Strategic Government Procurement Strategy

STRATEGIC GOVERNMENT PROCUREMENT STRATEGY

CME Proposal to leverage business innovation and create a level-playing field through strategic government procurements

DRAFT

FOR INTERNAL DISCUSSION ONLY

January 2012

Introduction

Challenges faced by Canadian manufacturing and exporting companies are numerous. The rise of the Canadian dollar, the international financial crisis, the restricted availability of credit in certain sectors, the current European debt crisis and the possibility of tighter credit in the Canadian financial market in the next months, the ever-greater competition and the accelerating pace of technological innovation, are some of the factors which explain the whirlwind of change in which the Canadian industry finds itself.

In this context, it is more crucial now than ever before for governments to make sure to adopt policies which support business competitiveness, establish rules and regulations which provide them with equal footing and apply these rules in an even and systematic way.

In recent years, political leaders, academics and business decision-makers put more emphasis on the role of innovation in manufacturing competitiveness. In a highly competitive environment, especially in Canada where the manufacturing sector is facing the double challenge of a high currency and increased competition from low-cost countries, innovation becomes the necessary condition to continue to compete globally.

Government procurement is one of the tools that governments have at their disposal to foster domestic economic development and drive business innovation. This approach is well-established and desirable for any economy which endeavours to support the development of a strong and dynamic domestic industry. This is why many countries use this approach.

Recently, the Expert Panel on federal support to R&D (“Jenkins”) published a special report on Procurement, which looked at ways the federal government could implement smarter policies that would have a positive impact on business innovation.

Other countries, including most of Canada’s trading partners, are increasingly using government procurement policies to stimulate the domestic economy and to create new jobs. This is especially true in the United States, Canada’s premier trading partner and the world’s leading economic power. Highways, roads, airport facilities and mass transit infrastructure projects are governed by laws, by-laws and policies which maximize economic benefits for the U.S. manufacturing industry, while allowing competition that is based on fair rules for all vendors. It is also true in developing countries that have not yet signed the WTO Government Procurement Agreement (WTO – GPA), which often implement even more drastic protectionist policies, such as the obligation to create joint ventures with local firms.

While most of the literature on government procurement and innovation has focused on the role of pre-commercial procurement and governments acting as first customers for innovative products developed domestically, CME argues that an international level-playing field through the implementation of a reciprocity policy also has to be considered when looking at improving innovation through government procurement. It is especially true for a country like Canada, which tends to impose less restrictions based on national content in its procurement practices than other countries, and which needs to address its innovation gap mostly through the attraction of foreign-owned multinational enterprises and their large R&D budgets. Indeed, in the current context, why would a multinational with a large percentage of sales in the public sector, choose Canada for its R&D and production facilities rather than another country? Not only does Canada not have a national procurement strategy aimed at fostering domestic innovation, but other countries impose restrictions based on domestic production that actually keep Canadian suppliers out of procurement markets in many sectors. CME argues that reciprocity in government procurement procedures is a necessary (but not sufficient) condition for the success of other types of domestic regulations like pre-commercial procurement and the procurement of innovation. These concepts are explained in greater detail later in the report.

What is strategic procurement?

The concept of strategic procurement has greatly evolved over time. Traditionally, this concept has been used mostly in areas like National Defence and the need for each country to protect its national security. The central idea was that in case of a major crisis, each country would have to preserve its domestic capacity to produce and deploy highly sophisticated defence systems. The creation of the Defence Advanced Research Projects Agency (DARPA) in the U.S. is a good example of how innovation played a central role in protecting U.S. national security by ensuring the technological superiority of the U.S. over other military powers.

However, in other countries like Canada, creating a demand for military technology based on the DARPA model is very challenging, mainly due to the relatively small size of Defence procurement in Canada. These countries took different approaches to ensure that Defence procurement could protect its “national security”. This is why today over 35 countries have adopted the Industrial Regional Benefit (IRB) model, which is a way to create some demand for innovation or other type of economic activities as a result of Defence procurements.

The IRB model requires companies that win contracts above a certain threshold to provide direct or indirect offsets in the national economy. The most common types of direct offsets are co-production and sub-contracts for the production and after-sale service of military products. The most common types of indirect offsets involve technology transfers, training, licensed production, or other types of purchases.

Recent policy initiatives aimed at fostering innovation AND Canadian manufacturing capabilities

The Defence and Aerospace sectors are often seen as the most obvious industry areas that would benefit from the use of procurements to foster innovation. The federal government has a unique and unprecedented opportunity to use its procurement expenditures of $240 billion (publicly stated amount) on defence and security to increase the technological capabilities of Canadian industry. In its 2011 budget, the Finance Minister made a commitment “to develop a procurement strategy in consultation with industry, to maximize job creation, support Canadian Manufacturing capabilities and innovation and bolster economic growth in Canada”. The results of these consultations are summarized in the “Jenkins” special report on procurement, published in November 2011.

The “Jenkins” report states that “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.”

Source: http://rd-review.ca/eic/site/033.nsf/eng/00318.html

One of the key recommendations of the Jenkins panel is to encourage innovation through “specifying requirements in terms of their performance or functional characteristics, rather than their design characteristics. This would leave greater scope for new ways of achieving or surpassing requirements and open the door to innovation. While performance specifications are mentioned in the federal government's contracting policy, it does not focus on this, stating only that the "best value may be promoted if performance specifications are stressed."

“Optional performance specifications are not likely to be used as frequently as desirable, since their use can involve greater risk and administrative costs than known, off-the-shelf design specifications.”

The federal government has taken steps towards the objective of supporting the national manufacturing capabilities with the adoption of the Canada First Defence Strategy, a plan to ensure a sustainable landscape of its federal fleet and vessels to promote Canada’s sovereignty and prosperity. CME strongly believes that the government could build on the success of this policy and explore other potential areas that would benefit from similar policies. In June 2010, the Government announced a $35-billion investment into a National Shipbuilding Procurement Strategy that would include large ship construction, small ship construction and the repair, refit and maintenance of the ships.

The National Shipbuilding Procurement Strategy features a ‘value proposition’ model, which is something new to Canadian defence procurement and somewhat different from the traditional IRB policy. The Value proposition model includes three main components, which take the form of commitments from the bidding companies when competing for the contract: Human Resource Development, Industrial Development and Technology Development. The policy is very flexible so the way companies fulfill these commitments can be quite broad, ranging from apprenticeship programs, to emerging design technologies and modern shipbuilding processes. Interestingly, the value proposition commitments are separate from the IRB requirements, which also apply to the shipbuilding contracts. But most importantly, what this model creates is a precedent where the winning bids constitute the basis of “best overall value to Canada”, which is a lot more work than simply checking the boxes on a list of mandatory requirements and function then selecting the lowest bid.

Canada’s IRB policy

Adopted in 1986, Canada’s IRB policy provides the framework for using federal procurement to provide long-term industrial and regional economic benefits. The policy states that Defence companies winning contracts worth over $100 million must provide offsets worth 100% of the value of the contract. The policy is discretionary for contracts between $2 million and $100 million and does not apply to smaller projects. Currently, there is over $10 billion in contracted activities that fall under the scope of the IRB policy. Beyond the Canadian content calculation of the offsets, the benefits must also provide high-tech and sustainable benefits, although the interpretation of high-tech can be broadly interpreted.

As a result of the IRB policy, bids are evaluated by a number of agencies jointly: the Department of National Defence (DND) evaluates the technical aspect of the proposals, Public Works and Government Services Canada (PWGSC) evaluates the price aspect and Industry Canada, along with the Regional Economic Development Agencies, evaluate the IRB proposals.

There are some good examples of innovation initiatives that are the result of the IRB policy in the Canadian Defence Sector.

For instance, Lockheed Martin satisfied IRB requirements on the CP 140 Aurora Structural Life Extension program with $1,000,000 to the British Columbia Institute of Technology to “help design and support the creation of the BCIT 3D simulation technology”, technology that can also “enable individuals to become adept problem- solvers, to learn new skills, and to prepare for hands-on activities in real work environments”.

The Boeing Company used its IRBs in the creation of the Canadian Composites Manufacturing Research and Development consortium, “a virtual centre of excellence” as an offset for the Medium-to-Heavy Lift Helicopter program.”

(Source: http://www.frontline-canada.com/Defence/index_archives.php?page=1778)

CME strongly believes that Canada should take advantage of IRBs in other sectors of government procurement, especially in infrastructure. This is discussed in more detail later in this report.

Strategic procurement in non-defence industry sectors

Strategic procurements have obviously taken different forms in other sectors. For example, most countries have negotiated a number of exceptions or exclusions to international trade agreements in order to make sure that Government procurements in infrastructure provided domestic jobs. The U.S. Government implementation of Buy American rules to its federal procurements, and more recently to the transfer of grants from the federal to sub-national governments under the American Recovery and Reinvestment Act, are probably the most obvious examples of strategic procurements used in non-defence sectors. Most other countries, both developed and developing, use some sort of policies based on national production, or domestic content, to provide offsets in their national economy.

In Canada, the use of domestic content has been used in certain sectors of government procurement, but mostly at the provincial and municipal levels. As an example, the Ontario Feed-in-Tariff (FIT) program provides incentives and guaranteed pricing for specific wind, solar, and bio-energy projects. The minimum amount of Ontario-based content required is 50 per cent for wind projects over 10kw, and 60 per cent for solar projects over 10kw. Some Canadian hydro-electricity producers impose domestic content requirements for the manufacturing of turbines and other equipment used for the production of hydro-electricity. Ontario and Quebec also require Canadian content in their respective acquisitions of public transit equipment. The industry sectors’ coverage of these domestic content requirements, limited in a few sectors of our economy and mostly in two provinces, are the only policies based on domestic content and are quite small compared to the extent these policies are used in other countries.

In addition, the Canadian government does not have a reciprocity policy, like the EU, that allows the use of procurement policies to “reward” countries giving Canadian suppliers open access, and to leverage negotiations with countries that do not allow Canadian suppliers to compete on a level-playing field. CME strongly believes that the absence of such a reciprocity policy is not only hurting Canadian interests abroad, including its ability to attract R&D facilities from major multinational companies involved in government procurements around the globe, but it also leaves us with a number of missed opportunities to grow our domestic manufacturing sector.

Strategic procurement, innovation and existing exclusions under international agreements

As stated in the introduction, no procurement policy aimed at fostering innovation can achieve its full potential if the Canadian government continues to provide wide open access to Canadian procurements, while so many of its trade partners still impose Canadian suppliers a number of market access barriers such as domestic content policies.

In addition, while the use of strategic procurements in Canada has been widely used in targeted sectors of our economy to provide industrial offsets, none of these policies have actually been developed around the notion of innovation, or very little. In fact, the IRB policy applied in the Defence procurement is the only policy that has a small requirement related to technological development, but it is not central to the policy.

CME argues that Canada can and should use its current powers and exclusions, as provided by international agreements, to better focus on innovation as a central objective of the strategic procurement policy. Canada can not only better focus the current policies on innovation, but it could also expand the coverage of these policies in other procurement sectors. Current exclusions in Canada’s international agreements that could be much more leveraged include: the use of the innovation exemption (pre-commercial procurement and the procurement of innovation), the use of the national security exemption, the use of Small-Business Set-Asides and a greater use of IRBs in non-defence areas of government procurements.