Volume 1: Beyond the Horizon: Canada's Interests and Future in Aerospace – November 2012

Part 3
Analysis and recommendations (continued)

Chapter 3.3
Leveraging government procurement

Government spending on aircraft the world over is significant, even if defence budgets are falling in many Western countries as a result of fiscal restraint. The vast majority of these expenditures are on military aircraft and equipment, though there is also some purchasing in support of police forces, emergency response organizations, and the like. Given that international trade rules contain exceptions for security-related procurement, governments in countries with companies that manufacture military aircraft and systems typically make their purchases at home, which sends industrial benefits rippling through the industrial structure of their economies. The U.S. military, for example, always "buys American" when it comes to combat aircraft, and the same is normally true for the armed forces in other nations with firms that make fighter jets, including Russia, China, France, and Sweden.

A country such as Canada, however, must typically buy its military aircraft from foreign sources. Given this reality—and the fact that the Canadian aerospace sector can only thrive if it is technologically advanced and well-integrated into global supply chains—it is essential that Canada leverage government procurement to build the domestic aerospace sector, just as every other country does.

Public aerospace purchases should be planned and executed with three goals in mind: providing men and women in uniform with products that meet their operational requirements, getting good value for the Canadian taxpayers' money, and strengthening the Canadian industrial and technological base.

Balanced achievement of these objectives has proven elusive in Canada.

Efforts to advance the first two goals require that there be clear responsibilities, checks, and balances among federal departments and agencies. User organizations—the Canadian Forces for military aircraft, the Canadian Coast Guard for some search-and-rescue aircraft, and the Royal Canadian Mounted Police for policing aircraft—should articulate high-level operational requirements, while Public Works and Government Services Canada should lead transparent bidding and selection processes with clear, firm timelines to ensure that the women and men in uniform have the equipment they need, when they need it. To the greatest degree possible, companies should be able to bring forward a range of options to meet users' operational needs. If the description of those needs veers too far into detailed specifications, it gives rise to the impression that there is a particular product being sought from a particular supplier. There is a perception among some in the industry that procurement decisions have been influenced by familiarity with specific assets or the fact that certain aircraft are already operated by Canada's closest allies. Whether or not it is well-grounded, such a perception can have an impact on competition, costs, and credibility—and can be avoided, or at least minimized, through well-designed and well-executed procurement processes.

The third goal—strengthening Canadian industry—can be advanced by requiring investments in the aerospace sector by companies that secure procurement contracts. It is standard practice internationally to require foreign vendors to "offset" military acquisition costs by spending money in the purchasing country. In fact, Canada was one of the first to introduce such a requirement. Since the mid-1980s, offsets have been secured in Canada through the Industrial and Regional Benefits (IRB) Policy, which requires firms that win government defence contracts to spend sums equal to the value of the contract on Canadian goods and services.

The merits of IRBs, however, have been much debated, and the Review of Federal Support to Research and Development issued a special report on procurement that called for government purchasing to be used more effectively to nurture Canadian businesses and stimulate innovation. Further work has now been commissioned on how, in practice, this could be done.

Procurement can also strengthen the Canadian industry when indigenous firms take on a significant share of the ongoing maintenance and repair of purchased aircraft. In the past, Canadian companies benefited from providing in-service support (ISS) for planes bought for the use of the Royal Canadian Air Force, using engineering and technical data provided by the aircraft manufacturers. This arrangement provided those companies with a steady earnings stream and allowed them to develop advanced engineering and design capacity that could be marketed to other clients in Canada and abroad. It also provided Canada with greater sovereign capacity to keep its air force flying, reducing any risk that in a time of crisis its combat aircraft might be grounded because ISS facilities abroad were too busy servicing their own countries' assets to carry out essential maintenance and repairs of Canadian planes. Finally, it permitted adaptation of equipment to Canadian operating conditions and requirements.

More recently, however, a "single point of accountability" model has been adopted, under which the aircraft manufacturer also provides maintenance and repair services. This change has been spurred by the intersection of several factors, including:

• manufacturers' desire to expand their business lines, realizing that there are good margins to be earned through the provision of ISS services, and reluctance to transfer data on sophisticated technologies that were developed through years of investment and complex engineering; and
• the Department of National Defence's desire to incent dependable asset performance rather than pay by the repair—and its assessment that as aircraft have become increasingly complicated, the companies that make them are best positioned to service them reliably and at reasonable cost.

Canadian ISS firms have voiced concerns about the recent change in approach, with some suggesting that its effects on the domestic industry could be devastating.

In both these areas—industrial benefits requirements and ISS—it is possible to adjust policies and programs in ways that will produce better outcomes for both the Canadian industry and for the government as the purchaser and user of aircraft.

Recommendation 13: Earlier, clearer, firmer commitments on industrial and technological benefits

There is broad agreement on the goal of ensuring that when the government purchases aircraft and aerospace equipment from manufacturers, those manufacturers spend money in ways that benefit Canada's economy. But there are questions about the best means of achieving this end.

During its first two decades, the implementation of the IRB policy was too ad hoc. Aircraft manufacturers with whom the obligations rested were given credit for a wide range of purchases made in Canada that did not do enough to enhance the technological foundations of the Canadian aerospace industry or position it to compete globally.

Changes to the policy in recent years have sought to improve the situation. These changes include better recognition of work that is given to Canadian companies on major aircraft platforms sold by the manufacturer around the world, work that helps to position Canadian companies in global value chains; an updated list of key technologies; and the establishment of incentives, through "multipliers," for the creation of research consortia involving industry and academic institutions.

Despite these improvements, Canada's approach to procurement-based industrial benefits still falls short. The main issue is that obligations to spend in Canada are generated at the time of purchase, but vendors, government, and the Canadian aerospace industry have insufficient clarity on how those obligations will be satisfied. As the years pass, manufacturers accumulate offset commitments in other countries to which they also have made sales—commitments that effectively compete with obligations to spend money in Canada. Over time, the sellers' obligations to the development of the Canadian industry and growth of the Canadian economy become ever more difficult to enforce, even as the government offers increasingly generous terms in an attempt to attract high-quality spending.

There are other approaches to leveraging procurements. The National Shipbuilding Procurement Strategy, for example, required that bidders describe the comprehensive value propositions of their proposals for Canadian industry before any contract was signed.

Negotiating clearer, more specific industrial and technological benefits plans earlier in the procurement process—when the government's leverage is greatest—will almost certainly produce quicker and more tangible results.

Each industrial and technological benefits plan should clearly specify the post-sale activities the vendor will undertake in Canada. Industry Canada should take the lead in assessing these plans as part of the bid selection process, with the assessment counting for a weight of at least 10 per cent in the scoring system used to rank bids.

The criteria for assessing industrial and technological benefits plans should include the extent to which, over a defined and reasonably tight time frame, they strengthen the Canadian aerospace sector's:

• capacity with respect to priority aerospace technologies;
• ability to innovate through collaboration involving industry and researchers; and
• position in global supply chains.

The more a plan advances these goals—through the sourcing of sophisticated systems and services from Canadian companies, technology transfer in the context of business relationships, investments in research and technology demonstration, and the like—the higher its score should be. Assessments may also consider the business opportunities for SMEs that a plan creates—which would be consistent with the existing IRB policy—to the extent that such opportunities add to the overall health and vitality of the Canadian aerospace supply chain.

An approach to industrial and technological benefits that requires clear, detailed commitments during bidding is overdue, but it does carry several risks. One is that bidders will be forthcoming with impressive commitments to win a sale, but will not deliver on those commitments once tendering has been completed. This risk can be mitigated through strong contractual language that empowers the government to impose penalties or seek damages if the stipulations of an industrial and technological benefits plan are not met.

A second risk is that the pressure to submit detailed plans will result in too many low-value transactions. The use of the criteria listed above to guide assessments will reduce this risk, as will more transparent processes that give bidders enough time to develop firm, credible plans, along with increased flexibility for companies to "bank" high-value investments in Canada, as long as they can demonstrate that those investments were motivated in part by the expected procurement.

A final risk is that circumstances will evolve in ways that make commitments that looked promising during bid selection less relevant and valuable over time. Excessively specific and rigid plans may impede adaptation to changes in markets, production patterns, or the Canadian industry itself. To guard against this risk, it is important that contractual provisions related to industrial and technological benefits plans focus on initiatives that are medium term in nature. Contract amendments should be permitted in the face of fundamental changes in conditions and the advent of new technologies, as long as these amendments are consistent with the objectives of industrial and technological benefits plans and agreed to by both the obligor and the government.

Recommendation 14: A partnership approach to in-service support

The choice of strategies for the provision of ISS for aircraft bought by the government needs to advance the twin goals of ensuring a single point of accountability for durable aircraft performance and strengthening the Canadian aerospace industry.

There is no inherent incompatibility between these goals. The government does not have to select either the aircraft manufacturer or a Canadian ISS firm to provide maintenance and repair services. Instead, it can use its purchasing leverage to create the conditions for mutually beneficial business relationships between manufacturers and Canadian companies.

The specific details of partnership arrangements would, of course, be up to the parties themselves, but as a matter of public policy, it is important that those arrangements provide for more work by the Canadian partner than simple "metal-bending" tasks. In addition, they should ensure significant and ongoing transfer of technical data and intellectual property, which will permit the Canadian company to develop engineering and design expertise that protects Canadian security interests and facilitates the company's participation in the global market.

The government should also explore, when existing procurement contracts come up for scheduled reviews, whether ISS arrangements can be revised to deliver more data and advanced engineering and design work to Canadian ISS firms.