The Pentagon funnels billions of dollars into a handful of defense contractors. But the technology that the military really wants is largely being produced by commercial companies with cutting-edge R&D departments. The military-industrial complex as we know it is coming to an end.

Writing in the journal Foreign Affairs, William J. Lynn III—a former U.S. deputy secretary of defense who was once a lobbyist for Raytheon—warns that the Pentagon still relies too much on defense companies that are lagging further and further behind large commercial companies in terms of technology investment.

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Consider, for instance, Google's acquisition of Boston Dynamics, the robotics company best know for creating mechanical beasts such as BigDog, a four-legged robot that can accompany soldiers into rough terrain. Although Google agreed to honor Boston Dynamics' existing defense contracts, it indicated that it likely would not pursue any additional military work. That's a sign that the Pentagon could lose its edge in the emerging field of autonomous robots, which once fell almost exclusively under its domain.

The Costs Of Consolidation

A few decades ago, this wouldn't have been a major concern. When World War II ended, the large, diversified industrial conglomerates that had produced equipment during the war maintained their defense divisions. These companies, joined in later years by AT&T, General Electric and IBM, passed technology fluidly between markets. Backed financially by the Pentagon and benefiting from long production runs, they created technologies ranging from drones to night-vision goggles, some of which—such as the Internet and GPS—eventually found their way into our daily lives.

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But, in the early 1990s, amid shrinking defense budgets in the aftermath of the Cold War, the Defense Department told companies to consolidate. The defense industry shifted away from diversified conglomerates, which could tap into their reservoirs of commercial tech. The result was multiple mergers, creating a handful of companies that focused exclusively on defense and still dominate the industry today.

As a result, Lynn notes:

Although the Pentagon historically exported many technologies to the commercial sector, it is now a net importer. Indeed, next-generation commercial technology has leapt far ahead of what the defense industry can produce in areas spanning 3D printing, cloud computing, cybersecurity, nanotechnology, robotics, and more. In addition, commercial information technology dominates national security today as much as it does the private sector. Soldiers now use smartphones to gather real-time surveillance from drones and send messages to fellow soldiers.

Keeping up with commercial innovations will be difficult, if not impossible. The combined R&D budgets of five of the largest U.S. defense contractors (about $4 billion, according to the research firm Capital Alpha Partners) amount to less than half of what companies such as Microsoft or Toyota spend on R&D in a single year. Taken together, these five U.S. defense titans do not even rank among the top 20 individual industrial investors worldwide. Instead of funding R&D, defense companies have been returning the overwhelming majority of their available cash to shareholders in the form of dividends and stock buybacks. As a result, from 2000 to 2012, company-funded R&D spending at the top U.S. defense firms dropped from 3.5 percent to roughly two percent of sales, according to Capital Alpha Partners. The leading commercial companies, by contrast, invest an average of eight percent of their revenue in R&D.

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Of course, the defense market is different from commercial markets in that the customer —the Pentagon—funds much of the R&D. But this budget has declined as well. Defense companies are therefore reluctant to invest their own cash in research that, because of uncertainty in the Pentagon's budget, may never yield viable products.

The Defense Department, Lynn says, should be courting commercial companies, many of which will not seek out defense contracts themselves. Instead, the Pentagon has made it so difficult to bid on defense contracts that many companies shy away. Some don't want to comply with what they see as unnecessary requirements. For instance, several software developers have turned down defense work because they fear they would have to relinquish the intellectual property rights to whatever they produce. Others are driven away by the extensive regulations for the acquisition of weapons that require companies to establish new and costly accounting systems.

As such, Lynn recommends new approaches that would effectively end the dominance of a handful of defense contractors:

Officials have discussed overhauling the Pentagon's Byzantine procurement system for decades and have instituted modest reforms, including relying more on independent cost estimates and weapons testing. But the gains have not kept pace with the rapid technological and industrial change in the commercial sector. Future reforms should move beyond improving costs and timeliness to lowering barriers to entry for commercial companies. The Pentagon can attract companies such as Google by loosening its stringent intellectual property rules, streamlining its audit and accounting requirements, and shortening development cycles. Sticking to the status quo will only put further distance between Washington and Silicon Valley.

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