Home Victanis' Blog Big Funds and Small Players: Powering Innovation in Defence

Big Funds and Small Players: Powering Innovation in Defence

Big Funds and Small Players: Powering Innovation in Defence

The increasing geopolitical tensions and the heightened commitment to defence spending by nations worldwide have highlighted the necessity for robust and innovative military capabilities. While the scale of the expenditure is significant, it is not exclusively the large established defence contractors that are influencing the sector. Smaller firms and startups contribute essential agility, fresh perspectives, and advanced technologies to the defence landscape, making their ongoing support a strategic priority for national security. The rise in venture capital funding within the defence sector signifies a growing recognition of the critical role that these smaller entities play. In response, governments have implemented dedicated grants and innovation funds to nurture these smaller players. Furthermore, with recently renewed commitments to enhance defence expenditures across Europe, these funding mechanisms are likely to expand, reflecting a developing consensus that the protection of national interests increasingly relies on a robust ecosystem comprised of both established leaders and disruptive newcomers.

Supporting the Small

As startups and SMEs are often the sources of disruptive innovation, governments implement several targeted measures to encourage this. Dedicated grants and funding streams have been established to enhance military capabilities through innovative approaches. These have already included the UK’s £800m Defence Innovation Fund & the EU Defence Innovation Scheme (EUDIS) €2 billion fund to boost technologies within the European defence industry. However, the budgets of both these funds were allocated before commitments to increased spending, which could well see them pushed even further to foster innovation.

Accelerators and incubators offer defence Startups technical expertise and access to government contracts. While not exclusive to the defence sector, an R&D tax credit system can accelerate technological advancements by increasing cash flows, which can then effectively finance military projects. Public-private partnerships are also beneficial in introducing new defence technology to the market by fostering collaboration between established defence organisations and innovative startups.

It isn’t just governments that are looking to foster smaller players; venture capital firms are also increasingly backing startups in the defence sector. VC investment in defence rose from $500 million in 2014 to an estimated $8.7 billion in 2024, making the industry an outlier with a growth of over 17x. These newly funded players are now winning business through their innovations and agility. However, this could, in itself, spur large players to strategically pursue acquisitions to add these specialised capabilities to their remit and reclaim market share. However, to achieve success, they must ensure that any integration does not negatively impact the startup by the process and bureaucracy of a larger, established organisation.

Balancing Innovation and Integration

Successful acquirers aim to absorb new capabilities without stifling innovation. Overly rigid corporate structures risk smothering the fast-paced culture of startups. Thus, many large companies structure deals to preserve the innovative processes of newly acquired tech firms.

In many instances, large defence firms are choosing to preserve the autonomous R&D pathways of acquired businesses, providing them with the financial resources, extensive market reach, and strategic networks to accelerate growth rather than integrating them into existing silos. For example, when L3Harris Technologies completed its acquisition of Aerojet Rocketdyne, a leading manufacturer of propulsion and rocket engines, in July 2023, it opted to run the business as a standalone unit. This approach recognises that fostering a research environment and retaining top engineering teams can be more valuable than merely possessing intellectual property.

By extending targeted support, such as capital, supply chain resources, or infrastructure, acquirers can provide the crucial elements of scale and reach while avoiding the pitfall of stifling innovative methods under conventional corporate processes. In the case of Aerojet, L3Harris has increased internal investments in the company by 40% year-over-year. Performance improvements since the acquisition include record-setting months of deliveries for five programs and a nearly 50% reduction in late deliveries.

Modern defence programmes are becoming increasingly complex, thereby exacerbating the impact of mergers and acquisitions-driven consolidation within the industry. The risk to entire product lines, including aircraft, missiles, and jet engines, heightens when these are managed by a limited number of suppliers. This concentration can lead to inflated costs, diminished innovation, and restricted alternatives in the event of quality concerns. This situation can be likened to the airline industry prior to deregulation in the 1970s when a limited cluster of dominant players restricted competition until more efficient disruptors stimulated innovation and operational efficiencies. Excessive dependence on a small cadre of dominant suppliers can similarly impede advancement in the defence sector, underscoring the critical importance of sustaining diversity within the supply chain.

Some organisations opt for strategic partnerships or joint ventures rather than outright acquisitions, thereby minimising both regulatory complexity and the potential for cultural misalignment. Joint ventures, in particular, enable companies to leverage the strengths of external innovators without requiring the level of operational integration that can inhibit creative development.

Big & Small Working Together

We’ve seen that joint ventures and strategic partnerships offer a structure that supports the goal of balancing innovation with the large-scale capabilities of more sizable firms. This is because they can reduce risks associated with blending corporate cultures while still enabling both parties to benefit from shared expertise, infrastructure, and market access. However, beyond the advantages to the operators, there are further benefits to the market as a whole, particularly to the nation in which it operates, encouraging joint partnerships over overly-integrated mergers and market consolidation.

Firstly, there are concerns that integration will upset the competitive balance in the defence sector, as reduced competition can stifle innovation, and large-scale consolidation by a single player may lead to monopolistic practices. Additionally, a merger may also risk supply chain vulnerabilities by reducing the number of independent suppliers. This increased reliance on a single or limited group of entities has a two-fold risk profile, as disruption to one supplier is more costly to overall supply. Secondly, in cases of multinational consolidation with a foreign acquiring entity, a more significant proportion of the supply chain is susceptible to external influences. It is, therefore, further removed from national oversight and scrutiny.

This is why government defence contracts and projects often stipulate that a portion of them must be delivered by smaller firms, which are not to be absorbed by their more significant partners, as this encourages diverse market participation. To this end, we have seen these strategic partnerships on the rise, mainly when their benefits are further driven by government efforts to reduce foreign dependency. One specific example is Project Brakestop, a UK MOD initiative to develop a “One-Way Effector (OWE) Heavy” that can be ground-launched from a mobile platform over a distance of more than 500 km. This project has already involved the collaboration of multiple UK defence and engineering companies of varying sizes, working together to target a cost of £400,000 per delivery platform.

Reflecting the pushback from the US Department of Defense against over-reliance on legacy primes, governments worldwide could likewise adopt policies to protect the interests of smaller players. In the US, this pushback entails broadening pathways for nontraditional vendors through rapid contracting mechanisms and open competitions, revising intellectual property rules to reduce lock-ins and ensure taxpayer-funded research remains accessible, and strengthening antitrust oversight to curb monopolistic mergers. Simultaneously, the DoD is promoting domestic R&D in critical areas—such as microelectronics, battery storage, and software—while streamlining the onboarding of commercial capabilities, supported by robust vetting and data-protection protocols. Through these measures, large defence markets increasingly seek to replicate best practices from the commercial sector. Such diversification initiatives aim to foster disruptive entrepreneurialism while addressing security concerns through thorough vetting and data protection protocols.

Conclusion

As the defence sector addresses evolving threats and ongoing geopolitical uncertainties, it is essential to leverage the strengths of both large and small entities to maintain competitiveness. Recent increases in defence budgets in the UK and Europe have created opportunities for fostering innovation among smaller market players. The UK government has announced that the establishment of a new support hub will accompany the allocation of defence spending. This hub is intended to provide support and guidance to SMEs on accessing the defence supply chain. It is noteworthy that nearly 70% of defence expenditure is directed towards businesses located outside of London and the South East, thereby contributing to the strength of local economies in Scotland and the North West also. Nevertheless, only 4% of this expenditure was allocated to SMEs during the 2023-2024 fiscal year. The introduction of the support hub and the investment targets outlined in this announcement aim to maximise the benefits of increased spending for c.12,000 SMEs, empowering them to secure financing and invest in workforce development. Additionally, this initiative is designed to strengthen the resilience of the UK's defence industrial base and harness the full potential of rapid technological advancements as part of the government's forthcoming Defence Industrial Strategy.

The transitions here and in Europe more widely benefit not only industry stakeholders but also enhance national security. By implementing targeted support mechanisms, structuring acquisitions to preserve creative independence, and establishing strategic partnerships or joint ventures, governments and prime contractors can ensure that cutting-edge solutions retain their integrity and do not become compromised within the confines of larger corporate structures. Thus, the defence industry can achieve a dynamic equilibrium: sustaining the reliable capabilities of established leaders while simultaneously unlocking the potential of emerging entities. This synergy is poised to shape future military and technological superiority on the global stage.

Therefore, it is important to adopt a balanced approach that safeguards against monopolistic practices while promoting new entrants and protecting vital security protocols. Such an approach is essential for maintaining the technological advantage necessary to address contemporary defence challenges.

Charles Sunderland

Written by Charles Sunderland