Solving Canada’s Innovation Problem

Why do we export so many world-class business ideas to the rest of the world?

The O’Hagan Annual Essay on Public Affairs is a research-based examination of the current economic, social, and political realities of Canada. Commissioned by the editorial team at The Walrus, the essay is funded by Peter and Sarah O’Hagan in honour of Peter’s father, Richard, and his considerable contributions to public life. Richard O’Hagan is a member of the Walrus Foundation’s board of directors.

Bob Fleet remembers where he was on June 25, 2009: at a restaurant, celebrating his teenage daughter’s birthday with about a dozen of her friends. On the surrounding television screens, news anchors were breathlessly reporting details of the deaths of Michael Jackson and Farrah Fawcett. But Fleet’s attention was elsewhere. Grant Forest Products had just entered creditor protection, and his name was on the press release. His cellphone kept going off—reporters calling for quotes. “It was surreal,” says Fleet, who was then vice-president of Grant Forest’s woodlands operations. “I’ll remember that day for the rest of my life.”

The family-run company—based in the northern Ontario hamlet of Earlton, halfway between North Bay and Timmins—had at one point been North America’s third-largest manufacturer of oriented strand board (OSB), a popular form of engineered lumber used in walls and floors. In the early 1990s, Grant Forest’s founder, Peter Grant Sr., constructed what was then the world’s biggest OSB plant, in Englehart, Ontario, just north of Earlton. He went on to build an even larger one in 2000, in High Level, Alberta. By 2004, at the height of the United States housing boom, his company was generating $506 million in annual sales from just three plants and 700 employees. That same year, Grant appeared on Canadian Business magazine’s list of the 100 richest Canadians. His personal net worth was estimated at $381 million.

With OSB prices reaching record highs near $500 per 1,000 square feet, Grant made his biggest bet to date—investing $400 million (US) to build two massive plants in South Carolina, a low-cost, business-friendly jurisdiction with plenty of local timber supply. But just as the first of these two plants was poised to open in late 2006, the housing market tanked, and OSB prices plunged to below $150 per 1,000 square feet. Grant began hemorrhaging money and collapsed under a $600 million (US) debt load. One of its many creditors, GE Leasing, sued in 2009 to push the company into bankruptcy protection. The plants were sold. Grant’s still-unfinished 65,000-square-foot lakefront home, believed to be the largest residence in Canada, was put up for sale.

Many forestry firms suffered a similar fate: hundreds of sawmills and pulp and paper plants from coast to coast were sold off or picked over for scrap. Between 2006 and 2009, almost 90,000 workers—25 percent of the industry workforce—lost their jobs. British Columbia’s forestry industry was able to deflect some of the damage by increasing exports to China and has since gone on to snap up a slew of US sawmills. But in Eastern Canada—home to the country’s largest companies and heavily dependent on newsprint—the industry is a shadow of its former self. Iconic paper producer Domtar was acquired by a US competitor. Montreal-based Tembec, its share price flirting with penny-stock status, has seen annual sales drop by more than half in the last decade. AbitibiBowater, crushed under $6 billion in debt, sought creditor protection in 2009. It has since re-emerged as Resolute Forest Products—and continues to lose money.

Fleet, who is now vice-president of Tolko Industries, a manufacturer of forestry products in BC, says Grant Forest was a victim of forces beyond its control. Who could have predicted that mortgage-backed securities would cause the US housing market to collapse so quickly and dramatically? A number of other external factors also conspired against the industry—the run-up in the Canadian dollar, the costly softwood-lumber dispute with the US, and a shift from newsprint to digital media. These were significant challenges, no doubt. But the seeds of the industry’s retreat had been sown long before, leaving Canadian producers more vulnerable to market shocks and technological disruption than any other major international players.

The woes of Canada’s once-mighty forestry industry present a microcosm of a larger trend: we start with the necessary ingredients for building world-beating companies and industries, then squander them. Though Canada is home to abundant timber resources, we have never had a forestry firm ranked among the world’s top twenty. Canadians discovered insulin, yet it was commercialized by an American pharmaceutical giant. We take pride in our brewing prowess, yet remain the only major beer-drinking country without a single global beer brand. The reasons are many—and include obsolete government policies, weak management skills, a lack of investment in research and development, and a long-nurtured sense of national inferiority. Addressing these issues, and unleashing our potential to create world-leading brands, is one of the great challenges of our time.

In the pages that follow, I will delve deeper into the roots of forestry’s decline, because it serves as a valuable case study for many sectors where we have missed opportunities to develop our resources, both human and natural, beyond our borders. But I will also take readers to the Ottawa offices of Shopify, a successful e-commerce company at the vanguard of a small but growing new generation of entrepreneurs who are more likely to take cues from Drake and his unabashed pride in being Canadian—and share his outsized ambition. “What Drake has done creates a precedent,” explains Michael Garrity, CEO of Financeit, a Toronto-based financial-technology (so-called fintech) company. “We have an opportunity every day to redefine our culture, including our entrepreneurial culture, and it’s time to be a lot louder about who we are and our goals of building world-dominating companies.”

The forestry industry has been an engine of the Canadian economy since before Confederation—built on a bounty of cheap electricity, the slow-growing long-fibre softwood ideal for making newsprint, and the huge US market to our south. The fact that Canada was the only major forestry producer in the world that relied almost entirely on publicly owned land didn’t seem to hold us back. Yes, there were conditions attached to Crown property. Operators were required to set up smaller mills in scattered remote communities in order to create jobs, and harvests were driven largely by government quota rather than market conditions. But our extraction costs were low. And when times were good, there was a whack of cash to be made.

But the world moved on: in recent decades, a revolution in tree genetics and planting has improved harvests, and new processing methods have allowed for the use of faster-growing southern species in paper production, destroying Canada’s dominance in newsprint. Scandinavian competitors adopted this new technology and expanded globally, while new low-cost forestry giants began to emerge in South America. Canadian companies, by contrast, stayed home and largely stuck to their knitting. “Why would you [invest in tree genetics]?” asks one former forestry executive I interviewed. “You aren’t going to do that [on public land], when there’s no guarantee you are going to be the one to harvest it.”

Canadian mills, particularly those in Eastern Canada, became increasingly small and antiquated compared with those of other countries. Most of our forestry companies remained geographically concentrated—not just within Canada, but within particular regions of the country. By the time the US housing crisis hit in the late 2000s, the industry had been in a slow decline for decades, its cost advantage long gone and its huge reliance on the US market making it particularly vulnerable to systemic shock. Not much has changed since, despite all the layoffs and mill closures. Canada, according to a survey of major producers, was the world’s least profitable forestry jurisdiction in 2013 and 2014.

While forestry in Eastern Canada limps along, other major forestry companies are continuing to reinvent themselves, investing in new packaging technologies and green tech. Don Roberts, a former vice-chair of CIBC World Markets who now heads up his own investment-banking boutique, Nawitka Capital Advisors, tells me that the Scandinavians and Brazilians, in particular, are using cutting-edge technology to find new uses for pulp and wood waste. A few Canadian companies are at the forefront of some of this technology, developing bio-refining processes that transform wood products into fuel, which Roberts believes are on the cusp of commercial viability. Yet our own forestry firms haven’t shown much interest in leading the charge in this area. For that, Roberts had to go to Brazil and pulp giant Fibria Celulose, which has made strategic investments in these innovative Canadian companies.

“Why aren’t we doing these pivots?” asks Roberts. “There is a general lack of support for transformative actions, and many companies simply don’t have the in-house expertise to understand the new technologies. It’s a different skill set, and the industry’s been so gutted, it focuses mostly on the short term. Anything that is not core to the business is cut.”

Illustration by Pete Ryan

In 2007, I published a business book with the title Why Mexicans Don’t Drink Molson. But it wasn’t about beer. It was my own Lament for a Nation—an analysis of why Canada and its major companies were failing to seize their moment on the world stage. I wrote it shortly after returning to Canada after having spent a decade as a business journalist in Latin America, where I’d reported on major changes affecting the global economy, from free trade and foreign investment to the rise of China as an economic power. Yet when I returned to Canada, I felt as if all this were happening on a different planet. I was worried that our failure to appreciate the tectonic shifts taking place beyond our borders could take a serious bite out of our standard of living. And, as a proud Canadian, I was disappointed that we seemed to have so little ambition.

I learned that Canada was an export-dependent nation without a true trading culture—a commodity producer that had a trade deficit with virtually every country in the world with the exception of the US. Our corporate giants, with only a few notable exceptions, were global pipsqueaks, often protected by government regulations. While Canadians had the reputation of being competent engineers, we couldn’t market ourselves out of a paper bag—which is why, even today, we don’t have a single corporate brand among the world’s top 100. We were reluctant to invest in new technology and equipment, preferring to compete on cheap labour and a low dollar. This strategy produced a yawning productivity gap with the US, and our manufacturing industry (particularly in Ontario) was gutted once the loonie gained value in the early 2000s. When we did get new technologies off the ground, we often sold them to more ambitious foreign buyers instead of commercializing them ourselves. In short, we were, as some Americans called us, “Mexicans with sweaters”—except the Mexicans had Corona.

So the question is, a decade on, has anything changed? In some areas, such as forestry, we remain mired in the same old bad habits. We also sustained a huge blow with the implosion of Nortel and the dramatic decline of Research in Motion (RIM), two anchor companies that were supposed to carry the country’s torch into the new tech era. But in other parts of the corporate landscape, there are promising developments that could help put the country on a new, more ambitious path.

Our buttoned-down banks weathered the devastating 2008 financial crisis better than most. And two in particular have built up a substantial foreign presence. Toronto-Dominion Bank is among the ten largest banks in the US, while Scotiabank runs the seventh-largest banks in Mexico and Chile, and the third largest in Peru. Over the past decade, we have witnessed the quietly spectacular rise of Brookfield Asset Management, and a clutch of Canadian pension funds have become some of the world’s largest infrastructure investors, with stakes in London airports, US toll roads, and Australia’s electricity grid.

Then there is the Quebec convenience-store retailer Alimentation Couche-Tard. Founded in 1980 by Chicoutimi-born Alain Bouchard, who began his career stocking shelves at a local depanneur, Couche-Tard is now the largest independent convenience and fuel retailer in North America, and has a strong presence in Eastern Europe and Scandinavia. With some fifty acquisitions, including the $3.8 billion (US) purchase of Texas-based CST Brands in August, Couche-Tard now has annual revenue of $34.5 billion (US), up from $10 billion just a decade ago.

But most of our large corporations—including those in retail, telco, media, and oil and gas—remain determinedly domestic. According to branding agency Interbrand, Canadian companies “prefer to rest on their laurels rather than step out of line and forge new paths to differentiation.” Says Alan Middleton, professor of marketing at York University’s Schulich School of Business, “If [Canada] had a C grade ten years ago, we’ve stumbled up to a B, but only in certain sectors and only for a brief period of time.”

Many of the government structures that have stifled innovation and stunted our global ambitions remain largely in place, from foreign ownership restrictions to agriculture marketing boards (most notably in the dairy sector) that fix prices and block foreign competition with prohibitive tariffs. Canada continues to be the only industrialized country without a national securities regulator. (Provincial leaders insist on maintaining their own, tying companies up in unnecessary red tape.) And, almost 150 years after Confederation, we still do not have free trade within Canada: provinces maintain rigidly protectionist policies on wine, for instance, banning cross-border sales and crimping entrepreneurial efforts to develop vineyards and craft beers.

The situation is further exacerbated by low levels of business enterprise spending on research and development, or BERD for short. Never Canada’s strong suit, it has declined from a high of approximately 1.3 percent of GDP in 2001 to 0.9 percent as of 2013, the last year for which authoritative data are available. The US, by contrast, had a BERD of 2 percent in 2013. Australia, a country that is just as heavily reliant on commodities as Canada, has seen business investment in R&D double from 0.6 percent in 1999 to 1.2 percent in 2015.

When I spoke to economist Glen Hodgson, senior fellow at the Conference Board of Canada, for my book a decade ago, he voiced concern that Canada’s long-term economic potential was “clearly fading.” A decade on, his outlook hasn’t changed much. Our labour productivity, the single most important indicator of the country’s ability to maintain its standard of living, remains anemic, while the growth rate of the workforce is expected to shrink significantly as baby boomers begin to retire. At the same time, environmental pressures and opposition to pipelines threaten to turn oil and gas, a key source of the country’s wealth, into stranded assets. “[Unless things change], I foresee us continuing to tread water, growing at less than 2 percent a year, [with] funding for health, education, and infrastructure getting squeezed,” he says. “We’ll end up fighting over who pays the taxes to pay for this and scaring away the high-end workers that business needs.”

It was February 2004 when computer programmer and entrepreneur Tobi Lütke made his very first sale—a snowboard to a customer in Pennsylvania. “There is nothing like that external validation,” says the German-born Lütke, who moved to Ottawa fourteen years ago to be with his now wife. “I decided that whatever I did, whatever happened to me, I needed to make it happen more.”

The company he started with a group of friends to sell snowboards online, Shopify, has since morphed into a cloud-based e-commerce platform that, as of last count, powers more than 300,000 small- and medium-sized merchants that, between them, produced merchandise sales of $20 billion in the last financial quarter. Shopify has developed partnerships with the likes of Amazon, Uber, and Facebook, and counts among its customers electric carmaker Tesla Motors and reality-star model Kylie Jenner, who recently snapchatted her thanks to Shopify for surprising her with a bouncy castle on her nineteenth birthday.

Shopify is the first, and so far only, Canadian tech company to have reached a market valuation of $1 billion since the dot-com bust of the early 2000s. With its 2015 public listing on the New York and Toronto Stock Exchanges, it has become the poster child for a renaissance in tech hubs from the Toronto–Waterloo corridor to Vancouver. The tech revival includes a host of impressive up-and-comers, including Wattpad, a content hub that links writers with readers; social-media management firm Hootsuite; and dozens of financial-technology firms.

“In the last five to six years, a bunch of exciting start-ups have begun to take off, attracting big-league American venture-capital money,” says Globe and Mail business reporter Sean Silcoff, co-author of Losing the Signal: The Untold Story behind the Extraordinary Rise and Spectacular Fall of Blackberry. “They are more real than the last time around, and they have a different mindset—they don’t act like Canadians, and in fact many, like Lütke, aren’t.”

Ironically, when Lütke first decided to launch Shopify, he wasn’t entirely convinced scaling the company was necessary. He made the decision to transition from snowboards to software when he realized none of the existing e-commerce platforms were up to his standards. “I knew the software needed to exist, so I built it. It wasn’t clear to me why there needed to be growth,” he says. Lütke changed his mind as the list of things he wanted to try expanded.

After receiving $22 million (US) in equity financing from a group of US funds in 2010 and 2011, Shopify’s staff grew from twenty to 130. The company secured a third round in 2013 for $100 million—one of the biggest gambles made on a Canadian start-up in years. This time, the funding was led by the venture-capital arm of OMERS, the pension fund for Ontario municipal employees. John Ruffolo, head of OMERS Ventures, agreed to back Shopify after a single meeting with Lütke over a cup of coffee. He was immediately struck by how quickly the company was scaling up, and how effective Lütke and the founding team were at running the business.

But what really got Ruffolo hooked was Lütke’s ambition. He wasn’t angling to sell out quickly for a hefty sum—he intended to stick it out and build something lasting. Ruffolo has made it his life’s goal to, as he puts it, “build Canada into an innovation powerhouse.” Just 5 percent of Canada’s fastest-growing companies generate 43 percent of all net new jobs, and Ruffolo believes tech-based firms are among the few capable of scaling fast enough to turn the tide on Canada’s flagging productivity and growth.

“Ten years ago, if we could exit [i.e. sell] a company for $100 million, I would have said, ‘By God, what a success.’ Now, no one cares. Yeah, it’s nice and makes a few people rich, but it doesn’t do anything,” says Ruffolo, who founded the ventures arm of OMERS in 2011—using $200 million in seed money from the fund’s total asset base of about $60 billion—to finance promising but underfunded Canadian tech start-ups. “It’s a specific strategy . . . how do we get start-ups to become billion-dollar companies, not $50 million exits?”

Ruffolo’s ambition of building Canadian-headquartered, billion-dollar companies has become the battle cry of an entire cohort of fiercely Canadian tech entrepreneurs, as well as mentors, investors and innovation experts. Many, such as Michael Serbinis, founder of e-reader company Kobo, have returned to Canada after honing their skills in the kill-or-be-killed shark tank that is Silicon Valley. For Serbinis, who takes a certain pleasure in his reputation as a “shark,” creating Canadian-headquartered tech giants is “a national imperative.” After building and selling three companies (including Kobo) for a combined value of approximately $1.2 billion (US), the former NASA engineer is now on his fourth start-up, League Inc., a digital health-insurance platform.

League closed a round of financing in June that involved only Canadian players—a first in Serbinis’s experience; funding came not only from OMERS, but also from strategic and corporate investors such as the Royal Bank of Canada, Manulife, and Mike Lazaridis, co-founder of RIM. “These are all building blocks,” says Serbinis of the Toronto–Waterloo confluence of Valley-trained entrepreneurs, investors, world-class universities, talented software engineers, and leading academics at the frontiers of artificial intelligence and quantum physics.

In what was seen for a huge coup for Shopify, Amazon closed its internal webstore to service merchants in 2015, outsourcing the business to Shopify, which is now the leading provider in this space. Shopify now employs a workforce of more than 1,500, mostly at its new upscale offices in Ottawa, and is forecasting revenues of more than $360 million (US) for 2016. The company, which is reinvesting in the business, doesn’t expect to turn a profit before the fourth quarter of 2017. With some 80 percent of revenues still coming from the US, there is plenty of room to grow here at home and overseas.

Lütke is clear that he wants Shopify to be a company that “sees the next century.” To remind himself of that, a few years ago he tracked down the customer who bought his first snowboard—and then he bought it back. He keeps it in his office. Whenever Lütke receives an offer to buy Shopify, he’s been known to respond in kind: “I send them one right back.”

When Grant Forest Products entered creditor protection in 2009 and put its mills up for sale, “people were lining up to buy them,” Bob Fleet recalls. Georgia-Pacific, the US pulp and paper giant, scooped up Grant’s South Carolina and Ontario plants, while Chinese and Indian conglomerates—better capitalized than the debt-ridden Canadian incumbents—have been picking up mills from Howe Sound, BC, to New Glasgow, Nova Scotia.

No doubt, many Canadians are perfectly content to see our country shed its old-stock role as “hewers of wood.” But the world still needs wood, wheat, minerals, and oil to go along with the high-tech services provided by the likes of Shopify. It’s not an either/or scenario. If Canada wants to reach its full economic potential, we need to be able to compete internationally across the spectrum, from remote forests to urban tech hubs.

In Peter Grant’s case, his company lacked the senior-management skills to assess market conditions, balance risk with opportunities, and make informed decisions. Grant bet the company that record-high prices would continue indefinitely, which never happens in any industry. “We were running a complex business without the ability to have the analysis and the analytics, the MBA brain power to operate at the level of sophistication that was needed,” says Fleet.

Stories such as these help explain why Ajay Agrawal established the Creative Destruction Lab at the University of Toronto’s Rotman School of Management. A professor of entrepreneurship and strategic management, Agrawal didn’t buy into the notion that Canadians were hobbled by an aversion to risk or a lack of capital. Most suffered instead from what he terms a lack of judgment—they didn’t know what business objectives to focus on or how to sustainably scale a business. In other words, they needed high-level business savvy and experience.

Agrawal uses the contrasting examples of artificial intelligence and mining to make his point. When researchers in machine learning from the University of Toronto shopped a potentially groundbreaking new technology that would significantly reduce the time required to discover new drugs, they were turned down by a slew of Canadian venture capitalists. Eventually, the start-up was snapped up by Silicon Valley, which is where the company is now based. Yet Canadians have no qualms about financing complex mining operations in remote locations with no roads or running water. Digging holes in the ground to find buried minerals is something we understand. Artificial intelligence, not so much.

With that in mind, Agrawal designed his lab to focus on two simple goals: promoting science-based technologies such as machine learning—a field in which Canadians are considered world leaders—and exposing graduate students to the best business judgment the country has to offer. So five times a year, fifty would-be entrepreneurs convene with the likes of Michael Serbinis, Ted Livingston of Kik Messenger, Daniel Debow of Rypple, Lisa Shields of Hyperwallet, and Shivon Zilis of Bloomberg Beta for an intensive day-long meeting to review business plans and benchmark progress. These mentors (“Founders,” as they are known) invest seed money in the most promising ventures and cut the ones that don’t perform.

When the lab was launched in 2012 (without government funding, Agrawal is quick to point out), its goal was to generate a modest $50 million in equity value in five years—now at $800 million, it has surpassed the original target. Thomas Hellman, the head of Oxford University’s Entrepreneurship Centre, has described it as “probably the best science-based accelerator in the world.”

But for all the buzz around these successes, Canada will need to create a few dozen Shopifys just to keep from falling behind other developed economies that are investing heavily in innovation. And that’s not even close to happening—in part because we keep losing many of our best people and companies. “We’re living beside a marketplace [the US] that is more than ten times the size, way more dynamic, and you have way more ability to make money,” says Bill Currie, vice-chair of Deloitte Canada. “Every once in a while, you get [successful Canadian entrepreneurs] who stay, guys who are passionately Canadian. But that’s a small cohort.”

Nevertheless, there is plenty we could be doing to make Canada a more attractive place to launch innovative, globally oriented businesses. And the Trudeau government will, in the tradition of many that came before it, take a run at this perennial challenge. Obvious targets for a new “innovation agenda” would include easing restrictions on recruiting global talent and rethinking scattershot federal R&D tax credits that do little for start-ups in their early, money-losing phase. Some in the tech sector say it’s time to “pick winners” and place big bets on such innovation hubs as the Toronto–Waterloo corridor by, for example, investing in a fast train between the two cities or introducing a capital-gains tax exemption for entrepreneurs who reinvest their millions in new companies.

For John Ruffolo of OMERS, immigration also has to be part of the equation. He would like to see Canada dramatically increase the number of immigrants we accept every year from 250,000 to 1 million. Our admission criteria, he argues, should in part target the world’s best and brightest—top science grads and promising entrepreneurs. Ruffolo believes a massive infusion of new blood will build prosperity in the tradition of previous generations of immigrants—from Seagram’s Samuel Bronfman to Barrick’s Peter Munk. “If we want to ensure our place in the world, we certainly aren’t going to do it with [our current population of] 36 million people,” he says.

Ultimately, however, it is business, not government, that creates jobs and wealth. The Australians get this. And in recent decades, they’ve pushed through significant reforms—such as disbanding marketing boards, opening energy utilities to private ownership, and encouraging close R&D collaboration between business and universities—that are believed to have contributed to higher productivity and R&D investment by business. “If we are really aiming to have growth, we need to enable individuals and companies with a competitive landscape that allows them to grow,” says Dan Breznitz, the Munk Chair of Innovation Studies at the University of Toronto. “We [Canadians] don’t even think this way.”

Of the four major markets where Shopify does business, Canada is by far the smallest, lagging behind the US, the United Kingdom, and even Australia in the adoption of online shopping. Still, says Lütke, he’d rather be based here than anywhere else. “Canadians are optimistic, hardworking, and extremely loyal, which is so in line with what is needed to build a tech company,” he says. There is really only one thing missing, he concedes, and that’s confidence.

“It breaks my heart to see all the things that haven’t been accomplished,” he says. “I spend my days constantly telling everyone how good [Canadians] are, that they are as good as Americans . . . I guess they need a German to tell them that.”

This appeared in the December 2016 issue.
Correction: an earlier version of this article misidentified the co-CEO and founder of Rypple, Daniel Debow. It has since been amended.

Andrea Mandel-Campbell
Andrea Mandel-Campbell is the author of Why Mexicans Don't Drink Molson.