Reed Simmons
Dual-use and defense technologies are at an inflection point. The return of great power competition has demonstrated the geopolitical importance of technological dominance. From semiconductors to AI, maintaining advantages in critical technologies is key to both national security and economic prosperity. As such, commercial and government investment incentives are increasingly aligned, presenting a growth opportunity for entrepreneurs and investors alike.
Haven’t we heard this hype before? A decade ago, the Obama Administration spearheaded many initiatives to bring Silicon Valley technology to government. But divides remained -- symbolized by Google’s 2018 Project Maven revolt.[i] For builders and investors in sectors where commercial interests and the public purpose interact, it is easy to conflate what one wants to succeed with what is profitable and technically feasible.
Yet there are reasons to believe the dual-use and defense technology sectors are on sure footing. Driven by the confluence of geopolitical, technological, and market forces, a transformation is occurring that describes a secular growth story – one that is resilient to the current market fluctuations. This is reinforced by four trends:
Business Model Innovation
Traditional defense models are based on cost-plus procurement. This overoptimizes for exquisite, yet expensive platforms. Its legacy of long-lead times, misaligned incentives, and requirements-driven investment constrained defense innovation to the speed of bureaucracy as opposed to the speed of technology. A new supply-side model is emerging. Rather than waiting on specific DoD requirements, companies like Anduril are building capabilities to mission, aligning risk and reward incentives, and enabling faster product development and iteration. The new model charges based on affect as opposed to one-off platforms, placing the onus of relevancy on the company rather than the government. Its success is breeding emulation. Companies like Saildrone, Rebellion Defense, and many more are offering the DoD capabilities faster and at lower cost than the traditional model is capable of.
On the demand side, the DoD knows it must become a better buyer. Much has been written on the Small Business Innovation Research (SBIR), Small Business Technology Transfer (STTR) and other integration programs – these are helpful but incomplete.[ii] Probably the most successful cross pollination initiative is the Defense Innovation Unit (DIU). DIU’s accelerated open solicitation, bidding, and contract process has been integral to the supply-side transformation, including awarding Anduril some of its first contracts. But there is a long way to go, particularly in software. Here the speed of change is faster and the need for constant updates essential. Private companies are not standing idly by. One example is Second Front Systems, which enables containerized SaaS applications to streamline the Authority to Operate process for use within government. If successful, such solutions will further unlock the massive DoD budget for commercial software companies.
Commercialization of New Domains
Technological advances are creating new markets and reinvigorating old ones. Perhaps the most striking example is outer space. Once the exclusive purview of governments, access is democratizing. Indeed, commercial constellation growth now outpaces government.[iii] The reasons for this are many, but crucial are accommodative government policies and declining launch prices – a phenomenon made possible by technological progress.[iv] This has opened entirely new markets from mining, manufacturing, and tourism and enabled further advances in communications, earth observation, and defense. Is the new space economy sustainable? Contrary to popular belief, government budgets are not the primary source of demand. Already satellite services and ground equipment make up more than two thirds of the $386 billion global space economy.[v]And demand signals will continue to proliferate as the space ecosystem integrates with the terrestrial economy.
The downstream effects of the space economy have a long tail. New aerospace manufacturing companies like Hadrian are pushing the frontiers of industrial efficiency. Their production advances using robotics, computer vision, and material sciences may power productivity in other sectors. And space is not the only example. Other dual-use technologies like AI, autonomy, and quantum computing also have the potential to radically transform previously static industries.
Expanding Security Awareness
The Colonial Pipeline cyberattack, Russia’s invasion of Ukraine, Covid, and technological competition with China—to name just a few—have injected a security consciousness within the corporate board room. Where “efficiency” previously reigned, now “resiliency” is an optimized function. Corporate spending patterns bear this out. Cybersecurity’s share of the corporate IT budget continues to climb, with overall security spending expected to reach $188 billion in 2023—an 11.3 percent increase despite recessionary concerns—and 66% of CIOs placing it as a top priority.[vi][vii] Moreover, rising geopolitical awareness and Covid disruptions are forcing corporations to reassess their operational and supply chain integrity. Over 1000 companies curtailed operations in Russia after the invasion, while many others are reevaluating their reliance on China.[viii]
New geopolitical realities present opportunities for domestic industry. They also make hardening the digital attack surface and securing critical components commercial and national security imperatives. Governments are taking the initiative. The recent CHIPS Act seeks to re-shore critical semiconductor production. “Friendshoring”—a new buzzword—captures similar aims for the macro supply chain. Will any of this work? Hard to know, but recent memory provides few parallels for such a confluence of forces pulling in the same direction. As Marc Andreessen put it, “It’s time to build.”[ix]
Availability of Private Capital
The dual-use and defense investor ecosystem is expanding. First In, Shield Capital, Razor’s Edge, A16z, 8VC, Lux Capital, Founders Fund, Point72 and many more are raising and deploying funds into dual-use and defense-adjacent technologies. Such firms represent potential partners, co-investors, and follow-on capital, creating a sustainable capital market. So far this year, over $7 billion has been invested in VC-backed aerospace and defense companies, putting the sector on track to surpass its previous high.[x] This figure does not include other dual-use and defense-enabling technologies like cybersecurity and AI—sectors with large commercial addressable markets and established exit opportunities. Moreover, the proliferation of defense-minded funds injects expertise into the technology community on how to sell to DoD, take advantage of grants, and scale sustainably. Like larger consulting firms, VCs spread best-practices to portfolio companies, continuous improving execution.
Yet as 2021 demonstrated, invested capital can be a weak proxy for commercial health. There will certainly be misses in this sector, as dreams lose their shine and animal spirits outpace economic reality. But fundamentals are aligning such that the overall sector continues to expand. The dual-use and defense sectors have come a long way from Project Maven. There is much to be done. Still, the future is bright – and it needs to be. For unlike in the first Cold War, when technological leaps often occurred within government, the centers of innovation have shifted to the private sector. China’s mandatory “civil-military fusion” policy has focused the West’s attention on integrating commercial and defense technologies. The necessity to compete will continue to foster innovation and growth for the years to come.
No comments:
Post a Comment