Is Canada Losing the Internet War?

Those who doubted the power of the Internet — and there were many not all that long ago — are probably still rubbing their eyes in disbelief. Just look at the numbers: by 2003, International Data Corp. estimates that the amount of commerce conducted over the World Wide Web will reach US$1 trillion. Intel, meanwhile, predicts that Internet users will hit the one billion mark by around the same time.

But beyond all the hype and great expectations, one question looms larger than all the others: which nations will be the winners and the losers in the global electronic economy?

Prominent Canadian IT executive Peter Watkins, the former CIO for the Canadian Imperial Bank of Commerce, has strong views when it comes to that question. And he raises some real concerns as to which side Canada will end up on.

In his paper, The Digital Economy and the Wealth of Nations, Watkins calls into question many of the assumptions regarding the digital economy. For example, he maintains that the widely held belief that the Internet makes for a level playing field for companies both big and small is a mistaken one. “Rather than a proliferation of competitive companies in the Internet world, we are witnessing massive consolidation around a few players,” he says. “These successful few are spending more and more money to create sophisticated service offerings to users so they will be able to lock out their competitors.”

America Online, for example, has achieved market preeminence, but not before investing a half-billion dollars — per year — into its sales and marketing initiatives. And two of the best travel sites — Travelocity and Expedia — are backed by the very deep pockets of American Airlines and Microsoft respectively. “You are dreaming if you think you can get into the online travel business for less than $10 or $20 million,” says Watkins.

Touted as one of the world’s top 200 Internet lawyers, Duncan Card of Toronto law firm Davies, Ward & Beck points out another hurdle for Canadian e-businesses. “Because we are the U.S.’s largest trading partner and because of our geographic proximity, Internet fulfilment programs are much easier for U.S. businesses, relatively speaking. That means Canadian retailers are going to be vulnerable to the lead that the U.S. has in business-to-consumer E-commerce.”

But there may be an up-side to this powerful American presence, Card believes. “Maybe the U.S. competition is a good thing, because the proximity might wake us up and help us think not in parochial terms but in global terms as retailers,” he notes. “This technology enables us to create world markets immediately, so not only is it a threat but also an opportunity for Canadian businesses to start to think globally.”


In October 1998, the 29 member countries of the Organization for Economic Development (OECD) assembled in Ottawa to create a framework for a so-called “borderless” world, a response to the global shift from the Industrial Age to the Information Economy.

The OECD ministers and their delegates believed that by working together to create a level playing field for electronic commerce, they would improve their individual national wealth and ensure the future success of their citizens. In conjunction with opening their markets, they are now actively working to rapidly connect their citizens to the Internet.

The Government of Canada stands solidly behind this approach, as is evidenced by the following passage from October’s Speech from the Throne: “For Canada to generate jobs, growth and wealth, it must have a leading, knowledge-based economy that creates new ideas and puts them to work for Canadians. To do this, it is essential to connect Canadians to each other, to schools and libraries, to governments, and to the market place — so they can build on each other’s ideas and share information.”

On the surface, this idea seems measured and reasonable. But there is one major flaw in it, Watkins argues: in the absence of Canadian brands, the faster Canadians are able to connect to the Internet, the faster they will be purchasing goods and services from U.S.-based and other foreign suppliers. That supposition is supported by a recent study for the Retail Council of Canada, conducted by IBM Canada, which found that more than 60 per cent of money spent by Canadian consumers on the Internet goes to U.S.-based Web sites, while only about 26 per cent of prominent Canadian retailers are offering online shopping, compared to 50 per cent of prominent American retailers.

Perhaps even more ominous, Boston Consulting Group (BCG) says Canadian retailers are losing ground to American competitors on the Web. The consulting firm contends that the gap will widen unless Canadian retailers become more aggressive in their E-commerce efforts. The firm says Canada’s share of North American online sales revenues is steadily declining, from 4.3 per cent in 1997 to 3.1 per cent in 1998 to an expected 2.1 per cent in 1999.

The biggest threat to Canada and the other OECD nations clearly lies with the U.S., which is currently the big winner in the growing E-commerce world, with no signs of slowing down. Incredibly, it is predicted that within the next three years, the goods and services produced in the U.S.’s electronic economy will account for a larger percentage of gross domestic product than the goods and services produced by its industrial economy.


When Canadian citizens go online to purchase goods and services via the Internet, they are likely to go to such popular sites as L.L. Bean, CDNow, Auto-by-Tel, Expedia, Carpoint, and Home Advisor, among others. While the goods and services offered by these companies are diverse, these sites share at least one thing in common: they are all U.S.-based.

The reason for the American predominance is due to the fact that few Canadian web sites have the brand, scale and service that can compete for substantial brand recognition with the U.S. providers. Studies by IDC Canada and Ernst & Young show that Canadian companies are slow to launch e-commerce businesses, leaving Canadians with few alternatives.

Trust may be another factor in the American predominance. According to James McQuivey, senior analyst with Forrester Research, at first there were only a handful of what consumers considered trustworthy sites in the U.S. But towards the end of 1998 several prominent retailers put up shopping sites on the Internet. “In Canada, that wave hasn’t hit yet,” says McQuivey. “We don’t see this huge push from the retailer side to make a commitment to this media.”

Nor can many Canadian sites match the deep discounts offered by the established players. Even with goods and services taxes added, it can be cheaper for a Canadian to purchase a book from than from local suppliers. That’s why it shouldn’t come as a surprise that even without any focus or marketing on the Canadian front, has already emerged as the third largest book retailer for Canadian consumers.


The overwhelming strength and momentum of U.S.-based E-commerce will make it extremely difficult for new entrants from other countries to compete. “Without correspondent improvement in the incentives and encouragement to local businesses to create globally competitive electronic commerce businesses,” Watkins warns, “the policies of the OECD member nations may be imperiling their future.”

Indeed, those nations may already have compromised their future. In November 1998, President Clinton and Vice President Gore unrolled their blueprints for a new economic age. Not surprisingly, their vision is for the U.S. to lead the world into the Information Age by creating a framework of globally accepted policies of free trade and incentives for competition. Any meaningful national countermeasures against the U.S. E-commerce juggernaut were effectively quashed when the U.S. and 132 other countries (including Canada) comprising the World Trade Organization signed a declaration to refrain from imposing custom duties on E-commerce.

By agreeing to this so-called level-playing field approach, the OECD member countries have, in effect, adopted U.S. trade policy in electronic commerce.

When OECD member countries start to frame legislation for a borderless world, they do so from the perspective of decades of experience in what policies and rules applied in an industrial economic model. However, success in the Information Economy is based not on the old industrial model of diminishing returns, but on the model of increasing returns to scale. Using this model, companies such as Sun Microsystems and Netscape have given core products away for free to achieve dominant market position.

Ironically, as Canada and other OECD member countries work quickly to connect their citizens to the Internet, they enable global “network effects” (the principle that the value of the network goes up exponentially with the number of people connected) to continue within their local economies. All of which can be ultimately self-defeating. These network effects exponentially increase the value of global established providers and make it correspondingly more difficult for local E-commerce providers to achieve the competitive scale of the established suppliers.


Peter Ferguson, deputy director general for Industry Canada, downplays the American advantage over Canada when it comes to the global digital economy. “As we understand it, smaller businesses in the U.S. aren’t any further ahead than Canadian (smaller businesses),” he says. “But the really good news is that the public response I’ve heard (from Canadians purchasing goods from U.S. sites) is, ‘we’d like to have a Canadian portal and Canadian opportunities.’ And I think that’s coming about, slowly.”

While Ferguson admits there are no simple answers in making Canada a world-class player in the digital economy, he says much of the solution “has a lot to do with raising awareness about the opportunities.” Indeed, Ferguson notes that Industry Canada and a handful of private-sector companies are currently working with the Boston Consulting Group to develop strategies and examine economic opportunities that Canadian companies can embrace in terms of going on the Internet.

Joe Greene, director of telecom and Internet research at Toronto-based IDC Canada, agrees that potential opportunities abound for domestic players. Greene notes that according to a recent study, 70 per cent of Canadian adult Internet users said they would prefer to shop at Canadian web sites due to factors ranging from patriotism to the unfavorable U.S. dollar exchange to customs hassles. But he added, “The sites are just not there. Canadian retailers have been somewhat slow to embrace the technology.”

But Greene believes the gap is only a temporary one. “I don’t know why everybody is surprised by the fact that Canada is a year and half to two years behind the States in the adoption of Internet E-business — Canada is about two years behind the U.S. in adopting anything that has to do with IT,” he says. “Americans are much more gung-ho and tend to develop and adopt technologies quicker than we do. But we do catch up.”

But in the case of major Internet sectors, catching up may be a monumental task.

“The entry-cost barriers are becoming large for each of the major Internet sector businesses,” says Watkins. “Companies and nations that have not already created a successful Internet-based business model will have difficulty competing in markets where Internet industry leaders are established. These leaders are determined to achieve lockout of companies and nations through increasing returns and network value relationships. In many cases, the level playing field model of the OECD member countries will make it exceedingly difficult for companies in those countries to reach sufficient scale fast enough to compete with the global leaders.”


Watkins believes that too many people haven’t fully understood the impact of some of these different strategic principles on national policies. Nor is there a prevailing awareness that in the digital economy, companies can locate anywhere.

“Some countries around the world have looked at this issue and said, ‘We need to create a competitive regulatory environment for the digital economy because it is different.’ If we just harmonize with other countries, how do we create a competitive advantage in a digital world versus the U.S. or other countries? Those nations that are choosing to create a competitive advantage around the regulation are having some success and probably more success than Canada is now.”

What should the federal government do to address the situation? Rather than have a Canada-wide point of view, Watkins believes we should pick some focal points — a region where we would try to create a “Silicon Valley North”, a community that would create a virtuous cycle of people, companies and so forth. “We have a number of advantages in terms of cost versus the U.S.,” says Watkins. “Salaries for professionals tend to be lower and we have the Canadian dollar advantage, as well as a highly educated and stable community. So in many ways Canada has a tremendous advantage and opportunity.”

For Canada to compete effectively, Watkins suggests a two-pronged strategy, based on the idea that nations must adopt strategic imperatives that are similar to those of the most successful companies in the digital economy:

1. Nations must establish policies that allow them to benefit on a massive scale from increasing returns and network effects for citizens and companies located in their countries. The types of activities that would create massive scale are highly incented tax legislation, digital signature legislation and regulatory environments that create significant incentives to locate businesses for electronic commerce in those nation states. Real estate in the digital economy for a number of industries is still relatively cheap. The key to success is to “get big fast”. Government policies need to support “get big fast” models irrespective of whether short-term profits and country revenues can be realized. It is a business model that the market has already accepted.

2. The pricing of global communications industry services will in a few years allow information to flow at very little cost. In the near future, a company can be based anywhere and deliver services globally essentially for free. Thus, what can a nation do to better its chances of being selected as a prime location for electronic commerce businesses? Highly educated and skilled knowledge workers, communications infrastructure, and low costs are key factors in facilitating businesses to locate in a country for electronic commerce purposes. Malaysia policies around the Multi Media Super Corridor and Singapore’s One Network for Everyone provide leading examples of how to incent business to locate in these countries as a base for providing E-commerce solutions.

Davies, Ward & Beck’s Duncan Card expands on these suggestions: “There are a lot of public policy things that government can do right now that would be beneficial: looking at tax incentives for knowledge-based workers, looking at tax incentives for investment to build a capital market, looking at immigration policy to create categories of knowledge-based foreign workers that would be much easier to entice to Canada. And, probably, federal and provincial governments working with academic institutions to make sure that they’re funded much better than they are for the new economy.”

But he cautions that Canadian businesses can’t wait for government support. “This is a time to market issue. Executive management from the very top down have to understand that we’re in a world economic revolution — that this isn’t about the Internet, it’s about an entirely new economy.”

In the final analysis, determining success will all come down to the speed at which nations move to create the right environment for electronic commerce and the motivation for local businesses to create global E-commerce solutions. “While each OECD member country may believe it can move at the required speed to create a leadership position in the digital economy, we know that very few countries will be winners,” says Watkins. “The OECD countries that thrive and prosper will be those that recognize a level playing field is not enough.”

His outlook for Canada? As we have the right ingredients for success, he firmly believes that with the right sense of urgency, intelligent aggressive policies, and a partnership between business leaders and government, we can emerge as a leader in the global digital economy.

David Menzies is a freelance writer based in Toronto. David Carey is a veteran journalist specializing in information technology and IT management. He is managing editor of CIO Canada.

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