The Changing of the Guard in Defense Technology
In times of conflict and international competition, the pistons of American innovation fire at an accelerated pace. Looking back on the 20th century, we can see the profound impact global conflict and competition has had in advancing the world of technology. At the start of World War I, soldiers arrived on horseback but left on airplanes. World War II drove the development of the jet engine, radar, penicillin, and nuclear capabilities. The Cold War era brought us advanced wireless communications technology, satellites, and GPS.
Today, for the first time in decades, the United States finds itself in yet another faceoff with peer level adversaries. At the same time, the advent of the internet, machine learning, and autonomous systems necessitates a shift in our defense infrastructure from a primarily industrial age force to a digitally enabled one. As has taken place in previous eras, this inflection point opens the door for radical ideas, brilliant technologies, and emerging companies to define a new generation of national security.
Drawing on my experiences as an Air Force Acquisitions Officer, an investor at Riot Ventures, and from conversations with leaders in the highest offices of the DoD, several trends point towards momentum for new entrants to make their mark.
1. Digital technologies threaten to disrupt the U.S. military’s power projection capability
The strength of the U.S. military is rooted in it’s power projection capability. With bases, equipment, and people operating across all domains (air, land, sea, space, and cyber), U.S. forces can be operational anywhere in the world within 24 hours. Three key drivers set the foundation for U.S. power projection — freedom of movement, access to ground level intelligence, and uninterrupted communications.
Over the past two decades, peer level adversaries such as China and Russia have dutifully studied our tactics, techniques, and operating capabilities. In turn, they’ve funded robust development programs specifically designed to disrupt our communications and information infrastructure at home and abroad. While kinetic attacks on critical infrastructure are a textbook military tactic, disruption is now more likely to occur in the form of a cyber-attack, inducing physical damage and/or decision making paralysis.
To compete in the digital age of warfare, the U.S. military must evolve beyond traditional systems. It needs to aggressively field a new generation of digitally native advanced technologies that are likely to be developed by non-traditional defense contractors. Only then can the military continue to project power unimpeded.
2. Incumbent defense contractor base is not positioned to move at the speed of relevance
Since the end of the Cold War era, the defense industry has been in a continuous cycle of consolidation. Over the same period, DoD procurement policy has bloated. The combination of these two trends has left us with a defense industry that is dominated by a few behemoth companies. These “Prime” contractors are more likely to mirror their government counterpart than the technology firm of the future.
The figure above shows that between 1976 and 2019, 225 companies consolidated into just six, with L-3 and Harris merging in 2018, and Raytheon and United Technologies merging in 2020. Remarkably, the dollar share of total defense contracts that these firms have won, shown in the grey area, has stayed fairly constant over the years at roughly 35%. The value (in 2019 dollars) of these contracts increased from around $70 billion spread across 225 companies in the late 1970s to $115 billion awarded to just six companies in 2019. (Source: Howell, S.T., Rathje, J., Van Reenen, J., Wong, J. 2020. Opening up Military Innovation: An Evaluation of Reforms to the U.S. Air Force SBIR Program.)
The existing industrial Prime Contractors have become experts at developing and deploying weapons and mobility platforms (planes, missiles, tanks, etc.) intended to last for decades. However, the new global power conflict will rely on digital techniques and our defense industry must adapt. The DoD acquisition model of single shot, long-term solutions has left the primes bereft of the incentive to innovate at the speed of relevance required in the digital age of defense.
The erosion of a culture based on rapid innovation has also left our defense industrial base at a severe disadvantage from a human capital perspective. Today’s brightest emerging technical experts seek employment at younger, flatter, and more nimble companies.
3. New Procurement Paths
One could argue that because many DoD contracts are open competition, the opportunity for new entrants has always existed. However, the procurement process is burdened with complex procedures and nuances making DoD contracts generally unapproachable. Compounded with the extended sales cycle of the DoD procurement process, doing business with the military has long been an unattractive proposition to traditional commercial entrepreneurs.
The monopsonic nature of the defense industry further increases the difficulty in creating competition. Absent the commercial laws of natural selection, dated technology can be delivered at premium prices.
Fortunately, in recent years, DoD Acquisitions leadership has recognized this misalignment and sought to create new pathways to engage with startups. Organizations like DIU, AFWERX, SOFWERX, NavalX, and others offer tremendous opportunities for non-traditional defense vendors to gain traction with DoD contracts. These organizations have accelerated the adoption of previously underutilized authorities like Other Transactions (OTA) and revamped the Small Business Innovation Research (SBIR) program to support this adoption.
OTA contracts are not subject to the rules set forth by the Federal Acquisition Regulation (FAR) and thus, can operate more like commercial contract agreements. Today, only a small subset of contracting offices are routinely using OTAs. However, the trendline (and my personal expectation) points to the dramatic expansion in the use of OTAs within the larger program offices.
While SBIR contracts do not represent recurring revenue and the overwhelming majority will never successfully transition to a Program of Record, they symbolize a changing of the guard in defense procurement. This is highlighted by AFWERX’s “Open Topics” SBIR model, in which the solicitation contains no direction regarding the technology — including software — that the applicant may propose. With an explicit reference to seeking “unknown unknowns” in the solicitation, Open Topics are designed to let the private sector do the work of identifying military applications for its technology. (Source: Howell, S.T., Rathje, J., Van Reenen, J., Wong, J. 2020. Opening up Military Innovation: An Evaluation of Reforms to the U.S. Air Force SBIR Program.)
This empowerment of new organizations focused on working with non-traditional defense firms is a demonstration of the DoD’s intent to work more closely with the startup ecosystem. At Riot Ventures, we chat with companies all the time who are excited about the SBIR contract they’ve been awarded and are looking forward to working the with the DoD as one of their key design customers.
The Way Ahead
Over the last several years, the initial cohort of 21st Century defense companies has emerged. Palantir (PLTR) and SpaceX have reached unprecedented scale and earlier stage companies like Anduril and Shield AI are not far behind. These companies are rapidly developing modular hardware/software platforms that enable the integration of artificial intelligence, computer vision, and edge capabilities at a speed commensurate with commercial technology leaders.
In the complex digital age of warfare, the DoD will look towards shorter term contracts that focus on rapid integration, deployment, and a frequent cadence of tech refresh. This is paramount as we cannot rely on single platform solutions to be effective over a period of decades.
In the coming weeks, I’ll dive deeper into each of these trends and cover topics including selling to the DoD, navigating the procurement process, common risks/pitfalls, and other information relevant to the new age of defense innovation.
Follow on posts: Investing in Defense: Supply Chain and Sustainment
If you’re building an advanced technology business with applications in defense, we’d love to connect with you to learn more (ryan@riot.vc)!
