Maintaining the U.S. defense sector’s competitive edge

US DEFENSE INDUSTRY

American power and prosperity are destined to decline unless Washington can reverse the decline of U.S. manufacturing capacity and the toxic effects of decades of defense consolidation.

The Defense Department has assessed that it was “increasingly reliant on a small number of contractors for critical defense capabilities” and that current policies and investments were not supportive of a defense ecosystem built for peer conflict. While there is no doubt the United States remains the world’s leading technology innovator, the Pentagon struggles to compete with China’s ability to produce new military capabilities at scale. America’s military edge requires a defense ecosystem and future industrial base that can identify, innovate, develop, and produce at scale new technologies able to change the face of modern warfare. Without competitive options and a resilient production capacity, the U.S. industrial network will lag behind China’s military-civil fusion, making it more difficult to deter conflict. 

Three actions can help correct the current defense sector imbalance and equip the Department of Defense with an industrial ecosystem that can rapidly access and adopt new technologies. First, the Pentagon should diversify the industrial base by incentivizing midsized enterprises to play a critical role in providing innovation, options, speed, value, and competition. Second, the government should create incentives for companies to serve as “innovation translators,” facilitating the scalability of demonstrated commercial prototypes to numbers that can be useful for the U.S. military. Third, the Pentagon should avoid investments in technology already being developed faster and more effectively in the private sector. 

The United States had 51 defense prime contractors in the early 1990s, compared to the five it has today. Moreover, even as defense contracting dollars increased over the past five years, the number of defense sector companies seeking those contracts shrank by 17,000 over the same period. However, this imbalance can be reversed. Midsized enterprises, specifically those between $1 billion and $5 billion in annual revenue, represent an important yet underutilized element of the U.S. defense ecosystem. By taking the following actions, the Defense Department would be better positioned to leverage innovation more rapidly and at scale. 

Recognize and Amplify

The Pentagon does not recognize midsized enterprises as a distinct asset class providing distinct capabilities. As a result, there is little advocacy for them. Meanwhile, midsized enterprises play vital roles in the defense ecosystem, particularly as integrators and suppliers of key components for major defense systems. Creating a robust program to increase the focus on identifying and supporting commercial technology in these midsized companies could result in more rapidly meeting operational requirements, catalyzing access to innovation, and diversifying potential supply to the Pentagon. Diversification provides three advantages. The first is speed. For example, having multiple producers of solid-rocket motors would allow the various missile systems that rely on such motors to be produced simultaneously, rather than having them all languish in a queue on the same production line. Dependence on one source leads to diminishing returns, even if additional resources are applied. The second advantage is resiliency. Multiple sources of supply reduce operational and supply chain risk that could be created through location-specific disruptions or attacks, raw material dependency, and costs incurred through distance. The third advantage is readiness. Multiple sources create the ability to provide a greater number of options if they are suddenly needed. In a future national emergency, the U.S. government will need and should have a ready-made plan of action to look beyond existing players to create needed outcomes requiring speed, resiliency, and readiness.

In addition, enhancing awareness and engagement with midsized companies will increase the number of business leaders who understand how to work with the Defense Department. The current level of consolidation to date has created fewer corporate leaders who understand the intricacies of doing business with the Pentagon. The challenge of working with the U.S. military, which includes implementing required security and compliance processes and waiting on contracting timelines, has been an impediment for companies that might otherwise have an interest in pursuing defense work, even if their technologies could be considered dual-use. 

The Pentagon should strive to amplify companies that fit in this “no man’s land.” A place to start would be identifying midsized suppliers or potential suppliers in the five “critical focus areas” (casting and forgings, missiles and munitions, energy storage and batteries, strategic and critical minerals, and microelectronics) highlighted in the Department of Defense’s competition report as components for which the Pentagon is reliant on limited and vulnerable domestic supply chains. Agile and innovative midsized enterprises can build resiliency in these five areas by serving as additional supply sources or providing a domestic alternative for a capability that the Pentagon is reliant on importing, such as batteries. 

Innovation Translators

The Department of Defense has improved its ability to work with small technology developers, particularly through its Small Business Innovation Research/Small Business Technology Transfer programs and Other Transaction Agreements. Those programs help small businesses navigate the acquisition process and provide funding for early-stage technology development — addressing at least one of the obstacles of incentivizing the private sector to invest in research and development. While the Pentagon has improved its access to innovation, small business funding effectively ends when the prototype is ready to be produced at scale. Middle- and late-stage technology development and production are far more resource-intensive than prototyping and primarily rely on the Pentagon’s cumbersome and lengthy budgeting processes. 

This is also where Congress can play a role to incentivize rebalancing the defense industry, specifically creating and funding “innovation translators” for the Department of Defense. The model should be shaped to clearly define the role between “innovators” and “technology owners” and the handover between these groups. This technology transition role could be filled by larger primes and supported by midsized enterprises. Congress should consider legislation that incentivizes large prime and midsized companies to establish technology transition functions that operationalize the technology on behalf of the government. Such additional measures can build on the existing Defense Department Mentor-Protégé Program, whose eligibility requirements are far too narrow to have an impact across the defense ecosystem. While helpful for those involved, only about 200 small businesses have benefitted from the program over the past five years.  

The model could entail the Pentagon’s identification of a particular technology or technology area where a start-up or small business is ready to bring commercial market products to the Pentagon (e.g., AI, robotics, cybersecurity capabilities, etc.). The Defense Department would engage either a major prime or midsized enterprise to act as the technology transfer agent. The innovator who developed and owns the technology would then license their product to the technology transition agent (prime or midsized enterprise) and also receive a financial share of future profits. In return, Congress could authorize the Pentagon to provide either the prime or midsized enterprise with an “approval” that would provide access to distinct types of contracts set aside for business entities engaged in technology transfer. Such an incentivization would be similar to existing contracts that are set aside for veteran- or minority-owned small businesses. There are other efforts complementing these recommendations such as the Defense Innovation Unit’s concept paper on how the Defense Department could become a “fast follower” for the operationalization of commercial dual-use innovation. “For commercial technologies that [the Defense Department] does not invent, [it] must become a ‘Fast Follower’ to gain rapid access to these technologies to maintain at least technological parity with adversaries.”

Congress should incentivize a new model of industry engagement with the Pentagon that establishes incentives for midsized enterprises and major primes to rapidly deliver the cutting-edge technological capability needed to meet growing challenges across the globe. 

Clarification Needed

The Pentagon’s research and development budget of $144 billion this year is the largest in history, but it is not necessarily a sign of success. For decades, the Defense Department was a leader in technological innovation, with classified programs several years ahead of what the U.S. commercial sector could produce. Over the last decades, that dynamic has flipped, with the U.S. commercial sector increasingly leading the discovery and development of technology on which the Pentagon is dependent. Given this reality, the department needs to recognize that it doesn’t need to invest in large amounts of redundant capital investment. As Former Under Secretary of Defense Ellen Lord told the Building the Base podcast, “All of our systems and processes focus on the government developing [new technologies]. We have major primes who have set up organizations to be very efficient and effective in that type of system, however, it doesn’t fit where we are today.”

The Pentagon should continue to undertake a comparative analysis to determine where the private sector is doing things more efficiently or effectively. Second, the department should be selective about where it takes the lead, and therefore invests its time, effort, and resources. The Pentagon needs to be a good integrator, not a replicator. To these points, the Office of Strategic Capital is a promising new initiative that seems to align with this approach in several ways and should be a good start along this path. 

As the Department of Defense curtails its redundant technology development role, a greater number of midsized companies can serve in a “first level” integration role and effectively create a bridge between small business solutions and department needs. Given their understanding of the innovation process, business solutions, and commercial efficiency, midsized companies can integrate the right subset of solutions and serve as the intermediary of the small businesses for the Pentagon. This delineation would be similar to NASA’s determination that it was more efficient to partner with industry on commercial and crew cargo programs, while the agency focused its technology development efforts on exquisite one-of-a-kind capabilities for which the government is the sole customer. 

Conclusion

It has been decades since the United States faced a serious peer competitor, and we need to broaden and strengthen the industrial contributors to the Department of Defense to meet that competition. It is time to better leverage midsized enterprises across the defense industrial base and throughout the acquisition process. While the United States cannot and should not try to duplicate the centralized structures of its peer competitors, it can employ a whole-of-nation strategy that leverages the full range of our commercial sector. To be successful, both the Defense Department and Congress must identify, utilize, and advance every tool and resource in the U.S. defense industrial base to ensure the nation is postured to deter, preferably, and win, if necessary, any conflict with a peer adversary. More importantly, the United States needs to transition from a Cold War–era industrial system to a broader, more dynamic future industrial network that taps into the innovation and production capacities across the U.S. private sector and fully employs the strengths of our free enterprise system. 

Kurt Scherer serves as a managing partner for C5 Capital, a specialist venture capital firm focused on providing mission-driven capital for the right leaders and technologies to preserve our way of life.

Fatih Ozmen is the chief executive officer of the Sierra Nevada Corporation, a global leader in aerospace and national security.