"Hey, we've got a problem here"
Will startups ever be able to compete against the primes?
Many people don’t realize that Tom Hank’s famous line in Apollo 13 is actually a mashup of two separate quotes spoken by astronaut Jim Lovell. “Hey, we’ve got a problem here” served to get NASA mission controls attention, and when the capsule communicator asked for Lovell to repeat the message he said, “Houston, we’ve had a problem; we’ve had a Main B bus undervolt.” But that’s a trivial digression.
Look, I know I’ve spent a lot of time writing about how Defense Tech and Dual Use startups can compete against primes, and why it’s important.
I’ve talked about using a roll-up strategy to create a new prime.
But events of the past few weeks have left me searching for new strategies and questioning how to best deliver innovation to the Defense Department.
The Data
Last week, Defense News released its Top 100 Defense Companies for 2023 (based on 2022 revenues).
This is the list of the 100 publicly-traded companies pulling the most revenues from the global defense industry. Please note, it’s not just U.S. defense companies.
The list shouldn’t hold any real surprises with the usual suspects topping it: Lockheed Martin had more than $63B in defense related revenues. Number 2, Raytheon (now RTX) had just under $40B. Northrop Grumman pulled in a bit more than $32B.
Notably absent from the list is Palantir, an AI darling focused on defense and intelligence use-cases. Palantir had a total of nearly $2B revenues with a little more than $200M of that coming from the DoD.
Now, Defense News put this list together using publicly available data, such as SEC filings, self reporting, etc. That’s the beautiful thing about analyzing an industry of public companies, it’s relatively easy.
By contrast, the Silicon Valley Defense Group had a far greater challenge in putting together its NatSec 100 list of the largest privately-held Defense Tech companies.
Nevertheless, they persisted and put together a respectable list topped by SpaceX, Anduril, Databricks, Sierra Space, and Chainanalysis. What’s really interesting, however, is that difference in revenues. During a call that explained their methodology and data, SVDG stated that while the NatSec 100 raised $40B in venture funding, the 100 largest private companies in Defense Tech only garnered about $2-4B in revenues.
It took 100 companies to earn less than 6% of what Lockheed Martin alone pulled in from defense sales.
The combined revenues of all 100 NatSec 100 companies would only sit somewhere around #30 - #50 on the Defense News Top 100 list. SpaceX, the largest private company in the world with a valuation somewhere around $150B only pulled in about $760M from defense revenues. Alone, it would make the Top 100 list, sitting around #84.
Number 2 private defense company, Anduril, wouldn’t even show on the Defense News Top 100.
So what?
The reality is that the defense industry remains dominated by a handful of companies that grew through consolidation from the 1980s to present. We can see that the “power law” with its massive disparity is absolutely in play—a very small number of companies earn a very large majority of the business.
So what should we take away from that?
The first take away is that building for defense is and will remain incredibly difficult. Founder, operators, and investors need to be prepared for a prolonged struggle to create sufficient revenues and turn a profit. But it can be done.
Secondly, I think that we continue to see a need for reform of the DoD acquisition and procurement processes, to continue to create an environment that is increasingly favorable to startups and consequently to innovation.
Third, I think that for many startups, they should consider a strategy that aims for acquisition as its exit. I had a great conversation with a good friend and Defense Tech founder this week about leveraging a strategy of being acquired to best increase innovation. In essence, a startup creates an innovative product, gains traction, and then exits through acquisition to scale the sale of that product leveraging the full power of the primes. In the best case scenario, this strategy gets that innovative product into the hands of the warfighter. If, for whatever reason, that product dies a quick death in the hands of the prime, the founder is hopefully freed up to create another innovative product to continue solving problems for the warfighter.
I remain hopeful that over time we will see continued reverse-consolidation of the defense sector. I think that will be the best thing for our national security and result in the greatest innovation. But these data point to the tremendous uphill climb for any company or portfolio of companies seeking to do that.
Nevertheless, it remains a worthy goal, so please,
Keep building!
Andrew