Defence Business: Defence industry R&D | ADM Dec 09/Jan 10
The reality may be different.
Gregor Ferguson | Sydney
What is the reality of Australia's industry R&D investment, and what are the secrets of successful innovation in the defence industry?
That, in a nutshell, is the focus of research carried out by the author between September and November 2009 as a Research Fellow of the Defence Materials Technology Centre (DMTC) in Melbourne.
This research forms part of the author's Ph.D research into "Factors affecting innovation performance in the Australian defence industry", which is being conducted through the University of Adelaide's Entrepreneurship, Commercialisation and Innovation Centre (ECIC).
To a considerable extent the Australian Defence Organisation operates like a command economy: it innovates in its tactics, techniques and processes, but increasingly seeks to buy equipment off the shelf.
In globalised markets where Defence is able to buy off the shelf from northern hemisphere prime contractors - aircraft, armoured vehicles and guided weapons, for example - Australian firms frequently can't compete on price with equipment developed overseas for bigger domestic markets, and haven't the resources to develop such products without Defence's support in any case.
Where it cannot buy off the shelf Defence specifies developmental solutions: this is the stimulus for industry innovation and is generally the process which generates new products; this is the market space in which local firms are best able to compete with each other and with foreign competitors for the Australian defence dollar.
As a defence industry executive taking part in the author's case study program stated: "Projects tend to lead to products in this industry, not the other way round."
Against that background, the Mortimer Review and George Pappas's Defence Budget Audit have serious implications for Australia's defence industry.
They both recommend greater consideration be given to Commercial or Military Off The Shelf (COTS and MOTS) purchases.
Pappas in particular, is damning about the risks, costs and delays associated with developmental projects, or projects in which existing products are ‘Australianised'.
But if Defence wants a world-class local industry that is creative and innovative in technical terms, the consequence of its absolute domination of the market is that it needs to provide the necessary stimulus, or provide assistance breaking into the export market and global supply chains.
This is an issue which Australian defence industry policy hasn't addressed in sufficient detail.
R&D Survey
Tackling the R&D question first, the last in-depth study of defence industry R&D was conducted in 2004 by Bob Wylie.
Wylie cited the most recent Australian Bureau of Statistics (ABS) figures, for 2000-01, which stated that Australia's total defence R&D in that year was about $275 million, of which industry contributed only $32 million - a 6:1 imbalance.
This suggested that the industry was under-investing in R&D; it also suggested that DSTO's dominance of the defence R&D space should deliver a stronger return in terms of IP commercialisation and a closer relationship with industry.
However, a recent revision of the ABS figures shows that total defence R&D for 2000-01 was actually $401 million, of which Defence contributed $238.6 million and industry a massive $158.1 million.
And the most recent ABS figures, for 2006-07, show Defence and Industry are approaching parity: total defence R&D was $824.5 million, of which defence contributed $405.4 million and Industry $378.9 million - a ratio of 0.93:1.
Looking at this another way, the ADM Top 40 listing for 2008 found that the country's 40 biggest defence companies and 20 biggest SMEs had a combined revenue of $7.094 billion; the $378.9 million which the defence industry invested in R&D in 2006-07 amounts to 5.3 per cent of this total, suggesting an industry-wide average of a little below 5 per cent.
Is industry deriving a commensurate benefit from this investment?
Or, in a technology-driven market such as defence is a high level of R&D simply the normal price to be paid for entry to this market?
After all, total defence R&D in 2006-07 was almost exactly 4 per cent of the defence budget, and almost exactly twice the 2.01 per cent of GDP the nation as a whole devoted to R&D, according to the OECD.
Considering the defence budget amounts to about 2 per cent of GDP, this suggests Australia devotes relatively more to R&D in the defence sector than it does to most other sectors of the economy.
Either way, the defence industry as a whole evidently spends considerably more on R&D than was previously thought - even if some of the ABS figures might be capturing expenditure of questionable value which is written off for tax purposes as R&D-related.
Exactly how much of the reported R&D is the real thing is unclear.
To triangulate the ABS figures the author conducted a short defence industry R&D survey in October and November 2009 and a series of case studies beginning in November 2009.
The R&D survey used many of the questions asked by Wylie in 2004 in order to provide a snapshot of changes over the intervening five-year period.
It found that 42.1 per cent of companies spend more than 5 per cent of revenue; 15.8 per cent spend between 2.1 and 5 per cent, and most of the remainder spend less than 1 per cent.
However, these figures from a small sample need to be treated with some caution - the case studies point to a much higher level of R&D and many of the case study respondents point out that much of what their companies do actually amounts to customer-funded R&D of one kind or another which isn't reported as such.
Similarly, many SMEs don't have an R&D department or budget as such because the entire company functions to some degree as an R&D organisation.
The survey found that 63.2 per cent of companies carried out R&D in capability areas defined by the DMO as Priority Industry Capabilities.
Only 52.6 per cent of companies rated the importance of introducing new or substantially improved products as High or Very High, compared with 59 per cent in 2004.
And 57.9 per cent rated the importance of new or substantially changed production processes as High or Very High, compared with just 44.5 per cent in 2004.
These figures are largely borne out by the Case Study responses.
Criteria for inclusion in the case studies were that the product must have been developed in Australia, it must have been developed for a defence application and it must have been offered for sale to, or entered service with, a paying customer (not necessarily the ADF).
Given the limitations on sample size and resources the case study methodology focussed on comparing matched pairs of successful and unsuccessful innovation projects.
The difficulty was finding sufficient failures - most locally developed products which enter service with the ADF work at least reasonably well so the definitions of failure, and therefore the selection criteria for the case studies, needed to be relaxed somewhat.
A failure was defined as a product which was judged an operational failure by the user, or reached the production stage but failed to secure an order.
The more relaxed criteria included products terminated during development, including Capability and Technology Demonstrators (CTDs) which saw a successful demonstration but were not developed further due to lack of ADF sponsor support.
Measuring performance
The case studies set out to identify factors which affect innovation performance.
Because the research focuses on business innovation, the measures of that performance are business-driven: did it work?
Did it sell?
Did it make a profit?
In all there were nine of these Dependent Variables, and the case studies set out to find which of 14 Independent Variables had any effect on them.
Many of the Independent Variables are drawn from the extensive literature on innovation success.
They are generic and represent what could be described as ‘best practice': proficiency in marketing, R&D and technical and business processes; proficiency in communicating, both internally and externally; willingness to source IP and expertise externally, if required; and market factors - the effects of speed to market, the intensity of competition, and the size and growth of the market.
Three Independent Variables were developed from the literature on ‘lead users' and ‘user-defined innovation', which reflect the behaviour of the defence market: the characteristics, processes and operating environment of the customer himself.
This is a significant factor in the defence market where the user - typically the ADF - identifies a threat or challenge and some sort of response.
Frequently, the response consists of some innovation in tactics, techniques and procedures (TTP); sometimes it is a more fundamental organisational change, such as the Hardened and Networked Army (HNA) and Adaptive Army.
In many cases, these user innovations need new or improved equipment to make them work: either something available off the shelf or, if this doesn't exist, a new product or system.
To a considerable extent it can be said that the ADF shapes the industry's innovation processes and directions because, although militaries are commonly decried as conservative and resistant to change, paradoxically they are one of the major drivers of innovation in the defence industry.
That said, the ADF like its peers, needs to maintain a healthy dialogue with the scientific community to remain aware of the technological dimension to future threats and opportunities, and must also maintain an open dialogue with industry so that it remains aware of what's available (and credible), while the industry needs to understand clearly the customer's current and emerging needs.
The final Independent Variable was the effect of market regulation, specifically issues such as security, export restrictions and ITARs.
Case Study results
At the time of writing, the case studies weren't complete due to delays caused by access and timetable issues and Non-Disclosure Agreements.
But sufficient had been completed for some clear results to have emerged.
Companies with a turnover of more than $100 million a year spend on average 1 per cent of turnover on R&D; in the $50-100 million bracket the average is 6.6 per cent; in the lower turnover categories R&D investment amounted to between 3 and 6 per cent of turnover.
As a general observation, it seems to make no difference to success or failure whether an innovator is Australian-owned; the majority of defence industry innovations have been in the electronic systems area; the overwhelming majority were developed for the ADF as a primary customer; and all the successful innovations entered production for both the primary and others customers.
The case studies found that almost all defence companies make a genuine attempt to follow best practice, and so far as generic behaviours and characteristics are concerned, the differences between successful and unsuccessful innovators are often slight.
However, some very clear distinctions emerged from the studies and one of the strongest was the issue of verifying customer needs and developing a functional specification for the product.
Unsuccessful innovators were more likely to experience difficulty identifying and verifying customer needs, generally because the customer didn't clearly articulate them or understand them properly himself.
Similarly, when the customer was able to state his performance requirements clearly, the functional requirements for successful innovations were more likely to have been developed by the innovator himself.
Very few of the innovations studied incorporated any IP from DSTO or elsewhere in Defence; and the majority of successful innovations were based on IP developed in-house.
Successful innovators tended not to need an external technology partner; they are more likely than unsuccessful innovators to invest in R&D with the specific aim of developing new products and IP; and having an overseas parent with expertise in the relevant technology area didn't seem to matter in the projects studied.
Generally, ITARs w not a factor in these projects, though ITARs and other national releasability issues restricted access to some markets for certain products.
Importantly, successful innovators were generally adept at marketing, both to shape the customer's view of his needs and available options, and then to support the sales process.
Successful innovators are pro-active in spotting opportunities, shaping the market and positioning themselves within it.
In the majority of cases the ADF was the intended primary customer, and its needs were generally for a significant leap in operational capability, followed by improved capability from existing equipment types, and then reduced operating costs.
To meet these needs, the majority of successful innovations were disruptive, in the sense that they were all-new products or systems rather than incremental enhancements of something that already existed.
Customer familiarity was an important factor in innovation success: in failed projects the customer was less likely to have acquired such a product or system before; in all innovation projects, both successful and unsuccessful, DSTO had done some R&D (or Science & Technology - S&T) work in this area already - but in more of the successful projects the customer also had a strong understanding of the technical aspects of the project and actively encouraged innovation by the contractor.
This in turn highlights the importance of the professional and technical expertise of the customer, along with an important role for DSTO even if its IP isn't a factor.
More generally, there was a correlation between the technical and professional understanding of the customer, the extent to which his acquisition processes take into account both user needs and project risk factors, and the extent to which the customer encourages innovation on the part of the manufacturer or contractor.
There is a strong correlation between the stability of a customer's requirements and innovation success; similarly, there is a strong correlation between the risk tolerance of the customer and innovation success and, associated with this, a strong correlation between risk tolerance and the professional and technical expertise of the customer.
Need it now
Innovation success is closely associated with a customer's high operational tempo and rapidly evolving threat environment: the customer's needs are driven by the imperatives of his operating environment.
This resonates with Israeli research by Tishler and Dvir who identified an urgent operational need as the single most important success factor in developmental defence projects.
However, if the user need is very urgent, resulting in a Rapid Acquisition Project (RAP), the emphasis shifts to a MOTS/COTS purchase.
It's becoming evident that many of the differences between successful and unsuccessful innovations lie in the nature of the relationship between customer and contractor.
It won't be a surprise to some readers that successful defence innovation depends significantly on a partnership approach: the majority of defence innovations, and the majority of successful ones, were not developed under competitive tender arrangements.
More common was the use of sole-source contracts, typically after some sort of ITR, RFP or market survey process, or as a collaborative effort between the customer, contractor and an agency such as DSTO.
Also, having a project ‘champion' in the customer group who represents the needs of the users was strongly linked to innovation success.
It's too early to be stating definitive conclusions from this research (and the statistical analysis hasn't been completed, in any case), but a number of tentative conclusions emerge: if Defence is concerned with the risks associated with developmental projects, one of the most important things it can do is ensure its own professional and technical mastery.
This will help it articulate its user needs and identify, assess and mitigate risk more effectively.
If defence chooses to pursue a developmental program, it must form a genuine partnership with the innovator early in the process and keep to a brisk schedule for key decisions and project milestones.
This in turn suggests the need for a sensible limit on the project's ambitions and close alignment with the user's needs.
Industry, for its part, needs to be able to perform the basics correctly: it's not enough to have a brilliant idea - the company must also do its marketing, product development and business planning methodically and proficiently.
And it must understand why it's doing R&D in the first place.
It's worth acknowledging that the Australia defence market operates at several levels and many local firms generate much or all of their revenue from acting as a sub-contractor or supplier to firms higher up the food chain.
But the local supply chain depends mostly on local prime contractors securing contracts from Defence.
Growing the market for lower-tier suppliers and sub-contractors by selling into the global supply chains of overseas primes could provide a stimulus for innovative local firms; it's too early as yet to be able to conduct case studies on local innovations developed for such markets under initiatives such as the Australian Industry Capability agreements signed by a number of overseas primes.
One area of innovation which the research hasn't yet examined is the ADF equipment sustainment market which is considerably bigger than the market for locally manufactured equipment.
What the prospects are for innovation isn't clear as yet, but the imperatives of the Strategic Reform Program suggest that anybody who can innovate effectively to deliver real savings in sustainment costs without compromising fundamentals such as flight safety may be in a strong position.
Whether or not this is possible without the active involvement of the OEMs (most of whom are overseas), or designing equipment from the start to be much cheaper to sustain, remains to be seen.
The author wishes gratefully to acknowledge the support of the DMTC and Mr Tony Quick of DIISR's Enterprise Connect Program for making this research possible.