Volume 1: Beyond the Horizon: Canada's Interests and Future in Aerospace – November 2012
Analysis and recommendations (continued)
Accessing global supply chains and markets
Fostering innovation is critical to securing the future of Canada's aerospace industry, but turning a healthy profit depends on finding enough customers for the new, superior products that innovation allows. Because the aerospace business is global—and because the Canadian domestic market is small—access to global supply chains and markets is essential.
The Canadian industry has done well in this regard. It earns 80 per cent of its revenue from sales abroad and is respected around the world for the quality of its products and the reliability of its services. But these past successes are not a guarantee of future performance. The rise of determined new players, pressure on suppliers to consolidate and do more technology development, and a high exchange rate all mean that Canadian aerospace companies will need to redouble their efforts to maintain and expand their place in supply chains and markets abroad. Public policies and programs need to keep pace.
Description of Figure
This horizontal bar chart shows the export intensity (in percentage terms) of 21 Canadian manufacturing industries in 2010. The export intensity of aerospace products and parts manufacturing is about 80% and ranks as the highest among all industries, followed by motor vehicles and parts, with an export intensity of almost 76%. The industry with the lowest export intensity is beverage and tobacco products, at roughly 8%.
Those policies and programs cannot, of course, guarantee sales. But they can help ensure that when Canadian aerospace companies venture into the global marketplace, they compete on fair terms, get a fair hearing, and have the information necessary to strike deals. This is the logic underlying Canada's Global Commerce Strategy, which was first issued in 2009 and is currently being updated.
Canadian firms seeking business abroad already receive support to attend international air shows and exhibitions, along with market intelligence and introductions to foreign companies from trade commissioners housed in Canada's embassies and consulates. In parallel, Export Development Canada (EDC) is available to provide financing in support of sales of Canadian aircraft, systems, and components. And the Canadian Commercial Corporation can facilitate sales to foreign governments by acting as a contractor and guarantor. These organizations' services are viewed positively by the Canadian industry.
In addition, under the auspices of the Organisation for Economic Co-operation and Development (OECD), Canada and other established aerospace nations have negotiated the Aircraft Sector Understanding, which sets out parameters for financing provided by EDC and other countries' export credit agencies. Similarly, the trade rules established through the World Trade Organization (WTO) can be invoked by any member country that believes another member has unfairly subsidized its domestic aerospace industry. Support provided to four of the world's largest OEMs—Boeing, Airbus, Bombardier, and Embraer—has been challenged at one time or another through WTO processes.
Canada has also introduced an array of export and domestic controls designed to ensure that sensitive technologies do not fall into the hands of organizations or countries for which there are security concerns. These controls help meet Canada's international security obligations and reassure the United States—still the Canadian aerospace industry's largest market and partner —that aerospace technologies can be shared and jointly developed with Canadian firms at no risk to national security.
Finally, Transport Canada certifies new aircraft designs to internationally recognized safety standards, then facilitates certification in other countries, thus enabling the sale of Canadian designed aircraft abroad. Transport Canada's expertise is well-regarded internationally, and its ability to conduct its work in a timely manner while ensuring the highest safety standards is key to the export success of Canadian aerospace companies.
These services and regimes go a significant distance toward giving Canadian aerospace companies a fair shot at securing business abroad. But in light of changing conditions, more is needed.
Export Development Canada and aerospace financing
Export Development Canada (EDC), Canada's export credit agency, operates on commercial principles, providing financial services such as trade and investment insurance, working capital guarantees, and direct financing to Canadian companies and to foreign buyers of Canadian goods. EDC's mandate is consistent with the role that governments around the world play in financing the export sales of the aerospace industry, a role that reflects the scale of the financial transactions and associated risks.
EDC provides all its aerospace sales financing on terms outlined in the Aircraft Sector Understanding (ASU) negotiated under the auspices of the Organisation for Economic Co-operation and Development. The ASU aims to level the playing field on sales financing among aircraft manufacturers by ensuring that competition is based on the quality and commercial competitiveness of the aircraft, rather than on the most favourable financing terms. It sets out the lowest financing terms and conditions that governments are allowed to support through their export credit agencies. In addition to Canada, other participants in the ASU are Australia, Brazil, the European Union, Japan, South Korea, New Zealand, Norway, Switzerland, and the United States.
As part of Canada's Economic Action Plan in 2009, EDC was temporarily granted the power to lend domestically without the normal requirement for ministerial authorization. These powers enable it to support loans on ASU terms to domestic airlines for new Canadian-made aircraft.
Recommendation 7: More inclusive multilateral agreements
Multilateral arrangements like the OECD's Aircraft Sector Understanding and WTO agreements help ensure that sellers from different countries compete for business on terms that are fair and consistent, and prevent governments from dipping deeply into their coffers to give their own companies an unfair advantage. It can take years of hard bargaining to hammer out these arrangements, but as long as all parties respect them, they minimize the chances that states will constantly ratchet up their spending in response to one another's actions. For a country like Canada—with a relatively small population, a large, export-oriented aerospace industry, and a commitment to fiscal probity—this is critical.
Current international agreements that shape trade in aerospace products have demonstrated their value, but are being stressed by two factors. The first is the rise of new aerospace powers such as China and Russia that are ready to invest substantial state resources and influence in building their aerospace sectors, and are not currently parties to the Aircraft Sector Understanding. As a result, firms from Canada and other established aerospace powers may be placed at a disadvantage for reasons unrelated to the quality of their products and services, the productivity of their workforces, or their cost competitiveness.
The second stressor is the lack of clarity in WTO rules with respect to the type and scale of permissible public support for aerospace companies. This ambiguity has resulted in time-consuming, sometimes costly disputes about the correct interpretation and application of these rules.
Amending and expanding international accords are obviously not within the exclusive purview of the Government of Canada, but only governments have the ability to push forward the negotiation of international rules that prohibit trade-distorting subsidies, minimize friction, and provide all competitors with a level playing field. Canada has a lot at stake and can be an effective advocate internationally. The long-term global competitiveness of Canada's aerospace industry will be enhanced if the government can successfully work with like-minded countries to clarify the ground rules around domestic support, and persuade China, Russia, and other rising aerospace countries to adhere to rules-based regimes governing the production and export of aerospace products.
Recommendation 8: More bilateral agreements
Multilateral arrangements can be complemented by more in-depth bilateral agreements that facilitate trade in aerospace and space products, as well as collaboration between aerospace and space companies and researchers from Canada and partner countries. Whether they take the form of broad economic framework agreements or more sector-specific accords, such agreements can play an important role in expanding market opportunities for Canadian aerospace and space firms.
In cases where a fairly comprehensive trade agreement is already in place, bilateral agreements can add value by drilling down to very specific areas such as clarifying security-related export restrictions, bilaterally opening up commercial and military aerospace and space procurement opportunities, and enabling greater mobility of people with critical skills. In other cases, when there are limited framework agreements to build on, a bilateral sectoral accord can enhance the broader trade relationship while encouraging collaboration and more open markets for aerospace and space goods and services.
Bilateral agreements should not be pro forma in nature. If they are to make a real difference for companies and researchers—and avoid the fate of the many bilateral agreements and memoranda of understanding that end up being little more than high-level statements of good intentions—they must provide for practical actions that are specific in nature, properly resourced, and embedded in detailed implementation and management plans.
To ensure that they advance Canada's interests, such agreements should:
- be negotiated with input from industry, researchers, and provincial governments;
- entail genuine reciprocity with respect to the likely benefits for each country, including improved access for Canadian companies to expanding markets and supply chains; and
- provide adequate protection for intellectual property and for Canadian investments in partner countries. Some exchange of technologies is inevitable in the context of globalized production and transnational partnerships, but such an exchange should be voluntarily negotiated by companies on the basis of commercial considerations.
Canada has relatively strong sectoral relations with the United States, Europe, and Japan, but there may be scope for using bilateral agreements to energize those relations and strengthen aerospace- and space-related collaboration, trade, and investment.
Emerging countries with which Canada should consider new or stronger aerospace and space sector agreements include China, Russia, India, and Brazil. Each offers a growing market for manufacturers of aircraft and aerospace and space systems and components, along with increasing opportunity for profitable partnerships—and in each, a combination of public policies and informal practices can pose hurdles for Canadian firms seeking to make sales and build business relationships. Government-to-government agreements can help remove those hurdles.
Recommendation 9: Senior-level economic diplomacy
There is a handful of sectors in which the high price and prestige of products and the benefits of sales to national economies result in vigorous and visible efforts by national leaders and senior officials to gain advantage for their countries' companies. That relatively short list includes nuclear power plants, major military hardware, large infrastructure projects—and aerospace.
"Commercial" or "economic" diplomacy refers to activities conducted by senior leaders and officials to support international business activities by their country's firms. As noted by the Working Group on Market Access and Market Development:
"With many countries viewing aerospace as a key national and strategic industry, engaging in 'economic diplomacy' and supporting campaigns of Canadian industries is crucial to complement efforts of Canadian firms abroad and often sets the stage for business relations."
China and Germany
Brazil and China
Indonesia and the United States
Edward Sirait, General Affairs Director for Lion Air; Robert Morin, Transportation Vice President for Export-Import Bank; Dinesh Keskar, Senior Vice President of Asia-Pacific and India sales for Boeing; U.S. President Barack Obama; (seated) Rusdi Kirana, President of Lion Air; and Ray Conner, Senior Vice President of Boeing.
Presidents, prime ministers, ministers, and senior officials around the world help open doors for their nations' aerospace firms by highlighting those firms' strengths and successes. Canada, almost culturally, has been reticent to engage in aggressive "diplomacy" of this kind. While making sales is the job of businesses themselves, it is important to draw the attention of foreign governments and companies to the world-class aircraft and aerospace systems the Canadian industry has to offer. Companies indicate that other governments have taken notice of Canada's relatively passive approach and have sometimes interpreted it as a lack of enthusiasm for and commitment to Canadian products. In many countries, state-to-state engagement is a very important part of successful aerospace business transactions.
Such diplomacy can be carried out by representatives from the highest political echelons—through more junior ministers—to senior officialdom from the public service and Canadian Forces. Each effort will be reflective of the opportunity and audience, but Canada needs to adopt a more assertive approach.
Recommendation 10: A balanced approach to export and domestic controls
The access of Canadian companies to global markets and supply chains is shaped not just by international agreements, bilateral accords, and economic diplomacy, but also by the export and domestic control regimes. Such controls are designed to guard against the leakage of sensitive goods and technologies, and are necessary both to protect national security and to preserve Canada's unique trade relationship with the United States.
Export and domestic controls
Export controls are intended to ensure that sensitive goods and technologies are not available to countries or organizations that might use them in ways detrimental to the security of Canada or to global peace and stability. These goods and technologies are identified in an Export Control List agreed to by the members of various international export control regimes and are based largely on multilateral and bilateral non-proliferation agreements. Items on the Export Control List range from enriched uranium to optical sensors to missile systems.
Complementing the Export Control List is an Area Control List, which focuses on specific countries to which all exports are controlled. Currently, North Korea and Belarus are the only countries on the Area Control List.
Each country administers its export control regime in its own way. In Canada, exports of controlled items require pre-approval in the form of export permits issued by the Department of Foreign Affairs and International Trade pursuant to the Export and Import Permits Act.
In order to ensure that sensitive goods and technologies are not accessed by people within Canada who may use them to threaten the security of Canada and its allies, the Controlled Goods Regulations were established under the Defence Production Act. Administered by Public Works and Government Services Canada, these regulations serve to prevent the unlawful possession or transfer of controlled goods in Canada. Controlled goods are a subset of the goods included in the Export Control List and include items such as weapons, military equipment, and satellite Global Positioning Systems.
The evidence suggests, however, that Canada's interpretation and application of these controls may be unduly sweeping and rigid, even going further, in some instances, than is typical in Washington. This stringency complicates the ability of the aerospace and space industries to sell their products abroad. Meanwhile, companies from countries with more balanced export control regimes, including North Atlantic Treaty Organization allies, are able to make sales in China, Russia, and elsewhere—sales that might otherwise have been made by Canadian companies. The result is lost business for Canada with no material enhancement of security.
"Like most countries with military and defence exports, Canada's export controls are not intended to hamper legitimate trade. Instead, Canada's export controls try to seek a balance between the legitimate commercial interests of Canadian exporters and the national [security] interests of Canada. While attempting to strike the right balance, Canada also attempts to ensure its controls are stringent enough to enable its exporters to benefit from more relaxed U.S. export controls…. Nonetheless, the impact on Canadian industry and the Canadian economy are still very significant. Compared to many other countries, Canadian exporters of controlled goods and technology incur higher compliance costs and opportunity costs (e.g., lost sales) … Unlike most countries, Canada also has put in place domestic controls which are some of the most stringent, if not the most stringent, in the world."
Advantage Trade Controls Ltd., Aerospace Export and Domestic Controls Review, July 2012. Research report commissioned by the Aerospace Review.
The timeline for obtaining an export permit can be long and unpredictable. While partly a function of the complexity and far-reaching nature of controls, this issue also relates to the types of permits that are used and the efficiency of processes for considering and approving permit applications. Whatever its cause, the effects on Canadian aerospace and space firms seeking international sales can be significant.
A robust set of export and domestic controls must be maintained. But the current regimes need to be examined to ensure that trade in non-sensitive technologies is not unnecessarily restricted because of overly inclusive definitions or interpretations. Such a review is particularly urgent with respect to controls on dual-use technologies—those with both civilian and military applications—that are easily obtained in global markets.
Wherever feasible, use should be made of general export permits and permits that allow for sales to multiple rather than individual countries. And to improve predictability for business and avoid a loss of sales due to procedural delays, reasonable timelines should be adhered to for processing export permit applications.
In parallel with these efforts, the government should encourage the United States to continue reviewing its International Traffic in Arms Regulations and export control regimes, given that the North American aerospace and space industries are highly integrated and that American companies and experts themselves have argued that U.S. controls may overreach.
The Committee on Science, Security, and Prosperity, co-chaired by Brent Scowcroft (former National Security Advisor under presidents George H. W. Bush and Gerald Ford) and John Hennessey (President of Stanford University), has expressed concern about the stringency of American export controls. In a 2009 report, the Committee stated:
"Our export controls retard both the United States and its allies from sharing access to military technology and handicap American business from competing globally.
"…As a nation, we cannot and should not abandon well-conceived efforts to keep dangerous technology and scientific know-how out of the hands of those who would use this knowledge to create weapons of mass destruction and other, equally dangerous military systems. However, such knowledge and technology represent a very narrow and limited set of goods, technology, and know-how… A strategy of international engagement is a path to prosperity that can be coupled with a smart approach to security using an adaptive system of government regulation and incentives."
National Research Council (U.S.), Committee on Science, Security, and Prosperity, Beyond "Fortress America": National Security Controls on Science and Technology in a Globalized World, 2009, pp. 2 and 81.
Recommendation 11: Cost recovery for certifications
Conducted by Transport Canada, the National Aircraft Certification program reviews and approves more than 1,500 new and modified aerospace products manufactured or used in Canada each year. This safety certification service is well-respected both domestically and internationally. When certifications are both rigorous and timely, they improve the competitiveness of the industry while protecting the public. Should they slow down because of a mismatch between demand and capacity, however, they will create a bottleneck that weakens the industry's ability to make sales. Such a situation has not yet emerged, but there are reasons for concern as new aircraft models come into service, production levels increase, demand rises for staff qualified to carry out certifications, and fiscal restraint in the public sector continues.
Transport Canada already has the ability to collect fees for aircraft safety certification, but at the moment, only a small part of actual costs is recovered. Existing cost-recovery authorities should be built upon to increase revenue, which should be applied directly to the maintenance and expansion of certification capacity. Cost recovery should be structured in a manner that protects the real and perceived independence and integrity of the certification regime by avoiding any perception that individual companies' payments result in special attention.
As it is renewed through a new funding model, Canada's expertise in safety certification could be a bargaining chip in the context of bilateral negotiations on sectoral agreements. Technical assistance in this area would be valuable to countries seeking to rapidly build their aerospace industries, and could facilitate quicker validation of Canadian certifications by countries where Canadian companies wish to sell. However, Canada's certification proficiency is also a competitive advantage, and assistance that would help other countries catch up should only be offered on the basis of reciprocity; that is, the Canadian aerospace sector—and by extension, the Canadian economy—must gain tangible benefits from any sharing of this capacity.
Recommendation 12: Supplier development initiatives
Although most of the media attention related to Canada's aerospace industry focuses on higher-profile OEMs and tier 1 companies, Canada's aerospace industry has a large number of smaller suppliers. These companies are facing challenges as a result of the globalization of supply chains—which is eroding any advantage they once enjoyed because of proximity to Bombardier and Boeing—and pressures to assume more of the cost and risk associated with technology development. The Small Business and Supply Chain Development Working Group went so far as to call this situation a "fundamental crisis for aerospace SMEs." The viability of these suppliers depends on rapid improvements to business practices and processes.
Dealing with these challenges is, first and foremost, the responsibility of the companies themselves. But given that suppliers play an important part in the overall aerospace "ecosystem"—spawning new ideas and supplying products and personnel to larger companies in higher tiers—it is appropriate for governments to partner with industry to support the upgrading of managerial skills among small suppliers, facilitate exchanges of information between them and larger firms with respect to technological and product development priorities, and improve their ability to operate globally. A strong and balanced Canadian supply base is important to the long-term growth and vitality of the aerospace sector.
The idea of systematic aerospace supplier development programs has gained momentum in recent years. Such programs have been set up by some OEMs and tier 1 firms, as well as through the cooperative efforts of industry and governments in aerospace clusters in countries such as the United Kingdom, France, and Brazil.
In Canada, aerospace supplier development initiatives exist or are being established in Quebec, Manitoba, and Ontario. The most advanced is the MACH initiative, a public-private partnership developed by Aéro Montréal that will spend $15 million over five years to help 70 suppliers better appreciate the needs and expectations of OEMs and tier 1 integrators, and build the internal capacity to operate at that level.Note 7
Launched by Aéro Montréal, the MACH initiative is a change program for accelerating the aerospace supply chain's competitiveness and performance through three main strategic goals:
- to create an improved business culture for more openness, collaboration and innovation;
- to improve supply chain competitiveness, one company at a time; and
- to develop new local integration capabilities.
The initiative also aims to develop strategies and projects that will help fill the gaps in integration capabilities in Quebec and to foster the development of a world-class supply chain.
With a budget of $15 million over five years, the MACH initiative targets 70 suppliers that will join the program in five annual cohorts. It enables participants to enhance their capabilities across key business processes and areas through a variety of tools and training.
Small and medium-sized enterprises (SMEs) participating in the program are supported in their activities by a larger equipment manufacturer that acts as sponsor or mentor for the SME. MACH helps suppliers assess their performance, identify gaps, and determine the actions necessary to improve.
The MACH initiative started operations in July 2011 with a group of 20 suppliers supported by nine sponsors. The second cohort entered in September 2012 with 10 additional suppliers and eight new sponsors.
Source: Aéro Montréal.
To foster supplier development across the Canadian aerospace industry, the government should co-fund either an extension of the MACH initiative across the country—as proposed in the Final Report of the Supply Chain Working Group—or more regionally based programs. The choice between these options should be based on consultations with provincial governments and industry, both of which should make their own contributions to program costs. Any supplier development initiative receiving public funding should:
- help suppliers understand and respond to the needs of OEMs and tier 1 firms;
- provide suppliers with information on global supply chains and with international business readiness training;
- be structured in a way that does not discourage consolidation among smaller suppliers where that is the natural tendency in the marketplace; and
- include rigorous measures to assess participating suppliers' performance and progress.