Nothing to Lose But Our Value Chains: Innovation Can’t Thrive in Captive Markets

By Laurent Carbonneau
CCI Director of Policy and Research

We talk a lot here at Mooseworks about the big ways that the economy has changed in the 21st century and how governance needs to catch up:

• The importance of innovation,
• The central role of firms,
• The need to create and defend intangible assets as the cornerstones of prosperity.

All of that is still very true. But many of the certainties that underpin our relationship with our American neighbours have melted into air. And that means that we need to start thinking about a lot more than just tariffs and trade agreements.

One area ripe for fresh thinking is the role of Canadian firms in American-led value chains.

Global value chains, if you’re not familiar with the concept, are the networks of companies and activities that take goods all the way from raw materials to production, and then finally to sales, making them more valuable at each step. The ‘global’ part reflects that value chains are rarely contained to one country.

One really important thing to understand about value chains is that they tend to be dominated by lead firms, who control the highest-value pieces of the chain. Those are usually either downstream roles like marketing and sales or some upstream ones like R&D around foundational IP. These lead firms then work with suppliers to offload the costs of low-value pieces.

So what does this have to do with Canada and our relationship with the United States?

There are lots of American-led value chains in innovation-heavy, complex industries. And American companies have been very effective at keeping Canadian firms in lower-value niches.

Semiconductors are a good example. During the Biden administration, our government put some effort into trying to get Canada included in a strategy of American investment in the northeast corridor. But for Canada, that focused primarily on packaging, assembly, and testing, which is traditionally the lower-value part of the semiconductor value chain. (There are some exceptions to this, but the point holds for most of the industry.)

The auto sector is another, and this example really illustrates how value chain lead-supplier relationships matter a lot. Cars and auto parts are a big part of central Canada’s economy. The fact that most parts cross the border several times before ending up in a finished car is a very salient fact in light of tariff threats.

But what does the Canadian auto industry really look like if you zoom in?

Ford, GM and the Entity Formerly Known as Chrysler (now Stellantis) are the Big Three American automakers. (Stellantis is now based in the Netherlands but the company’s relationships with suppliers are based on American lines, as we’ll see). Japanese automakers Honda, Toyota and Nissan also have presences in Canada. Canadian autoparts giants like Magna and Linamar are our homegrown players who operate in the supply chain of the big integrated manufacturers.

There are different models for how lead firms interact with suppliers. If you, as the lead firm, can send over a clear spec and a lot of potential suppliers can produce it without too much trouble, you’re looking at a simple market relationship. There’s no need for close collaboration or integration. You can switch suppliers very easily. With more complex products that might require some back-and-forth and exchange of proprietary information, you’re looking at a modular relationship. Switching is still possible, just a bit harder.

Where it gets a lot more complex is a situation where it isn’t simple to codify your needs. For those kinds of supply chains, you need closer collaboration and integration. And how you do that matters. If you have highly capable suppliers, you end up in a relational or symbiotic model. But if your suppliers are less sophisticated, you end up with a captive model where the suppliers are dependent on the lead firm.

Auto parts are very complex products that have proven hard to codify since cars have so many interlocking systems – it is hard to change a part in isolation and the industry demands constant novelty. (And of course, EVs are changing the industry in big fundamental ways at the same time, with value shifting from engines to batteries.)

American carmakers, in contrast with Japanese peers, have resisted the shift to relational models and try to force a low-margin market model on their suppliers to extract as much  value for themselves as possible. Even where expertise in designing parts has moved to suppliers, design and engineering involves information going back and forth as parts manufacturers essentially work to design new parts on spec. They then have to bid on a contract to manufacture the part they spent time and money designing.

This is actually very valuable work – but the costs are being internalized to a Canadian company and the benefits neatly extracted to an American one. You could characterize this as an ambiguously vampiric relationship where the big American carmakers skim off the cream of Canadian innovation and productivity.

These supply relationships are surprisingly easy to quantify, with a Working Relations Index published annually that gives insight into how suppliers see their relationships with carmakers.

As you can see quite clearly, the two biggest Japanese manufacturers have enjoyed consistently good relationships with their suppliers, who see them as trustworthy and their relationships as mutually profitable. GM, to their credit, has recovered over the last decade. Japanese Nissan is similarly on the road to recovery, while Ford’s relationship with suppliers has worsened in the last 5 years. Stellantis has seen a deep decline over the last decade.

It made a lot of sense, from the years of the Auto Pact onwards, for the deepest integration to be with American companies for reasons of economic geography and economic gravity. But that’s why policymakers have to be aware of these dynamics and deliberate about how they work to influence theCanadian economy.

We want to steer our companies away from bad relationships that lock them in to subordinate roles. The winner-take-most dynamics of the innovation economy, where IP, data and other intangibles determine who gets a spot at the very exclusive winners’ table, make this even more important 

As we talk about diversifying markets and products and building up Canadian companies that can conquer the world, we have to be very aware that unless we’re talking about wholly new industries, we are going to be stepping into value chains. And that means we have to pick our partners wisely, and encourage relationships that allow Canadian companies to grow versus being compelled to internalize the costs of foreign companies and kept locked away from the real action.

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Laurent Carbonneau is CCI's Director of Policy and Research. He can be reached at lcarbonneau@canadianinnovators.org. Mooseworks is the Council of Canadian Innovators' innovation policy newsletter. To get posts like this delivered to your inbox, sign up for CCI's newsletter here .