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Key takeaways:
- The FY27 budget requests $1.5 trillion in defense spending—a 42% increase—with investment accounts making up more than half the budget.
- Defense company CapEx has dropped to about 3% of revenue since 2010, well below what's needed to meet DoD's demand to double or quadruple capacity in areas like munitions.
- Short-term contracts and limited demand visibility discourage the long-term capacity investments the DIB needs.
- Critical bottlenecks—from critical minerals to shipyards to sub-tier suppliers—can't be fixed by simply adding capacity, as constraints shift across the system.
- Defense leaders should target capital at systemwide bottlenecks, coordinate across the supply chain, adopt new funding models, and build resilience into expansion.
Defense spending remains a cornerstone of US national security. Yet transforming this investment into the rapid, sustained industrial output needed today is increasingly challenging. While budgets rise and investment-focused spending grows, many companies often struggle to keep pace with demand—not because they lack capital but because they are challenged to deploy it effectively at scale to increase system throughput at the rate the customer requires. And that challenge is about to intensify, because the demand signal is surging to historic levels. A significant shift is taking place across the defense industry, creating massive investment opportunities for leaders who can lean in and act.
A generational investment in the defense industrial base is underway
The US Department of Defense (DoD) is embarking on a historic investment in capabilities. The White House's FY27 budget requests $1.5 trillion in total spending, which the administration describes as a 42% increase over 2026. This proposal includes a $350 billion reconciliation package to address critical capability gaps with mandatory investments in the defense industrial base (DIB) and substantial increases in funds for research, development, testing, and evaluation (RDT&E). While this budget request is unlikely to get through Congress without changes, such a dramatic shift in the demand signal points to a secular shift and the need for a step change in industrial capacity and investment—contrary to the historically conservative capital allocation across the US A&D sector.
The new defense budget request is a catalyst for change
Regardless of where the final FY27 budget lands, its composition should send a strong message that the DIB should confront the need for profound change. Key shifts among budgetary priorities are as significant as the sheer scale of the year-over-year increase. Investment accounts would constitute more than 50% of the budget, a more than 200% increase from two years ago, and more in real terms than the overall budget just 10 years ago.
To understand the need for change, it helps to look back. Following the Cold War, the DoD and the US defense industry focused on stability. The goal was to more efficiently maintain the country’s place in the global order with lower investment while preserving capabilities that can provide strategic advantage. Planning relied on steady demand, lengthy program cycles, and minimal need for production surges. Inventories were kept lean, while contractors were consolidated, supplier networks simplified, and capital intensity carefully managed. For the defense industry, this approach helped deliver efficiency, consistent performance, and strong financial returns for decades. While defense spending increased steadily after 2001, the DoD prioritized operations and maintenance over R&D and stockpiles. It wasn’t until the renewal of great power competition a decade ago that this 25-year-long trend began to reverse. In the last two years, this strategic reset has become impossible to ignore.
Investment surges to close strategic gaps
The post-Cold War trend has now completed an about-face. The rationale for a surge in defense spending isn’t tied only to recent geopolitical conflicts. Multiple demand drivers behind the surge seek to address critical strategic gaps.
The DoD is also resetting expectations, seeking to significantly reduce schedule delays, budget overruns, close capability gaps, rebuild stockpiles, and expand industrial capacity. Speed, scale, and resilience are key priorities. Industrial depth has shifted from a secondary concern to a primary factor in military readiness.
The FY27 budget priorities highlight the need for change. Munitions, missile defense, shipbuilding, space, nuclear modernization, scaling autonomous systems, and connected, AI-enabled combat and command architectures are capital-intensive priorities that rely on physical infrastructure and strong supplier networks. A top goal of the FY27 budget request is to make sure that long-term funding commitments and capital are no longer main constraints.
It’s time to confront bottlenecks in defense procurement and the DIB
Bridging this gap calls for targeted investment, innovative funding models, and strong coordination across the DIB. The question is, can A&D leaders turn rising investment into real capacity at the speed and scale that the customer requires?
The last decade has seen a series of incremental DIB initiatives, including the Defense Innovation Unit (DIU), the Office of Strategic Capital (OSC), and the use of Other Transaction Authority (OTA) contracts. The Pentagon is doubling down on innovative policy tools and funding models to help close the DIB gap and accelerate novel approaches that are working. OSC funding, for example, is poised to increase by more than an order of magnitude, transforming it into an investment bank to help address critical bottlenecks in the defense supply chain.
Defense A&D requires new models to help address the capacity and CapEx challenge
Since 2010, leading US defense company reinvestment in capital expenditure (CapEx) has declined to about 3% of revenue, generally below their peers across the broader A&D industry. That level of investment maintains operational stability and incremental upgrades but often falls short of building the surge in capacity that the DoD requires. In some areas, such as munitions, the Pentagon wants industry to double or quadruple capacity. The newly created Missile Acceleration Council (MAC) stands ready to support execution.
Part of the gap is structural. Legacy policy and procurement models require shorter-term contracts and limit long-term funding commitments, making long-term demand signals uncertain and prone to funding swings. Underwriting capacity-building initiatives for a single customer without long-term contracts offers an uncertain path to earning an acceptable return on invested capital (ROIC). As a result, defense contractors are traditionally conservative when it comes to capacity investments. Their boards also have a fiduciary duty to avoid major capital investment when long-term capital investment is too uncertain. This has created a structural business model gap for the DIB, especially legacy contractors.
Meanwhile, venture-backed defense technology companies have a structural business model advantage—not because they’re inherently more innovative but because their investors generate returns differently. While legacy publicly traded contractors seek ROIC through predictable free cash flow, investors in startups and private companies seek returns through liquidity events such as acquisitions or IPOs. This can give them greater flexibility to pursue bold investments—to make high-risk, high-reward bets on capacity expansion and growth.
How capital can fall short across the DIB
The business model gap is most evident in the DIB’s critical industrial bottlenecks, including supplier relationship management (SRM) issues. These include critical minerals, munitions, solid rocket motors, castings and forgings, shipyard infrastructure and throughput, propulsion systems, drones, critical electronics, and a host of sub-tier components. These are the bottlenecks where production slows, schedules slip, and throughput stalls.
Simply expanding capacity isn’t enough to resolve these issues. When one part of the system advances, bottlenecks can move elsewhere. Even as funding rises, capacity grows unevenly, limited by where capital is deployed.
For capacity to grow sustainably, CapEx should align with system constraints. Yet investments are often spread across programs instead of focusing on the system’s residual bottlenecks. Structural factors can also slow investment, especially below the prime level. Many primes or tier 1 suppliers plan to ramp up their own internal capacity but are constrained by reliance on external suppliers and partners. Many sub-tier companies are even more challenged, confronting the demands of multiple customers who all want to ramp up production at the same time.
How legacy contracting timelines can frustrate critical investment
Legacy procurement conventions can aggravate these problems at each level of the defense A&D ecosystem. Defense production contracts have typically been awarded annually or in limited multiyear increments, despite program life cycles that extend beyond a decade. This mismatch can limit demand visibility and discourage suppliers from investing in long-lead infrastructure and equipment. Long payback periods can also make it challenging to finance bottleneck assets through traditional balance-sheet methods alone.
The DoD is beginning to address this problem through new DIB policies and by prioritizing longer-term contracts in such areas as munitions. This can enable companies and their boards to underwrite aggressive capacity investments with longer-term payback periods. While these efforts remain in their early stages, momentum is building for companies that can adapt to this evolving model.
These challenges aren’t limited to the US defense market. In Europe, funding targets are doubling—at a minimum—even while many European nations face even bigger capability and capacity gaps than the US does. Beyond their financial constraints, some confront multilateral policy gaps and even greater DIB deficits. For US companies whose global supply chains run through European allied nations, such exposure can compound the urgency of their capacity and execution challenges.
How execution can falter at the system level
Expanding one part of a production system without aligning suppliers, workforce, infrastructure, and supporting capabilities often creates new constraints elsewhere. The structure of the DIB only exacerbates the problem. Primes, sub-tier suppliers, government stakeholders, and capital providers have their own incentives and timelines. Without coordination, expansion efforts can become fragmented and slow.
Scaling production can also bring new risks. Larger volumes increase exposure to cyber threats, supplier fragility, export controls, and operational disruption. Without building resilience into expansion efforts, new capacity can introduce new vulnerabilities.
The main challenge isn’t just securing sufficient funding capacity but bringing together capital, incentives, and execution across the board to make sure investments deliver consistent, large-scale results.
Renew your CapEx strategy to build sustainable capacity now
For defense leaders, shifting priorities are already influencing where to invest, how to secure funding, and how to perform under pressure. Your goal now is to not only deploy capital but to transform it into measurable increases in throughput as well. Here are key strategic steps to consider.
Execute with foresight to drive success
Remember, scaling capacity simultaneously scales risk. With increased production, supplier fragility deepens, operational pressures intensify, and risks like cyber or export controls amplify. Expansion risks are creating new bottlenecks.
To keep pace, rethink your renewed CapEx strategy to integrate with an industrial footprint and supply chain strategy, boost digital integration, supplier checks, and compliance measures as you expand physically. The goal is capacity expansion that can endure disruption, perform under stress, and build resilience.
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