Mind the (R&D Spending) Gap

Today marks the 79th anniversary of the allied invasion of Normandy to liberate Europe. We are still inspired by that generation’s heroism and sacrifice. Their spirit lives on, as part of the inspiration for our arsenal of democracy mantra. We started this newsletter to continue to inspire our generation to build the great Arsenal of Tomorrow.

This week’s post:

• 🫡 A New DoD R&D Strategy?

• 🛩️ The Next Fighter Opportunity

• 💰 Term Sheet

• 🚩 Red Team Update

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A New DoD R&D Strategy?

The problem

The US way of war, especially post-WWII, has been to rely on technology advantage to reduce mass and economize use of force across vast geographic distances in deterring conflict and securing victory. This strategy clearly depends upon maintaining said technology advantage, which seems to be eroding. Commercial leadership in global R&D spending feels as assumed today as it would have felt for DoD leadership in 1960:

What is causing the erosion? A Congressional Research Service report groups causes into three primary categories:

1. Rapidly evolving global landscape for innovation

2. Changes in the composition of R&D funding

3. Increasing technological prowess of potential adversaries

Today, we focus on #2: changes in the composition of R&D funding.

Commercial firms have outpaced the federal government on R&D spending ever since a crossover point around 1980:

Since then, the commercial market has been the primary driver of US R&D spending, with the implication and reality that commercial firms have the technological edge over the federal government in many areas, including those that the DoD CTO cares most about. What’s to be done?

Strategies for adaptation to a changing R&D landscape

Broadly, the DoD could:

1. Change to be less reliant on technology (not feasible nor prudent)

2. Increase spending to match commercial R&D or at least close the gap (infeasible for the foreseeable future - DoD has to diversify across a wide swath of technology areas where commercial firms can find niche product to market fits and become exquisitely capable in focused areas)

3. Realize #2 is infeasible and get better at leveraging commercial technology (this is the raison d’etre for entities like DIU)

There are many responses to approach 3. One is to examine how the DoD gets innovative technology: we’ve covered how the DoD spends its RDT&E dollars previously, as well as other mechanisms like SBIRs/STTRs for working with smaller companies. We should rightly be focused on new ways of obtaining new technology, but we should also economize existing paths.

That means taking a closer look inside commercial R&D spending.

Ensure existing DoD suppliers are keeping pace with their commercial competitors

Some disclaimers: R&D benchmarking is squishy, and it can sometimes be a dark art with the way companies can amortize expenses into R&D lines. It’s also not a perfect correlation to innovation: spending R&D money does not mean you are delivering innovation. And it’s hard to compare across industries: one market with intense competition may mean heavy R&D spending is needed to maintain position, where another firm can get by with less R&D spending with less competition (cough, cough).

We analyzed the most naïve R&D benchmark you might expect, to take a look at if the DoD is using innovative suppliers: publicly reported R&D expenditures: total, and as a percentage of revenue:

Some things worth noting:

Traditional DoD primes spend a lot less on R&D than commercial tech companies, in both absolute and proportional terms:

• $9B (total spent by top 5 market cap primes) is a lot less than $132B (total spent by 7 large cap tech companies we chose)

• The DoD spent $119B on RDT&E in 2022, 15.3% of its total budget

15.3% places it in good stead as compared to these commercial entities, but remember it has to spend across many different industries to use and integrate technology from all of them. So $119B for “all tech” is much different than $40B for R&D in a focused market (Google).

It’s also worth noting that this comparison isn’t exactly apples to apples. For instance, there’s no dual-use market for surface to air missiles. A prime only has to compete with another prime for many things the DoD needs (or a start-up), meaning many of them are not very competitive markets. You see that with only one to two firms bidding on some large contract opportunities (NGAD, for example).

So what, and how does an entrepreneur with $0B R&D compete?

The “R&D deficit” creates an opening. Large primes are still spending money on R&D, but it’s not enough. Further proof of this is the rate at which they invest in, and acquire competitors. If they do not, or cannot, spend enough to maintain a technological edge relative to other industries, their strategy has to be to partially outsource the development.

At the same time, there’s an R&D arbitrage opportunity in porting commercial technology over to DoD.

A defense tech entrepreneur strategy should roughly be: find or ensure your technology is underrepresented by DoD suppliers (so, not a new missile control fin) and aligns to a critical area, then use non-dilutive funding like SBIRs/STTRs to grow. Depending on your technology, you could:

• be a subcontractor to the primes

• look for an acquisition by a prime

• compete head-on if you are differentiated enough

That last part is obviously exceedingly difficult to do, especially with the amount of money primes spend on business development and lobbying to maintain their market positions.

We’ll take a look at that dynamic in a future edition.

Air Force Seeking Designs for a Next Gen Fighter

The Air Force formally opened bidding for the Next Generation Air Dominance (NGAD) program contract a few weeks ago. This highly secretive program has already narrowed down the competition to two prime contractors submitting advanced designs for the lucrative next fighter aircraft program.

While the primes are favored for the contract, the program offers an array of opportunities beyond just the headline fighter design.

Understanding the Next Generation Air Dominance Program

The US air combat technology advantage has eroded over the years and the competition has heated up. To stay ahead of the competition and ensure the US could dominate the skies (something we are seeing as an absolute necessity in Ukraine), DARPA was solicited to develop technologies that would be incorporated into America’s next fighter jet. DARPA’s evaluation determined a lone fighter would not suffice; instead, a “family of systems” approach was recommended. This implies a coordinated network of manned and unmanned systems working together.

Some of the most important differences NGAD will bring to the fight will be the family of systems component, modular hardware and software attributes, and design and/or implementation speed of new and emerging technologies.

The “Family of Systems” Approach

The “family of systems” approach will involve manned and unmanned teaming, or, basically, a manned fighter teamed with an unmanned drone or ‘family’ of drones. The Air Force is planning to buy 1,000 combat collaborative aircraft (or drones) to pair with the NGAD and F-35.

Placing our engineering hats on for a moment, single features in a platform such as long range radar or range, by themselves, are easy. Combining all the required features into one aircraft / drone is extremely hard. If you design a stealthy aircraft, it usually is not the best in other attributes such as weapon payload capability and if you make an aircraft that can carry a lot of payload or weapons, the aircraft might not be as stealthy or maneuverable. A major aspect of the NGAD program that is particularly interesting for startups is its focus on a combination of manned fighters with unmanned drones. NGAD will serve as a data hub that manages and hosts a swarm of AI generative drone wingmen.

Modularity: The Key to NGAD’s Success

The modular or open-architecture systems enables upgrade or replacement of physical components such as weapons or sensors and possibly engines without needing to redesign or replace the entire aircraft. Same with open-architecture software approach will allow for rapid adaptations to changing requirements or threats, as well as easier integration with other systems.

NGAD and Rapid Design: The Model Based Approach

Model-based everything is a new method of design and engineering that employs digital models throughout the product lifecycle. The newest aircraft from Northrop Grumman, the 6th generation B-21 stealth bomber utilized this model-based systems engineering to design, develop and build the bomber in a digital environment, which significantly sped up development and testing timelines. These digital tools allowed for virtual testing of subsystems and components before manufacturing even started, saving considerable time and resources. By employing the mode-based design approach with NGAD, the US could rapidly iterate and evolve both manned and unmanned components of the system, ensuring timely responses to emerging threats and adapting effectively to adversary tactics.

NGAD Open Architecture Contracts and the Opportunities for Startups

Both the collaborative AI wingman drones and open-architecture design offer considerable opportunities for startups and entrepreneurs. The Air Force's plan to procure 1,000 autonomous wingmen implies a myriad of contracts to be awarded to vendors for designing and manufacturing these drones. This presents a significant opportunity for any startup working on drone or AI technology.

The NGAD contracts will be split into three main phases:

1. Design

2. Manufacture

3. Sustainment of the aircraft and family of systems (most expensive component of F-35 program for reference)

Very few companies could deliver on all three contracts, so firms could potentially specialize in one of these areas. For instance, if you’re a startup building the next generation aerospace manufacturing factory (looking at you Hadrian) there will be opportunities with this massive program.

Some of the additional technology needed, and by no means an all encompassing list, will be propulsion: adaptive cycle, smart tools in manufacturing, 3D printing, thermoplastics, composites and generative AI.

The open architecture approach creates significant potential for R&D investment to become profitable, provided entities can compete for diverse technological features throughout the extensive lifecycle of a major defense program. The limitation of allocating the entire F-35 program to a single defense prime, such as Lockheed Martin, is that it offers little motivation to invest in R&D for novel fighter jet technologies or family of system capabilities. In contrast, the open architecture model motivates companies, including startups, to persist in innovation for the duration of the program, fostering a competitive and dynamic technological landscape.

Case Study: F-35 Stealth Fighter (5th-Gen) Program

One way to determine how much potential contract opportunity exists with NGAD is analyzing historically similar programs.

Lockheed Martin’s F-35 is the latest 5th generation fighter that is DoD’s largest weapon procurement program in terms of total estimated acquisition cost.

In the last decade, contracts worth $198B were awarded and $48.9B in subcontracts for the F-35 program. Over 700 disclosed subcontractors have been awarded throughout the lifetime of the F-35 program. This example is indicative of the potential opportunities for startups and smaller defense companies in large weapon programs such as the F-35 and eventually, NGAD.

We believe with the right technology and vision, smaller firms can compete and contribute to this ambitious initiative, opening up opportunities in sectors such as AI, drone technology, manufacturing, and more.

We’re looking forward to covering more on NGAD as the program matures.

Red Team Update

China is developing a 6th-Gen figthter called the J-28

• “Expected IOC: 2035 or Earlier” - Wang Haifend, a chief architect at Chengdu Aircraft Research and Design Institute who also participated in the development of the J-20 and J-10 was quoted by the China state-owned Global Times

• Artificial intelligence (AI) will play a critical role in these next-gen aircraft. AI will assist pilots in processing vast amounts of information, making decisions in complex battlefield environments, and carrying out mission objectives more efficiently. AI will also be a core feature in what Yang Wei calls an "OODA 3.0" loop in air combat decision-making

• Wang also stated the aircraft program might have laser technology, adaptive engines, hypersonic weapons, and swarm warfare

Russia is developing the new MIG-41, a 6th-Gen Fighter

• Russia's sixth-generation aircraft will be based on its Su-57 'Felon' fighter and will feature a network-centric system that includes drones, space, and ground systems. This approach is similar to the one opted by the US for its Next Generation Air Dominance (NGAD) fighter, intending to create a system of systems

• The sixth-generation aircraft will include both manned and unmanned versions, with hardware elements like advanced electronic warfare and radar systems already being tested on prototype versions of the Su-57. The aircraft will also be equipped with a unified electronic warfare system serving multiple functions including radar, data transmission, and communication equipment

• While Russia continues to improve its fifth-generation fighter capabilities, plans are underway to ramp up the production of the Su-57s. The production expansion will allow 12-14 units to be produced per year. Furthermore, the Su-57 will be fitted with the next-generation Saturn 'Izdeliye 30' engine, which is more potent than the current Saturn AL-41FM1 engine, and is expected to be incorporated into the Su-57 before 2025

China’s Military Industrial Espionage Detailed in New Book

• China's Technological Modernization: Over the years, China has embarked on a rigorous technology modernization campaign, enabling it to nearly reach parity with the US in military capabilities. A series of national security, intelligence, and cybersecurity laws have facilitated the government's control over the state-owned enterprises as well as private-sector companies

• Intellectual Property Theft: China has been openly supporting its domestic companies to become global leaders in technology through the "military-civil fusion," where the military and intelligence services provide R&D secrets and intellectual property obtained through cyber activities to these companies. This has allowed China to rapidly develop advanced military capabilities based on stolen designs

• Cyber Threats: The US defense industry remains under constant cyber threats from adversaries, with intellectual property theft and espionage on the rise. The US military could potentially face an advanced Chinese adversary armed with weapons developed from stolen American technology

About Us

Our team has 30+ years of combined experience as military officers using the end products. We’ve worked in both government and industry. From MIT to Wharton, Wall Street to biotech, and DARPA to the flightline, we offer you a unique perspective on how to navigate America’s defense tech industry.

The opinions expressed in this newsletter are solely those of the authors and do not necessarily reflect the views of DoD, our employers or any affiliated organization. This newsletter is for informational purposes only and is not intended to provide legal, financial or professional advice.