Despite the Pentagon’s efforts and reforms in recent years to attract more innovative companies into its ecosystem, it is still challenging for companies outside the traditional base to do business with the department, a new report finds. 

The Reagan Foundation and Institute graded the health and resilience of what it calls the U.S. national security innovation base. This concept includes a wide range of stakeholders, such as national security agencies, research centers, laboratories, universities, traditional defense contractors, startups, venture capital, and allies and partners. 

The report card gave the country a generous A- in innovation leadership; a strong B when it comes to funds available to national security innovation initiatives; and a B when it comes to the willingness of the private sector to work with the federal government.

But the U.S. got a tough grade in customer clarity, or the ability of the government to signal demand not just through communicating innovation priorities and issuing strategies, but also through providing stable funding and utilizing acquisition pathways available to the Defense Department to buy at speed.

While the government communicates its innovation priorities to the industry somewhat well, budget instabilities and limited application of novel acquisition pathways that the Pentagon continues to use as an exception rather than the rule is what lowered the grade.

“For the first 80 yards in the last 10 or 15 years, the clarity from the Pentagon has been 20/20. Whether it be the strategy documents they put out, the national security documents, the war games we are invited to. The red zone — I can understand some of the grades that were given,” Eric DeMarco, the president and CEO of Kratos Defense, said during the National Security Innovation summit Wednesday. “The companies that actually bring a product forward, it might not be 100% of the requirement, but it’ll be 90-95% of the requirements. They get to that red zone and then the traditional process takes over.”

While the Pentagon has signaled through various reforms that it wants to do business with small and non-traditional companies, the majority of contracts still go to the top defense contractors. 

And the top 25 Small Business Innovation Research awardees, some of whom received less than $100 million in funding through the DoD SBIR program, got less than $500 thousand in the subsequent round of awards, indicating that DoD awards companies that don’t transition their technology into production.

“If we do not have more production contracts, if we do not see startups winning programs of record, because you can only require Silicon Valley to be as patient as it can be for a little bit of time before people start saying, ‘Okay, it’s impossible to work with the DoD.’ So we do think there has been an extraordinary change in the way we communicate, extraordinary education on both sides within the DoD on how venture works, within venture capital on how the DoD works and the expectations there, but we have to see some more wins in the next few years or I do think we are going to see capital dry up,” Katherine Boyle, the general partner at Andreessen Horowitz, said. 

Last year, the Pentagon announced Replicator, the department’s program to field thousands of small, cheap drones. Congressional appropriations allocated more than $200 million in 2024 to push the effort forward, which could provide a boost in sales for smaller companies. Assistant Secretary of the Army for Acquisition, Logistics and Technology Doug Bush said the service is the biggest participant in the first round of the initiative so far. One system the service was working on made the cut for the initial round of the Replicator program, and the Army is already proposing several systems for the second round of the program. Air Force Vice Chief of Staff Gen. James Slife said the service has plans to participate in the second round as well.

And the Defense Innovation Unit, designed to connect technology companies with the Pentagon, just got a major funding boost. Congressional appropriators proposed an additional $800 million in the DIU accounts. That’s up from the $191 million enacted last year. 

Additionally, Bush said major reforms, such as Mid-Tier Acquisition and the Software Pathway are making a difference as defense officials are pushing Congress for more contracting flexibilities.  

“It does take time to filter through the system, but it’s becoming more normal to do, for example, a properly structured [Other Transaction Authority acquisitions] versus a FAR-based contract for certain activities. We’re moving away from fixed-price development, except in very exceptional cases; we’re able to go much faster with Middle-Tier Acquisition and Software Pathway, to get programs started, respond to urgent needs, and actually get something up in the field. So I think the loosening of the reins, so to speak, is having an effect, but we’re far from where we want to be,” Bush said.

How can DoD and industry traverse that last 20 yards?

“We are doing all of the things, we’re investing in the innovation base, we’re putting together DIU, we’re increasing SBIR spending, we’re communicating more openly about programs where companies are going to have a real shot, whether it’s Replicator or whatever. But actually transitioning that into real production is virtually impossible,” Trae Stephens, the co-founder and executive chairman at Anduril Industries, said. 

Stephens said that, in the end, it comes down to decision-making. 

“We can certainly offer hundreds, if not thousands of policy suggestions, authorities that need to be changed, ways that oversight can play into the process in more effective ways. But at the end of the day, I think it’s primarily just decision-making. If you assume you have all the policies, you need to make the right decisions; can we make the right decisions or not?” he said.

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