The Gazelle Shortage
For years now, the federal government has been trying to get Canadians to diversify away from our dependence on natural resources by building new kinds of companies — bigger, bolder ones that can compete internationally and win. The government promotes entrepreneurship via a tantalizing smorgasbord of federal and provincial grants, loans and tax incentives for start-ups — one of the richest sets of subsidies in the OECD. A new entrepreneur with a decent accountant can write down a lot of business costs and write some off altogether, while paying a very low tax rate overall.
On paper, it seems to be working. Canada is now the second-easiest place in the world to start a company, reports the World Bank, meaning that we trail New Zealand. And according to the Global Entrepreneurship Monitor (GEM), nearly 17 per cent of working-age Canadians, versus about 13 per cent of Americans, either are currently engaged in setting up a company or are already owner-managers of a “baby business” that’s generating revenue and is less than three and a half years old.
But despite all this entrepreneurial activity, the productivity gap is not closing. And Canada’s lousy record on innovation isn’t improving.
That’s because most Canadian start-ups never amount to much. As with new businesses the world over, the failure rate is high; one-half don’t make it past the five-year mark. Most of those that do survive don’t grow into thriving, bustling enterprises. The majority of Canadian companies that start out small stay small, experiencing zero or negative employment growth. Of the 1,170,000 businesses in Canada, 98 per cent have fewer than a hundred employees — many fewer, in most cases. More than three-quarters employ ten or fewer people, and more than half are micro-enterprises, with no more than four employees.
Small businesses are hardly irrelevant; they contribute roughly 30 per cent of each province’s GDP, and employ 70 per cent of Canadians who work in the private sector. But just a handful of those small companies are actually highly productive and growing, creating new jobs and more wealth.
High growth firms (HGFs), regardless of sector or region, share one big similarity: they tend to be export oriented. Exporting and innovation go hand in hand. Companies that are exposed to new markets are also exposed to new technologies and global best practices in their industries — and, crucially, to competition, the stiff kind that forces them to up their game by innovating, which begets higher revenues and turbo-charges job creation.
Our economy needs more gazelles — or even moose, which aren’t so nimble but at least can lumber along at a reasonable clip when they’re determined to make progress. A lot of Canadian entrepreneurs, however, more closely resemble sloths. It’s hard to blame them, though, because plodding along slowly has worked beautifully up to this point. Competition has been minimal, aggregate corporate profits have been higher than in the United States, and it’s been easy and cheap to be late adopters of innovations pioneered in the U.S. — the incentives for growth and change haven’t exactly been strong. But what’s worked in the past is not going to cut it in the future, because the rules of the game have changed. Yet the sloth-like behaviour continues.
“The first, and arguably most significant, obstacle to growth is the apparent dearth of business owners with an appetite for strong development in the first place,” according to a 2013 report by the Centre for Digital Entrepreneurship and Economic Performance (DEEP), a think tank in Waterloo.
Even in the early, rose-coloured-glasses phase of launching a start-up, few Canadians are dreaming big. Only one-fifth aspire to provide twenty or more jobs five years down the road, according to GEM; two-thirds are not planning to have even six employees by then. As for exporting, 17 per cent of early-stage business owners have no plans whatsoever to sell their products or services abroad; 55 per cent aim to generate just 1 to 25 per cent of their revenue that way.
Think about that for a moment. Almost three-quarters of our newest entrepreneurs, the ones the government is incentivizing left, right and centre to build businesses and revitalize our economy, have no intention of competing in the global economy. Not every entrepreneur has to yearn to be the next Roy Thomson or Ted Rogers, of course. But the days when Canadian businesses could be highly profitable without exporting and attempting to innovate are drawing to an end. If governmental policies are meant to be paving the way for the next BlackBerry and Uber, but in fact what’s being stimulated is a glut of mom-and-pop operations, we urgently need to question whether our tax dollars are being spent wisely. Artisanal enterprises are not going to save the Canadian economy, and they are no match for global behemoths.
Ambition, as it turns out, really matters when it comes to the creation of high-growth firms, so it’s a significant problem that our new entrepreneurs seem to have so little of it. Ambition is a key determinant of entrepreneurial performance, according to a comprehensive survey conducted by the Business Development Bank of Canada (BDC) in 2015. The point of the exercise was to determine how HGFs differ from garden-variety businesses, and the BDC reported, “Though growth and size are important criteria in defining high-impact firms, the mindset of the executive team is a critical factor for competitiveness. Without the right mindset, the other criteria become far less predictive.” Makes sense, right? If your main business goal is to get by and avoid bankruptcy, chances are excellent that your company won’t be as big or as profitable as it would be if you’d set out to become a leading exporter to China. So, what’s the right mindset? A highly ambitious, achievement-oriented one that spurs an entrepreneur to “unrelentingly pursue innovation and higher growth by investing and taking appropriate risks.” In the BDC survey, the most ambitious, risk-tolerant Canadian entrepreneurs had 10 per cent greater revenue growth and 9 per cent more international sales than moderately ambitious ones.
In a glass-half-full way, this is great news: Canada’s gazelle shortage isn’t related to a shortage of business talent. The issue is that we have an attitude problem, related to our traditional, junior-sidekick-of-the-US business culture. While it’s socially acceptable to admit to an ambition to cure cancer or win the Stanley Cup, saying you want to build a billion-dollar business just sounds so … tacky. Overweening. American. That’s a big problem, because billion-dollar businesses don’t just happen. They start with unapologetic ambition.
To make entrepreneurial ambition socially acceptable—desirable, even—we could start by cleansing the word ambition of its brassy overtones and reframing it in positive terms that are aligned with Canadian cultural values. For instance, the ambition to export could not be more Canadian. Canada is as far from xenophobic as it’s possible for a country to be. More than 20 per cent of us were born somewhere else, which should give us a massive advantage in terms of understanding, and making inroads into, foreign markets, as we desperately need to do.
But only 12 per cent of small businesses and 28 per cent of medium-sized ones ship stuff out of the country. More than one-quarter of non-exporters see no benefit in trying to branch out. Unsurprisingly, then, export activity is heading in the wrong direction: as a percentage of GDP, exports dropped from 46 per cent in 2000 to 30 per cent in 2012.
We should be encouraging new entrepreneurs to be a whole lot more ambitious, not so they can ape Americans but so they can be successful in a distinctly Canadian way: by reaching out to the outside world and sharing the best of what our country has to offer.
Many entrepreneurs are proud that their businesses are small and independent, and some of their customers probably are too. A fair number of us love to hate big-box retailers. But the smaller the company, the less productive it is; big firms can take advantage of economies of scale, and they have much greater resources to put towards R & D, new technology and all the other kinds of things that help companies become more efficient. The small-firm disadvantage is especially pronounced in Canada. While American companies with fewer than 500 employees are 67 per cent as productive as those with more than 500 employees, in Canada smaller companies are only 47 per cent as productive as big ones. Forty-seven per cent! It’s not the story we like to tell, but the hard truth is that “the small size of companies in Canada, while often celebrated, is actually a drag on productivity and the wider economy,” as was noted in the DEEP report.
Nevertheless, Ottawa continues to wheel out ever more enticing incentives to encourage yet more people to start yet more new businesses. The government’s main incentive for entrepreneurship is an indirect subsidy: the small business tax deduction (SBD), which was recently lowered to 10.5 per cent on the first $500,000 of active business income. That’s great news for small business owners, but not such great news for the rest of us unless those small businesses are creating a lot of jobs, because the SBD costs the federal Treasury more than $3 billion a year. And growth is actually penalized. If your business starts generating a ton of revenue, well, sorry — you don’t get the deduction anymore. It might as well be called the “stay small” business deduction.
A massive tax deduction that stimulates entrepreneurial activity but not economic growth is a triple whammy: it encourages not-so-good entrepreneurs to enter the ring, it doesn’t provide the boost really talented entrepreneurs need for their businesses to grow, and it costs the rest of us a ton of money. But Ottawa likes tax deductions: they’re egalitarian! No one can claim to have been snubbed. The entrepreneur in Calgary whose main goal is kicking back at the cottage for the summer gets exactly the same amount of tax relief as the entrepreneur in Regina whose main goal is building a kick-ass company that employs a lot of people and creates a lot of wealth. It’s as though the government believes that ambition is irrelevant, and maybe even a little obnoxious.
Instead of gazelles, all this fairness is breeding a large herd of marginal businesses. How do they manage to stay afloat? Well, the DEEP authors explain, they survive because there are not enough disruptive upstarts and strong-armed rivals battling for market share: “the degree of creative destruction and competitive pressure in many sectors is insufficient to either weed out poorly run companies, or reward superior enterprise performance.”
In other words, Canada is a great place to start a mediocre business because, thanks to a lack of competition, it will probably survive longer here.
Excerpted from How We Can Win by Anthony Lacavera and Kate Fillion. Copyright © 2017 Anthony Lacavera. Published by Random House Canada, a division of Penguin Random House Canada Limited.