Why Doesn’t an “Elon Musk” Save the DOD From Itself?
Next-gen defense procurement in the United States has been failing for decades. Why doesn’t a commercial innovator shake things up?
From the desk of James D. Blythe —
It’s been clear for many years now that the Department of Defense (DOD) in the United States has struggled to successfully realize truly new capabilities and weapon systems within its Armed Services. While, the DOD has been adept at iterating on existing systems and adapting to the conflict of the day, it has struggled to define the nature of future battlefields and what capabilities must be proactively invested to meet those challenges.
There’s a word for this forward-looking procurement ethos in the defense world — modernization. It’s an understandably complex and challenging process to divine what is needed to dominate the battlefields of tomorrow. Various DOD agencies have attempted to crack that nut many times in many different ways.
Future Combat Systems (FCS) was modernization for the Army for over a decade. Eventually the program was cancelled and is largely considered a failure today. The Navy has struggled to successfully realize an effective rail gun technology and a range of surface ship programs. Even the Air Force — often considered the leading edge of American weapon system development — has not been immune to procurement kerfuffles. A range of stealth fighter concepts, most notably the F-35, have come out with significant black-eyes in recent years.
This isn’t to say that it’s been all bad. The MRAP family of vehicles was considered a qualified success in most circles. Similar successes were also seen in the development and adoption of unmanned aerial drones and advanced telecommunications technologies leading up to, and during, the Global War on Terror. Despite this, the list of roadblocks and dead-ends is long (and very public) while the list of obvious successes is short.
As a result, the American people are understandably skeptical about the DOD’s ability to get business done competently. Public perception seems to be that defense spending is little more than a way to funnel tax-payer dollars into the bulging bank accounts of the wealthy and connected. [1] Regardless of the veracity of this sentiment, most tend to agree that a modern nation needs a modern fighting force with modern equipment.
How can we succeed in this if our military and civilian leadership can’t competently develop and procure the capabilities needed for the future? When in a pinch, America often falls back on the entrepreneurial spirit of innovators in commercial industry.
But can commercial innovators really save the DOD from itself? They’ve done it before. The real question, is are they even interested in doing so now?
Join with me as your author (a lowly engineer) tries to make sense of these questions.
But wait, aren’t the armed services and DOD agencies the “experts” when it comes to weapons? What could civilian industry possibly contribute?
Obviously, the idea of commercial industry selling product to the military is not new, though it is typically unpopular. For better or worse, the discussion about the military industrial complex and its myriad evils is part of the modern American lexicon. Few of these discussions have any positive connotation in popular discourse.
That being said, the efforts of corporate entities in saving the Armed Services, and government (civilian) experts, from themselves is well documented.
In the book Death Traps, Belton Y. Cooper recounts his service during World War II (WWII) and experience with the M4 Sherman. This iconic tank was originally designed by the Army Ordnance Corps.
Despite some success early in the war, by the time the European front opened in earnest, the M4 was found wanting. Much to the detriment of American lives, the tank was significantly less survivable, lethal, and reliable than its adversaries on the battlefield. Ultimately, Cooper recounts that it fell to tankers on-the-ground to chop-shop-style modify vehicles in an attempt to save themselves and win the war. As feedback came in from the front, commercial industry picked up the slack to make the vehicle more producible, more sustainable, and more effective in the fight.
The book Freedom’s Forge by Arthur Herman fills in the gaps where Cooper’s first-hand accounts leave off. The author covers efforts on the home-front to get soldiers the materiale needed to win WWII. Herman gives most of the credit to commercial industry for saving the Army from itself and fixing many of the flawed systems produced within its halls. This is summed up concisely in Herman’s recounting of Chyrsler’s reception of plans for production of the Army’s tank designs.
In the end, Chrysler would basically redesign the entire vehicle [M3 Grant]— just as later, Chrysler, Ford, and GM would reengineer the M3’s successor, the M4 Sherman… months, and not a few lives, were lost because the Army insisted on pushing ahead on its own design without once asking if the professional experts might do it better… It would take some time before American companies learned to challenge the War Department on how to design and build the weapons it wanted (aircraft makers of course had known this for years).
The modern analogy to this is the rise of commercial space ventures — notably Relativity Space, Blue Origin, and Space X. In a world where American space technologies and initiatives have languished for decades, these newcomers are showing that the “old way of doing business” is obsolete. The U.S. government’s chosen OEMs (the venerable members of the United Launch Alliance) seem to be content to tow the line of unimaginative federal agencies and regulators leaving major opportunities for those daring enough to challenge the status-quo and do better.
If they can do it for space exploration, can’t the Musks and Bezos(s) of the world help the DOD solve their problems as well? Much like ULA, existing defense OEMs don’t seem willing or able to “shake things up” and guide the DOD toward success. Shouldn’t this leave a gigantic hole in the market for someone to exploit?
If so, why isn’t there a Muskian or Bezosian actor in the wider defense market trying to make the tank or plane of the future? None of the big personalities in entrepreneurship have expressed any real interest in working more directly with the DOD on these topics. They likely never will. Why?
There are many reasons, but here’s a big one —
The revenue and profit potential in defense manufacturing is dismal compared to other ventures. Not only is defense an unpopular topic area but the risk is high, the customer difficult, and the force of federal law all-encompassing.
Let’s do the thought experiment together, shall we? Let’s pretend that we are a potential, interested innovator and entrepreneur looking to break into the defense market. Is it worth our while?
What does potential market revenue for defense manufacturing look like? Does it justify the risk associated with attempting to “break-in” for a Musk or Bezos?
In 2022, the total DOD budget was northwards of $700B. That’s a significant amount of money. This is important because, unlike in commercial industries, there is very little customer mobility in defense. If you make a product for the US DOD, there are significant legal barriers to taking those items to other customers. Even if the DOD says “no thanks”, it can’t then be sold to other nations for (hopefully) obvious security reasons without approval by the government.
So, back to the $700B+ in DOD funding… That bucket funds everything that makes the Armed Forces tick. That might be tanks, airplanes, guns, bullets, uniforms, night vision optical devices, wages (civilian and military), spare tires for the Jeep, cans of Coca-Cola, bottles of Tabasco sauce, medical and social benefits, pens (military grade), MS PowerPoint licenses (for the Rangers), facility upkeep, public relations, overheads for the research labs, fees for maintenance of “army.mil”, toilet paper (also military grade) and much much more. What this means is that the DOD’s herculean budget is spread extremely thin.
As a result, it’s a bit hard to tell how much “market” a potential new actor in the defense manufacturing world could really expect to attack in our notional business case. Certainly not $700B.
Okay, so that’s a bust. Let’s narrow our market research a bit.
We will assume our new enterprise only has capital and expertise to focus on one product area to start. For the sake of the thought experiment, let’s say our company is interested in breaking into the militarized tractor (armored fighting vehicle) market. Additionally, we want to understand whether the effort expended in breaking into this area outweighs potential opportunities we’d be giving up in other markets. For this purpose, we’ll make some comparisons between the opportunities in our hypothetical AFV market and commercial automotive which share some similarities in product form.
Most notable in the area of armored ground vehicles is the upcoming Optionally Manned Fighting Vehicle. Tracked vehicles procurement efforts are budgeted around $3.6B in 2023. That’s pretty sweet. But wait, that’s not just for the new OMFV platform, that’s for all tracked weapon systems the Army is buying, of which there are a few. So only a small portion of that $3.6B is potentially up for grabs. That’s still a chunk of cash though, right? Especially as the army de-emphasizes support of legacy platforms and looks to the future.
Is capturing a portion of a $3.6B industry sufficient enticement for Grade A innovators?
To compare earnings potential, let’s look at Tesla and the automotive market. In 2019 — before the disruptions of a world-wide pandemic — the international automotive industry was estimated at total revenue around $1.9 trillion. That’s nearly 530X the entire budget for all tracked vehicle procurement in the Army. This isn’t particularly surprising, but it means there’s a lot more potential money in making Model Ys than putting guns on them for the Army. Essentially, the total market opportunity for a“Tesla Tank” or Model AMM-TSF (Armored Musk Mobile — Tracked, Space Faring) is likely less that 0.1% of the existing automotive market Musk is attacking. Youch.
Okay, but defense contractors are super profitable enterprises, right? Lobbyists and beltway-insiders make sure of that, yea? So that might swing the risk of jumping into the defense market as a newcomer with fresh innovations and ideas.
What kind of profits could we expect to see from defense manufacturing if we decided to jump-in?
The profitability of defense contractors in comparison to commercial industries has been hotly debated since the dawn of time (war). Herman comes in here with another keen insight in Freedom’s Forge and describes the state of relations between defense contractors and the United States Government at the end of World War I.
The post-war reaction against “war profiteers” led Congress and the Treasury Department [after WWI] to impose sharp curbs on the profit companies could make… In addition, every government contract for a new airplane or tank or vehicle required bidding companies to pay for the production of their prototype and the new machine tools to manufacture it… As one executive from Boeing put it, “There was no sound of coin in Uncle Sam’s jeans.” An aircraft maker looked at an average of a half-million-dollar investment just to enter a bid — with no guarantee of winning. Even if he did and problems or delays developed, the government was not above pulling the contract, leaving the company high and dry.
That story still rings true today. If our notional “new business” wants to pursue tracked vehicles we will have to work to a firm fixed price contract that mirrors, in many ways, the policies described by Herman. But surely the reward (potential profit) outweighs the risk?
Let’s take a look, shall we? How much money are the biggest and baddest defense contractors making (revenue)? How profitable are they in comparison to other household names in tech and automotive?
To put this in context, in 2023 General Dynamics — the world’s second largest defense contracting conglomerate — had revenue and profits less than Coca-Cola Company ($43.5B revenue, $9.9B net income). More humorously, selling sodas was a more profitable venture than the world’s Number 1, multi-national defense conglomerate, Lockheed Martin!
Don’t take my word for it. Multiple publications have examined profitability of defense contractors over decades and not been able to come to agreement about whether defense contractors are more or less profitable than their commercial peers. [3]
Table 1 has a comparison of some very simple numbers here, it’s clear that even the largest defense conglomerates in the world make a fraction of the revenue of tech and automotive giants. These data seem to show that the government is largely successful in curtailing contractor profits to 5% — 10% per existing policies. [4] This is in stark contrast to big tech companies which might see 20% margin or more at the end of the day. Even the established “old guard” of automotive make double digit profits while Tesla seems to be pushing 16% or better in recent years.
How can an innovator justify attempting to break into a capital intensive, high-risk, highly regulated industry like defense manufacturing with these types of numbers? The earning potential simply isn’t there and the risk is massive.
The result is that this market and regulatory environment is to the benefit of large defense conglomerates with existing relationships within the DOD, extensive lobbying capability, and established infrastructure which mitigates their total business risk. [5]
Not only are there significant barriers to the entry of new innovators, but the market incentive doesn’t seem to be there to entice them anyway.
The bottom-line: Musk is not coming to save the day for the DOD.
Unfortunately, the DOD is stuck with their existing procurement system and defense contractors. There is not a Muskian or Bezosian heir-apparent that could justif attempting to break into this industry. There is too much risk and not enough reward on the table. How would you even entice investors to help you get off the ground with those kinds of numbers?
Worse, there is very little incentive for existing mega-conglomerates in non-defense areas to attempt to dip their toe into this arena. Why would GM or Ford attempt to enter a market when it seems likely to drag on their margins? Given that the DOD doesn’t seem to have any interest in changing the way they do business, there is very little incentive for existing defense OEMs to do much real innovation. It’s better to maintain the status-quo and take the ticket through the window.
This is a complex problem to solve and an unpopular topic to discuss. How do we attract Grade A innovators to this critical industry? A problem for brighter minds than mine.
This author, for one, is looking forward to the Model AMM-TSF and is happy to volunteer to take it for a spin on the test track. But for now, it looks like there is little hope to see a true revolution in military procurement in the near future. Until then, good luck and good hunting.
References and Footnotes
[1] We won’t get into the ethics of defense spending, the philosophy of its application, rationals of policy makers, or the other political machinations which govern this area and public perceptions.
[2] Values are 12-month trailing compiled from public releases summarizing data ending December 31, 2022. Net Income is defined as the total dollar amount after expenses required to produce the relevant product or service. Be mindful that profitability of these ventures varies somewhat based on the metric utilized — EBITA, ROA, PMR and other metrics are not assessed here.
[3] Reference Wang and San Miguel, The Excessive Profits of Defense Contractors: Evidence and Determinates. While this study advocates that defense contractors make “excessive profits” — depending on the metric used — it also notes the historical disagreement on this analysis by other authors. It is unclear which metric is the appropriate metric by which “excessive profit” is assessed and what those absolute numbers or percentages are.
[4] Reference Arnold et. al., Defense Department Profit and Contract Finance Policies and Their Effects on Contract and Contractor Performance.
[5] Curiously, many defense conglomerates in modern times are the result of the consolidation of enterprises originally born from non-defense companies. As a result, there are very few “new” enterprises that are dedicated solely to production of major defense articles for the government. There are some exceptions when an industry transitions from a “specialty product” to a “commodity product”.
