SR&ED and the law of unintended consequences

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By Francis Moran

Canada’s Scientific Research and Experimental Development tax credit program is undoubtedly one of the most popular industrial incentive schemes around. Shortened to SR&ED and usually referred to as “Shred,” the program provides a 35 percent investment tax credit, topping out at just over $1-million a year, to private Canadian companies that carry out eligible R&D activities in Canada. Many other Canadian entities, including public corporations, can tap SR&ED for a 20 percent tax credit, soon to be reduced to 15 percent, and several provinces add even more with their own programs.

It’s the Canadian government’s single largest support program for industrial R&D. It costs the federal coffers about $3.5-billion annually, and provinces that piggyback on SR&ED kick in another $1.5-billion. To say that it is immensely popular would be an understatement. I don’t know a single technology startup CEO who isn’t annually seized with his or her SR&ED application and the implications it will have for cashflow, and for many of them, it means the difference between profit and loss most years. A lot of foreign companies establish development shops here in Canada singularly because of this generous incentive program. An entire ecosystem of lawyers, accountants and consultants has developed around the program, all focused — with greater or lesser degrees of competence, transparency and integrity — on maximising their clients’ so-called “shreddable” activities.

“Innovation Canada: A Call to Action,” last year’s landmark report by Open Text chairman Tom Jenkins on how Canada can get a better return for its massive investment in industrial innovation, left SR&ED relatively untouched, arguing only that it be made even easier for small companies to apply. In response, the federal government was even less adventurous in its latest budget, doing little more than reducing the tax credit rate for larger companies and fiddling with some of the eligibility requirements.

Now, I am a huge fan of SR&ED but like almost any beneficial initiative, it is not immune to the law of unintended consequences. There are two in particular that have dire implications for marketing.

The first is a more general consequence. With its emphasis on the product-development end of the go-to-market process, an emphasis shared by almost every other industrial incentive program in Canada including the federal Industrial Research Assistance Program and Ontario’s Interactive Digital Media Tax Credit, SR&ED can’t help but encourage Canadian companies to be product-focused rather than market- or customer-focused. Engineers already have a bias towards making stuff rather than marketing it. While these programs are all pretty good at getting innovation off the lab bench and into commercialization readiness, they do nothing at all to help get those products out the door and down the street into the hands of actual paying customers.

The second consequence is less general, but it is the inevitable end point of the same product-development bias. It’s not manifested at every company that benefits from SR&ED, but it is an incredibly entrenched reality at many companies I see, especially those that are, perhaps, a bit longer in the tooth.

The temptation is very real at almost every company to design a new product in response to a single customer’s description of what they’d really like to see. When the R&D department can, thanks to its SR&ED subsidy, build that product with 65-cent dollars, there is far less incentive to ask the tough questions about how many other customers might want this new product or refinement. The result is that one customer gets a subsidized new widget, and marketing gets yet another product for which there has been no rational business case made but that it is expected to go out and flog.

Over time, this creates a massively distorted picture of which departments within the company are performing the best, a picture that tragically reinforces the prejudice against investing in marketing in the first place. R&D, which may not even have covered its entire costs from that single customer, still looks like a profit center because of its heavy SR&ED subsidy. Even worse, CEOs can do the simple arithmetic of subtracting the annual SR&ED cheque from revenues and watch their lovely black numbers turn horribly red, a contemplation that tells them they cannot afford to cut back on R&D activities. Meanwhile marketing, which has been stuck with a succession of products that only one customer in the world ever wanted, ain’t showing such great returns. Any rational CEO or CFO is going to continue to sign off on R&D’s budgets while sharply questioning marketing’s, creating the most vicious of circles.

What can marketing do about this? Strategic marketers must arms themselves with a far greater ability to conduct critical financial analysis. They have to be able to show, using the same spreadsheets and financial data relied on by their CEO and CFO, that R&D is not a profit center without its SR&ED crutch, if that is indeed the case. Even more critically, they need to be able to demonstrate that the marketing of a strategically conceived product — one that enjoyed a proper customer needs analysis and business case before it went into development — was successful in ROI terms. If they can compare the success of such products with the dreary track record of the one-offs, they will be well on their way to changing the picture. The final step will be to show how the most profitable of outcomes can be achieved when effective, market-driven product strategies are married to an R&D process that applies generous-but-still-not-unlimited government incentives only to the most promising projects.

Image: The Self Employed

/// COMMENTS

7 Comments »
  • Coffee with Julie

    December 06, 2012 3:44 pm

    Amen! Amen! Amen!

  • Francis Moran

    December 06, 2012 3:50 pm

    Sounds like you may have witnessed this first-hand, Julie?

  • Coffee with Julie

    December 06, 2012 7:11 pm

    Nah … what gives you that idea? ;)

  • Andrew Penny@kingsford

    December 06, 2012 7:26 pm

    As market consultants we whole heartedly agree. Your point on bringing a bit more science to marketing is a great message in face of the highly quantifiable engineering and financial elements on the other side of the table.

  • Francis Moran

    December 06, 2012 8:06 pm

    Great to hear from you, Andrew. Marketers definitely need to better arm themselves with boardroom weapons if they’re to properly represent their function’s best interests.

  • Andrew Arnott

    December 07, 2012 5:09 pm

    This is great insight and solid thinking Francis. I for one echo your sentiment.

    For innovation to lead to the creation of sustainable companies and employment in a knowledge based economy, surely SR&ED eligibility criteria should be enhanced to cover the marketing of a strategically conceived product, and not be solely based on the research and development of the product.

  • Julie Harrison

    April 06, 2013 7:20 pm

    Amen! The “unintended consequences,” as you note, of SR&ED are so clearly laid out here in your post, but rarely so (in my limited experience, at least) in day-to-day business.

    I agree with you that marketers need to “own” this and prepare to arm themselves with a better ability in financial analysis. But I think it also needs to be noted that Marketing is sometimes (often or mostly?) silo’d off from R&D and has no access to the financial data required to do the analysis in the first place.

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