Emerging tech-focused firms could reshape the Top 100

WASHINGTON — A new 30-foot-long, gray drone quietly arrived at a U.S. Air Force base last fall, without a public announcement until weeks later.

The drone’s arrival was discreet, but represented a key moment for its manufacturer Kratos Defense and Security Solutions — and the potential for a wave of business opportunities.

The service’s 40th Flight Test Squadron at the Florida base took possession of its first Kratos-made XQ-58A Valkyrie, and a second followed soon thereafter. Inside the drone’s core was intricate programming to allow it to fly on its own, without humans directly providing instructions or controlling it.

Within weeks, airmen began flying the new Valkyries, using rockets to launch them off rails and, in at least one case, flying them in tight formation with an F-16 fighter jet.

For nearly four years, the Air Force had experimented with the Valkyrie and other drones as it grew increasingly confident the idea of autonomous drone wingmen in combat could work — and become a cornerstone of how to fight wars.

Click here to see the Top 100, a ranking of the largest defense companies in the world.

Steve Fendley, president of Kratos’ unmanned systems business, said the Air Force’s acquisition and testing of those two Valkyries showed the emerging possibilities for the company and other similarly sized firms.

In the 2023 edition of Defense News’ Top 100 list, which ranks companies around the world based on their defense revenue, Kratos took 88th place — appearing on the list for just the second time in nearly a quarter century.

While the same group of large contractors remained at the top of this year’s list, unveiled Aug. 7, experts say there’s growing evidence the defense market may be evolving to offer better and more work to mid-tier firms, particularly those specializing in technologies central to the Defense Department’s modernization plans.

For years, Defense Department officials have spoken about the importance of a diversified industrial base, and tried to create opportunities for companies beyond the top-tier firms that have traditionally dominated the market.

Five years ago, Fendley told Defense News in June, the best shot for a company like Kratos was to sell the DoD a part for a subsystem. A top-tier defense firm would then put that into a major system. Today, Fendley said, firms his size have a shot at scoring contracts for the subsystems themselves. And, he noted, greater opportunities could soon start opening up for smaller and mid-tier firms to compete at the major system level.

“That momentum is still building,” he said. But in the near future, “there will be receptiveness toward small and mid-tier companies even providing systems. Certainly in five [years], maybe one or two.”

Top service officials have repeatedly said that in order to win the next war, the military must deploy more than traditional fighters, bombers and ships of the past. Instead, it should look to autonomous drones, unmanned surface maritime vessels, hypersonic weapons traveling at more than five times the speed of sound, and waves of small, cheap airborne drones armed with explosives.

To make this a reality, the services are attempting ambitious modernization efforts — many of which hinge on technologies such as autonomous software and advanced rocket engines, often produced by nontraditional firms.

An upstart has little chance of becoming one of the top-ranked businesses that typically lead major, multibillion-dollar programs, defense contracting expert Alan Chvotkin told Defense News. But, he added, the bottom half of the Top 100 rankings could see a reshuffling in years to come — and that for a smaller company, a little growth could go a long way.

“If you think about hypersonics and things of that sort, those are tailor-made for the mid-tier and the technology-oriented companies,” Chvotkin said. “I see opportunity there for awards, and for growth. … Ten percent growth in a smaller company is very different than what a larger company needs to sustain the beast.”

Defense industry analyst Byron Callan of Capital Alpha Partners said that while tech-centric companies such as Shield AI and Anduril have not yet cracked the Top 100 list, they have an opening to do so in the years to come.

“This isn’t so much about bending aluminum, or carbon fiber,” he said. “It’s about software. Typically when you see new entrants in the defense sector, it’s because they ride a wave of new technology. … It’s going to be things like [collaborative combat aircraft, or drone wingmen], or brand new software that will drive this forward.”

And there are signs it may be starting to happen, including at Kratos.

Its unmanned systems division has seen revenues grow 67% since 2018, to nearly $222 million. The steady growth in this area has helped Kratos bolster its bottom line, with the company landing back on the Top 100 list. This is the second time Kratos has made the list in nearly the last quarter century; in 2021 it notched a spot at 94th before falling back off the list.

Defense News each year ranks the top defense contractors for its Top 100 list, by collecting and tallying information on firms’ revenues from the companies, their annual reports, analysts and other research. Defense News tallied defense revenue of $534 billion in fiscal 2022 — a 10% decline from the $595 billion recorded the previous year. Nearly 56% of the defense revenues in FY22, or $298 billion, went to the 10 largest defense firms.

Callan said the decline in revenue in FY22 was likely due to a variety of factors — including different companies making the list, international currency fluctuations, merger and acquisition activity, and individual companies’ bottom lines shifting for their own reasons — and not a sign of overall weakness in the industry.

‘The tide has shifted’

For years, the Top 100 list has been dominated by mega-corporations such as Lockheed Martin, Boeing, Northrop Grumman, General Dynamics, BAE Systems and Raytheon, now known as RTX, with only minor fluctuations in rankings.

But the lower half of the list typically shows more churn, with new companies coming on and others falling off as their fortunes and the defense market shift.

Spirit AeroSystems — a Wichita, Kansas-based airframe manufacturer that supplies top defense firms — returned to the Top 100 list in 86th place this year. Its defense revenues grew 11% in FY22 to $650 million. Since Boeing spun off the firm in 2005, Spirit has made the list twice, with the other instance from 2021 when it eked into 99th place.

In recent years, Spirit has provided structural components used in the E-7 Wedgetail, V-280 Valor Future Long Range Assault Aircraft and B-21 Raider to defense giants Boeing, Bell and Northrop Grumman, respectively. Spirit will also build the struts and nacelles for the B-52 bomber′s major re-engining program.

In earnings calls this year, Spirit executives sounded bullish on the company’s opportunities for future growth, even setting a goal of reaching $1 billion in defense and space revenues by 2025.

In a February call with analysts, a company executive said Spirit sees five growth areas: hypersonics, unmanned aerial systems, next-generation effects, next-generation aircraft and space.

Meanwhile, AeroVironment, whose Switchblade loitering munition has become a notable weapon in Ukraine’s arsenal against Russia, also recorded an 8% increase in defense revenue to $294 million in FY22. It didn’t make the Top 100 list, but its prominent role in the Russia-Ukraine war and its growth over the past year make it emblematic of the shifting landscape for smaller defense firms.

AeroVironment’s chief executive, Wahid Nawabi, said in a June interview that the shift from waging war in the Middle East — which relied heavily on drones — to preparation for a great power conflict doesn’t mean the end of smaller uncrewed systems.

“For more than a century, the world thought about defense and warfare [in terms of] tanks, aircraft carriers, submarines, ships,” Nawabi said. “It doesn’t mean that those things are not going to play a role in the future — they will. But this concept of a distributed warfare, where smaller teams, smaller forces [are involved], is what we see in Ukraine. Small drones and loitering munitions have enabled Ukraine to do massively different things that nobody thought they could even do.”

The defense market still favors the largest prime contractors with the lobbying power and political influence against which smaller companies can’t compete, Nawabi noted.

Lockheed Martin and RTX led this year’s Top 100 list, and they remained unchanged at slots 1 and 2 respectively. Northrop Grumman — the prime contractor on major programs such as the B-21 Raider bomber and LGM-35A Sentinel intercontinental ballistic missile — rose one slot to 3rd this year, and Aviation Industry Corp. of China moved up from 6th to 4th.

Boeing, which had been 3rd last year, slid to 5th, as its defense revenues dropped 12% to $30.8 billion. In 2022, Boeing’s defense sector struggled with billions of dollars in charges on troubled programs such as the KC-46 Pegasus tanker, T-7 Red Hawk trainer and VC-25B Air Force One presidential aircraft.

Dan Grazier, a military analyst for the watchdog group Project on Government Oversight, said the so-called revolving door of former Pentagon officials leaving public service for lucrative industry jobs often benefits major companies. This can make it harder for smaller firms to take advantage of such relationships, he explained.

Grazier pointed to his organization’s report titled “Brass Parachutes,” which found the top 20 defense contractors in FY16 had hired 645 former senior government officials, military officers, lawmakers and senior legislative staff as lobbyists, board members or senior executives in 2018. Nearly half of those revolving door hires, 312 of them, went to five of the largest U.S. defense firms in FY16: Lockheed Martin, Boeing, Raytheon, General Dynamics and Northrop Grumman.

“Big defense contractors have pretty deep pockets,” Grazier said. “There are probably a lot of these smaller companies that want to break into this market, that are trying to figure out ways that they can attract some of those high-profile, former Pentagon officials.”

That has started to change in recent years, with ex-Trump administration officials, including former Defense Secretary Mark Esper, Army Secretary Ryan McCarthy and Air Force acquisition chief Will Roper, going to nontraditional firms after leaving the government.

Nawabi said a movement is underway that is creating an opening for companies such as AeroVironment to broaden their share.

“The tide has shifted,” Nawabi said. “The U.S. DoD has been more open to seeking companies like us to be more involved and have a better shot at these things. But it’s still a struggle; it’s nowhere near where it needs to be.”

Seeking growth

With the Air Force ramping up its effort to develop drone wingmen, the service is working with roughly 35 companies providing both aircraft and autonomous capabilities, service acquisition chief Andrew Hunter said in a May 18 discussion at George Mason University’s Arlington, Virginia, campus. And over time, many more could join the effort, Hunter said.

Hunter said the Air Force has a “heavy focus” on nontraditional providers as it develops collaborative combat aircraft, or CCA, though traditional firms are also involved. Hunter did not identify those companies, and Kratos’ Fendley declined to say what his company is specifically doing for the CCA program, citing its classified status.

But other companies and systems likely to be involved include Boeing, maker of the MQ-28 Ghost Bat drone flown as part of Australia’s loyal wingman program, and Lockheed Martin, whose Skunk Works division has been working on its own drone wingmen concept.

Asked about Northrop Grumman’s plans for the CCA program, chief executive Kathy Warden said in a July 27 earnings call the company is “looking at it closely.”

Hunter said businesses won’t need to be able to create an entire CCA to participate in the program. If “a company has real game” and can produce a specific portion of an autonomous system, he noted, there is a place for it at the table.

The Air Force wants to “lower the stakes” and have continuous competition on the CCA program so more companies can participate — and live to fight another day if one bid doesn’t go their way, Hunter said.

“If you don’t succeed in the first increment of CCA, if you’re not selected, that may be a one-year bump in your business plan, and you can come back strong the next year and win,” he explained. “No one is ever out of the game if they still have game to offer.”

Since Eglin received its Valkyries, Fendley said, the base’s work with the drones has rapidly progressed and focused on key technology areas related to autonomy and the operational effectiveness of manned-unmanned teaming. Kratos has also sold Valkyries to the Navy and Marine Corps to conduct similar tests.

The company has expanded its production facilities and staffing to support that work, Fendley noted, and now the Valkyrie is in low-rate production for several customers to accommodate the growing demand for drones.

Fendley said large, comprehensive drones are an example of the kind of complex systems mid-tier and smaller firms might provide within five years.

“Our biggest discriminator is our ability to look at a requirement and develop a very affordable solution against that requirement,” Fendley explained. “It’s not going to be the gold standard. We don’t try to be the gold standard. We try to be the affordable solution that can satisfy the need.”

The most important thing the Pentagon can do to foster this kind of growth, according to Callan of Capital Alpha Partners, is to start picking winners and awarding those kind of smaller firms significant contracts. That doesn’t mean giving those companies awards simply for the sake of propping them up, he said, but the Pentagon must keep an open mind when considering bids, rather than reflexively reaching for the big-name primes.

The Defense Department has long talked a good game about wanting to foster more diversity in the industrial base, Callan noted. But if they don’t put real money behind it — as soon as the FY25 budget proposal — the investors some smaller companies rely upon will start to look elsewhere, he said.

“Frankly, DoD at times is going to have to take risk” on companies that don’t have as extensive a track record as traditional firms, Callan said. “It can’t just be $5 [million] or $10 million contracts. If the contracts aren’t there, the capital is going to dry up and people are going to find other sandboxes to play in.”