Canada’s Offset Program
does not attract as much investment as it could
CHRIS MACLEAN
© 2017 FrontLine Defence (Vol 14, No 1)

After months of research and in-depth consultations with stakeholders, the Canadian Association of Defence and Security Industries (CADSI) prepared a report on how Canada’s Industrial Benefits program (then called IRBs or Industrial Regional Benefits) could be improved to maximize jobs, innovation and economic activity in Canada from defence spending. It was submitted to the Industry Canada minister in July 2012.

A representative group of 34 companies provided the original feedback in 2012. These included foreign and domestic OEM business leaders with direct and flow-through obligations (the obligors), domestic companies including recipients of industrial offsets (the recipients), and Canadian exporters who were directly involved in the offset programs of other countries.

The report identified Canada as one of the first countries to introduce an offset (IRB) program. However, there is arguably much room for improvement as its various iterations have been negatively compared (from both policy and program management perspectives) to programs of other countries over the years.

CADSI is currently researching for a revised report to be released in 2018. “Canada’s defence and security industries are vital and innovative sectors of the Canadian economy. In 2014 alone, they contributed to 63,000 jobs, $6.7 billion in GDP, and $10 billion in revenues of which 60 percent were from exports,” notes CADSI President, Christyn Cianfarani.

Should we care about how Canada’s offset program is viewed by the corporate world? The answer is “absolutely”. Clearly, the numbers quoted by Cianfarani are reason enough to take notice.

Offsets result in valuable investments in the economy by the obligors – those who carry obligations through their sales of defence and security materials – thus contributing to the economic well-being of the nation. What is often under-appreciated by (or completely lost on) government decision-makers, however, is the “long game” of business decisions. Corporate investment does focus on election cycles; it is long-term, and decisions are critically and repeatedly re-examined under the cold light of financial viability.

As the 2012 report accurately noted, a company’s willingness to invest in strategic technology – and in sustained business activity beyond the life of an obligation – is directly dependent on how attractive Canada’s offset program is, compared to those of other countries. Offsets are part of the global environment, and Canada must create competitive incentives if it wants to tap the full potential of economic investments that can be generated while satisfying defence requirements.

Ironically, Canada is placing so many restrictions on itself that it can and does results in reduced interest by some of the best companies.
Successful companies have many benchmarks that have to be met before committing to any project, and they typically have multiple options to choose from. Contrary to public sector belief, the focus is not solely on the prize of a prestigious contract. All aspects must be considered and weighed. For instance, protecting Intellectual Property is sacrosanct as it is the life-blood of the most successful corporations, and asking them to jeopardize IP security will most likely result in the most successful companies walking away from the table.

The Value of Policy
As CADSI noted in its executive summary of the 2012 report, a sound offset policy enables the government to mandate investment by a domestic or foreign OEM (original equipment manufacturer) and to advocate for economic development in its national interest, and also enable Canadian industrial success in international markets.

These multiple roles need a creative and flexible culture that will attract and retain the investment and business presence of major corporations interested in the Canadian defense and security market.

Since then, a number of adjustments and name changes have been incorporated into the program that is intended to attach long-term economic benefit to Canada as an obligation to winners of high-priced defence contracts.

Generically known as “offsets”, the Canadian program has morphed into a combination of Industrial and Technological Benefit (ITBs) plus a weighted and rated element called a Value Proposition.

FrontLine recently revisited that five-year-old report and concluded that most of the recommendations still make sense, are still relevant, and that more improvement is urgently required if the goal of increased foreign investment is to be met.

The 2012 CADSI study concluded “overwhelmingly” that:

  • The IRB program is not being provided the broad government policy support that it needs for success;
  • While improved in principle in some areas since 2009, the IRB program is inadequate overall from a policy perspective because it does not provide incentives for industry to be creative and take the calculated risks that are part of the decision-making process;
  • The IRB program is being managed and implemented in a way that will not produce the intended results; and,
  • Because of these problems, the IRB program will not maximize economic benefits to Canada, and, by discouraging some companies from bidding, may be restricting the Canadian Forces’ ability to access capabilities that fully meet their operational requirements.

The above statements are still true and relevant, and in urgent need of attention.

The report went on to state that “Unless the IRB program offers a more positive, progressive, competitive policy environment and much more practical, business-friendly management practices, it will not achieve the government’s objective of maximizing jobs, developing unique technological innovations and creating maximum economic activity in Canada from defence and security spending.”

The CADSI summary points out that, for an offset program to be successful, it needs “broad government policy support”. It also notes the importance of attracting investments (not simply mandating them).

Policy Creates Stability
A clear policy establishes a stable environment within which a corporate entity feels secure in making long-term investment.

An industrial policy will take into account national interests, priorities, capabilities and resources, to create a stable road map for future progress.

CADSI suggested that the government collaborate with industry to “develop a strategy framework to leverage defence and security procurement to maximize jobs, develop unique technological innovations, and create the business climate required to generate maximum economic activity in Canada by exploiting Canada’s industrial strengths and emerging capabilities.”

Somewhere along the way, it was decided that only the defence sector should benefit from offset benefits. This is both limiting and counterproductive if the goal is improving prosperity.

Let the market decide where to invest. The tax base of the entire country contributes to the defence budget. It is only fair that the entire country stand to benefit from offsets from those large contracts. Are student jobs or other jobs any less worthy or less needed than a defence-sector job? There are undoubtedly many companies with a variety of investment propositions that could materialize from the offset process. Why penalize all other sectors of society in favour of a small cross-section? Find other ways to stimulate specific sectors, if that is a goal, such as declaring it a national interest, which serves to assure companies that investment in that sector will be sustainable in the long-term.

Attract Investments
Business opportunities will drive the  future once priority areas have been identified, and so, it is incumbent upon the government to identify its national interest – which subsequently highlight priority areas for investment. This is necessary to stimulate foreign interest in Canadian business opportunities in those priority capability areas. After all, offset projects must make business sense, otherwise they will be short-lived and ineffective.

Not many public servants have experienced the ruthless financial pressures of a corporate boardroom. This is demonstrated by an underestimation by the government of the value of allowing OEMs to bank and pool offset credits – indefinitely. This speaks directly to the attractiveness of investing in Canada. Limits on investment are, quite simply, counterproductive in the long game of corporate investment.
Understandably, the CADSI report’s main focus is support to the defence and security sector, however, FrontLine contends that attracting investment to Canada need not be confined to those sectors. Why single out one sector when all taxpayers share the cost of military purchases?

Reduce Restrictions
Currently, each company that wins a defence competition is basically forced to find the least-disruptive solutions to its offset obligations. It may reorganize its supply chain, or feel forced to invest in areas it has no long-term interest in, or other less-than-optimal solutions. It takes a lot of time and resources just to manage these decisions. It is seldom considered an opportunity, but that can be changed.

Instead of an albatross around the contract winner’s neck, offset obligations can become a win-win for all concerned if those obligations are treated as a versatile component, restricted only by a company’s own business development innovators/negotiators.

Reforming the process – to become more effective at enhancing prosperity – can be easily accomplished with three simple changes to the current system:

  • Allow full credit no matter what sector. Removing the sector restrictions has very obvious, wide-ranging benefits for Canada’s economy as a whole.
  • Allow credits to be banked with no ­expiration date. Removing credit expiration dates allows companies to make long-term investments without forcing them to wait until a specific contract gets underway (which is now the case). Putting a time limit on credits can only be self-defeating if the intent is long-term investment in the Canadian economy. Eliminating the time limit will wipe out the current double-punishment of not resetting banked credit timelines to zero in the event that a bid is lost. Penalizing a company’s advance investment in this way defies logic.
  • Allow obligations to be traded or sold. Such flexibility opens the door for the bidder to negotiate in imaginative ways, setting the stage for investment success with a variety of other companies, and creating a wider range of employment opportunities than the OEM could have ever contemplated from within their own business lines. This can be achieved with the usual conditions in place such as causality and incrementality.

There are so many ways a company could, with a little imagination, use offset obligations to their own benefit while creating advantages to Canada with new and innovative solutions. Long term investment in Canada should be the top priority, not subsidizing any particular sector. There are many types good jobs that could be created but are now de-incentivized through restrictions. Real success is all about business incentives (which does not only mean tax breaks). Making offsets a positive and versatile component of the bidding process will go a long way towards enticing the best companies to offer their best products to Canada and know that it won’t cause boardroom grief in the process.

Small & Medium Enterprises
In addition to removing the restrictions to investment, there are additional ways to make it easier for an OEM to meet its offset obligations.
CADSI suggested the government make it is easier for SMEs to secure successful collaborations with obligors by providing more information and support to small business owners. Good progress has been made on this front to date, but removing the sector restrictions will allow many more SMEs to step up another level on the prosperity ladder.

Onerous Paperwork
CADSI and many others have pointed to the “onerous and time consuming verification and crediting processes currently being employed” and suggests it would be better to focus on “assessing the outcomes of business transactions and investments.”

The CADSI report also advocated “ongoing collaborations with industry on how government policies and programs can be improved.” Streamlining the reporting processes based on feedback from industry will improve efficiency and transparency and will also facilitate outcome assessments.

Goals
Let’s look at the goals of the offset program itself. It is intended to convert the costs of huge defence and security contracts into economic enhancement for Canada. This is a very reasonable and attainable goal, best done with an eye to collaborative and mutual gain rather than penalties and restrictions that impede success.

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Chris Maclean is the Editor-in-Chief at FrontLine Defence magazine.

 

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