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There are a lot of questions around how the United States government will spend its expanded defense budget of $700 billion. Will the Pentagon return to investing in traditional long-term weapons development programs, or will it look to pursue new partners to invest in creative technology solutions? Recent tax reform has led to a large cash flow for US businesses, and a handful of aerospace & defense (A&D) firms have committed to investing in R&D – though the amount is unclear.
One thing we do know is that the A&D industry is at a crossroads and companies must be bold and daring to ensure a lucrative future. A&D companies have to be nimbler and more forward-thinking than ever before, confronting head-on the challenges of determining how to allocate capital expenditures that will help support new technologies and capabilities, design and engineer new products more quickly and, of course, maximize shareholder returns.
A more flexible approach is necessary. The sector is undergoing disruption from commercial technology entrants that can innovate rapidly, and global adversaries such as China and Russia are expanding their A&D capabilities as they strengthen their defense capabilities, developing air-to-air missile systems that use advanced imagery and sensors to thwart enemy intrusions.
As these shifts happen, we are starting to see a move towards a more rigorous and less risk-averse approach to evaluating and making strategic investment choices that yield long-term value within the A&D industry. For example, some defense firms have developed unorthodox innovation strategies to jumpstart new programs that formerly would not have been in their wheelhouse. This includes initiatives like retrofitting foreign aircrafts for the U.S. Air Force, developing commercial drones, and implementing advanced pilot training systems.
Other A&D companies are looking to M&A or partnerships to establish themselves as digital leaders. But it’s still not enough. To stay ahead of competition and reach business goals, A&D companies need to develop a global strategy built upon their own innovation and capabilities.
So the question becomes, how can they best develop an investment strategy? For starters, A&D firms need to adopt a more disciplined approach to valuing strategic options, beginning with analyzing certain financial indicators (such as cash flows or intrinsic value) generated by the company’s current strategy. The cash flow can then be used to develop newer and more advanced products, instead of simply returning capital to shareholders.
Slow-walking R&D efforts is never a recipe for long-term success. It’s about time for A&D executives to turn uncertainty into opportunity and determine how to allocate capital in a way that will help them innovate.
Read our latest report, A&D trends: Keeping pace with a focus on innovation.