ITBs: Are Regional Requirements ­Counterproductive?
BY STEPHANIE BATSTONE
© 2019 FrontLine Defence (Vol 16, No 3)

There has been a lot of dialogue within Industry circles on the “recent” changes to Canada’s industrial offset policy. These changes were ushered in following the approval of the Defence Procurement Strategy (DPS) in 2014 and resulted in what we now call the Industrial and Technological Benefits (ITB) Policy, and more significantly, the Value Proposition (VP), a framework that allows Canada to weight and rate a portion of a bidder’s economic submission to Government.

Though it’s been five years since the first “Value Prop” was applied to a defence procurement, Industry continues to wrestle with the changes it has brought about, and many remain uncertain about whether Value Proposition is in fact leading to Canada’s intended outcomes.

Where you stand on this issue very much depends on where you sit. The folks at Innovation Science and Economic Development (ISED), the department responsible for implementing the ITB Policy, argue the policy is working exactly as intended, citing the fact that investment into innovation, skills development and training, and export is at an all-time high (since the inception of Canada’s Industrial and Regional Benefits Policy in 1986). For those bidding into large scale defence programs and experiencing firsthand some of the unintended consequences of Value Proposition, its success is somewhat less of a certainty.

Regardless of your perspective, it’s critical to understand some of the nuances of the debate. It is easy to put a marker in the sand based purely on generalities, but as those who truly understand the Policy know, the devil is in the details.

For example, regional distribution is one detail that often gets overlooked. Regional distribution is a long-standing pillar of Canada’s offset policy – so long in fact, that its benefit is no longer assessed but instead assumed. Few have really taken the time to consider if the mechanism used to encourage the regional distribution of work is actually working and if it even has a role to play in the new ITB regime.

With a Federal election campaign underway, what better time to discuss the effects of regionalism and, more specifically, the consequences of incentivizing regional distribution in this new era of the Value Proposition.

The Big Change
Value Proposition is a strategic tool used at bid time to leverage strategic investment into Canada. Bidders are incentivized through points (and a portion of the overall evaluation weighting) to make investments with their bids that align with Canada’s Key Industrial Capabilities (KICs) and fall in areas of priority for the government, including innovation, skills development and training, and export.

The introduction of Value Proposition was, and still is, a big change for those used to bidding under Canada’s old regime – the IRB Policy – where commitments, while contractual, were neither rated nor weighted at bid time.

At the same time Value Proposition was being introduced (just to add to the confusion), Canada changed the name of the Policy itself – from the Industrial and Regional Benefits (IRB) Policy to the Industrial and Technological Benefits (ITB) Policy. This change led people to assume that the entire policy (including the contractual rules around crediting and management) had been revamped to account for changes one might assume necessary with the addition of VP. In reality, however, the mechanics of the policy itself have remained almost untouched.

And therein lies the issue. The lack of change to the contractual terms of the policy has resulted in what some call an “IRB hangover”, whereby the legacy of the old is limiting the potential of the new.

The addition of the Value Proposition has, without a doubt, led to many of Canada’s desired behaviours within Industry. Conversations around economic benefit have elevated, investment is being channeled with purpose and bidders are being forced to think strategically about their economic offering well in advance of bid submission. However, the complexities VP has added to the process have led bidders to weigh the risk and reward of their economic commitments more carefully at bid time.

In the context of regional distribution, this need to mitigate risk is seeing bidders think twice about where they place work – which, more often than not, results in decisions to undertake business activities in regions with more capacity. There is little incentive (given the rigidity of the policy on the other side of contract award), for bidders to take a chance and place work in a region with limited “replacement” options.

To fully appreciate what this means, it’s important to understand the type of ITB/VP information bidders on major defence procurements are required to provide at bid time.

How are Commitments Leveraged through the ITB/VP Policy?
The regional objectives of the IRB policy made sense in the context of the day, but that context has changed significantly in the last 5-10 years. At the time, the Government was prioritizing work with businesses in certain “designated regions” in order to build capability in more economically depressed areas of the country. In those days, the designated regions included: the West (British Columbia, Alberta, Saskatchewan, and Manitoba); Northern Ontario; Quebec; and Atlantic Canada (New Brunswick, Nova Scotia, Newfoundland & Labrador, and Prince Edward Island).

The context started to shift in 2009 with the establishment of Southern Ontario as its own region – officially making every part of the country a designated region under the policy. Southern Ontario boasts 36% of Canada’s population, contributes almost 40% of Canada’s GDP, has over 426,000 Small and Medium sized Businesses (SMBs) and attracts 40% of Canada’s venture capital investments. By all accounts, it is a robust and diversified economy. To include it today as a designated region under the ITB Policy, begs a broader question about what the policy is actually trying to achieve when it comes to regional distribution.

To be clear, the government does not use mandatory regional targets, nor does it provide points in a bid evaluation for regional distribution. The leveraging of regional distribution is far more nuanced, and tied to the information that bidders are required to provide in their proposals.

When submitting proposals for major defence contracts, bidders are required to provide a set of VP/ITB “commitments”. These are expressed as a percentage of the contract value. In addition to these “commitments”, bidders are often asked to “identify” a portion of their commitments – which means provide detail on select activities that they intend to use to achieve their ITB commitments.  

But here’s the thing – when these activities are “identified” in a bid, they become contractual obligations. This means, after contract award, the winning bidder becomes contractually committed to, the scope of work, the value of the work packages, the recipient companies, and the regions where the work will take place for each identified activity in its bid.

Once contractually committed to these activities, the policy ‘rules’ make it very difficult to make adjustments. If something falls through after contract award, the Contractor is forced to find replacement work of similar size and scope in the same committed region.

And here’s what that means – if the Canadian company identified in the bid goes out of business, or changes location, or sells the business, or any number of unforeseeable events occur that are beyond the control of the Contractor – too bad.  Now, of course, throughout the long life of a defence program, things change and activities that were once legitimate, are no longer viable. In these cases, ISED may negotiate a substitute work package. But even still, all the attributes of the original activity must be present in the new substituted activity. For instance, if the original activity was to be undertaken with a small business in Atlantic Canada, then the substitute work package must also be with a small business in Atlantic Canada.

If an appropriate substitute cannot be found, the Contractor risks falling short of its original commitments with underperformance subject to financial penalties equal to 10% of the shortfall.

Now, put yourself in the position of a bidder trying to maximize the evaluation score in a Value Proposition at the lowest possible cost and at minimal risk. What would you do?

  • You would select your suppliers carefully in order to mitigate against the risk of financial penalties;
  • You would likely avoid small businesses in regions where substitute activities might be challenging to find;
  • And, as a result, you would be left with safe choices in safe regions like Southern Ontario and Quebec.

And therein lies the irony. The tool Canada is using to encourage regional distribution is the same tool driving bidders to suppliers in central Canada.

Now What?
The changes made to defence procurement in 2014 brought about an opportunity to realign objectives and leverage more strategic investment into Canada. Some might argue VP is doing exactly that. Others might take a more nuanced position and suggest some legacy aspects of the old IRB Policy are cramping its true potential. Either way, the dialogue is likely to continue.

One thing is for certain however – as long as the objectives around regional distribution remain murky, the very companies the policy intended to support (SMBs in the regions) will remain the ones losing out – certainly at bid time.
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Stephanie Batstone is a Managing Partner at NyRAD Inc, an Ottawa-based, woman-owned business consultancy providing strategic guidance and hands-on support in the niche areas of defence procurement and the associated Canadian industrial participation landscape.

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