Opinion: Why Private Capital Is Essential To U.S. Defense

The chorus for change in defense acquisition grows louder each day. The new U.S. administration, key members of Congress, potential disruptors and incumbent prime contractors are all calling for improvements in how the nation develops and acquires military capability. However, these ideas and efforts likely will fall short without a critical ingredient: private, at-risk capital. This type of funding is essential to increase innovation, expand capacity and enhance productivity.

Multiple efforts to improve acquisition practices and strengthen the industrial base have largely failed to stem rising unit costs. One of Augustine’s Laws projected that by 2054, the entire U.S. defense budget would be enough to pay for just one tactical aircraft. Although Augustine wrote this in jest, the challenges facing the defense industry are more acute than ever. Efficiency, delivery schedules and capacity are inadequate. A 2024 report by the Government Accountability Office listed 26 of 31 major acquisition programs (80%) as delayed, over budget or both. For decades, investment levels have failed to keep pace with GDP growth or defense requirements. 

Achieving step-change improvements requires billions of dollars of increased investment. But from where? Government R&D and procurement budgets are constrained and likely to remain so. Defense budgets have grown only modestly in real terms, while spending on procurement and research, development, test and evaluation (RDT&E) has gradually declined as a share of GDP since World War II. Outlays for RDT&E have barely rebounded since falling to 1% of federal spending in fiscal 2020. Of course, the U.S. Defense Department and Congress could better allocate funding toward the highest priorities for countering future threats. But history suggests that nimble shifts in spending in response to changing needs are unlikely.

Incumbent prime contractors are inclined to invest more but have been constrained by shareholder expectations, cost-plus contracting, low market volumes, capped program margins, inflexible business models and uncertain demand signals. Top contractor independent R&D budgets have not outpaced revenue since the end of the Cold War.

In other industries, private, at-risk capital plays an important role in advancing innovation and improving productivity. It is increasingly taking this role in the defense industry, too, given unmet customer needs and private capital’s greater appetite for risk. SpaceX, for example, disrupted the national security launch market by dramatically reducing cost per launch and time to market. Companies like Anduril Industries have raised significant capital, aiming to disrupt other segments of defense. Private capital inflows into the sector have grown markedly since 2019, according to Bain & Co. analysis (see chart).

Private capital can serve as a catalyst in two important ways: Venture capital can fund startups developing new capabilities and seeking step-change improvements in cost and time to market; and private equity can help more mature companies increase manufacturing scale and production capacity, improve on-time delivery and reduce unit costs.

We expect private capital inflows to continue growing, as investors are increasing their focus on the aerospace and defense markets. In the past, generalist funds and limited partners have been wary of the sector, given the high barriers to entry, low unit volumes, high customer concentration and unique go-to-market costs of selling to governments. Their reticence is decreasing as they better understand the risks and as demand for private capital grows.

On the customer side, the Pentagon has shown considerable interest in buying from new entrants and commercial-focused companies, and the new administration seems inclined to continue that. Proposals like the Fostering Reform and Government Efficiency in Defense (Forged) Act and recommendations like those from the Defense Innovation Board would also reduce impediments faced by new entrants. The challenge is significant: The top 10 defense contractors’ share of procurement and RDT&E spending has averaged more than 70% since fiscal 2020.

Faster, simpler acquisition processes and increased capital inflows would greatly enhance U.S. defense capabilities, especially in high-need areas such as uncrewed systems, proliferated space satellites, command-and-control software and enabling technologies like artificial intelligence. Incumbent suppliers, seeking to defend their businesses, would likely respond by investing to meet customer needs better. The defense industrial base as a whole stands to benefit from greater and more focused investment.

Michael Sion is a partner in Bain’s Aerospace, Defense & Government Services and Private Equity practices.