Munich Security Report 2017
Defense Innovation: Changing Gear
Defense has traditionally been one of the hardest industries to disrupt due to high entry barriers, low risk tolerance, and the high level of specialized technical knowledge required. However, the digital revolution sweeping through other industries is now increasingly disrupting defense as well.
“Achieving sustainable growth is not just about chasing government contracts, it’s about chasing innovation.”5
ADM MARK FERGUSON, USN (RET.)
Digitization is changing both where and how defense companies compete. First, the “where to compete” is shifting from “traditional” defense to IT-based products. New battlefields like cybersecurity and big-data analytics have allowed pure IT players to gain a foothold in the security and defense business, and budgets for these areas are on track to grow faster than those for ”traditional” defense. The share of the US Department of Defense budget allocated to the areas of C3, intelligence, and space has doubled since 1976.1 The four digital giants Google, Amazon, Microsoft, and Intel alone spend more than USD 50 billion a year on digital innovation, with dual use2 offering militaries an opportunity to innovate within constrained defense budgets.3 Second, digitization is changing the factors that differentiate defense solutions, meaning the “how to compete” is changing too. The increasing digitization of weapon systems (“Defense 4.0”) impacts and even disrupts the very core of defense. This development is best evidenced by shifts in technology investment. While military platforms have long been pieces of “embedded software,” the ratio of “software” to “hardware” has changed more rapidly and significantly in recent years. As the absolute value of electronics in a platform has almost tripled from one generation to the next,4 advancement in this area has become the driver of innovation. The extent to which the door is open for disruption by new civilian players can best be seen in the “New Space” industry.
Ministries of defense, established defense companies as well as their suppliers (especially tier 1 and tier 2) all face the need to adapt their ways of doing business. Externally, they must demonstrate the ability and willingness to engage with non-traditional companies in non-traditional processes. One approach involves using “innovation units” and “hubs” to move closer to civilian innovation. Internally, procurement processes could focus on overcoming the disconnect between lengthy procurement cycles and shorter innovation cycles. Experiments with non-traditional methods such as competitions and direct awards for prototype technologies have proven successful. A ministry of defense strategy for sustained technology development should allow for an outside-in innovation process, a streamlined approach to defining requirements, and simplified procurement of digital technologies. New forms of partnering with emerging tech companies will also be needed. Traditional defense contractors will face the challenge of introducing digital innovation cells within their companies and identifying candidates for mergers or acquisitions, along with competitive pressure to digitize their industrial processes. New strategies will therefore be essential for “traditional defense” to sustain growth in the Defense 4.0 era, while maintaining a technological edge is mission-critical for militaries as well.
This page was prepared by MSC’s knowledge partner McKinsey & Company.
- Office of the Under Secretary of Defense (Comptroller), “National Defense Budget Estimates for FY 2017,” US Department of Defense, March 2016, http://comptroller.defense.gov/Portals/45/Documents/defbudget/fy2017/FY17_Green_Book.pdf.
- Civilian goods, software and technology which can be used both for civilian and military purposes.
- Justin Fox, “The Big Spenders on R&D,” Bloomberg, 29 April 2916, https://www.bloomberg.com/view/articles/2016-04-29/amazon-and-facebook-are-big-spenders-on-r-d.
- Analysis based on comparison of fighter aircrafts F/A-18 E/F vs. F-35A and the guided missile destroyers DDG-51 (Flight III) vs. DDG-1000. For underlying budget data for the F/A-18 E/F, see “Department of the Navy Fiscal Year (FY) 2012 Budget Estimates, Aircraft Procurement, Navy Volume I: Budget Activities 1-4,” February 2011, http://www.secnav.navy.mil/fmc/fmb/Documents/12Pres/APN_BA1-4_Book.pdf; for the F-35A, see “Department of Defense Fiscal Year (FY) 2017 President’s Budget Submission, Air Force, Justification Book Volume 1 of 2, Aircraft Procurement, Air Force Vol−1,” February 2016, http://www.saffm.hq.af.mil/Portals/84/documents/FY17/AFD-160208-044.pdf?ver=2016-08-24-102038-590. For the DDG-51 (Flight III) and DDG-1000 see “Department of Defense Fiscal Year (FY) 2017 President’s Budget Submission, Navy, Justification Book Volume 1 of 1, Shipbuilding and Conversion, Navy,” February 2016, http://www.secnav.navy.mil/fmc/fmb/Documents/17pres/SCN_Book.pdf.
- Private interview, January 2017.
- Data provided to MSC by McKinsey Visual DoD.
- Data provided to MSC by McKinsey SILA. New Space tend to be <$1B in size and work across a broad range of topics related to space – incl. launch, small satellites, data analytics, earth observation, and services. On several transactions the type of investor is unknown and hence not included in the analysis.