DoD’s Kendall wants more research spending from industry

The Defense Department is continuing to push industry to do more of the lifting in the research and development sphere, as the trend continues of defense contractors spending a small portion of their revenue on innovation.

Frank Kendall, DoD’s undersecretary of acquisition, technology and logistics said he “would like industry to make greater investments” in innovation, during a Nov. 7 speech at the Reagan National Defense Forum in Simi Valley, Calif.

“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.

Stock buybacks are when companies buy back stocks from investors to make shares more valuable to those who still own stakes in the company.

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DoD requested about $75 billion for research and development for fiscal 2016 — that’s about 12 percent of the entire defense budget. On the other hand, Wesley Bush, CEO of Northrop Grumman, said his company spent about 4 percent of its revenue on R&D this year.

That trend stays steady for most defense companies. Boeing spent a little over $3 billion in 2014 for R&D, about 3 percent of its total revenue, states a report by AeroWeb, an aerospace and defense market company.

Similarly, Raytheon spent $500 million in 2014, only 2 percent of its total revenues.

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.

A lot of the government money for R&D goes to subsidizing defense companies’ R&D. For example DoD awarded an $80 billion contract to Northrop Grumman last month. DoD will fund the R&D for that contract, Kendall said.

That money, however, is not factored into the percentage that companies report as R&D spending. When Kendall said he wants industry to invest in R&D, he meant by using company funds.

Non-government technology companies, by comparison, spend billions more and a much higher percentage of their revenues on R&D. Apple spent $2 billion on R&D in the first quarter alone of 2015. Samsung spent $13.4 billion in 2014 on R&D and Microsoft spent $10.4 billion.

Keeping a technological edge

DoD recently has turned to some of these companies to keep its technological edge.

Gwynne Shotwell, president and COO of SpaceX, said defense industry R&D spending is “incredibly low” and that a huge part of the reason defense companies have an innovation problem is because of the low funding.

Defense companies, however, say that the marketplace is different from the commercial marketplace.

“The investments required are very large and they are very long term before you get a return,” Kendall said. “We buy in many cases very specialized, very complicated, very expensive products that take a long time to develop and we buy them in an environment in which the assurance that there’s going to be sales is kind of limited.”

Bush said private R&D is a very limited view of what defense companies do. He said Northrop Grumman’s scientists usually have no idea if the project they are working on will translate to the marketplace.

“If we are going to have the technological superiority we keep talking about, the only way we get there is to ensure that we are developing that capability long before it is ever available commercially,” Bush said. “It’s easy to say as a commercial company I’m investing X percent in R&D and have that X sound very big … but it is actually an invalid comparison of what is happening in the different companies.”

Bush said his company is making investments in products it will not commercialize and the moment it is commercialized it begins to “wash away” technological superiority.

That, however, does not take into account if companies later release technologies commercially once the technology gap has been closed by adversaries.

DoD is asking for more investment in R&D at a time when the department is trying to further its technology beyond that of its adversaries.

Kendall said in some areas he thinks U.S. rivals already have bridged the technology gap. In reaction to that concern, last year DoD announced the Defense Innovation Initiative, which will invest heavily in cyber, space and other high tech areas.