By Alan M. Field
Confronting the innovation lag in Ontario clusters
According to a recent report by Toronto-based Institute for Competitiveness and Prosperity, of the forty-one clustered industries in Ontario, nine are service-oriented, thirty are manufacturing-oriented, and the remaining two clusters are in other goods-producing industries (rather than manufacturing). Between 2002 and 2011, manufacturing employment changed dramatically in Canada, and the impact was felt on the clusters of Ontario. While Canada lost 23.1 per cent of its manufacturing jobs during that time, Ontario lost 27.4 per cent of its manufacturing jobs. As expected, Ontario’s manufacturing-oriented clustered industries suffered a loss of 3.2 per cent of their national employment share, and shed an average of 18 per cent of their jobs.
Nationwide, most of the Canadian manufacturing industries that lost jobs between 2002 and 2008 were in low value-added industries, such as textiles, according to that report. Overall, “manufacturing employment has shifted away from less productive ﬁrms to higher value and more sophisticated Canadian manufacturing industries, such as production machinery and medical devices, which are growing in employment and productivity,” said the report. In the innovation process, the patenting of newly invented designs and devices is a critical step, and a handy benchmark for comparing Ontario’s performance with that of other, competing jurisdictions.
So how are Ontario’s industrial clusters performing when it comes to innovation? Ontario’s clustered manufacturing industries continue to signiﬁcantly trail the U.S. peer median of 17.45 patents per 10,000 employees, according to the same report. Ontario patents also trailed in natural resource sectors. Among Ontario’s top ten patenting clusters (deﬁned by patents per 10,000 employees), Ontario signiﬁcantly lags its U.S. peer median. In all but two of Ontario’s top ten clusters — information technology, and oil and gas products and services – Ontario companies patent less than the U.S. peer median. At their current rate of 9.25 patents per 10,000 employees, Ontario’s clustered industries would need to increase their patent output by 89 per cent just to reach the median performance of their U.S. peers. Ontario also trails in natural resource industries and has a small advantage in dispersed industries, which tend to produce very few patents per employee.
Some of the forty-one clustered industries in Ontario contribute more to productivity and innovation than others do, so the mix of clustered industries matters. Ontario’s relative employment strength in industries such as ﬁnancial services, automotive, metal manufacturing, and publishing and printing, has created an attractive mix of clustered industries, said the report. However, although Ontario has an excellent industry and cluster mix, its “cluster effectiveness,” as measured by average wage rates, is much lower than that of its North American peer states (in Canada and the U.S.). Across all clustered industries, the average wage rate in Ontario is 17.4 per cent lower than the North American peer median. This lower wage reﬂects lower productivity and innovation in Ontario’s clustered industries, which in turn reduces economic performance across all industries.
Ontario has a solid physical infrastructure and quality educational system, and that has helped to strengthen the performance of its clusters, noted the report. However, Ontario’s “structures of specialized support and competitive pressure” are inadequate compared with those in clustered industries in the North American peer states. By this, the report is referring to factors such as the number and quality of university/industry research collaborations; the quality of its management schools; the quality of its scientiﬁc research institutions; and the local availability of specialized research and training services. Because of the relative lack of higher-quality supports and pressures, too few Ontario ﬁrms and industries have developed strategies and operational systems that drive their productivity and wages to match those of their North American peers. The same report also found that Ontario’s clustered industries draw less on workers in creativity-oriented occupations than their counterparts in U.S. peer states. Moreover, clustered Canadian industries underperform their counterparts in the U.S. frequently as a result of the smaller scale of operations in their Canadian manufacturing facilities.
If Ontario clusters were as effective as U.S. clusters are, annual wages in companies that belonged to those clusters would be $15,400 higher per worker, said the report. Since clustered industries account for 34.1 per cent of Ontario employment, and there is a strong relationship between wages and productivity, overall productivity would rise by 14.7 per cent. Consequently, the productivity loss from the lower effectiveness of Ontario’s clusters is $6,100 per capita. Compared with workers in the United States, the machinery, equipment, and software used by Ontario workers are less up-to-date, since private sector investments are lower. As a result, Ontario workers are less productive. The report added, “This shortage of investment reduces Ontario’s productivity by $1,300 per capita, based on the simulation of Ontario’s GDP if the economy had matched the U.S. level of private sector investment in machinery, equipment, and software. A large portion of this capital investment gap is the result of lower purchases of information and communications technology (ICT).”
Equally discouraging, Statistics Canada has projected that Ontario’s demographic proﬁle – the province’s potential labour force as a percentage of its total population – which is currently higher than the North American peer median, will deteriorate during the coming decade. So Ontario’s economy will be dependent on the output of a smaller number of workers, relative to its total population. Innovation is the key to overcoming this challenge – and clusters are widely seen as critical to boosting innovation.
Are cultural barriers a factor in cluster under-performance?
Could cultural factors be at least partially responsible for the underperformance of Canadian manufacturing clusters? More specifically, might Canadian managers’ relative aversion to risk-taking be a factor behind the slower pace of innovation in Canadian firms that belong to clusters? According to a study by Deloitte & Touche Canada, Canadian and U.S. business leaders present themselves as having “similar levels of risk tolerance,” based on their self-assessment tests. However, the same study showed that there were differences between U.S. and Canadian business leaders’ willingness to make investments in new products and technologies, given the uncertainty of earning a return on their investment.
Another study, known as The Survey on Innovation and Business Strategy (SIBS), showed that Canadian business leaders identify risk and uncertainty as one of the three main obstacles to innovation. The other two obstacles they identified were a lack of skills within the enterprise and a lack of internal ﬁnancing. More positively, the same survey also pointed out that “the percentage of enterprises taking measures to mitigate obstacles to innovation is high” (that is to say, roughly 90 per cent of all firms in the manufacturing sector took such measures); thus, revealing an “active attitude” among Canadian business managers, when it came to mitigating such obstacles, according to the report by the Institute for Competitiveness and Prosperity (ICP). However, the fact that Canadian firms nevertheless lag behind their North American peers when it comes to innovation and levels of investment “seems to prove that businesses do not follow through with efforts to innovate and invest,” according to a report by Industry Canada.
Other research about Canadian attitudes may also yield some useful clues about the origins of the problem. According to another survey of Canadian and U.S. business leaders conducted by Deloitte & Touche Canada, Canadians are far more optimistic about the current and future state of their country’s economy over the next five years than their peers in the United States are about their economy. And yet, despite such optimism, fewer Canadian business leaders are planning to invest in the types of activities that are required to improve productivity. “Our study substantiates for the first time that it’s true – not a hypothesis – that Canadians are indeed more risk-averse than Americans, despite our current positive economic climate,” said Bill Currie, Deloitte & Touche Canada’s Vice Chair and Americas Managing Director, Consulting.
According to the report, despite self-reporting similar risk tolerances as Americans, and being more optimistic in their outlook on the economy, Canadian business leaders are, on average, a full 13 per cent less tolerant of risk than their American counterparts. This gap widens to 18 per cent when adjusted for the more negative current economic state and future outlook of Americans. Deloitte surveyed more than 900 North American business leaders and conducted a deep examination of more than 25 drivers of productivity – everything from the Canadian national brand to military spending.
A third survey also points to conﬂicts between attitudes and behavior patterns about investment and innovation among business owners and entrepreneurs. In an effort to derive a clear picture of the Canadian small and medium size enterprises (SME) population, the Business Development Bank of Canada (BDC) conducted an online survey with business owners of companies that have fewer than 500 employees about their attitudes toward investment, innovation, and growth prospects for their businesses.
The survey showed that Canadian business owners understand the importance of investment and innovation, but they often do not fully grasp the process of innovation, or they do not plan appropriately for future innovative efforts. For example, although roughly half of the Ontario respondents indicated that product or service development was among their future investments, only 21 per cent of them said that they might invest in research and development in the future. That reveals a failure to relate the two activities, say the authors of the BDC study. Instead of making that mental connection, many Canadian owners of small and midsize companies seem to be relying on the casual development of new products or processes rather than on pursuing a rigorous process of innovation through costly research and development.
Another striking feature of the BDC survey was that only 9 per cent of small and midsize business owners afﬁrmed that they had a strategy for innovation in place, whereas 72 per cent of the respondents admitted that they followed an “ears-to-the-ground” approach; that they tried to funnel ideas generated by people around them and other elements into their business environment. Business owners also pointed out that the main obstacles to innovation and growth are lack of funds, lack of time, and lack of skilled workers.
Policy directives and directions
What can Canadian policy makers and executives do to overcome the cluster productivity gap – and to inculcate a more a more rigorous and strategic approach to innovation among managers of smaller companies? The solution is all about fostering innovation, internally and with help from outside. “Innovation has got to be a very important part of any strong economy and strong company,” said Ontario Innovation Minister Duguid.
Each of Ontario Centres of Excellence (OCE), located around the province, co-invests in commercialization, technology transfer and talent development projects in those segments of the economy “that will drive Ontario’s future prosperity and global competitiveness,” according to the Ministry. These segments include energy and environment (including water); advanced manufacturing; advanced health technologies; information, communications technologies and digital media; and social innovation. The OCEs work directly with academia and industry to bring prospective partners together to turn ideas into income, said Mr. Duguid. Ottawa-based 360pi, noted earlier, is one of those companies, along with such other young firms as 4DM (remote sensing technology); CellAegis Devices (healthcare devices); Client Outlook (medical imaging); Energent (energy informatics); Impakt Protective (sensor devices); Morgan Solar (optical technology for solar panels); and OneChip Photonics (fibre optics). Ontario Centres of Excellence are a key partner in delivering Ontario’s so-called “Innovation Agenda” as a member of what is known as the Ontario Network of Excellence (ONE).
More broadly, the Institute for Competitiveness and Prosperity suggested in its latest report that the private sector, academia and governments cooperate to pursue these fundamental goals:
Improve management capability: Why is this necessary despite the emergence of so many innovative young companies? In its report, ICP measured the quality of Canadian management in the manufacturing sector compared to that of its counterparts in other countries. While Canada’s performance was solid, the quality of management improved as the percentage of an organization’s management team had university degrees. Unfortunately, a lower percentage of managers have a university education in Ontario than in the United States, said the researchers, and a higher percentage of them have only a high school diploma. “Ontario businesses need to look critically at their human resources strategies for their management positions. They cannot expect to realize their full innovation potential without a highly capable management cadre,” said the report.
Invest in skilled workers: Canadian companies, academia and governments need to focus more than ever on training their workers with the skills they need to make and manage the latest innovations. “Companies must realize that investing in the skills of their employees is to their economic advantage,” and that innovative products don’t just happen without such training.
Boost investment in machinery and equipment, especially now when the Canadian dollar is high, in order to “capitalize on the benefit of stronger purchasing power. Closing the investment gap offers the potential for closing the prosperity gap, since higher machinery, equipment, and software investment will make the work force more productive.”
Invest in modernizing and maintaining infrastructure in order to facilitate the production and distribution of manufactured goods not just across Canada, but in international markets. Border crossing infrastructure, especially in Southern Ontario, “risks becoming a critical choke point for trade with the United States” and the health of the manufacturing sector in the province depends on investment outside Ontario, added ICP’s report. Advocating their investment needs to the federal government on behalf of West Coast seaports and airports all across Canada will help Canadian companies realize the full potential from expanded trade with the Asia-Pacific countries. The report added, “The Institute commends the federal government on its commitment to building a new Detroit-Windsor bridge. Ontario needs more of such initiatives to address inadequate infrastructure, which inhibits trade growth.”
How powerful a role should federal, provincial and local governments play in fostering these processes? For his part, Jamison Steeve, Executive Director of ICP, said, “What we need to do is make our clusters more competitive. We need to look at public policy options for doing that.” Canada can derive benefits from its own economic policies of the past, and from a strong Canadian dollar. “Canadian companies are holding cash,” he said, making it less expensive than in the past for Canadian firms to pay for the imported capital equipment they may need to facilitate innovation and become more competitive; even if it is harder for them to export from Canada as a result of the loonie’s strength.
While government incentives and assistance programs are important tools for encouraging clustered (and other) companies to pursue innovation, Ontario Innovation Minister Brad Duguid believes, nevertheless, that governments in Canada should not take too assertive a role in the process. “What are the lessons of the past? Governments cannot run clusters. That would be a disaster. They need private leaders, and should be driven by the private sector, but with governmental support.” If clusters are to succeed in Ontario – and Canada’s other provinces – “we need to create an alignment between government, business, academia and labour, to push the envelope of competitiveness.” That is precisely what Mr. Duguid says he has been attempting to achieve. The good news about the prospects for success, added Mr. Duguid, is that there are many stakeholders in a large number of Canadian companies “who used to work in separate silos, but who are now pooling their efforts to make sure that they build competitiveness; at times, even sharing their [own companies’] intellectual property” in order to achieve that critical goal.