Monthly Archives: December 2013

The Missing M in SME

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Canadian industry data reveals a recent trend in the falling number of medium sized firms (100-499 employees) in the Canadian economy – referred to as the ‘Missing M in SME’ problem.

The Globe & Mail raised the alarm in 2012 with the article Canada’s Vanishing Mid-Sized Firms based on BDC’s report on medium sized firms.  According to the Globe & Mail Between 2007 and 2010, 527 mid-sized firms exited the economy representing a 3.6% reduction.  Canada is managing to sustain about 40 large and multinational Canadian owned businesses as reported by the Institute For Competitiveness and Prosperity based on data reported in  2009 for firms exceeding $1B. The importance of small businesses to Canada’s economy has received more attention lately as reported by Industry Canada’s small business statistics because as of 2012 small businesses represent 98.2% of all Canadian firms with medium firms making up 1.6% of firms and large making up 0.2% firms. So if the economy is composed primarily of small firms why is ‘The Missing M’ problem important?

Why Is ‘The Missing M’ Problem Important

As the Globe & Mail observed medium firms ‘are more productive, hire more Canadians, and have more clout on the international stage‘ and in 2012 ‘mid-sized businesses, which represent 12 per cent of Canada’s gross domestic product and 16 per cent of the jobs’.  Mid-sized firms grow into large firms that can compete better in the global economy.  The Institute for Competitiveness and Prosperity trend data from 1985 to 2009 does reveal that the number of large firms has increased over this time period, but only slightly, as some firms have exited.  Canada is an exporting country with about 75-80% of GDP derived from export trade so if Canada is not growing more medium sized firms the country’s growth will remain slow. Emerging economies represent tremendous opportunities for Canadian firms but if firms are not large enough to enter these markets and compete the benefits will go elsewhere.

What Is ‘The Missing M’ Problem

What is ‘The Missing M’ problem? Is it a company growth problem? Is it a national productivity or competitiveness problem? Is it the number of medium sized firms or is it the revenue contribution of the medium firms what matters?   Was this a short-term phenomena as a result of the 2008 financial crisis? Is this a result of global economic structural change? ‘The Missing M in SME’ problem needs to be clarified.

What Is Causing The Missing M Problem

What is causing the ‘The Missing M’ problem? Is this phenomena because of the shift from goods production to service delivery economy? Or is it because of the pivot to a more resource-based economy from a manufacturing-based economy? How does this problem manifest itself in different industry sectors or different regions of the country?  Is the Canadian economy comprised of more private firms whose data is more difficult to see? Does the problem reflect in other business measures such as R&D expenditure where there is a distinct ‘U-Shaped’ phenomena in Canadian industry data as reported in a previous post?

Various causes suggested, but not fully substantiated, include:

  • Lack of business leadership growth ambition particularly internationally;
  • Risk adversity;
  • Preferences for ‘Life-Style’ companies;
  • ‘Branch-Plant’ effects where foreign firms acquire mid-sized businesses to gain foot-holds;
  • Canadian M&A activity;
  • Inability to raise capital in medium revenue range;
  • Investor liquidity influences;
  • Management experience;
  • Effects of international competition;
  • Currency effects of a high Canadian Dollar;
  • Tax policy somehow disadvantaging medium sized firms;
  • Small domestic market size;

At the moment no one has fully connected the dots to reveal a clear understanding of the problem nor is there a sense of urgency to fix this problem. Canada’s future economic growth is dependent on the country solving this problem and increasing the number of medium sized firms.

How Does Canada Compare With Other Resource Economies

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Growth in emerging nations is radically altering the global economy in particular the demand for resources to support among other things an expanded middle class. The demand for resources has increased dramatically increasing the number of resource-driven economies from 58 to 81 countries. How nations effectively translate resource endowments into long term prosperity was the subject of McKinsey Global Institute study Reverse the Curse: Maximizing the potential of resource-driven economies.

The McKinsey study primarily explores the socio-economic aspects of how non-OECD countries have failed to fully reap the benefits of resource endowments and how to improve the injustices of resource exploitation by other countries or their own internal problems. The study also provides an important methodology to benchmark resource driven economies and provides a unique independent view of resource-driven economy best practice and how Canada stacks up against upper-middle income and high income countries. The data presented portray the full spectrum of national approaches to effectively translate resource endowments into long term prosperity from the best to worst. The study also does a good job of removing biased agendas using ‘Dutch Disease’ or extreme environmental arguments replacing with a more objective rationale for how to properly benefit society in low income resource-based countries from increasing resource demand. What the study does not do however is look at the broader implication of what population growth and global middle class on the capacity of the planet to support the level of demand in the long run.

Resource Economy Growth Model

McKinsey suggests that resource-driven countries (particularly low income nations) need a new growth model with six core elements:

  1. building the institutions and governance of the resources sector;
  2. developing infrastructure;
  3. ensuring robust fiscal policy and competitiveness;
  4. supporting local content;
  5. deciding how to spend resource windfall wisely; and
  6. transforming resource wealth into broader economic development.

McKinsey applied these elements to rank resource driven economies to evaluate their national effectiveness at translating resource endowments into long term prosperity. McKinsey structures these metrics in three key areas : Develop Resources (Building Institutions and Governance), Capture Resource Value (Fiscal Policy and Competitiveness), and Transform Value Into Long-Term Development (Spending the Windfall and Economic Development). McKinsey defined a resource-driven economy as one whose oil & gas and mineral sectors account for more than 20%  of exports, generate more than 20% of fiscal revenue, and resource rents are more than 10% of economic output.

Main Conclusions

McKinsey concluded that in 2011:

  • 81 countries have resource-driven countries up from 58 in 1995;
  • Those 81 countries account for 26% of global GDP up from 18% in 1995;
  • 69% of people in extreme poverty are in resource-driven countries;
  • 90% of resource investment has historically been in upper-middle-income and high-income countries;
  • Half of the world’s known mineral and oil & gas reserves are in non-OECD and non-OPEC countries;
  • $17 Trillion of cumulative investment in oil & gas and mineral resources could be needed by 2030 or more than double the historical rate of investment.
  • 540 million people in resource-driven countries could be lifted out of poverty by effective development and use of reserves;
  • Opportunities to share $2 Trillion of cumulative investment in resource infrastructure in resource-driven countries to 2030;
  • There are 50%+ improvement potential in resource-sector competitiveness through joint government and industry action.

How Does Canada Compare

How does Canada stack up on the six elements of the McKinsey resource-driven economy growth model compared to 81 resource-based economies?

  • Building Institutions and Governance: 2nd (Behind Norway)
  • Developing Infrastructure: 1st
  • Robust Fiscal Policy and Competitiveness: 1st
  • Supporting Local Content: 1st
  • Spending Resource Windfall Wisely: 3rd (Behind Norway & Australia)
  • Transforming Resource Wealth Into Broader Economic Development: 5th (Behind Norway, Qatar, Australia, Iceland)

These rankings and their underlying basis are helpful to evaluate where Canada needs to improve beyond the domestic partisan debates.   In a global context though Canada is within the top 5 resource-based economies out of the 81 resourced-based economies. When compared to high income peers the country is very fortunate compared to less stable low income countries but Canada ought to be doing better in transforming value into long-term development (spending wisely and economic development). Other leading countries will strive to improve so Canada should not be complacent and target improvements particularly in transforming value into long-term development or Canada risks falling behind in prosperity.

Improving Canada’s Performance – Transforming Value Into Long-Term Development

Looking deeper into the McKinsey metrics for transforming value into long-term development spending the resource windfall is based on quality of budgetary process, level of savings, and effectiveness of delivery while the economic development is based on the McKinsey Global Institute economic performance score. The McKinsey economic performance score is based on 21 metrics categorized under five dimensions of: productivity, inclusiveness, resilience, agility, and connectivity.

In terms of spending the resource windfall McKinsey observed that there are five ways to send the resource windfall:

  • invest the money abroad;
  • invest the money domestically;
  • allocate money to specific regional areas;
  • consume the money or resources in the domestic economy; and
  • direct transfers to citizens.

McKinsey suggested that there are six broad principles to guide effective spending of resources revenue: set expectations; ensure spending is transparent and benefits are visible; smooth government expenditure; keep government lean; shift from consumption to investment; and boost domestic capabilities to use funds well.

In terms of economic development McKinsey observed that most resource-driven economies have found it difficult to reap a permanent or longer lasting dividend from their endowments due to boom-bust cycle. Canada however was identified along with Norway, Oman, and Indonesia as examples of sustained growth post the 1970s oil price spike. Interesting though that Canada did not view itself as an Oil & Gas superpower at that time with very different economic drivers (ie. proximity to the US, strong manufacturing, and NAFTA). Today this is a very different story with a declining manufacturing sector, over-reliance on the US, and stagnant NAFTA growth. McKinsey suggest that resource-driven economies focus on five distinct groups of sectors that operate differently from one another and require different interventions:

  • Resource sector itself;
  • Manufacturing sector;
  • Resource riders (transport, construction, professional & technical services, real estate, wholesale goods, and utilities) sector;
  • Local services sector (Financial services, retail, information media and telecoms, hospitality, and administrative support); and
  • Agriculture.

McKinsey also explores the concept of benefaction in the context of economic development as a strategy that leverages an existing sector to create additional jobs and economic activity in subsequent (down-stream) stages of the value chain.  McKinsey notes that although benefaction is attractive there are potential downsides including: subsidizing economically unfeasible activities; and increased regulation that may undermine the global competitiveness of the extraction sector. McKinsey suggest that governments consider the following lessons when attempting to capture downstream value:

  • Understand the potential value of moving down-stream;
  • Understand the fit with local capabilities;
  • Establish supporting regulations;
  • Don’t just regulate but build enablers; and
  • Monitor and enforce.

Specific data how Canada performs according to these measures was not provided except in a couple case examples but it would be useful for Canada and indeed regions such as Alberta, BC, Saskatchewan, and Newfoundland to assess their current performance and set targets for improvement. In a broad sense Canada has implemented well along these various aspects of transforming value mainly because the economy was largely diversified and well developed when resource income began expanding rapidly in the 1990-2000s time frame. The five sectors all have flourished (particularly in western Canada) but Canada has not fully developed benefaction in terms of down-stream value chain activity.  Canada understands its fundamental constraints in terms of fit with local capabilities in areas such as skills mismatch and transportation but is taking steps to solve these problems. Arguably work on supporting regulations, enables, monitoring and enforcement is proceeding but interprovincial political differences/barriers remain problematic.