US defense firms are at risk of losing their edge to new rivals

WASHINGTON ― Despite a growing defense budget, U.S. defense and aerospace companies are at risk to be superseded by emerging competitors, a new PwC sector trends report cautions.

Not only are established companies receiving domestic pressure from emerging innovators like Elon Musk’s SpaceX, but also Chinese and Russian companies backed by state funding. The PwC report notes “China is making a big push to develop military artificial intelligence technologies, and China and Russia are developing sophisticated air-to-air missile systems that use advanced imagery and sensors to thwart enemy intrusions before they pierce the skies.”

The defense sectors reluctance to take risks by investing their own funds in research and development also is a major impediment. Despite their large budgets, aerospace and defense companies spend less on R&D than nearly every other industry.

That’s going to have to change if these firms want to remain competitive. PwC’s report recommends companies “adopt a more rigorous and less risk-averse approach to evaluating and making strategic investment choices (for example, product development, technology innovation, and R&D) that yield long-term value. Accept uncertainty as part of the normal course of business; view it as an opportunity, not a danger.”

Some companies are also trying to diversify their portfolios through mergers and acquisitions. The report cites Thales $5 billion acquisition of Dutch-based Gemalto as one example of such diversification. The buy gained Thales a strong position in the cybersecurity market, opening up new revenue streams from technology.

So how can company’s adjust their investment strategies to combat challenging, ambitious newcomers? PwC suggests companies reduce costs by earmarking R&D funds for specific project priorities, rather than allocating the funds to business units to decide how to spend the money.

The group also suggests a change in corporate culture, and encourages firms to hire a younger workforce with “the tech aptitude that increasingly drives weapons equipment efforts and advances today.”

Companies can also alter incentive and compensation programs. Offering traditional bonuses for meeting annual performance metrics, according to the report, “is counterproductive because executives can achieve these goals while actually destroying value in the company by, for instance, seeking savings through cutbacks in R&D.”

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