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The State of Entrepreneurship in Canada

4. An Overview of Canada's Entrepreneurial Performance

Entrepreneurial activity can occur in organizations of any size. Unfortunately, we simply do not have data on the entrepreneurial activity that takes place in large organizations, so we can't address such basic questions as "how many entrepreneurial businesses are there in Canada?" What we can do, however, is examine indicators of entrepreneurial activity in new and growing firms. Encouragingly, the most recent available evidence on new and growing firms in Canada suggests that a great deal of productive entrepreneurial activity is happening here. Table 3 summarizes Canada's performance on the five performance indicators described in the previous section. Where there are available data, the table shows how the performance of Canadian businesses has changed over time, from 2001 to 2006.

4.1 Birth and Death Rates

Having a healthy rate of creation of new businesses with employees is one sign that there are people within a country with the motivation, capabilities and resources to start new firms that have the potential to contribute to the economy. These new firms form the pool of businesses in which entrepreneurial activity can take place. At the same time, it is to be expected that competitive dynamics and other factors will lead to the demise of some established businesses. Entrepreneurship is healthy in economies where the number of new businesses exceeds those passing out of existence within a given time period. The first row of Table 3 presents the birth rate of new firms in Canada. The birth rate as a percentage of total employer enterprises improved from 9 percent in 2001 to approximately 12 percent in 2006. Within that period, the rate did diminish slightly in 2003, but has otherwise remained steady or improved slightly. During this same period the death rate held relatively constant, varying between 8 percent and 9 percent from 2002 to 2005. These numbers convey good news, in that the pool of potential entrepreneurial firms has been growing.

4.2 Survival Rates

Survival rates tell us what types of businesses are being established in a country. High survival rates suggest that businesses are productive, innovative and resourceful enough to have staying power in the face of changing market conditions. Fortunately, this is the case for Canadian businesses. The data on survival rates show that more than half of Canada's new firms survive at least five years, and that the rate of attrition drops each year.

Specifically, between the early 2000's and 2006, there was a slight decrease in the percentage of Canadian businesses with employees that survived over the one-year, two-year, three-year and four-year time frames. For example, 87 percent of businesses with employees founded in 2001 survived until 2002, whereas 85 percent of those founded in 2005 survived until 2006. This decrease appears slight and variable. More significant is that, for the years for which data are available, the rate of decline diminishes. Looking at firms founded in 2001 for example, shows that approximately 13 percent failed in the first year, another 13 percent failed in the second year, 9 percent failed in the third year, 7 percent in the fourth, and an additional 7 percent in the fifth year, leaving 51 percent of those firms founded in 2001 still functioning in 2006.

It's worth noting that a failure rate in the 50 percent range after five years is to be expected. Young organizations face many vulnerabilities and liabilities. They may lack sufficient financing, business networks and skilled employees in their early days. They may still be having problems ensuring consistent production quality. It takes time to develop a reputation in the market and a stable set of customers and suppliers.^{Footnote 10} The fact that as many as 50 percent of firms survive to the five-year mark suggests that Canadians are establishing businesses that are able to attain a competitive advantage in their markets.

4.3 High-Growth Firms and Gazelles

Perhaps the most important indicator of the entrepreneurial activity associated with Canadian firms is how many of them are high-growth firms or "gazelles." By definition, high-growth and gazelle firms consistently outperform other businesses in the economy in terms of growth in sales and/or growth in employment. Gazelles are the subset of high-growth firms that are very young (they are less than five years old at the end of the observation period). Generally, we consider rapidly growing firms to be truly entrepreneurial because there is something significantly novel about their products, their processes, or their markets that allows them to expand rapidly.^{Footnote 11} In other words, high-growth rates reflect innovativeness, a cornerstone of entrepreneurship. Further, high-growth firms are economically important to the Canadian economy because they contribute disproportionately to job creation.^{Footnote 12}

As Table 3 shows, about 4 percent of Canadian firms^{Footnote 13} classify high growth in terms of employment and nearly double that number qualify as high growth in terms of sales, in the years for which data are available. Further, about 0.5 percent of Canadian firms classify as gazelles in terms of employment, and over 1 percent qualified as gazelles in terms of sales. While the percentages of high-growth and gazelle firms are not large, the fact that there are a number of established and young businesses operating at this growth level is a good sign.

4.4 Research and Development Expenditures

In order to understand entrepreneurship, it is essential to understand innovation. As the renowned management scholar Peter Drucker stated, "Innovation is the specific instrument of entrepreneurship. It is the act that endows resources with a new capacity to create wealth."^{Footnote 14} In other words, it is innovation that results in the creation of something new, the essence of entrepreneurship.

A traditional measure of innovation is the extent to which firms are investing in research and development (R&D). Firms that spend 20 percent or more of their total expenditures on R&D can be considered to be innovative. In 2007, about 5 percent of SMEs in Canada were doing so. Of these firms, 10 percent were wholesalers or retailers, 14 percent were professional services firms and 24 percent operated in knowledge-based industries.^{Footnote 15} Further, a recent report concludes that the more established Canadian businesses do not score highly on innovation in terms of their R&D expenditures: "Canada is having difficulty keeping pace with the best innovators ... Canada remains in the middle of the Organisation for Economic Co-operation and Development (OECD) pack of 30 countries and sixth in the G-7 in business R&D as a proportion of Gross Domestic Product (GDP)."^{Footnote 16}

It is difficult to know how to interpret these findings, because R&D expenditures are not a perfect measure of innovation. Innovations are outputs — products, services or processes that are novel to a sector, a nation, or even to the world.^{Footnote 17} R&D expenditures are clearly inputs to the innovation process, and it may not be the case that expenditures are always linearly and directly related to innovative outcomes. High-growth rates and the presence of gazelles suggest the presence of innovative outcomes, but do not measure them directly. At the present time, we simply lack reliable measures of actual innovation at the firm level, and should neither over- nor under-estimate the innovativeness of Canada's businesses.

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