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Defense innovation: endemic problem or echo chamber of negativity? 

PA CONSULTING GROUP | national defense magazine | 13 june 2016

The defense sector has been considered to be at the forefront of innovation. Microwaves, GPS and the internet are just a few examples of technologies incubated in the defence sector prior to widespread commercialization. 

This viewpoint has changed dramatically over the years, with many currently pronouncing that defence innovation is dead, or at least on life support. Yet the defence sector’s primary customer, the U.S. government, needs creative solutions more than ever. With that in mind, and contract research-and-development funding harder to find, defence executives need to be mindful about their approaches to driving innovation.

Dozens of reports have lambasted the defense industry for a poor track record on innovation. The sector has itself reinforced this view and been critical of itself, ranking low in poll after poll among industries with respect to successful innovation. Indeed, polling for PA Consulting Group’s 2015 report, “Innovation as Unusual,” demonstrated that defence executives, when asked “Which Industries Have the Most Innovative Leaders?” ranked their sector a distant nine out of nine. 

With this in mind, are we facing an endemic problem, or just a negative feedback loop due to preconceptions from a sector-led echo chamber?

According to leading industry reports, the two major failures in the industry are a lack of market insight — including poor understanding of the competitive environment — and poor communication between the customer community and industry as it relates to innovation. As a result, the prevailing wisdom is that the Department of Defense, and by extension, its suppliers, have been ineffective at identifying and cultivating innovation. 

Chief among those constraints is the reality that government has been the defence sector’s “market maker.” Whereas commercial firms can develop and market innovative offerings to create new markets independent of end-user demands, defence firms have little ability to do the same. As such, defence firms tend to view innovation through a lens of what the government wants. 

This creates two sets of problems. First, industry has not been incentivized to create new ideas and must deliver solutions defined by the customer, who often lacks awareness or understanding of the array of solutions industry is capable of providing. The result of this paradox is a laundry list of programs and solutions that have been over budget, delayed or canceled outright. Second, this reality creates a sharp contrast in approaches to research and development that differentiates defence firms from their commercial counterparts. 

Commercial firms often invest 10 to 20 percent of revenues into IRAD (internal R&D). In comparison, even cutting-edge defence firms spend only about 3 to 4 percent of revenue on IRAD, with many at 1 percent or less — and even that usually focuses on value added to existing capabilities. 

Further, Wall Street and the investor community tend to measure return on investment based on large contract wins, rather than risks taken through IRAD. This means that firms seek to drive innovation more through acquisitions or partnerships rather than major internal initiatives. Risk in the industry is typically not rewarded by the City and the Street. This is in sharp contrast to commercial firms, which are often valued based on R&D pipelines or creative demand generation. 

Because defence firms lack the ability to create new markets, they tend to chase contracted R&D. When firms have chosen to buck this trend and invest IRAD to advance novel concepts — particularly those not stated as government requirements — the result has often been an inability to generate demand, and thus a lack of realized value.

DoD’s Defense Innovation Initiative, launched by Secretary Ashton Carter, aims to address some of these issues by evolving the department’s relationships with defence firms while exploring new ones with small, innovative commercial firms on a parallel track. The Pentagon is also advancing its “third offset strategy,” which offers a vision to “offset,” or effectively neutralize, potential adversary attempts to erode U.S. technological advantage by investing where the defence industry has been overtaken by commercial technologies. Examples include artificial intelligence, man/machine interfaces, cyber capabilities, wearable technologies and robotics. 

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DoD’s Defense Innovation Initiative, launched by Secretary Ashton Carter, aims to address some of these issues by evolving the department’s relationships with defence firms while exploring new ones with small, innovative commercial firms on a parallel track. The Pentagon is also advancing its “third offset strategy,” which offers a vision to “offset,” or effectively neutralize, potential adversary attempts to erode U.S. technological advantage by investing where the defence industry has been overtaken by commercial technologies. Examples include artificial intelligence, man/machine interfaces, cyber capabilities, wearable technologies and robotics. 

DoD has earmarked $18 billion over the next five years to incubate these technologies and hopes to use entities like the Defense Innovation Unit – Experimental (DIUx) to form closer bonds with technology clusters around the United States. 

But despite the rhetoric, the president’s fiscal year 2017 budget request to Congress represents only 1 percent of funding for research, development, testing and evaluation. This suggests that Pentagon leaders believe they can drive defence sector innovation simply by engaging new players through such venues as the DIUx. While this may occur to some extent, it ignores the variety of issues unique to the defence sector, particularly the challenges faced by defence firms seeking to innovate without access to contracted R&D. 

So far, defense firms have tried a number of strategies to innovate, including a desire to add greater commercial exposure where innovation is better rewarded, buy or import innovation through inorganic activities, or simply chase contracted R&D funds. But these strategies are not new, and are typically not enough to drive innovation in a meaningful way. 

The defense sector sits at the nexus of capitalist market forces — profit, return on investment, revenue — and bureaucratic realities — slow moving acquisition regulations, profit limiting contract vehicles, political agendas. Going back to basic economics, markets work best under conditions of “perfect competition.” Defense innovation often fails because the nature of its government customer makes the system inherently flawed. While Apple and Google succeed at innovation because of the same tenets that drive markets in general, the defense sector lacks a large number of buyers — disincentivizing buyers from fully engaging sellers — and “perfect information” between buyers and sellers. 

In typical markets, no participant has enough market power to set prices, which is not the case with government acquisition. In fact, most would agree that the government is not a “rational buyer” as many budgetary decisions are based on political demand or programmatic momentum. 

Current solutions to the innovation problem are not addressing the fundamental flaws in the system. The increase in dialogue between defense industry and commercial firms is no doubt a step in the right direction, but the government needs to do more to become a better buyer and advocate. To develop a true culture of innovation in the defense sector, the onus is on the government to re-evaluate policies and create channels of innovation that go beyond looking at commercial best practices. This is critical in a sector that is beholden to Federal Acquisition Regulations and operating in an environment where the buyer almost exclusively sets demand.

While the U.S. government does need to re-evaluate its role and policy toward innovation, there are examples of success where industry has taken the lead and become its own market maker. SpaceX, which has disrupted a long-standing monopoly in U.S. government space launch by offering a capable and reliable alternative at lower cost, is among the most recent examples. 

Companies can put innovation at the heart of the firm’s culture by making it a subject of conversation internally and especially with customers, and build it into recruitment, training and incentive structures. They can create an innovation strategy founded on a rigorous assessment of the trends shaping customers’ operating environments and broader technology trends in adjacent spaces. And they can be innovative in ways that are not solely technology development oriented. They should create mechanisms to track innovation efforts closely and cull those that are redundant, not in alignment with strategy, or are not progressing as planned.

The stereotype of the defense sector as being unable to harness innovation to deliver game-changing capabilities is just that, a stereotype. Continued belief that industry is bad at innovation is becoming a self-fulfilling prophecy. Government surely needs to allow industry to be more flexible and creative as it relates to innovation, whether in the realms of technology, business models, organizational structures, or other novel ideas. However, both government and industry need to take more calculated risks. 

While most agree that innovation is something that is both positive and necessary, there seems to be very little emphasis on how the process of defense innovation can itself be more innovative. Today’s plans and concepts to foster a more innovative culture rest on a desire to replicate tried and true methods from commercial industry. These initiatives are a good start, but with a foot in government and industry, much more is required to return the defense sector to the cutting edge of innovation where it once operated.

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