Innovation and Trade Can Boost Small Business Productivity and Profitability in Canada

As Small Business Week 2024 nears its close, it seemed a good occasion to highlight the importance of small enterprises in the Canadian economy as well as the opportunities and challenges they face innovating, exporting and growing.

At last count, small businesses—defined as enterprises with less than 100 employees—made up nearly 98% of Canadian companies. The highest prevalence of small businesses is in real estate and leasing; other services; agriculture; construction; professional services; transportation and warehousing; hospitality; and retail and wholesale trade. But as we’ve highlighted in the past, these sectors were among the most likely to be struggling External link. at the end of the COVID-19 pandemic and the least likely to expect to repay their Canada Emergency Business Account (CEBA) loans External link.. They’re also the sectors that tend to have the lowest labour productivity (graph 1).

Low productivity among Canadian small businesses is a long-standing issue. They are not only less productive than larger enterprises in Canada, but also their American peers of similar size in the same industries. According to McKinsey External link., SMEs are about half as productive as large companies. Structural issues that are often highlighted as contributing factors are a lack of access to financing for growth and investment, as well as the added cost of greater distances between producers, their customers and their suppliers. But it’s more than that. Our research External link. found that Canadian small and medium-sized enterprises (SMEs) are slow to integrate new innovations into their business processes, citing insufficient time, training and resources.

In the past, small businesses have seen high productivity growth when new technologies became cheaper, more widely available, and more easily used and integrated into existing business processes. Think back to the widespread adoption of information and communications technology (ICT) in the mid-to late-1990s. The pandemic later accelerated the adoption of digital technologies, as small businesses rapidly shifted their activities online. Much of this happened organically, without the need for politicians and public servants to intervene. Indeed, where innovation policy has been deployed, the impact has tended to be marginal at best (for example, the Canada Digital Adoption Program and the once-lauded superclusters). Some other programs have even been accused of providing a disincentive for companies to scale up, such as the Scientific Research and Experimental Development (SR&ED) tax incentives (CD Howe, 2024 External link.).

What’s more, Canadian small businesses have been slow to adopt the latest generation of new technological innovations, such as artificial intelligence External link.. This is unfortunate, as more innovative and productive companies also tend to be more profitable. And given the prevalence of small businesses among total enterprises, their lower productivity holds back productivity for the whole economy.

International trade engagement is also an important driver of small business productivity and profitability. Companies that trade tend to be more competitive, operationally efficient and prone to adopt new technologies. And with the share of Canadian small businesses that export lagging their peers in the Organisation for Economic Co-operation and Development (OECD), there is a lot of room to grow (graph 2).

From uncertainty over foreign regulations to limited access to export financing and the increasing volatility of cross-border commerce, the barriers and risks to international trade can be daunting. Indeed, the upcoming US presidential election and what it means for Canadian trade External link. is front of mind for many SMEs. But our recent research External link. shows that there are ways to mitigate the risks. These include diversifying export markets (something that immigrant-run businesses are known for); expanding into new provincial markets; diversifying suppliers; increasing supply chain resiliency; accelerating digitization and modernization; and leveraging existing export promotion programs. None of these approaches to mitigating trade risks are mutually exclusive. All are instead mutually reinforcing.

Together, greater trade engagement and adoption of new innovations can help small businesses improve their productivity and boost their profitability in the process. The risks are real, but there are ways of mitigating them. Sitting on the sidelines means missed opportunities, which leaves individual businesses and the Canadian economy worse off.