Government Procurement as a Driver of Innovation
Making government procurement an effective means to carry Canadian technologies through the valley of death depends on inter-departmental communication
In June this year following budget cuts to Innovative Solutions Canada (ISC), ISED launched a consultation program into overhauling how government procurement can be used to support Canadian small businesses which closes on July 26. The timing dovetails well with the planning around the capstone agency proposed to oversee Canadian research funding, given that there is a need to align efforts across the entire innovation pipeline if any of these initiatives are to have an impact individually.
In this article, I discuss the factors that led to the failure of ISC through a comparison with the much more successful Small Business Innovation Research (SBIR) program in the US. I fit the role of academic research and private sector commercialization efforts into context in the broader scope of an effective innovation pipeline, focusing on using the proposed capstone agency as the bridge between them, and an overhauled procurement approach as a means to carry technologies through the valley of death after that handoff.
At the end of the article, I also directly address the procurement-related questions that are asked in the consultation call. This article, and the responses to those questions, have been directly submitted to ISED.
A Brief History of ISC and the SBIR Program
Typically, academic funding might carry a technology as far as TRL3 or 4, while established businesses and investors only invest around TRL6 or 7. The gap in between is called the valley of death, and many promising technologies fail to cross it due to a lack of funding. This problem is particularly pronounced in Canada.
One of many ways that the American government addresses this gap is through the SBIR program. Established in 1982, the program had 4 primary goals: to stimulate innovation using technology; to engage small business in federal R&D targets; to encourage minority participation in R&D; and to incentivize private sector efforts toward commercialization of inventions arising from federally-funded R&D. This is currently done by mandating that federal government departments spend 3.2% of their annual budget procuring solutions to technological challenges from American small businesses. The central idea is that the government can provide direct, non-dilutive funding for product development and early commercialization to take technologies from idea to product, and then create immediate demand for that product by being the first customer. By aligning this with departmental goals, the SBIR seeds a virtuous cycle of new economic activity that specifically addresses the problems faced by the government. It’s an elegant solution to a set of complex problems.
The process involves 3 phases: Phase 1 is a small exploratory grant, on the order of a few hundred thousand dollars over 6-12 months, to demonstrate proof of concept. Phase 2 is for prototype development following Phase 1 success, and is funded on the order of 1-2 million dollars over 24 months. If successful, in Phase 3, the government actually buys the result, becoming the first customer for the technology developed by the company, and does so as a sole-source contract that is not required to go through the usual competitive process for government procurement. As one might imagine, specific allocations of funds for this last step is critical, given that early prototype technology is rarely the cheapest possible solution to a problem that would otherwise be picked up by a competitive process.
About $2.5B is spent each year under the SBIR, and fully half of the businesses that receive funding have fewer than 25 employees, in recognition (or support) of the fact that truly small businesses are much more likely to develop innovative technology than large ones. Businesses to not need to have revenues to be eligible, making the SBIR an excellent vehicle for deep tech development in particular. While some of the funding allocated results in failure, this is built into the program mandate, and SBIR on the whole has been highly effective at bridging the valley of death for almost 4 decades.
In typical Canadian fashion, our government tried to replicate this program (twice) without considering the context and factors that made it successful, with predictably lackluster results. In the most recent iteration, ISC, most Canadian government departments were mandated to spend 1% of their budget procuring solutions to their problems from Canadian small businesses under the umbrella of ISC, though in practice less than one third of this spending was actually realized. With the most recent budget, cuts to this program reduce the mandated spend to the actual historical spend.
While the ineffectiveness of the program to date certainly suggests a need to rethink about we go about using procurement in the early stages of commercial technology development, simply cutting the program should not be the answer. Instead, it is important to reflect on why ISC failed to deliver results, to learn from the failure, and to use that learning to rebuild a more effective approach.
Lessons Learned
The reason for the mismatch in overall effectiveness between SBIR and ISC boils down two main causes.
The first is quite simple: Canada mostly skips phase 3. Among projects that are funded by ISC, the government typically does not actually buy the result in the end. The reason for this is acknowledged in the consultation call itself: Canada does not have a set-aside for sole-source procurement from Canadian SMEs in the way that the US and others do, and the government has historically taken the view that such a set-aside would violate Canada’s fair trade agreements with several international parties.
This is certainly a solvable problem, since in many cases the counterparties to those same free trade agreements have set-asides that do functionally the same thing. Either Canada signed extremely one-sided free trade agreements, or we need to more carefully look at how others are managing their set-asides for domestic small business procurement and learn from their examples. The fact that Canada is intent on non-violation of free trade agreements in a corner case that our trade partners are exploiting regularly is representative of a counterproductive risk-aversion that pervades all of Canadian policy-making and that must be overcome if anything resembling ISC is to have an impact.
Recommendation 1: Any attempt to overhaul government procurement should start by establishing mandatory carveouts for sole-source procurement from domestic small businesses that develop innovative technologies as a result of phase 1 and 2 funding. Without confidence in phase 3, everything else is a waste of time and money.
The second reason for failure is slightly less obvious, and related primarily to the scale of the programs. I’ve written more than once about the need to align the outputs of each stage in the innovation pipeline with the input of the next. A subset of the output of academic research forms the input to the development pipeline for commercial development of that technology.
In the US, the amount of funding and the variety of challenges available means that alignment happens naturally: any deep tech ready for commercial development can usually find a related challenge, and challenges are often built in response to promising technologies arising from publicly-funded research. Not so in Canada, where novel technologies developed in Canadian research institutions are more often than not developed in a silo independent from the calls for solutions arising from ISC, and the challenges posted cover such a narrow range of technology sectors that most truly innovative research has no associated challenge.
In other words, part of what makes SBIR work without requiring a major matchmaking effort between new technologies and government challenges is sheer scale, which Canada does not have. If we are to build an effective SBIR analog, we cannot simply replicate the structure and hope it will work, we must first recognize that scale is a key factor and adjust the Canadian approach to acknowledge and address the fact that we do not have the luxury of a laissez-faire approach to technological matchmaking.
Fortunately, there is currently an opportunity to address the issues that led to the failure of the ISC that did not exist in previous iterations of this conversation: the proposed capstone agency. In its position as overseer of Canadian academic research, the capstone will have a unique and comprehensive view of technologies being developed by publicly-funded research and will be in a position to identify potential solutions to government challenges while the research is still being conducted. Similarly, by running departmental challenges through the capstone, an overhauled version of ISC could ensure that the challenges for which procurement can be an effective vehicle are able to inform allocation of research funding.
Recommendation 2: Calls for challenges to be addressed through the next iteration of ISC should be directly informed by the research that is being funded, and vice versa. There should be active matchmaking between innovative technologies, teams willing to develop it commercially, and related procurement funding, mediated by the proposed capstone agency.
Playing this role in the innovation ecosystem also affords an opportunity for the capstone agency to facilitate academic tech transfer. Currently, tri-council agencies leave management of intellectual property (IP) to the individual institutions, where more often than not an understaffed and underfunded tech transfer office must decide if something is worth patenting before having a clear expression of interest from industry. This rarely, if ever, results in an optimal outcome for the technology. If the capstone agency were actively seeking ways to match funded research to commercial development and procurement opportunities before the research was complete, this would give confidence that research is worth protecting and provide a direct path from academic tech transfer to procurement that would further encourage institutions to license their technologies to supported small businesses in a way that is consistent with capstone agency-defined best practices.
Recommendation 3: Phase 1 funding under an overhauled ISC should be accessible to researchers considering spinning out companies from Canadian academic research institutions, conditional on formation of a startup and licensing terms consistent with capstone agency best practices.
The Canadian government has long called on businesses to invest more in innovation. After twice trying and failing to replicate the SBIR in Canada largely due to an unwillingness to full invest in the technologies being supported, it should not come as a surprise to policy makers that the call is not convincing. There is an opportunity right now for the government to lead by example and demonstrate a commitment to Canadian innovation. The overhaul of procurement processes should occur in close consultation with the design of the capstone agency. Built together, the capstone could be the nexus point from which outputs of Canadian research become the inputs to Canadian innovation, funded by an overhauled procurement mandate that gives confidence to research institutions in the value of licensing their technologies to startups eager to develop it.
Specific Questions from the Consultation Call
What are your views on the role of public procurement in supporting innovation?
A customer is more valuable to a small business than a grant. While grants have a key role to play in carrying technologies across the valley of death, a customer who actually uses the result of commercial technology development signals confidence and value in the solution developed. By being the first customer for innovative domestic firms, the Canadian government provides confidence by the private sector that their efforts in Canada will be worth the investment of time.
What has been your experience to date with respect to public procurement to support research and development, and innovation from Canadian small and medium sized enterprises?
It is clear from the failure to deliver of ISC in its current form that the program is deeply flawed. The lack of carve-out for sole-source procurement and the prevailing view that such a carve-out would violate Canada’s free trade agreements ensure that support for innovative domestic small businesses is not actually being delivered by the program. Combined with Canada’s small scale relative to the US and poor alignment between challenge call and technologies that are being funded by the tri-council, and there simply are not enough projects that fit.
In your view, would legislated targets or targets enshrined in policy improve outcomes for small and medium sized enterprises and, if so, how?
Having the Canadian government as an anchor customer signals confidence in the technology and in the solution. That early income is far more valuable to an SME than an equivalent grant. Having legislated targets would be a step in the right direction for this reason, with some caveats addressed in the next question.
Would a legislated target be enough to drive change? Are there other mechanisms that would support greater access to federal procurement? What innovation or procurement program has helped you the most?
Legislated target will be effective if and only if sole-source carveouts can be included for procurement of the resulting technologies by the government. Until there is complete follow-through on the actual procurement step, any funding before that point will have limited impact.
Any attempt to overhaul government procurement should start by establishing carveouts for sole-source procurement from domestic small businesses that develop innovative technologies as a result of development funding. Without confidence in sole-source procurement of the result of successfully funded projects, everything else is a waste of time and money.
Are there any considerations that we have missed or elements we should explore further when addressing this topic?
The creation of the capstone agency presents a unique opportunity as a matchmaker between technologies that are being developed through academic research and the early stages of commercial development that can be supported using procurement carveouts. These two programs should be developed in tandem for the sake of maximizing the impact of both.
Similarly, procurement practices including ISC have historically completely ignored academic research, but academic resource is the source for the technologies that can address these challenges in the first place. Without knowing what technologies are in development, procurement challenges are unlikely to be aligned with Canadian research outputs.
Calls for challenges to be addressed through an overhauled procurement strategy should be directly informed by the research that is being funded, and vice versa. There should be active matchmaking between innovative technologies, teams willing to develop it commercially, and related procurement funding, mediated by the proposed capstone agency. Phase 1 funding under an overhauled ISC should be accessible to researchers considering spinning out companies from Canadian academic research institutions, conditional on formation of a startup and licensing terms consistent with capstone agency best practices.