In response to a new era of geopolitical uncertainty and a rapidly shifting national security environment, countries across the world are transforming their military capabilities. And, as new mission needs in this transformation take shape across multidomain operations, different tools are in demand—increasingly supplied by a range of new entrants to the defense industry.
National security customers are showing demand for technologies sourced by firms outside the traditional defense industrial base. This dynamic is not new but has materialized in three distinct waves of defense tech start-ups over the past 20 years (exhibit).
For example, in the United States, SpaceX and Palantir were notable companies in the first wave in the early 2000s; both designed technology for government channels other than the Department of Defense.1 A second wave began in the mid-to-late 2010s, represented by new entrants like Anduril and ShieldAI—both now unicorns—that leveraged commercially derived technology tailored to defense applications (such as sensor fusion at the edge and AI pilots).2 A third wave of disruption is now on the rise—a much larger ecosystem of start-ups and nontraditional companies that are driving innovation, attracting significant venture capital (VC) funding, and looking for the means to scale.
In many cases in Europe and the United States, these start-ups (along with their commercial hyperscaler counterparts) are well positioned to fulfill critical national security needs, complementing the traditional industrial base that might not have enough capabilities to respond to evolving demands on its own.3 Before large-scale solutions can be reliably supplied for national security users, however, challenges need to be overcome. Effective strategies tailored to fit defense customers could ease the journey, and leveraging dual-use technology (suitable for both military and nonmilitary applications) could be critical to accelerated growth for successful organizations in this environment.
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New defense priorities spur new technology needs
For several decades, national security agendas focused primarily on asymmetric and transnational threats such as terrorism and cybercrime. However, sometimes the uncertain global geopolitical environment can cause peer and near-peer competition, as evidenced in the national security strategies published since 2022 in Germany, Japan, the United Kingdom, and the United States.4 These strategies can lead to demand for new technologies to increase resilience and efficacy—in particular, technologies that will support new disaggregated and “joint all-domain” concepts. We have noticed that there is a call for three overlapping sets of capabilities:
- Disaggregating capabilities: By disaggregating capabilities into networks of smaller nodes, force planners can reduce points of failure and increase the likelihood of successful missions connecting air, land, sea, and space assets. This could improve operational coverage while boosting resilience. Instead of one high-value satellite, for example, the preference might be for an array of smaller, linked satellites; instead of one manned submarine, a coordinated fleet of unmanned underwater vehicles.
- Effective communication networks: For such disaggregated assets to function collectively, real-time intelligence sharing—enabled by resilient and effective communication networks—is important. Resilient networks can ensure instant communication between assets (meshing sensors to effectors) and allow for smooth, responsive operations. Resilient network-enabling technologies such as 5G, phased-array antennas, artificial intelligence (AI), and high-density computing can enable the movement of responsive decision making to the tactical edge where they can have the greatest mission impact.
- New technologies: Engineering high bandwidth, resilient networks would likely involve retrofitting existing platforms—or developing entirely new architectures (such as AI-powered command-and-control systems that connect users across services and collation partners in air, land, sea, and space). The density of technology-enabled mission systems is likely to continue to increase for the foreseeable future. Either way, new technologies—including decentralized cloud computing, data management, edge analytics, autonomy-enabling systems, and a plethora of hardware solutions and novel materials—are frequently cited capability needs.
In addressing these needs, the traditional defense industrial base can bring various strengths to national security customers: for example, an understanding of specific missions; deep technical expertise in designing for those missions; long-established security protocols and infrastructure to host classified data; business development, customer relationships, and acquisition; program management excellence; and integration opportunities within existing, installed platforms.5
These capabilities alone, however, may no longer be enough. In response to evolving needs, a new generation of security tech companies has materialized. This new cohort features both start-ups and commercial technology hyperscalers and can offer different but complementary benefits:
- greater spend on high-risk R&D, relative to size, than the average defense contractor
- top-tier software and a new generation of STEM talent with fluency in digital technologies such as AI, quantum computing, and advanced microelectronics
- product-oriented business models that tend to be faster, cheaper, and more innovative
- a focus on commercially priced, scalable products and services
The European Union and the United States have signaled interest in these novel capabilities. The US Department of Defense has taken steps to access commercial technology through new acquisition and budgeting authorities—for example, increasing the prominence of the Defense Innovation Unit and establishing the Replicator initiative in 2023 to rapidly field autonomous, attritable systems.6 NATO has formed an innovation accelerator (DIANA) to foster collaboration with start-ups and other tech companies, and has announced the €1 billion NATO Innovation Fund focused on dual-use technologies.7
Private capital has also indicated an intent to pursue defense tech opportunities, and we have observed that VC investment in such technologies outpaced the overall growth in venture spending between 2019 and 2023. Meanwhile, traditional defense firms have increased their corporate venture funds to be able to access the emerging tech.
New defense tech companies face obstacles
Despite this momentum, many next-generation defense tech firms have struggled to do business at scale with national security organizations.8 This is likely due to three main challenges:
Reconciling program-centric versus product-centric operating models. National security customers often seek bespoke solutions to very specific problems versus an “out of the box” commercial offering. With limited access to classified information and other sources of insight, tech firms can struggle to understand the precise nature of these problems. The effort to tailor an existing solution to the “last mile” in defense may also not be compatible with the commercial scale business models favored by tech companies.
Building a go-to-market muscle for defense markets. New defense tech companies can be constrained by unfamiliarity with the government sales and contracting landscape. Scaling a solution in defense markets requires a robust government affairs operation and an understanding of unique government procurement processes. Start-ups, in particular, often lack a track record of performing on programs of record at defense agencies, which can be an important requirement for winning new contracts.
Aligning revenue timelines with investor expectations. Government contracting often offers an atypical return profile to private capital (such as VCs and growth equity) that has become the primary backer of defense tech start-ups. Private investors tend to look at three- to five-year horizons for returns—which can be out of sync with the slower (traditionally seven- to ten-year) pace of defense programs of record. A start-up may run short on funding before consistent revenue from government contracts begins to materialize. This mismatch is likely to deter private investment.
Public markets are unlikely to fill this gap entirely, given their emphasis on short-term results and an aerospace and defense investor base that often emphasizes stable cash flows versus at-risk investments in novel technologies. Meanwhile, governmental entities in Europe and the United States generally invest less in innovation than their private sector counterparts: for example, the US national security community has recently been spending less than 5 percent of its total budget on developing innovative technologies, whereas a typical commercial technology firm spends three to four times that share of revenue annually.9
Successful defense tech disruptors use five strategies
How to tackle these challenges? Lessons learned from successful defense tech companies include five strategies that they effectively employ.
Lay the infrastructure for scaling from the outset. Most defense tech companies ultimately become hardware companies, and many are now facing the same scaling challenges as their more at-scale peers and competitors—such as maintaining manufacturing speed and quality, resilient supply chains, and machining or technical talent. Building scaling infrastructure into the initial plan, from prototyping resources onwards, can make the difference on time to market.
Lower barriers by leveraging more established partners. Once a product’s validity has been demonstrated, partnership with an established industrial defense company could facilitate its entry to market. Established suppliers can bring installed bases, mission expertise, and customer familiarity that complements tech companies’ capabilities. Established suppliers often shape access to the aircraft, land systems, and ships that new mission systems will be integrated into by providing the “socket” into which a disruptor’s “lightbulbs” can plug. The list of recent partnership announcements between defense tech disruptors and traditional defense organizations span hardware and software across a range of technology focus areas, including 5G, hypersonic aircraft, autonomy for next-generation tactical aircraft, AI, and edge networks.10
Take, for example, defense disruptor, Helsing, which was able to get to a program of record in fewer than three years by partnering with an existing defense prime (Saab). Helsing’s AI and signal processing expertise complemented Saab’s hardware-based sensors and self-protection systems. As a result of the two companies growing closer, Saab in September 2023 made a sizeable investment of €75 million in Helsing’s most recent venture round, at an overall valuation of €1.5 billion.11
Go dual use. Purely can struggle to achieve scale defense-focused start-ups before investors become frustrated with delays. But, companies that find nonmilitary applications for their technologies can build scale in commercial markets, while buying the time needed to secure a long-term defense contract. However, pursuing dual-use innovations may also mean designing a two-speed business model to accommodate disparate timelines and unique international security requirements.
Strong demand and healthy capital inflows have allowed certain dual-use tech organizations to thrive. Private investors, who have a higher tolerance for risk than public markets or government R&D appropriators, in many cases are looking to back dual-use technology, given its large potential returns and broad applicability.12
Vertically integrate to provide software and hardware in one solution. Defense customers generally are comfortable with purchasing integrated hardware and software products, rather than stand-alone software capabilities that can be applied to a range of hardware. For tech disruptors, opting to sell a piece of differentiated software packaged within hardware can be beneficial (for example, a fleet of ready-to-deploy drones rather than a drone operating system).
Tailor sales capabilities to the customer. Selling to defense customers can be a challenge if a company hasn’t set up a government affairs unit with proper clearances and extensive experience. Tech companies can look beyond a defense organization’s broad requests for proposals and focus on communicating with potential customers about granular needs.
Defense oriented technology is a vital and enduring component of national security. Start-ups, scaled commercial organizations, traditional defense contractors, and investors all have roles to play in integrating innovative new technologies into the defense ecosystem.
