Are some of the behemoth defense companies like Lockheed Martin and General Dynamics losing some of their stature?

As new companies enter into one of the most risk-adverse business sectors, old guard companies like Raytheon and Boeing are watching their market getting a little more crowded, according to a new study from PwC.

It seems defense companies prerogative to pay their shareholders instead of investing in the future is coming back to bite big defense companies.

“They may have once ruled the military equipment landscape and even led in innovation but that doesn’t insulate them from hungrier, more determined competitors,” the report stated. “In its short life, SpaceX has already proven its ability to disrupt the defense business with a breakthrough that allows it to recover and reuse booster sections.”

New companies with more bravado and willingness to reinvest profits into research and development are starting to get attention from the Defense Department.

Executives at defense “companies must confront a critical imperative: change how you make decisions about capital expenditures and R&D spending to increase support for new technologies and partnerships with the goal of designing and engineering new products more quickly,” the study stated. “Accept uncertainty as part of the normal course of business; view it as an opportunity, not a danger. At the same time, collaborate with defense customers to tap into technology innovation outside the aerospace and defense industry and adapt it to future platforms rather than developing bespoke solutions.”

DoD has been asking for more innovative technologies for years. Former DoD acquisition chief Frank Kendall even scolded big defense companies in 2015 for putting their money in stock buybacks instead of reinvesting.

“Industry is doing a lot of stock buybacks, which I understand why they are doing it, that improves some financial metrics and so on, but I think a better investment for the long term is in technology for future products,” Kendall said.

A report by the Information Technology and Innovation Foundation found that R&D spending as a share of sales by defense contractors declined by nearly one-third between 1999 and 2012.

“In 1999, Boeing’s defense unit, L-3 Communications, Lockheed Martin, Northrop Grumman, and Raytheon spent a combined $2.4 billion on R&D, which represented 3.3 percent of sales. By 2012, that combined figure had grown by approximately 50 percent as sales more than doubled and R&D share fell to 2.3 percent of sales,” the report stated.

Defense company spending has gone up in the past year. Boeing, for example, spent the most in 2017 with $4.63 billion. That’s about 5 percent of its total yearly revenue. It’s also important to note that Boeing has a substantial commercial market.

Lockheed Martin spent $1 billion in research and development in 2017, about 2.1 percent of its sales.

Apple, one the other hand, spent $3.8 billion or 4 percent of its net sales on research and development in the first quarter of 2018 alone.

DoD started reaching its hand out to nontraditional companies during the Obama administration. DoD started what it called the Third Offset Strategy to counter tech growths in China and Russia.

During that time the Pentagon started a handful of initiatives like the Defense Innovation Unit Experimental to reach out to those companies and do business with them.

DoD also increased its use of other transaction authority agreements, which work with a consortium of companies, some of which much be nontraditional.

The PwC report offers some advice to the big defense companies: listen to your customer.

The report urges the companies to invest more in research and development and to team up with new, innovative companies to meet DoD’s demands.

To keep shareholders happy, the report recommends reducing expenses by “focusing on the assets, markets, business portfolio, technology, and core capabilities that provide the company’s competitive advantage.”

To change the risk-adverse culture of defense companies, the report suggests incentive and compensation programs for executives who make innovative investments decisions. The report also recommends mixing up the workforce.

“The average defense contractor’s workforce is skewed to a middle-aged demographic that is strong in developing and maintaining proprietary systems, but does not have the tech aptitude that increasingly drives weapons equipment efforts and advances today,” the study stated.

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