chain, as Canada is promoting with the JSF.

Some countries have chosen to adopt a formal defence industry strategy while some, like Canada, have not. Some countries have thriving defence industries and equally impressive exports.

Others choose niche priority areas and depend on international trade to meet their overall military needs. Many countries have chosen to have formal industrial offset programs similar to Canada where 100 percent of the contract value must be met, while some leave room for negotiation in the bid process for their offset practices. Still others, like the United States, do not condone offset practices at all, although in the case of the latter the purchase overseas of defence-related goods is a rarity. While each of the countries exist in a unique context, their study is useful to determine what does and does not work in their specific cases, so that we can arrive at a better understanding of our own.

A report on this issue (Grover Report) was prepared for the Treasury Board Secretariat in 2008. It compared key defence procurement policies and practices of Australia, Denmark, the Netherlands, the UK, the US and Canada. It noted that, while not all countries have a formal defence industry strategy, "all the countries except the U.S. have an offset requirement, and they all refer to it by some euphemism: industrial participation, industrial co-operation or, in the case of Canada, Industrial and Regional Benefits." The report concluded that "given the very significant investments being made in new defence equipment, and the resultant increase in defence industry activities, it may be worth investigating the value of renewing Canada's defence industrial policy."

Australia, the United Kingdom and the United States are worth examining because of their close ties and foreign and defence policy similarities. Australia is often referred to as Canada's strategic cousin, the two countries sharing some demographic, cultural and economic similarities. Several other countries are also worth examining: France, with its strong economic and defence industrial base, and the Netherlands, having made significant investments to its military, are both NATO members who have strong defence ties with Canada. Sweden, for its size, maintains a very healthy defence industry base and has been a very successful exporter of military equipment.

Australia

Australia is an important comparator because it is also a middle power with a small domestic market and limited scope for competing directly with major military supply countries. In recent years, it has made significant changes to its approach to defence procurement.

A new approach to defence procurement was put into action with the 2007 Defence Industrial Policy statement and its follow-up in 2010. The primary goal of the strategy is to ensure the cost-effective delivery of equipment and support to defence in line with Australia's strategic circumstances. This goal is to be achieved through nine strategies:

  • a strategic approach to equipping and sustaining the ADF
  • maintaining local priority industry capabilities
  • securing value for money through bestpractice procurement
  • creating opportunities for Australian firms
  • encouraging SMEs
  • supporting development of skills in the defence industry
  • facilitating exports
  • driving innovation in defence technology
  • defence and industry working together.

Like other countries reliant largely on foreign prime contractors for their major defence procurement requirements, Australia has had a history of using industrial offsets to increase domestic participation in such contracts. However, in the defence procurement review (Australian Government Department of Defence 2010, Building Defence Capability: a Policy for a Smarter and More Agile Defence Industry Base, p. 57 [available online at: http://www.defence.gov.au/dmo/id/dips/DIPS_2010.pdf]), a new approach was taken.

"In general, offsets and quotas do not work. They provide a revenue stream only for the period of the acquisition contract and related only to the goods being procured at the time. Instead of protecting local defence firms from foreign competition, Defence now seeks to increase the opportunities for them to win work in global programs.

This represents a fundamental move away from offsets. Under this policy, there will be no local industrial participation targets. Any nominated local industry activities will be individually costed and will only be funded as part of the Defence procurement process if they are deemed to represent value for money."

Australia's new approach to defence procurement is based on the overriding objective of integrating Australian SMEs into the global supply chains of large international primes and their major subcontractors, while competing on a value-for-money basis. There are no specific offset requirements, but foreign firms are required to address domestic participation in their bids on all major contracts.

In practice this means defence contractors' providing SME domestic firms with subcontracting opportunities and technology transfer, and helping them develop in-service support capabilities.

The core of the policy is the establishment of a list of Priority Industry Capabilities (PICs) that confer an essential strategic advantage by being resident in Australia and, if not available, would undermine its defence and self-reliance capability. The list is regularly reviewed and updated. It currently includes the following specific capabilities: acoustic technologies and systems, anti-tampering capabilities, combat uniform and personal equipment, electronic warfare, system and system of systems integration, high frequency and phased radars, infantry weapons and remote weapons stations, in-service support of submarine combat systems, ballistic and munitions explosives, ship dry dock facilities, signature management, and support of mission-critical and safety-critical software.

Based on a ten-year, forward-looking capability plan, companies are encouraged to submit innovation proposals relating to PICs for direct funding as development contracts under the PIC Innovation Program with a view to having good prospects for driving additional work in Australian industry or providing cost savings for future defence contracts. The plan is supported through a Capability Development Advisory Forum, which allows industry to communicate regularly with Defence, as well as web-based information and business access offices in major cities.

Australia has also established a number of collaborative government-industry-academic research institutions, such as the Defence Science and Technology Organisation, and a Defence Industry Innovation Centre, as well as specific programs such as Rapid Prototyping, Development and Evaluation Program, similar to Canada's new Project ACCORD.

United Kingdom

While it is difficult to compare the Canadian and British contexts because of size differences in defence expenditures, the UK, like Australia, has taken a number of steps in a long process to improve defence procurement. With roots in the 1980s and 1990s, the reform effort has sought to tap expertise available in the private sector and reduce public expenditures. Cost overruns and delays had become rampant in the wake of the cold war, and these failures were brought to the surface in a 1997 report by the UK National Audit Office.

The Defence Industrial Strategy dates back to 2005. It has two essential features: setting out those industrial capabilities required in-country (while recognizing other capabilities will be sought through international collaboration and competition), and explaining more clearly the factors that will influence procurement decisions. Its overall aim is to retain in the UK those industrial capabilities (infrastructure, skills and knowledge) needed to ensure appropriate sovereignty.

The strategy has three interlinked components:

  • the defence capability requirements going forward (e.g., new projects, upgrade and modifications to existing equipment) that it seeks to retain in-country
  • a review of different industrial sectors and crosscutting capabilities (in the context of future needs, including how mismatches between the two can be filled)
  • an outline of how the strategy will be implemented (i.e., the principles and processes that underpin procurement and industrial decisions) and the implications for Defence and industry as a whole.

Although it is a major defence exporter (an average of $8.5 billion a year), the Ministry of Defence recognizes that British companies attempting to export directly from the UK frequently face barriers to trade in the form of protectionist measures or stringent offset regimes. It views "industrial participation" as a flexible response to these barriers and encourages offshore companies to work with the UK's defence industry without some of the negative effects sometimes found in more restrictive offset policies. Firms must, however, indicate the level and nature of domestic participation as part of their proposals, and all proposed work must be defence related.

In terms of direct support, the Defence, Science and Technology Program Office of the Ministry of Defence invests about two thirds of its annual research budget in projects delivered by industry and academia. Further, there is a greater emphasis, through a program called Niteworks, on collaborative project work between government and industry. Other programs involve establishing a Centre for Defence Enterprise that funds innovations that have potential defence applications, and INSTINCT, a program that engages business and academia in technology demonstrations for security application.

United States

If it is difficult to compare Canada and the United Kingdom in terms of defence expenditures, it is even more difficult to make comparisons with the United States. The US military is unique in terms of the funding allocated to each branch, the independence of each branch in military acquisitions, and the very hands-on role of Congress in military procurement. Meanwhile, each service of the armed forces is so large that they are individually responsible for their procurement programs. It would in fact be more useful to compare each branch of the US armed forces with those of a given country.

The US has a clear, if not explicitly labelled, defence industry policy, with a deputy undersecretary of Defense responsible for all decisions regarding: mergers and acquisitions, domestic and foreign, affecting the US defence industry; the department's relations with NATO defence and aerospace industries; and the overall health of the US defence industrial base. The US officially opposes industrial participation policies and practices, viewing them as distortions of free and open markets.

The Grover Report noted that "The US has numerous defence industrial policies: assuring sources of supply for critical items; protecting key technologies; and generally ensuring a domestic defence industrial base capable of supporting the nation's national security interests."

The US government procures about $600 billion worth of goods and services annually, and defence procurement is about two thirds of the total. The scale of defence procurement has a pervasive impact on US technological capabilities. In planning its acquisitions, however, the Department of Defense identifies promising technologies from all sources, domestic and foreign. There is therefore significant potential for Canadian-developed innovations reaching more than a domestic defence procurement market. Canadian access to the US defence procurement market is governed by a long-standing bilateral agreement and is assisted by the Canadian Commercial Corporation (CCC).

One of the key R&D facilitators for the US defence effort is the Defense Advanced Research Projects Agency (DARPA). Unlike Canada's DRDC, DARPA does not run its own research laboratories but funds project teams drawn from business and academia. It has historically focussed on high-risk investment in radical innovation for identified defence needs, from research through to prototyping. For example, the JSF began as a DARPA-funded project. DARPA's annual budget is about $3 billion or ten times that of DRDC. Much of the US defence research effort, however, amounting to up to $60 billion, is performed in-house by the various services of the armed forces.

In recent years, the concept of national security has been broadened to include energy, and the US government has established the Advanced Research Projects Agency–Energy (ARPA-E) as an important civilian counterpart to DARPA. ARPA-E is similar in concept to Canada's SDTC and funds projects aimed at "transformational innovations" with explicit attempts to promote follow-on procurement by federal agencies.

France

France is a unique case when examining military industrial bases because of the enormous degree of state control in defence companies, often as a majority or joint partner in major suppliers. The French Defence Industrial Strategy aims to "rationalize the European Defence Industrial and Technological Base (DITB) around centres of excellence which include a reasonably ambitious French component." The Department of Defence has a 30-year Prospective Plan for its military needs.

The French strategy seeks to maintain knowhow in mature sectors and develop know-how in emerging or growing sectors. France also strives to develop export markets for its defence industry to reduce dependency on domestic defence acquisitions. The strategy also takes explicitly into account the impact of the defence procurement cycle. Mitigating the risk of losing or lacking industrial capability because of economic downturn or overcapacity, for instance, constitutes an important element of the French approach.

State ownership and control is an important feature of the French procurement experience. The Direction générale de l'armement (DGA) is directly involved in the governance of aerospace and defence. It holds majority and minority shares in companies involved in ships and submarines, explosives and aerospace. The French government, through the DGA, works in the interest of these companies and promotes the development and reinforcement of industrial capabilities deemed necessary to its strategic autonomy. The DGA is an active member in the implementation of the French government's economic strategy and also has a regional economic action policy to promote the development of industrial capacity, namely among SMEs.

Overall, France has managed to preserve a broadly based defence industry to meet its future requirements. This has been achieved through pursuing a coherent, if not formally stated, defence industrial strategy. Despite France's new emphasis on collaborating with other European nations in the development and production of defence equipment, it appears to be a policy of collaboration à la carte, allowing it to maintain a foothold in all major defence industrial sectors, particularly at the systems level.

Sweden

Sweden's days as a military power with a successful defence industrial base date back for centuries in support of its position of armed neutrality. The backbone of the current Swedish defence industrial base is its aerospace sector, where Saab AB is the leading contributor, enjoying a healthy export market. Apart from the aerospace sector, which has been a strategic priority for its defence industrial efforts, Sweden has also found success in domestic and export markets for shipboard gunnery, armoured vehicles and anti-tank systems and submarines.

These are all indications, along with the absence of public cost overruns and delays, of a thriving and successful defence industry for both domestic needs and export potential.

Sweden does not have a formally stated policy related to the sustainment and development of its defence industrial base. Successive parliamentary spending Bills on Defence and Security, however, have referenced the importance of maintaining industrial capability in support of foreign, defence and trade policy.

More recently, there has been special focus on the aerospace sector through a special working group that presented to the government a vision for the Swedish aerospace (defence) industry and a strategic program of enabling actions by companies, research institutions and the government to realize the vision. In response to the working group's submission, the Swedish government adopted a comprehensive strategy to guide actions directed at the technological leadership and international competitiveness of its aerospace industry.

For industrial offsets, the responsible authority is the Ministry of Defence and the program's policy objectives are to support the long-term protection of essential Swedish defence and security interests, secure the participation of the domestic defence industry, promote the transfer of advanced technology to the defence industry, and increase the export of Swedish defencerelated products, systems and advanced technology. These offsets are required for projects at a threshold of €10 million and must equal a minimum of 100 percent of the contract value.

The Netherlands

The Dutch defence industrial strategy, similar to the policies of the UK and Australia, is premised on the recognition of the importance to the nation of having a domestic defence capability and is predicated on the assumption that its defence industry can be successful only if companies form part of international networks focussing on the development, production and maintenance of equipment supply chains.

The strategy seeks to harness international opportunities and to promote synergy between the needs of the Dutch armed forces and those in the civil market due to the relatively small size of the Dutch defence industry. This relatively small size has led the Dutch government to prioritize certain areas for specialization. From this context, the strategy identifies fields of technology where Dutch industry has the capability to excel and consolidate its position in the global (primarily European) defence market. The six priority technology areas in the Dutch DIS are: C4I (command, control, communications, computers and intelligence); sensor systems; integrated platform design, development and production; electronics and "mechatronics"; advanced materials; and simulation, training and synthetic environments.

The strategy also accords the defence ministry an important role in acting as lead customer for specific new technologies. In doing so, it recognizes the need for it to take part in multinational development and production programs from their earliest start phase, as is the case of participation in the JSF.

The most important financial instrument is the National Technology Project (NTP) under which proposals can be submitted by one or more research institutes, by industry, or by both. In principle, the NTP covers 100 percent of the cost incurred in carrying out the technology development. Specific defence R&D-related projects are carried out by the National Defence Research Organization and its three laboratories.

This technology orientation reflects the view that, whereas the Dutch industry may lack the range and depth of industrial resources necessary to develop and produce major weapons systems other than naval ships, it possesses the requisite skills and expertise to be a strong participant in a wide variety of international programs from their development to their life cycle maintenance. In some cases this includes final assembly and testing of major weapons systems that it procures.

The Netherlands pursues a policy of "compensating" Dutch companies when defence materiel is purchased from foreign suppliers. Orders may be placed only with foreign suppliers on condition that the Dutch industry is involved in carrying them out or that Dutch companies are given orders for goods or services that are not directly connected with the project. In practice, the policy results in a 100-percent offset commitment.