Home / Industry / Rising Merger mania, less spending on R&D driving Pentagon, defense contractors out of step on technology research and innovation

Rising Merger mania, less spending on R&D driving Pentagon, defense contractors out of step on technology research and innovation

In 2018, the Department of Defense (DOD) concluded that technology advancements among potential adversaries posed growing challenges to U.S. defense capabilities, putting U.S. battlefield superiority at risk. In this environment, DOD has renewed its efforts to foster innovation and secure technological supremacy.


In response , the Pentagon’s undersecretary for research and engineering in 2018 laid out several big idea research areas that would be most relevant to maintaining an edge on China or Russia. Griffin’s priorities for emerging technologies are: hypersonics (for offense and defense); directed energy; machine learning and artificial intelligence; quantum science, including encryption and computing; and microelectronics, he wrote in testimony submitted to Congress in April. “In all of these areas, we are establishing near, mid, and long term goals that are measurable,” said Griffin. Many are in the very early stages of maturation; the biggest breakthroughs are expected in the second half of the coming decade.


The mergers have been  a continual trend since cold war since then 51  aerospace and defense companies have shrank to five. Between 1993 and 1998, there was a burst of defense industry mergers and acquisitions. Some companies were sellers, for example, General Dynamics,
Loral (after 1996), Ford Aerospace, Texas Instruments, and North American Rockwell. Other companies were buyers, notably Raytheon, Martin-Marietta, Lockheed, Loral (before 1996), and Boeing.


The U.S. government  promoted defense industry consolidation in the past decade as part of its acquisition reform policies, to help control costs and promote efficiency. The purpose of the consolidation policy was to encourage mergers that reduced the level of assets allocated to defense. At the time, DoD focused on reducing physical assets: property, plant, and equipment. Total assets include tangible assets (physical assets plus working capital) and intangible assets or “goodwill.”They believe that the consolidation will offer American companies a competitive edge over foreign rivals in the contest to supply allies with military and civil aerospace hardware. The consolidation process came to an abrupt end in 1998, when DoD and the DOJ became concerned about the impact of industry consolidation on competitiveness. DoD turned down the proposed Lockheed Martin acquisition of Northrop and the proposed acquisition by (a reemergent) General Dynamics of Newport News Shipbuilding.


Defense mergers have accelerated recently, in part because of “early guidance from the new U.S. administration” that defense spending would be on the rise, consulting firm Deloitte said in a 2017 report. The mergers continued later when United Technologies bought Rockwell Collins for $30 billion, defense companies Harris Corp. and L3 Technologies agreed to merge in a $34 billion deal, and Northrop bought rocket-maker Orbital ATK for $9.2 billion.


Over past years  United Technologies sold its Sikorsky helicopter unit to Lockheed Martin, the Pentagon’s biggest contractor, for $9 billion.  In jan 2019, a California-based defense contractor, Parsons Corporation, announced  it would buy Virginia-based government contractor OGSystems for an undisclosed sum. The hardware manufacturer Textron Systems announced its purchase of Howe and Howe Technologies, a Maine-based manufacturer of robotic military vehicles.


There was a significant decline in the number of prime contractors and top system integrator companies in the defense-aerospace sector.  The five contractors doing the most business with the Pentagon in 2018 were Lockheed in the top spot, followed by Raytheon, BAE Systems, Northrop Grumman, and Boeing; United Technologies ranked 11th.


The latest deal is between Raytheon, already one of the top five US defense contractors,, builder of Tomahawk cruise missiles (acquired when it bought Hughes Aircraft in 1997, which acquired it when it purchased General Dynamics’ missile division in 1992) and ground-fired Patriot air-defense missile systems, with United Technologies. That company is a major contractor in its own right, with booming aerospace business—jet engines (including those for the F-35, as well as the F-15, F-16, and F-22) and cockpit electronics.  The  new company— known as Raytheon Technologies—would have annual sales of about $74 billion-  second only to Lockheed Martin.


The changes have given rise to concerns in some quarters that the shrunken defense industry won’t be able to rise to the challenge of another great military conflict and that the industrial base can’t be sustained, let alone reconstituted. In May, the Government Accountability Office (GAO) noted the dire effect of consolidation. Even though the Pentagon has cut four programs from its must-have list, the GAO said, its remaining 82 major programs had grown in cost by $8 billion, to a cool $1.69 trillion. “Portfolio-wide cost growth has occurred in an environment where awards are often made without full and open competition,” the Congressional watchdog agency added. “Specifically, GAO found that DOD did not compete 67 percent of 183 major contracts currently reported for its 82 major programs.” Nearly half of those contracts—47 percent—went the current Big 5: Lockheed, Boeing, General Dynamics, Northrop, and United Technologies.


The Justice Department is the federal agency that reviews such mergers, with input from both the Pentagon and the Federal Trade Commission. The Pentagon’s Office of Industrial Policy is primarily focused on the national security impact of such consolidations that might reduce military might, while Justice and the FTC are more concerned with broader antitrust issues that could lead to military-hardware monopolies.


Government Accountability Office report, released in October 2017, details problems the services are having keeping the F-35 fleet ready for combat. One problem it highlighted was that, at a time when the Pentagon is desperate to ramp up production of new aircraft, the services have to wait an average of 172 days—nearly six months—to repair components for the F-35 Joint Strike Fighter (JSF), when it should only take between 60 and 90 days. The report revealed a much more fundamental and systemic problem involving most of the latest high-tech weapon systems: Defense contractors are creating complicated support systems for the increasingly complex weapon systems the Pentagon buys, which allows the contractors to secure long-term contracts for which they have no competition from other companies.


These mergers are also leading to Less competition that can  dampen innovation. When  one company is innovating they all have similar vision and mission of the company but when two companies merge, it may lead to the confusion among its employees of the vision and mission of new company and resulting loss in motivation and innovation.


The innovation is also dmpenng as defense contractors are spending less on R&D. Those data show in 2018, information technology companies invested far more in R&D than defense contractors. Amazon leads the pack with $23 billion in R&D spending, followed by Alphabet, the parent company of Google, with $16 billion. Intel, Microsoft, and Apple each invested from $12 to $13 billion in R&D last year. The largest R&D investments by defense contractors were Boeing and United Technologies, with $2 to $3 billion each.


In addition GAO found that defense contractors spend more on incremental innovation than on disruptive innovation.


Contractors spend most of their money on safer bets, GAO  found in 2020

In 2020, GAO  has found that defense contractors in the past four years have been putting only 40 percent of their independent research dollars, sometimes called IR&D, against those priorities. GAO analyzed the data of top Defense Industry Companies  in their Department of Defense Independent Research and Development Engagement Lockheed Martin,  Raytheon Company, BAE Systems, Inc.,  Northrop Grumman,  Boeing Defense Space and Security, General Dynamics Mission Systems,  L3Harris,  Pratt and Whitney,  Huntington Ingalls Industries and Ball Aerospace. Specifically, their selected sample included six contractors that had the highest annual IR&D expenses and corresponding revenues attributable to DOD contracts. These six contractors developed and produced a wide range of DOD products such as aircraft, sensors, satellites, and armored vehicles, among others.


The Defense Business Board defined three types of research and development conducted by the defense industrial base.

  1. IR&D is conducted by contractors undertaking research and development activities of their choosing for which costs are reimbursed, in part, with government funds. The amount reimbursed by DOD depends on a number of factors, including the percent of the contractor’s business base for which DOD accounts and the indirect cost factors negotiated with the government.
  2. Contracted Research & Development is the primary external method DOD uses to identify and develop new technologies. In contrast to IR&D, DOD awards research and development contracts to contractors using Research, Development, Test and Evaluation. (RDT&E) funding and specifies within the contract the objectives for research and development work DOD expects the contractor to
    pursue. DOD also uses its RDT&E appropriations to develop and test new weapon systems, among other products. A subset of RDT&E
    funding is specifically identified to fund science and technology (S&T) efforts.
  3. Self-funded, or company-funded, research and development expenses are paid out of a company’s own capital and return on R&D
    investments would come through higher profit margins. Most selffunded research and development within the defense industry is
    performed by companies that also have commercial divisions


DOD has long relied on the defense industry’s Independent Research and Development (IR&D) as a key source of such innovation. The unique business environment in which many defense contractors operate—DOD is often their primary or only customer—incentivizes them to pursue IR&D projects that they anticipate will be of interest to DOD and offer potential future business opportunities. This dynamic contributes to a natural feedback loop that exists between DOD and the defense industry regarding IR&D. Essentially, contractors rely on DOD to communicate its modernization needs as a key input to the IR&D projects they choose to undertake, and DOD relies on contractors to share information about these projects to inform DOD of industry’s progress in advancing technology.


Allowable Independent Research and Development (IR&D) Project Categories

Research category                                               Description

Basic research : Basic research is directed toward increasing knowledge in science. The primary aim of basic research is a fuller knowledge or understanding of the subject under study, rather than any practical application of that knowledge.

Applied research :Applied research is the effort that (1) normally follows basic research, but may not be severable from the related basic research; (2) attempts to determine and exploit the potential of scientific discoveries or improvements in technology, materials, processes, methods, devices, or techniques; and (3) attempts to advance the state of the art. Applied research does not include efforts whose principal aim is design, development, or test of specific items, or services to be considered for sale. These efforts are within the definition of the term “development.”

Development:  Development means the systematic use, under whatever name, of scientific and technical knowledge in the design, development, test, or evaluation of a potential new product or service (or of an improvement in an existing product or service) for the purpose of meeting specific performance requirements or objectives. Development includes the functions of design engineering, prototyping, and engineering testing. Development excludes— (1) subcontracted technical effort that is for the sole purpose of developing an additional source for an existing product; or (2) development efforts for manufacturing or production materials, systems, processes, methods, equipment, tools, and techniques not intended for sale.

Concept and system studies: Analyses and study efforts either related to specific IR&D efforts or directed toward identifying
desirable new systems, equipment or components.


The primary statute governing IR&D at DOD is 10 U.S.C. § 2372.  The regulations of 1991 encourage contractors to engage in research and development activities of potential interest to the DOD, including activities intended to accomplish any of the following:
1. Enabling superior performance of future United States weapon systems and components.
2. Reducing acquisition costs and life-cycle costs of military systems.
3. Strengthening the defense industrial base and the technology base of the United States.
4. Enhancing the industrial competitiveness of the United States.
5. Promoting the development of technologies identified as critical under section 2506 of this title.
6. Increasing the development and promotion of efficient and effective applications of dual-use technologies.
7. Providing efficient and effective technologies for achieving such environmental benefits as improved environmental data gathering,
environmental cleanup and restoration, pollution reduction in manufacturing, environmental conservation, and environmentally safe management of facilities.


In 2016, Congress amended the statute. It Deleted the provision to encourage contractors to engage in research and development activities of potential interest to the DOD. It  Did not include the requirement encouraging contractors to engage in the seven IR&D activities of potential interest to the DOD


But GAO found that defense contractors in the past four years have been putting only 40 percent of their independent research dollars, sometimes called IR&D, against those priorities. Specifically, that report found that disruptive innovation projects are those that carry a higher risk of failure, but significant rewards via potentially breakthrough technology in the longterm. The report also found that incremental innovation projects are lower risk efforts intended to be integrated quickly into near-term products.


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