Last week, Secretary of Defense Ashton Carter visited Silicon Valley in pursuit of closer ties with America’s premier center of technological innovation. Carter told executives at Facebook and other tech companies that the Pentagon wants to fashion a partnership enabling the military to leverage the latest commercial innovations, thereby maintaining its warfighting edge over potential adversaries. He announced creation of a “defense innovation unit” in Silicon Valley to facilitate sharing of technology and skills relevant to military needs.
There’s nothing new about Pentagon leaders trekking to California in pursuit of cutting-edge technology. A generation ago, that quest led mostly to aerospace companies. But the aerospace companies were heavily dependent on government largesse for their success, and today’s tech companies are not. So Carter has quite a selling job to do, because the San Francisco-San Jose area has never been noted for its martial spirit. Here are five reasons why tech executives are likely to recoil in horror when they realize what it means to work with today’s Pentagon.
1. The margins are lousy. The most successful tech companies are accustomed to generating returns that match their innovative performance. Apple and Google last year produced operating margins in the 30% range, while Facebook and Intel were around 40%. In Washington, that kind of profitability would earn contractors an investigative hearing before the likes of Senator McCain. The biggest, most successful defense companies typically generate operating margins in the 14-16% range, and the Pentagon has policies for preventing them from making much more. For instance, Lockheed Martin’s F-35 fighter is one of the greatest technological achievements of this generation, but after 14 years of work, the company’s profit margin on the program has yet to break into the double digits.
2. Intellectual property is at risk. Pentagon policymakers have gotten religion about the need to develop combat systems that use open architectures and modular designs so that the systems can be readily adapted to changing threats. However, they think the only way to assure future adaptability is to control the intellectual property at the heart of systems — even if it was developed using company funds rather than taxpayer money. Secretary Carter was at pains during his Silicon Valley visit to assure wary executives that their IP would be protected if they partnered with the Pentagon, but recent policy trends within the five-sided building aren’t encouraging in that respect. And Congress gets a vote on just how protected contractor property will be.
3. The regulatory burden is stifling. The Founding Fathers wanted a government of laws, and not of men. What we actually got was a government of lawyers. There are literally thousands of pages of regulations specifying how contracts must be awarded and administered. Many of these rules impose burdens unheard of in the private sector such as how much can be charged for a product, what kind of compensation executives can receive, and what sorts of subcontractors companies must use in assembling a supply chain. Former Deputy Secretary of Defense John Hamre has estimated that the cumulative burden imposed by all these regulations adds 30% to the cost of a typical acquisition program. So the business environment for Pentagon contractors is more like an Ayn Rand dystopia than a setting conducive to entrepreneurship.
4. Bureaucrats don’t trust market forces. Having suffocated innovation among its traditional suppliers, the Pentagon now must look elsewhere for help in keeping up. However, it is culturally incapable of embracing the commercial practices that made places like Silicon Valley innovation hubs. Look at what happened to United Technologies (a contributor to my think tank) when it sought to use a commercial contract to support the military version of a jet engine it had developed with its own money. The Pentagon’s inspector general subpoenaed information the company wasn’t even required to collect, hinting that the government was being overcharged — even though the Air Force customer had already ascertained it was saving billions of dollars by being charged the same rates as commercial operators.
5. The real customer is a political system. When you do business with the Pentagon, your customer isn’t a military service or a defense agency — it’s a political system. That means considerations like cost efficiency and operational suitability are often subordinated to the imperative of getting reelected. So bad ideas with hard-wired constituencies get funded year after year, while good ideas that lack a constituency get neglected. The judgment of military professionals is ignored when it isn’t politically convenient, and technology programs are routinely raided if legislators need a bill-payer. Tech entrepreneurs who try to work within this system invariably come away frustrated.
Secretary Carter’s outreach to Silicon Valley recalls a similar foray two decades ago, when the Clinton Administration wanted to reap a “peace dividend” by not investing in new military equipment. So it proposed acquisition reforms that would enable the Pentagon “to exploit technological advances in the commercial sector of our economy more effectively.” That strategy was quickly forgotten once the money started flowing again after 9-11, and that’s what will happen this time around too – a new threat will materialize, and policymakers will realize they don’t need to change their stripes to keep up. That’s one reason defense executives aren’t worried they will lose market share to Silicon Valley.
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