How will US funding for defense technology innovation evolve?

Companies that focus on defense technology innovation will benefit from a strong understanding of the US Department of Defense budget.

The United States and its allies operate in an increasingly complex security environment, and defense technology is rapidly advancing in response. The Pentagon recognizes the challenges ahead and has recently made public statements that emphasize the importance of prioritizing science and technology innovation to maintain the US military’s edge. 1 US policy makers are also looking to the private sector—commercial companies and nontraditional defense contractors—to accelerate technology development and application. 2 The 2022 US Department of Defense (DOD) budget also included a record research, development, test, and evaluation (RDTE) request.

US policy makers are also looking to the private sector—commercial companies and nontraditional defense contractors—to accelerate technology development and application.

But when it comes to innovation, how much funding is readily available, and which organizations receive it? And which technologies are major targets for investment? These questions are critical for both defense firms and investors considering opportunities in the segment. To answer them, we assessed the DOD’s R&D budget for defense technology innovation, which we defined as investment in early-stage science and technology programs, technology development, prototyping initiatives, and pilot programs related to AI software and digital technologies.

Our analysis revealed that innovation funding accounted for only $34 billion of the $857 billion US national-security budget for 2022—approximately 4 percent of the total (Exhibit 1). Notably, that share has not changed significantly over time.

US funding for defense technology innovation is a small subset of total national-security spending.
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With such relatively low funding for defense technology innovation, it is unclear whether there will be enough capital to support the high-tech priorities embedded in the DOD’s future architecture designs. Similarly, defense start-ups and commercial technology firms (as well as investors across public and private markets) may question whether the demand for defense tech innovation is sufficient to justify a focus on these offerings.

The percentage of the US security budget devoted to defense technology innovation is not expected to change meaningfully over the next five years, based on the DOD’s plan for fiscal year 2023. In dollar terms, funding could rise from $34 billion today to $40 billion in 2023 and then remain largely flat through 2027 (not including inflation changes and congressional add-ons).

The DOD has allocated another $92 billion to late-stage R&D—more mature platforms—in its fiscal year 2023 plan. Since traditional platform primes typically win most late-stage R&D funding, nontraditional providers are more likely to find opportunities by attempting to secure a portion of the $34 billion in DOD RDTE funding that goes to defense technology innovation.

The DOD’s latest Future Years Defense Plan also provides insight about trends related to specific technologies (Exhibit 2). Air platforms and platform systems, hypersonic and strategic strikes, air and missile defense systems, and space and space-based systems are among the areas receiving the greatest portion of funding for defense tech innovation through 2027. Other areas that will receive a large share of funding include micro­electronics; science, technology, engineering, and mathematics research; and command, control, communication, and computers operations. Air platforms and platform systems also rank highest for projected future growth.

US spending on defense technology innovation is divided among Department of Defense priority areas, each receiving less than $4 billion in 2022.
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For defense start-ups seeking to raise funds or live up to lofty valuations, the relatively small portion of the DOD budget allocated to defense technology innovation may not be sufficient to attain scale unless they carefully consider their options. Successful defense tech ventures likely will “follow the money” to the technologies and markets with the most favorable funding outlooks, dual-use applications, and near-term ability to access programs of record.

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