UPSCALE: Using Private Sector Capital for the Alliance

Executive summary

Australia has entered a new era of intense strategic competition and must find new ways to both develop and finance its national security. Specifically, the Australian Government must draw in the private sector – consisting of capital lenders, equity providers – and national security and technology companies to create sovereign defence capabilities. The urgency of the challenge and need for government to do business differently from the past is captured in the 2023 Defence Strategic Review (DSR).

The DSR emphasised the need for a more “whole-of-nation approach” to Australia’s national defence that harnesses “all elements of national power.” The Review brought into stark relief the sheer scale of Australia’s national security needs over the coming decades. Beyond fielding new military capabilities, Australia requires infrastructure and facilities, manufacturing capability, logistics and everyday operational requirements, and workforce support. The Australian Government agreed with the DSR’s recommendations in whole or principle and made one of its priorities for immediate action to rapidly translate emerging technologies into capability in close partnership with Australian industry.

Although the end goal has been articulated, the path to leveraging the private sector for national security is not straightforward. As a starting point, it requires appreciating Australia’s current domestic capacity and private sector appetite for partnership as well as how all the different moving parts fit together to create a functioning whole. Ultimately, Australia must create a ‘defence-finance-tech ecosystem’ where one has not existed previously.

Creating a defence-finance-tech ecosystem is not just a matter of convincing Australian capital providers like banks, superannuation funds, private equity and venture capital of the business case and identifying appropriate domestic defence and technology companies to enlist. As this report unearths, producing sovereign defence capability for Australia in a self-sustaining system at speed requires targeted policies geared to multiple dimensions. It involves policies directed towards Australian defence and dual-use start-ups and small and medium enterprise (SME); foreign-owned Defence Primes; Australian industry groups and networks; the university and academic sector; the AUKUS partnership; private capital across the spectrum; different government agencies; and Commonwealth Ministers. Multiple stakeholders with different interests and priorities must be forged together for the national good.

As this report unearths, producing sovereign defence capability for Australia in a self-sustaining system at speed requires targeted policies geared to multiple dimensions.

This report’s broad driving question of how to finance national security has generated numerous recommendations for action. Individual recommendations have varying levels of urgency, with some that could be acted on immediately while others require sustained effort over years. One recommendation that, if implemented, would underpin progress is to map Australia’s defence and dual-use companies and investment landscape. Such a resource would be valuable to government, business, and private capital alike.

The report’s other recommendations are directed towards addressing challenges associated with three broad groups: (1) Australian start-ups, small and medium enterprise, and universities; (2) Australian industry, private equity and venture capital; and (3) the Australian Government. Although there are too many recommendations to summarise here, critical, enabling recommendations with the greatest capacity to move the dial are below.

Short term

• Defence should accelerate outreach to a wide group of private sector actors on the Advanced Strategic Capabilities Accelerator (ASCA) and AUKUS Pillar II advanced capabilities priorities and establish an AUKUS Pillar II “trusted network” to advise ASCA on relevant technology issues.
• The Treasurer’s Investor Roundtable should be convened to deepen collaboration between government and the investment community on Australia’s national defence priorities.
• An independent Private Capital Advisory Board should be established to provide high-level guidance to the Department of Defence on capital sources, financing instruments and talent.

Medium term

• Government should create a stronger demand signal to business by developing a clear investment pipeline for core Defence functions and enabling industries and offering co-investment.
• To support strategic defence investment, government should play a matchmaker function to connect start-ups and SMEs with private investors where the path to procurement is clear.
• When speed to capability is required, rather than a blanket pre-requisite for open tenders, Defence should select known and trusted Australian suppliers, companies, and Defence Primes with a track record of delivery.

More challenging reforms include

• Continuation of Defence restructuring its procurement contract process to reduce the costs for SMEs of doing business with government.
• Cultural change in the Defence Department to accept greater risk through Senior Executives leading by example, ministerial-level political support, and APS reward structure.

Each of these recommendations comes with its own challenges be they systemic, structural, legislative, procedural, cultural, or convening. In many cases, they not only require a commitment to new ways of operating but also a change in mindset and approach of government ministers and their supporting departments. This will be more difficult than the everyday challenges faced by government and, in some cases, these recommendations upend decades of entrenched policy and practice. Implementing these changes will feel uncomfortable for department officials and place greater pressure on government ministers to deliver results. But, without this change, government processes and defence industry will not move fast enough to rise to the challenge presented by the current strategic circumstances and will fall short of implementing the DSR’s recommendations and AUKUS requirements.

Without this change, government processes and defence industry will not move fast enough to rise to the challenge presented by the current strategic circumstances and will fall short of implementing the DSR’s recommendations and AUKUS requirements.

While its strategic challenges are daunting, Australia has the benefit of working closely with allies and partners in the Indo-Pacific region in meeting them. Responding to the DSR, Australia’s Defence Minister Richard Marles underscored the need for Australia to continue to work closely with its Alliance partner, the United States, to achieve strategic balance and stability in the region. The US defence enterprise offers critical lessons and manifold opportunities for a partner such as Australia looking to harness private sector technological prowess and capital for national security purposes.

Two factors above all have sharpened the US Government’s focus on better connecting national security to commercial technologies and private finance: the challenge posed by China to US military and technological primacy, and a profound transformation in the US national innovation system towards one where the private sector now dominates R&D for new technologies. This report draws five key lessons from the US finance-defence-tech ecosystem:

• The paramount importance of military strategy in overcoming status quo bias – faced with the challenge of military modernisation at speed, strategy must be in the driver’s seat. Reforms to acquisition processes may yield dividends, but clarity as to what to buy (rather than how to buy) is even more critical.
• Leverage your strengths – harnessing existing and emerging private sector strengths is a better approach than seeking to recreate a more government-centric innovation system.
• Coordinate, coordinate, coordinate – with defence R&D only a fraction of the Pentagon’s, there is no alternative for Australia’s Defence Department but to focus on better coordination and collaboration across government and the private sector to deliver advanced capabilities.
• Money matters, but so does culture – governments need to work simultaneously to improve financial incentives and change cultural parameters to deepen private sector involvement in the defence enterprise.
• Innovation does not rely on an org chart – the US defence-finance-tech ecosystem underscores the power of networks in the innovation process with no single pipeline or pathway to success.

Minister for Defence Industry, the Hon Pat Conroy MP announces the launch of an aircraft coating facility.Source: Australian Department of Defence

Concrete steps should be taken by the US and Australian Governments in the context of the Alliance. These include:

1. Establishing an Australian presence for the Pentagon’s Defense Innovation Unit (DIU) in order to draw from US experience leveraging commercial technologies for military application, and to widen the pool of potential capital sources for Australian technology companies.
2. Embedding an Australian Defence presence in the Pentagon’s Office of Strategic Capital to assess the most effective tools for enlisting patient, private capital investment in new and emerging technologies.
3. Progressing a series of shared technology initiatives, including AUKUS Pillars I and II and the successful conclusion by the US Government of International Trade in Arms Regulations (ITAR) reforms.

Australia’s national defence task calls for new models of collaboration between government and sections of society – private capital providers, dual-use technology companies, university research institutes and the like – that traditionally have not seen national security as core business. Although all parties will need to come together for a successful outcome, the driving force needs to originate with government. The private sector has commercial imperatives. Yet for Australia’s Defence Force to have the capabilities it will require in the future, government must attract a wider network of private sector actors. The report provides targeted solutions in support of that goal.

Australia's national security financing challenge

Australia’s senior most leaders and recent strategic documents recognise that Australia faces its most challenging security environment since the Australia’s senior most leaders and recent strategic documents recognise that Australia faces its most challenging security environment since the Second World War (WWII).¹ China’s rapid military expansion and challenge to US hegemony, Russia’s illegal war in Ukraine, grey zone warfare and economic coercion, and rapid technology advancements are combining to create a less stable and more competitive international environment. As well as a deteriorating strategic outlook, domestically Australia faces major fiscal challenges. Large national expenses for health, aged care, disability insurance, and servicing government debt are adding additional pressure to the Commonwealth. Against this backdrop, the Australian Government must find ways to pay for and speed up the delivery of national security for the public good. This is the urgent challenge this report seeks to address.

For its part, the Australian Government has committed to spend more on defence and broader national security. In the 2023-24 Budget, the government committed to increase defence spending from its current 2.1 per cent to around 2.3 per cent of GDP by 2030.² More broadly, the government is also financing the National Reconstruction Fund (NRF) to the tune of A$15 billion, including A$1 billion each for advanced manufacturing and critical technologies. Although these additional resources are channelled to national defence and related industries, there is a resource shortfall. This is evident in the defence capability trade-offs already being made, including ‘reprioritising’ and cancelling existing defence projects.³ Increased commitment of public funds by the government should be seen as a necessary but not sufficient condition for the sort of defence investment and preparedness demanded by the Indo-Pacific’s deteriorating strategic outlook. The independent 2023 Defence Strategic Review (DSR) public version provides a useful lens to approach the challenge of financing Australia’s national security. Three themes of the DSR serve as anchor points for this report. The first is the call for a “much more whole-of-government and whole-of-nation approach” to defence and national security based on harnessing all elements of national power. The second is the imperative for a more rapid translation of emerging and disruptive technologies into advanced military capabilities. And the third is the need for new approaches to defence capability acquisition, procurement, risk management and innovation that reflect the scale and urgency of Australia’s strategic challenge.⁴

Taken together – a whole-of-nation effort, rapid translation of technology to capability, and faster pathway to defence outcomes – it becomes clear that the necessary response is for Australia to urgently develop a new defence-tech-finance ecosystem.

Taken together – a whole-of-nation effort, rapid translation of technology to capability, and faster pathway to defence outcomes – it becomes clear that the necessary response is for Australia to urgently develop a new defence-tech-finance ecosystem.

The DSR identified the need to enlist a wider network of public and private sector actors and institutions that would support Australia’s national defence strategy beyond the narrow, traditional focus on the Department of Defence and defence industry firms. To implement the DSR’s recommendations, Defence will need to forge new collaborations with sections of society such as private capital providers, dual-use technology companies, and university research institutes that traditionally have not seen national security as their core business. This sort of holistic thinking and whole-of-nation approach to national defence has been rare outside of wartime, certainly in Australia. However, today’s strategic environment demands a more joined up approach.

Getting more private sector skin in the game

A wider network of private sector actors will need to be enlisted to deliver the Australian Government’s ambitious national defence strategy, including the full range of advanced capabilities the Australian Defence Force (ADF) will require in the future. The Department of Defence needs to “take risks and do business differently” (a point acknowledged explicitly by senior Australian officials in consultations for this report). Although, the challenge presented by Australia’s changed strategic environment is not one for Defence to grapple with alone.⁵ This dual reality comes through clearly from the DSR.

The DSR, as well as outlining the scale of Australia’s security challenge, provides an indicative guide to the substantial commercial opportunities for Australia’s private sector in the defence and national security realm over the coming decades. These extend well beyond a focus on advanced technology capabilities and include major investments in infrastructure and facilities, new sovereign manufacturing capability, logistics and everyday operational requirements, and workforce support.

A non-exhaustive list of DSR priorities endorsed by the Australian Government includes:

• Infrastructure developments and upgrades for the Nuclear-Powered Submarine Pathway
• Sovereign industrial capability for the acquisition of nuclear-powered submarines
• A commitment to continuous shipbuilding › Development of domestic missile capability
• Enhanced domestic manufacturing of Guided Weapons and Explosive Ordnance
• The upgrade and development of Australia’s northern network of bases, ports and barracks
• Fuel storage and supply
• Transport logistics tasks
• Accelerated development of AUKUS Pillar II capabilities
• Additional enhanced cyber and space domain capabilities › Workforce training challenges, including ICT and cyber, capability acquisition, engineering, project delivery, and finance.⁶

This extensive demand pipeline, federal budget constraints, and the need to tap private sector resources and technological capability suggest a broad lens be adopted when considering the scope for public-private partnerships and new mechanisms to facilitate private investment. The task will require considerable flexibility in Department of Defence operating procedures, authorities and policy instruments, as well as additional investment in specialist expertise. There is no cookie-cutter approach for working with a diverse range of defence, finance and technology firms as well as research institutions, or for developing policy tools to pull through private capital investment. This flexibility and agility go to the nub of what it means for Defence to take risks and do business differently in a new era. Key lines of effort for deeper public-private collaboration should include: (1) dual-use technology companies and start-ups with products and services at mid- to late-stage development; (2) potential investors in defence infrastructure and infrastructure-like projects looking for stable, long-term rates of return; and (3) Australia’s defence sector small and medium enterprises (SMEs)⁷ where improvements in government communication, support, innovation and contracting processes can help unlock greater private financing for sovereign capability at scale.

Porton Barracks, QueenslandSource: Australian Department of Defence

These lines of effort in no sense diminish the role of large, global Defence Primes⁸ in Australia’s defence enterprise. They will remain central to capability development and defence industry policies geared towards the acquisition of major platforms or weapons systems, such as naval ships or guided missiles. The Primes are, however, well known to government defence planners. And in the context of nurturing a nascent defence-finance-tech ecosystem, they tend not to be direct sources of disruptive technologies (compared with technology firms with private customer-facing, dual-use products and services). Nor are they likely to rely at the margin on Australian financial institutions for capital.

Recommendations

• Defence should adopt a broad lens when considering the scope for greater private capital investment
• Key lines of effort should include: (1) dual-use technology companies and start-ups with products and services at mid- to late-stage development; (2) potential investors in defence infrastructure and infrastructure-like projects; and (3) Australia’s defence sector SMEs where improvements in government communication, support, innovation and contracting processes can help unlock greater private financing for sovereign capability at scale.

Harnessing private finance: A first step

The Albanese government’s endorsement of the DSR’s central recommendations and the pipeline of future investments sketched above opens the door to a national conversation about the role that private finance can play in supporting Australia’s national security objectives. This issue takes on added significance given the deterioration in the regional strategic environment and the reality that many critical technologies with both commercial and military applications rely on private sector innovation systems and private capital investment. Importantly, the foundations for this new conversation are in place.

At a broad level, Australia has sophisticated and mature private capital markets and a well-regulated financial sector. It has the world’s fifth largest pool of pension assets based on the nation’s superannuation system, and the world’s 11th largest stock market. The Australian dollar is the sixth most traded currency internationally.⁹

Australian banks are strongly capitalised, profitable, and held to high standards by the Australian Prudential Regulation Authority (APRA). These banks – especially the four major retail banks – are a key source of finance to Australian SMEs, which form the vast majority of firms in the Australian defence industry. More than 90 per cent of outstanding debt owed by Australian SMEs is held by banks, and SMEs in Australia are three times more likely to apply for debt than equity financing, in part because SME owners usually want to maintain control of their business and avoid diluting their equity.¹⁰

Other forms of non-traditional finance (with new products and providers including non-bank lenders) have grown strongly over the past decade, though off a low base. While these forms of funding can be more expensive than bank financing, processes around obtaining finance can be quicker and easier, helping to build momentum at key stages of business growth.¹¹

Private equity and venture capital (VC) firms increasingly provide sources of financing to innovative technology enterprises in Australia. Australia-focused private capital assets under management more than doubled in the past five years, reaching an estimated A$118 billion as of September 2022. Of this total, private equity accounted for A$41.7 billion (35 per cent) and the VC industry for A$17.9 billion (15 per cent).¹² With their central role in Australia’s innovation and tech start-up ecosystem, private equity and venture capital need to be part of the conversation on harnessing private finance for national security.

Superannuation funds also need to be at the table. The continued growth and consolidation of superannuation funds in Australia continues to transform the Australian investment landscape. Around 17 million Australians collectively own around A$3.5 trillion in superannuation assets.¹³ The superannuation system presents an important source of capital in the Australian economy and superannuation funds have shown increasing interest in alternative investments in recent years, including private equity and venture capital. So too has the Future Fund (Australia’s sovereign wealth fund).¹⁴ There are considerable opportunities for superannuation funds in areas such as defence infrastructure investment.

Treasurer Jim Chalmers has made a point of engaging Australia’s private finance community on future investment needs in areas of national priority. Established in October 2022, the Treasurer’s Investor Roundtable brings together leaders in the investment community including some of Australia’s largest superannuation funds, the major banks and global asset managers focusing on particular asset classes. Initial areas of focus have been on housing and clean energy.¹⁶ In August 2023, the Treasurer observed that there is “an opportunity for the defence industry to be a bigger part of our thinking when it comes to the role of superannuation and other institutional investors in our economy.”¹⁷

There is no more important national priority than securing the investment foundations of national security.

There is no more important national priority than securing the investment foundations of national security. At the earliest opportunity, the Treasurer’s Investor Roundtable should be convened to deepen government collaboration with the private finance community on Australia’s national defence priorities. To inform this discussion, Defence – working with Treasury and the Department of Finance – should undertake a detailed analysis of the Defence balance sheet, including stock and flow variables. This would help to identify the potential role private capital could play through direct funding mechanisms, helping in turn to free up scarce taxpayer resources for vital national security priorities. Any discussion of private financing for national security capabilities inevitably raises issues around environmental, social and governance (ESG) investing, a topic that has become increasingly prominent in recent years. These issues should be aired openly and viewed holistically, given the wide range of investment opportunities in the national security realm and the evolving strategic threats confronting Western liberaldemocracies. At least in northern hemisphere financial capitals, Russia’s invasion of Ukraine in 2022 has spurred a more nuanced and realistic discussion about ESG constraints on investment in defence firms and defence-related activities given the new security challenges facing free and open societies.¹⁸

The Treasurer’s Investor Roundtable provides a useful forum for discussing ESG issues, including the ‘boundary cases’ where private financing of national security capabilities will remain limited. An important area of focus should be on private capital sources in Australia for dualuse technology companies, without losing sight of the broad scope for private investment in defence firms and relatively uncontroversial areas such as infrastructure. Together with the Treasurer, the Defence Minister should lead this conversation.

Recommendations

• The Treasurer’s Investor Roundtable should be convened at the earliest opportunity to deepen collaboration between government and the investment community on financing Australia’s national defence priorities
• To inform this discussion, Defence – working with Treasury and the Department of Finance – should undertake a detailed analysis of the Defence balance sheet, including stock and flow variables
• Together with the Treasurer, the Defence Minister should lead a conversation on the impact of environmental, social and governance constraints on private financing of national security capabilities

Rethinking defence innovation: Understanding the power of networks

Another significant pillar of a dynamic and robust defence-finance-tech ecosystem is Australia’s scientific research community. The DSR highlighted the importance of fast-tracking the translation of scientific and technology research into advanced military applications. In the process, it shone a spotlight on Australia’s defence innovation system and the need for reform.

The Australian Academy of Science reports that, in global terms, Australia has contributed to more than 4 per cent of the world’s published research, while having just 0.3 per cent of the world’s population.¹⁹ Several Australian universities score highly on international rankings of research output, including in areas relevant to military modernisation such as engineering and quantum computing.²⁰ In general, however, Australia sits well below OECD average levels on R&D spending (government and private sector combined).²¹ As a share of total federal government R&D spending, defence R&D fell from around 11 per cent at the end of the 1980s to around six per cent in the early 2000s. This share has remained broadly stable since then, with Defence portfolio R&D expenditure put at A$646 million in 2022-23.²² This compares with strong growth in an area such as health and medical research which, at time of writing, accounts for more than 20 per cent of total government R&D spending in Australia.²³

The DSR placed particular emphasis on the need for clear demand signalling by Defence to industry and the research community, including the university sector, and highlighted the critical role of international partnerships in accelerating the development of more technologically advanced capabilities. Specifically, the DSR recommended the development of AUKUS Pillar II Advanced Capabilities be “prioritised in the shortest possible time.”²⁴ As part of AUKUS Pillar II, Australia, the United States and the United Kingdom agreed to collaborate across a spectrum of critical technology areas.

List of AUKUS Pillar II Advanced Capabilities

• Undersea capabilities
• Quantum technologies
• Artificial intelligence (AI) and autonomy
• Advanced cyber
• Hypersonic and counter-hypersonic capabilities
• Electronic warfare (EW)

A key focal point for advanced technology capability development in Australia is the Advanced Strategic Capabilities Accelerator (ASCA) within Defence. The priorities identified for ASCA are hypersonics, directed energy, trusted autonomy, quantum technology, information warfare and long-range fires. As such, ASCA is charged with delivering innovation outcomes for some, but not all, AUKUS Pillar II priorities.

Hypersonic rocket testSource: Australian Department of Defence

While reforms to government structures and processes have the potential to pay real dividends in this area, no less important is embedding a firmer grasp within government, including the Defence Department, of the intangible (and messy) features of the innovation process. Part of accepting greater risk is embracing in practice a networked approach to the innovation process, including a greater willingness to share information with trusted technology partners within industry and the research community.

In his 2020 book How Innovation Works, science writer Matt Ridley offers an array of examples (through history and across various fields) of how innovation is invariably a “bottom-up” (not “top-down”) process.²⁶ He argues innovation arises most commonly from networks, not hierarchies, created through the exchange and recombination of ideas, often in a manner that is unpredictable and serendipitous. Wherehierarchies tend to reinforce stability, clear lines of authority and standardised delivery against established processes, networks are characterised by their decentralised nature. Their strength lies in their ability to foster creativity, leverage diverse perspectives and encourage collaboration that can ultimately form an ’ecosystem.’²⁷

Another name for an ecosystem is a ’trusted partner network’. Building such networks across diverse and otherwise siloed domains of Defence, other arms of government, the finance sector, the defence industry, technology firms and the broader research community will not arise from business as usual. And while additional resources will be necessary, spending alone will not of itself deliver much-needed innovation outcomes. Defence will need to mobilise a network of critical technology stakeholders, working with other centres of knowledge within government, including the Department of Industry, Science and Resources, the Department of Home Affairs, the Department of Education, and CSIRO’s Main Sequence Ventures. As part of this exercise, and consistent with a whole-of-government approach to national defence, the Australian Government’s Chief Scientist should be afforded full visibility and scope for input into defence innovation reform.

A prime candidate for urgent attention is the development of an Australian AUKUS Pillar II ‘trusted partner network’. In key AUKUS Pillar II critical technology areas, such as AI and quantum computing, the vast bulk of expertise and investment capacity sits outside government. By its nature, this network will take in researchers, financiers, and entrepreneurs as well as government decision makers, many of whom are yet to conceive of themselves as part of such an ecosystem. This would build on emergent networks in select technology areas in AUKUS partner countries. For example, the UK Government has established the UK National Quantum Technologies Programme as a collaboration between industry, academia and government to secure emerging quantum opportunities, while Australia’s National Quantum Strategy aims similarly to build a thriving Australian quantum ecosystem by improving coordination and collaboration between government, research bodies and industry.²⁸

Government has a critical role to play in deploying its unmatched convening power to bring stakeholders together, provide essential information, communicate a clear policy direction, and present itself as open to working flexibly towards shared technology goals as part of delivering on AUKUS Pillar II. This will need to occur based on a support structure of fast-tracked security clearances and enhanced cyber protection. The resourcing of these issues should be a priority, along with accessing specialist skills in the key technological areas of ASCA and AUKUS Pillar II.

Recommendations

• The Australian Government’s Chief Scientist should be afforded full visibility and scope for input into defence innovation reform
• Defence should establish an AUKUS Pillar II ‘trusted partner network’ to advise ASCA on relevant technology issues, with additional resources devoted to fast-tracking security clearances and cyber protection as a matter of urgency.

Shape – Attract – Scale: An organising narrative for Defence

Economist Robert Shiller has identified the important role narratives can play in shaping public policy, as well as organisational and economic behaviour.²⁹ Narratives serve to orient government decision making and influence the response of societal actors. Three watchwords – Shape, Attract, Scale – encapsulate the task for Defence in seeking to harness private sector investment and capability in support of Australia’s national security objectives.

An explicit narrative is a way of reinforcing the clear directive and mandate provided by ministers to streamline processes, make quicker decisions, accept more risk, and devise innovative mechanisms to tilt financial metrics on specific investments. By fostering a shared sense of mission across Defence stakeholders, it gives day-to-day meaning to the injunction for a new organisational mindset and greater licence for defence officials to take different approaches or means to achieving set objectives or ends. In the process, Defence leaders can incentivise personnel to pursue problems and technologies that are deemed to be of the highest priority and to share information, coordinate and collaborate more readily.

An organising narrative would also aid public understanding and awareness that national defence should no longer be thought of as a public good that can be delivered solely through government resources and processes. It would therefore help to play an educative role within the wider Australian community, one that accords with the thrust of the DSR based on the need for a more unified, whole-of-nation approach to Australia’s strategic environment. This is especially important given prevailing trends and debates within the finance sector regarding legitimate areas for ethical investment in the public interest.

The imperative to shape reflects the centrality of clear and continuous communication with stakeholders about what precise capabilities Defence is seeking to acquire. It draws maximum leverage from the unmatched convening power of government, but equally implies government will place deeper trust in partners called on to put their own financial ’skin in the game’.

The need to attract investment ultimately highlights the need for commercial benchmarks to be met, where private sector parties make investments on a risk-weighted return basis. This underscores the need for stable, longterm government funding commitments and for flexibility in policy tools and instruments and in contracting terms geared to pull through private capital. Consultations with private capital providers for this study underlined their responsiveness to the detail of contract terms.

A focus on scale reinforces the essential element that underpins sustainable businesses and a durable, robust ecosystem capable of developing innovative solutions to capability challenges. Scale is the factor that makes a defencefinance-tech ecosystem more than the sum of its parts, and ultimately one that is dynamic and self-sustaining.

Of course, the issue of scale looms large in another sense. Australia accounted for an estimated 1.4 per cent of total military expenditure of the 15 countries with the highest spending in 2022 – lower than Italy (1.5 per cent), though higher than Canada (1.2 per cent).³⁰ The United States, as Australia’s strategic alliance partner, accounted for an estimated 39 per cent of total expenditure.³¹ The relatively modest scale of Australia’s defence enterprise in global terms necessarily imposes constraints and trade-offs.

Modest scale should not mean sub-optimal effort or outcomes. On the contrary, “manageable” scale can provide Australia with an advantage in working with larger allies and partners. AUKUS Pillar II provides the ideal vehicle for greater clarity of focus and superior networked coordination of effort. A strong and cohesive national offering should define Australia’s approach to technological capability development under AUKUS Pillar II. This would better position Australia to leverage international technology partnerships for national security dividends.

Recommendation

• Defence should establish an explicit organisational narrative to foster a shared sense of mission and help orient policy and personnel towards the goal of harnessing private finance for national security.

The US defence-finance-tech ecosystem: Lessons from a work in progress

Enlisting more private sector resources and capability for national security purposes, translating new and emerging technologies into advanced military capability, and reforming defence innovation and capability acquisition systems that are no longer fit for purpose have been (and continue to be) the subject of analysis and multiple policy initiatives in the United States. The parallels between the military imperatives and challenges of Australia and its alliance partner are demonstrable.

The Pentagon once played a central role in the US national innovation system as investor and first adopter, based on its far-reaching contracting power and ability to direct research. By contrast, the private sector now dominates R&D for new technologies, with a focus on the development of new products and services for commercial markets. This transformation in how America creates new technology – and what it creates – has altered immeasurably the relationship between US national security and innovation activity.

The global military primacy of the United States has long rested on unrivalled strengths in foundational research, innovation, and technology development. This position is now under clear and present threat with the rise of China across military, economic, and technological domains. Various studies have pointed to the United States falling behind China in key critical technologies and highlighted weaknesses in the US defence industrial base.³² Further gaps and vulnerabilities were exposed in the wake of Russia’s 2022 invasion of Ukraine, with mounting evidence that the Pentagon faces not only production line challenges but also difficulties gaining access to elements essential to the manufacture of modern military technologies.³³ This backdrop helps explain a sharpened focus within the US Government on better connecting national security to private sector finance and technology development.

The Biden administration’s 2022 National Security Strategy (NSS) surveyed a world where the risk of conflict between major powers is increasing, competition to develop and deploy foundational technologies is intensifying, and authoritarian powers are working more aggressively to implant and export illiberal models of domestic and global governance.34 The 2022 US National Defense Strategy (NDS) outlined how fast-evolving technologies and applications “are complicating escalation dynamics and creating new challenges for strategic stability” – where new applications of artificial intelligence, quantum science, autonomy, biotechnology, and space technologies have the potential not just to change kinetic conflict, but also to disrupt day-to-day supply chain and logistics operations.³⁵

The 2022 NDS calls for urgent action to “build enduring advantage across the defense ecosystem – the Department of Defense, the defense industrial base, and the array of private sector and academic enterprises that create and sharpen the Joint Force’s technological edge.”³⁶ A major emphasis is given to close collaboration with allies and partners, with the Pentagon charged with incorporating them at every stage of defence planning.

Being the world’s largest military power and the nation with the deepest and most sophisticated “finance-tech” complex globally, the US defence enterprise offers critical lessons and manifold opportunities for a partner such as Australia looking to harness private sector technological prowess and capital for national security purposes. Not all these lessons are positive or readily applicable. Yet the sheer scale and breadth of the US military footprint in adjusting to new strategic and technological realities provides valuable insights on the approaches and tools that may be useful to attract private investment and convert new technological advances into military capabilities.

DARPA Robotics Challenge, June 2015Source: Getty

From Los Alamos to Big Tech

The marriage of national security objectives to technological innovation and private sector capital (often seeded by federally-funded R&D expenditure) is by no means a new story for the United States. Various forms of what now would be called public-private partnerships have been central to the development of US defence capabilities from the earliest years of the Republic.

In the 20th century, WWII inspired unprecedented whole-of-nation mobilisation with the United States acting as the manufacturing arsenal of democracy and global technological frontier. The harnessing of government, industry and cuttingedge scientific research during wartime found unique institutional expression in the Office of Scientific Research and Development (OSRD) led by Vannevar Bush. OSRD provided funding and advice for cutting-edge missions (from the Manhattan Project to radar technology to antibiotics development). At its peak, it directly employed almost 6000 US scientists across 300 universities.³⁷

Through the Cold War, the United States was able to combine prominent emerging technologies with new operational concepts to overcome the numerical superiority of Soviet forces, first with nuclear weapons and later with precision weapons and stealth. In the 1950s and beyond, the US military played an important role in the rise of Silicon Valley and the development of the United States’ electronics industry. In 1958, the US Government started a program allowing for the creation of small-business investment companies (SBICs) that would receive cheap government loans and tax breaks to invest in other small companies. In the process, military investments helped seed the emergent VC industry and by the mid-1960s, there were hundreds of small investment companies.³⁸

Also founded in 1958 in the wake of the ‘Sputnik shock’, the Defense Advanced Research Projects Agency (DARPA) is the US Department of Defense’s research and development agency.³⁹ DARPA’s role in making pivotal investments in breakthrough national security technologies with wider application is well acknowledged. With an annual budget of around US$3.5 billion, DARPA lays claim to at least partial credit for game-changing developments including Global Positioning Systems (GPS), stealth technologies, drones and the internet.⁴⁰ It formed one part a wider government-led innovation ecosystem that encompassed federally-funded R&D centres, university-affiliated research centres, national laboratories, as well as a range of other government departments and agencies.

In the 1980s, the US Government launched further projects designed to develop and harness new technologies for national security purposes. The Strategic Defense Initiative, for example, stimulated considerable research on missile defense technologies and, following congressional authorisation, for the first time the Pentagon began investing directly in technology start-ups. Between 1982 and 1988, the federal government, led by the Department of Defense, spent more than US$1.35 billion on such startups – nearly 10 per cent of all venture capital investment over this period.⁴¹ Late in the decade, DARPA helped fund SEMATECH, a consortium of chip manufacturers founded to help advance US research on semiconductors.

The end of the Cold War and resulting declines in defence spending saw national security slip progressively from the centre of the US national innovation system.

The end of the Cold War and resulting declines in defence spending saw national security slip progressively from the centre of the US national innovation system. In the 1990s, US geopolitical dominance, the rise of the information economy, and deeper globalisation within a liberal marketbased order contributed to the emergence of a more decentralised, diverse and commercially-oriented national innovation system. The nexus between large, agile and sophisticated sources of private capital and Silicon Valley came to play an outsized role both in the US national innovation system and in the structural transformation of the US economy.

These developments were not lost on parts of the US national security community. Among early initiatives designed to leverage emergent information and communications technologies for national security purposes was the establishment in 1999 of In-Q-Tel (IQT), a non-profit arm of the US intelligence community. IQT continues to perform a focused role as a strategic investor and vehicle for harnessing cutting-edge (usually dual-use) technologies coming out of Silicon Valley.⁴²

In-Q-Tel as an early mover

As a strategic investor, IQT works with companies to enhance their technology with a view to government agency testing and use within 12-24 months. Investments typically range from US$500,000 to US$3 million and involve multiple government partners. Companies obtain financial resources, market understanding, engineering expertise and access to government partners. In the process, private sector investors are alerted that a company has potential to deliver national security capabilities. Over more than 20 years, IQT has made more than 500 investments. Roughly three quarters of these investments have been field-tested by US government partners, and approximately 50 per cent have been adapted for use.

By 2000, the federal government’s share of total R&D funding in the United States had fallen to 25 per cent.⁴³ While defence-related R&D continued to account for more than half of all federal R&D spending, by the mid-2000s private industry accounted for more than 70 per cent of total US R&D expenditure. Of this amount, 76 per cent was development, 20 per cent was applied research, and only 4 per cent was basic research.⁴⁴ The rise of the ‘Big Tech’ platforms and US leadership in the digital economy tended to overshadow the strategic implications of the far-reaching transformation of innovation in the United States. As one 2022 study observed from an historical perspective:

Following WWII, the United States seized a lead in advanced technologies by under - standing and leveraging the scientific and industry landscape. Guided by Vannevar Bush’s vision in “The Endless Frontier”, a knowledge-generating triangle of govern - ment, academia, and industry carried us to the moon, seeded Silicon Valley, and created the internet. Yet, in only a few decades that triangle began to evolve, and the role of government in setting and driving the agenda for new scientific frontiers began to diminish. Silicon Valley and modern venture capital grew into a force of its own. More recently, the information age opened the door to a fifth player – “the crowd” – that has bolstered individualized capacity to provide sources of funding and driven new research outside of traditional institutions. The innovation has changed, but thus far America has not fully adapted.⁴⁵

China’s rapid economic and technological development and its accelerated integration into the global economy in the early 21st century both reinforced the relative decline in manufacturing’s share of the US economy and deepened its integration into global value chains. The return of great power competition to the centre of US national security strategy in the second decade of the 21st century brought with it heightened concern about a military force that could no longer claim unsurpassed technological superiority.

By the mid-2010s, a growing number of US defence strategists came to appreciate both the scale of the challenge posed by China’s newly acquired military capability and the extent to which the eclipse of the old government-centric national innovation system exposed the United States to greater strategic vulnerability. The dual quest to accelerate the Pentagon’s adoption of commercial technology and strengthen the US national security innovation base led former US Defense Secretary Ash Carter to establish the Defense Innovation Unit (DIU) in 2015. In partnership with other Pentagon agencies, the DIU was designed to act as a bridge between US Defense and the commercial technology sector. It is now possible to point to a proliferation of defence innovation labs, hubs and centres across various arms of the US defence enterprise following the creation of the DIU.⁴⁶

DIU provides Pentagon-wide focus on commercial technology

A primary goal of the DIU is to shorten the procurement cycle through rapid prototyping, piloting and iterative development that quickly evaluates technologies for military application. With offices in Silicon Valley, Boston, Austin, Chicago and inside the Pentagon, DIU teams aim to deliver scalable revenue opportunities with commercial vendors within 12 to 24 months. Companies the DIU has backed have been awarded around US$5 billion in contracts from US defence agencies.

In recent years, the DIU has been joined by a proliferation of new players across various arms of the US military. One study identified more than 60 defence innovation organisations as part of the DoD innovation ecosystem. As well as DoD-wide organisations like DARPA and the DIU, specific bodies under the umbrella of the Services include: Army Applications Lab, Army Research Lab and XTechSearch (Department of the Army), CNO Rapid Innovation Cell, NavalX, and Marine Corp Rapid Capabilities Office (Department of the Navy), and AFWERX, AF Ventures and Air Force Rapid Capabilities Office (Department of the Air Force).

The Trump administration’s 2018 National Defense Strategy (NDS), as well as formalising a shift in the focus of US defence planning from terrorism to great power competition, highlighted the way rapid technological advancements were changing the character of war. It drew a direct line between many technological developments coming from the commercial sector, expanding to more actors with lower barriers to entry, and the erosion of the “conventional overmatch” to which the US military had grown accustomed.⁴⁷ The Biden administration’s 2022 Defense Strategy represents a further evolution of this thinking around accelerated force development and incorporating new technology more quickly. The Strategy outlined a layered picture of US technology investment priorities.

We will fuel research and development for advanced capabilities, including in directed energy, hypersonics, integrated sensing, and cyber. We will seed opportunities in biotechnology, quantum science, advanced materials, and clean-energy technology. We will be a fast-follower where market forces are driving commercialization of military-relevant capabilities in trusted artificial intelligence and autonomy, integrated network system-of-systems, microelectronics, space, renewable energy generation and storage, and human-machine interfaces.⁴⁸

Implicit in this approach is the recognition that the Pentagon no longer has the sort of policy reach it used to command in the development and application of cutting-edge technologies. The technology leadership of the United States in what President Biden calls, the “decisive decade” for global geopolitics will require the mobilisation of a much broader network of private sector actors within the US defence-finance-tech ecosystem.

Bridging the Valley: Military modernisation in a transformed innovation system

A comparative assessment of corporate R&D expenditure highlights the challenge defence planners confront in nudging the contemporary US innovation system towards areas of military priority. The five Big Tech giants combined – Amazon, Alphabet, Microsoft, Apple and Meta – spent an estimated US$127 billion on R&D in 2020. The equivalent combined R&D expenditure of the top five US defence contractors – Lockheed Martin, Raytheon, General Dynamics, Boeing and Northrop Grumman – was estimated at just over US$8 billion, less than seven per cent of Big Tech’s R&D footprint.⁴⁹

The divide between the US military’s technological demands and the centre of gravity of the US innovation system can be seen through the prism of three related challenges. The first is the type of financing model – VC – that plays such a central role in the system. The second relates to the technology incentives that are most lucrative to innovative firms from a commercial perspective. And the third concerns persistent obstacles and gaps that limit the capacity of Pentagon agencies to facilitate adoption of new technologies into the hands of warfighters.

The VC investment model encapsulates the different perspectives and incentives between how the United States creates new technology based on commercial imperatives and the national security architecture. The growth cycle of start-ups, with their high-risk/high-reward, scale-up-quickly mindset and constant search for additional capital to continue existing, is not well aligned with the military’s low-risk, deliberative approach to developing, testing and integrating technologies where the focus is on reliability and performance. Divergence in risk appetites, timelines and ultimate objectives makes aligning government and private sector incentives a major challenge as this summary of the VC investment model makes clear. As assistant professor of history at Georgetown University, Jamie Martin, explains:

The aim of venture capital is to bet on the long tail: Invest in many different start-ups, knowing most will fail but hoping at least one big success will more than offset the losses. For this reason, the business has always focused on technology companies, which offer the greatest potential for fast growth and outsize returns. Most venture capital firms today are located in Silicon Valley, and nearly all the major tech companies, including Amazon, Apple, and Google, relied on venture capital funding to get off the ground. The playbook is simple: Raise capital from institutional investors such as pension funds and university endowments, buy an equity stake in young companies, and then oversee their operations until they go public and investors can cash out.⁵⁰

This incentive structure is reflected in turn in the sorts of products and services of most interest to private investors. VC firms in the United States have traditionally remained heavily weighted towards digital platforms and consumer technologies – defined by low-cost scalability, low barriers to entry and relatively quick profits. This innovation model places a premium on getting a product out quickly and fixing the bugs later. There is less appetite for costlier (and hence riskier) investments in ‘deep technologies’ such as advanced manufacturing, biotechnology and quantum computing that require significant upfront capital and longer periods to mature and where the emphasis is on working correctly and meeting defined standards from the outset.⁵¹

This incentive structure is reflected in turn in the sorts of products and services of most interest to private investors. VC firms in the United States have traditionally remained heavily weighted towards digital platforms and consumer technologies – defined by low-cost scalability, low barriers to entry and relatively quick profits.

Where these incentives and tensions converge from a technology policy perspective is around bridging the so-called “valley of death.” This is defined as the gap in the development, production or successful fielding of a technology based on a demonstrated degree of technological readiness. Based on the traditional Technology Readiness Level (TRL)⁵² scale, it tends to apply to TRL levels five (laboratory testing) and higher. In this context it includes the period of time in which a business is seeking to transition a prototype or commercially available product to a defence contract.⁵³ A detailed study of the US defence innovation system by the RAND Corporation found that while the Pentagon has funding available to support technology development, “much of that funding is concentrated in the early stages of development, and there is limited support for testing and proof-of-concept demonstrations that can help sustain a company.”⁵⁴ Due to misaligned processes or incentives, many technologies stall in the valley of death without a clear path to continued development or transition. The RAND report concludes that the “biggest gap” in the commercial technology pipeline “is that no one has both responsibility and authority for solving the valley of death and transitioning innovative commercial technology at scale.”⁵⁵ In short, no one entity owns the entire problem.

The latest attempt by the US Defense Department to address this challenge is the creation within the Pentagon of the Office of Strategic Capital (OSC). Established in late 2022, the OSC’s mission is to connect companies that are developing technologies vital to national security with sources of private capital, recognising that many such technologies “often require long-termfinancing to bridge the gap between the laboratory and full-scale production.”⁵⁶ Moreover, many critical technologies are not purchased directly by the Pentagon with the result that existing procurement programs struggle to support immediate capital needs for companies specialising in these areas.

Hence, the dual mission of OSC is to identify and prioritise promising critical technology areas and to enlist funding for these technologies, including supply chain technologies not always supported through direct procurement. To achieve this, OSC will partner with private capital providers and other federal agencies to employ investment vehicles that have been successful in other contexts. The objective is to both ‘crowd in’ private capital and to attract patient capital to bring critical technologies to scale.

In summary, the quest within the US Government to adapt to the new geometry of the US national innovation system and bridge the different worlds of defence planners, venture capitalists and tech entrepreneurs remains a work in progress. There is evidence that recent measures are paying dividends. An analysis of dualuse venture fund flows between 2014 and 2018 found strong growth in funding into Pentagon technology priorities, with initial round funding rising from US$5.2 billion to US$14.9 billion over the period and with the defence share of total VC funding tracking at around 20 per cent.⁵⁷ These trends have strengthened further in the wake of the war in Ukraine, with PitchBook data showing that US venture investment in defence start-ups surged from less than US$16 billion in 2019 to US$33 billion in 2022.⁵⁸ And, in a break from the past, there are signs of increasing preparedness on the part of large VC firms in the United States to invest in technology that can have kinetic effects.

The success of several dual-use ‘unicorns’⁵⁹ also points to a dynamic, self-sustaining element to the US defence-finance-tech ecosystem. Successful firms such as Anduril, Palantir, SpaceX, Cloudfare, Tanium and ShieldAI are testimony to the fact that barriers, both incentive-based and cultural, to engagement with the Pentagon are not insurmountable. Factors identified as helping to unlock new contracts for a wider range of defence and dual-use start-ups include the rapid development of AI, greater procurement flexibility in certain areas and enhanced capacity to sell directly to those carrying out specific military missions.⁶⁰

At the same time, various studies continue to highlight bureaucratic acquisition processes, lack of funding for relevant technologies and firms at key development stages and unfulfilled expectations on the part of various actors in the innovation system.⁶¹ Complaints by defence tech startups and bodies such as the Silicon Valley Defense Group continue to surround the Pentagon’s attachment to systems and procedures that favour large incumbents, as well as what some capital providers see as a stubborn unwillingness on the part of defence bureaucracies to understand relevant business models and to take account of commercial objectives.⁶²

Five takeaways for Australia

For Australia, several lessons can be drawn from efforts by the US military to strengthen its innovation ecosystem. Some are suggestive of what Australian policymakers should focus on; others point to what they should temper or seek to avoid. The following summarises five takeaways that could help to inform the development of approaches and tools to be implemented in an Australian context.

1. Strategy must win out

Strategy must inform decision making in technology and acquisition. From a resourcing perspective, the vast bulk of US defence spending is in the domain of ‘big bets’ on major weapons systems. This is widely seen as reinforcing a high degree of status quo bias in Defense Department operational concepts and capability acquisition programs, and established processes, long after new strategic circumstances demand course correction. Hence, the Pentagon’s established technology focus has long been on large platforms capable of locating and destroying adversary hardware at a distance. With its origins in the Cold War, this strategic focus has carried through strongly to today via campaigns in the Middle East and the Balkans in the 1990s and Afghanistan and Iraq in the 2000s, with substantial legacy bias.

For the most part, policy reform proposals tend to focus on institutional failings such as inherent risk aversion, poor communications, rigid contracting processes and inadequate development financing, that can result in costly failures and cause fast-moving technology companies to disengage. Yet there is a powerful case to suggest that, in confronting the new geometry of defence innovation and the changing nature of war, the more fundamental issue is not “that the DoD doesn’t know how to buy; it doesn’t know what to buy.”⁶³

Official Pentagon statements over the past five years all but concede the essential thrust of this critique. The 2018 NDS talked of the United States “emerging from a period of strategic atrophy” where it failed to adapt to a world where rapid technological developments in the commercial sector had changed the character of war.⁶⁴ The 2022 NDS describes the Pentagon’s force development, design, and business management practices as “too slow and too focused on acquiring systems not designed to address the most critical challenges we now face.” The current orientation, it argues, “leaves little incentive to design open systems that can rapidly incorporate cutting-edge technologies, creating longer-term challenges with obsolescence, interoperability, and cost effectiveness.”⁶⁵

This underlines the fundamental importance of strategy in defining what to buy when faced with the challenge of military modernisation at speed. Strategy – and the clearly defined functional needs and effects that flow from strategy – are paramount in the development and acquisition of advanced military capabilities within set budget constraints. This point was registered strongly in an Australian context by the DSR; it is the implementation that matters.

2. Leverage your strengths

A positive lesson from the US defence-finance-tech ecosystem is the pragmatic focus on core strengths. However subject to trial-and-error various policy initiatives may be, harnessing existing and emergent strengths is a better strategy than seeking to recreate a more government-centric innovation system characteristic of a bygone era. What tends to unite various initiatives adopted by the Pentagon and military services over recent years is the desire to work with the grain of US business and financial models, commercial imperatives, and innovation drivers to build deeper connective tissue between the national security apparatus and the private sector.

However subject to trial-and-error various policy initiatives may be, harnessing existing and emergent strengths is a better strategy than seeking to recreate a more government-centric innovation system characteristic of a bygone era.

With its extensive network of strong research universities, federal laboratories, deep and sophisticated financial markets, risk-taking and entrepreneurial culture, the United States continues to hold vital cards in the quest for technological advantage. The challenge is to remodel the linkages of the transformed US innovation system to the changing demands of the Pentagon in a way that unlocks the full potential of the US defence-finance-tech ecosystem.

For Australia, the task is similar – to identify and leverage core areas of strength and take advantage of emergent trends in finance, technology and research. As the world’s 12th largest economy with strong governance, deep and sophisticated financial markets, a skilled workforce and highly ranked universities and research institutions, Australia has many of the ingredients needed for a world-class defence-finance-tech ecosystem. A more complex and threatening security environment should provide the impetus to combine these attributes for enhanced military capability.

3. Coordinate, coordinate, coordinate

For a country with the military scale and reach of the United States, quantity can have a quality all its own. Hence, a case can be made that the dozens of military innovation units across the various US defence forces allows for a more dispersed and richer model of experimentation (that is, trial and error) when it comes to applying commercial technologies to military application.

For Australia, however, the lesson is more around what to avoid. Budget constraints and scarce resources suggest no alternative but to prioritise, coordinate and collaborate relentlessly across government and the private sector to the highest degree possible. For example, Australia’s annual defence R&D budget is of the order of US$420 million.⁶⁶ The US Democrat’s Fiscal Year 2024 budget request for defence research, development, test and evaluation amounts to US$145 billion. Even then, the need to better align US efforts and budgets across defence innovation organisations – based on geographic focus, technology area, and stage of funding – continues to be made.

4. Money matters, but so does culture

While some companies may have ideological reasons for not working with defence institutions, there is growing evidence to suggest there is less than meets the eye on this front. The DIU, for example, has worked with more than 100 vendors that do not usually bid on defence contracts, including many who had never before worked with the Pentagon. “Change the incentives, and the innovators will come” is a reasonable conclusion from the US experience.⁶⁷ The emphasis in this context tends to be on funding above all else.

Nonetheless, there can be residual cultural factors that work to constrain private sector involvement in the defence enterprise. The mismatch between a risk-averse defence capability acquisition process designed to manage complex, linear weapons acquisition programs in a deliberative way and a private-sector-led innovation system weighted towards moving fast, accepting risk and disrupting established ways of doing things continues to discourage public-private partnerships. Hence cultural problems can impede the adoption of innovative commercial technology for military use.⁶⁸

Here, DARPA offers useful hints as to the sort of organisational and human resource model that should be contemplated if Australia is serious about reforming its defence innovation. Nearly 100 of DARPA’s roughly 220 government employees are program managers, who oversee approximately 250 research and development programs. DARPA goes to great lengths to identify, recruit and support program managers at the top of their fields. Individuals come from academia, industry, and government agencies for limited stints, generally three to five years. Special statutory hiring authorities and alternative contracting vehicles allow the agency to take quick advantage of opportunities to advance its missions.

The lesson for Australian policymakers is reasonably straightforward. Ultimately, both incentives (money) and culture (people) matter as part of a comprehensive approach to gearing Defence towards more rapid translation of technologies into advanced military capabilities. Encouragingly, Australian Government ministers have given the Defence Department the clear imprimatur and instruction to take risks and do business differently.

Both incentives (money) and culture (people) matter as part of a comprehensive approach to gearing Defence towards more rapid translation of technologies into advanced military capabilities.

5. Innovation and the limits of the org chart

The evolving US defence-finance-tech ecosystem and the wider innovation system in which it operates are testimony to the power of networks in the innovation process. A defining feature of the US national innovation system in the age of Big Tech and VC is its “incremental and distributed nature.”⁶⁹ As one think tank analyst posited:

It is not linear. Tangled connections are the norm in VCs, since a deep knowledge of the industry is essential. Serendipity plays animportant role when research in one area turns up something of use for another problem. Many firms and institutions are involved, with researchers and entrepreneurs building upon and expanding the work of others.⁷⁰

This bottom-up, unpredictable element needs to be factored explicitly into policy design. Innovative activity will not arise from a new org chart in the Defence Department. It requires a much more forward-leaning outreach agenda from government designed to shape, attract and scale private investment in defence related innovation activity.

As much as lines of authority, it needs to emphasise the intangible, enabling elements of the policy environment based on the role of networks and the importance of diverse feedback loops. A key feature of the US experience in seeking to identify, develop and apply commercial technologies for military use is its lack of uniformity. There is no single pipeline or pathway of commercial technologies from concept to fielding. Potential paths are neither linear nor sequential and the path an innovative technology, product, or service takes can differ depending on characteristics of the technology and business, financial considerations, and alignment with other US Defense Department processes.⁷¹

Actions within the alliance framework

In the context of the Australian-US Alliance, several steps could be taken to join up respective defence-finance-tech ecosystems and harness the lessons and strengths of each.

Firstly, the Australian and US governments should explore how best to draw from US experience leveraging commercial technologies for military application. As an interim step, and short of new institutional initiatives on the part of the Australian Government, a DIU presence in Australia could be established in a manner similar to that of IQT, which has been in Australia since 2018.

Secondly, Australia should look to embed a Defence official with appropriate finance expertise in the US OSC. This would provide a firsthand, real-time window into approaches and tools that are likely to be effective at leveraging patient, private sector capital in technology areas that traditionally have struggled to access adequate finance.

Thirdly, as has been well established elsewhere, reforms to US International Trade in Arms Regulation (ITAR) are essential to a raft of shared technology capability building initiatives – including AUKUS Pillar I and Pillar II. This requires action at both the US executive and congressional levels as well as reforms to Australian procedures to ensure harmonisation of export controls.⁷²

Fourthly, Australia and the United States could better leverage the commercial solutions and supply chains that exist in each country. Partly, this will be addressed via the AUKUS partnership, along with the United Kingdom. But there is wider opportunity for Australia, the United States and their allies and partners to scope solutions across each other’s national defence industry and pool experts for shared, labour-intensive tasks such as unsolicited defence innovation proposals.

Australian Government defence innovation and SME growth initiatives have been insufficient

Tactical Air Defence Radar System antennasSource: Australian Department of Defence

Australia’s size and capacity is substantially different to the United States, meaning Australia’s output will never approach the same scale or be of the same character. However, having to do more with less can lead to favourable outcomes and Australian scientific ingenuity has produced world-leading defence technologies in the past. Australia’s development of radar technology, for example, is outstanding and has resulted in its export to the US military.⁷³ Developed in the 1970s and 80s, Australia’s high-frequency over the horizon radar (OTHR) and related Jindalee Operational Radar Network (JORN) have been described as Australia’s technological crown jewel.⁷⁴ Australia’s national defence industry also has global comparative advantages in quantum computing, acoustics and biotechnology.⁷⁵

Although Australia has shown great capacity to create and innovate in recent decades, Australia’s government-led defence innovation initiatives have had limited success and Australian industry is yet to be fully leveraged in support of the national interest.

Australia’s publicly funded hub for defence innovation is DSTG within the Defence Department. DSTG has an annual budget of around A$408 million, making it the second highest publicly funded research institution in Australia after the CSIRO.⁷⁶ DSTG has prioritised developing technologies ranging from cyber warfare, to spacebased and undersea surveillance, to quantum positioning, navigation and timing.⁷⁷ Since the 1990s, DSTG and Defence more broadly have overseen initiatives to spur innovation in partnership with Australian industry and more quickly transition technologies into Defence capability. Primary among these has been the Capability and Technology Demonstrator (CTD) program, later renamed the Defence Innovation Hub (DIH) and the Next Generation Technologies Fund (NGTF). DIH was targeted at later stage capability development while NGTF was focused on early-stage research.⁷⁸

The CTD, then later DIH and NGTF did not result in enough new military capability or export opportunities to be considered successful programs. Concerns have been raised by some industry executives about the DIH and NGTF investment frameworks. While not fully representative, some within the private sector believe the frameworks skewed official decision makers towards more evenly distributing innovation funds across Australian companies as opposed to deliberately selecting companies with the greatest chance of success or most valuable offering to Defence.⁷⁹ Defence’s reluctance to ‘pick winners’ and instead spread the resources more thinly across multiple companies had the effect of limiting the success any one company could enjoy. Rather than completing 10 years of operation out to 2026, DIH and NGTF projects and funding have been rolled into ASCA.

Clearly, the Australian Government and industry has concerns about the effectiveness of the nation’s defence innovation system. Citing Defence’s innovation system “not performing as well as intended” and calls from industry for it to be overhauled, the Australian Government commissioned an independent Defence Innovation Review in 2021.⁸¹ A public version of the review was released in March 2023, however the findings were heavily redacted.⁸² Although the findings are unclear, industry’s concerns provide an insight into what the review might have concluded. In particular, Australian innovators and companies assert they are impeded by inconsistent and opaque processes, complex contractual requirements, and frequent changes to requirements by government.⁸³

To address the underperformance of previous initiatives and spur new defence innovation, while in Opposition, the Labor party proposed an Australian version of DARPA.⁸⁴ Originally this initiative had the working title of ‘Advanced Strategic Research Agency’ and was intended to support AUKUS through working with DARPA and the UK Advanced Research and Invention Agency (ARIA) to fund breakthrough technologies.⁸⁵ After Labor won office in 2022 however, the concept evolved and expanded beyond an organisation modelled off DARPA to a more all-encompassing model, now represented in the Advanced Strategic Capabilities Accelerator (ASCA). The change in name is significant. Rather than defence research and innovation – as DARPA and ARIA are tasked – ASCA is seeking to transition technology solutions into the hands of Australian military personnel at speed.⁸⁶ The Defence Department’s intention is for the hub of defence innovation to remain within DSTG and not in a separate institution.

The Advanced Strategic Capabilities Accelerator: Australia’s new effort for speed to capability

ASCA launched on 1 July 2023 and has been allocated A$3.4 billion over 10 years, which is a considerable amount considering DSTG receives A$408 million annually.⁸⁷ ASCA’s funds are being sourced from within the Defence portfolio through subsuming DIH and NGTF funding and other offsets. During its initial 18-month operating period, ASCA has committed to consider technology solutions across the TRL spectrum – from low TRL technologies at the basic discovery level to high TRL technologies that are ready to be tested and operationalised. In private, Defence officials describe ASCA has having responsibilities similar to three US agencies: DARPA, DIU, and the Strategic Capabilities Office.⁸⁸

Given ASCA is commonly equated with DARPA and the fact DIH and NGTF programs are being subsumed by ASCA, it is understandable the expectation from Australian industry and external observers is that ASCA is itself intended to create new technologies and innovate. Instead, ASCA is attempting to rectify the shortcomings of the DIH and NGTF which stumbled at the last hurdle – the actual translation of technology and innovations into defence capability. ASCA is being asked to identify and pull through asymmetric innovations into Defence capabilities in priority areas like hypersonics, directed energy, trusted autonomy, quantum technology, information warfare, and long-range fires. This leaves Australia without an exact DARPA equivalent.

Launch of the Advanced Strategic Capabilities AcceleratorSource: Australian Department of Defence

ASCA’s oversight structure and ability to attract talent raise questions regarding whether it is best positioned for success. ASCA’s governance structure remains within Defence, meaning it is predisposed to adopt a similar culture and direction as previous innovation initiatives. ASCA will be overseen by four senior Defence executives, although with a new external advisory committee drawn from industry, academia and government. Ultimately however, Defence senior executives will have discretion and, while they are unrivalled in terms of their appreciation for government’s needs and priorities, they do not have capacity to be intimately connected to or integrated with Australia’s broader innovation ecosystem. ASCA will have dedicated ‘missions’ and its mission program leader roles will be open to private sector professionals as well as officials. Defence has committed to hiring from outside the Department to fill the first of these mission program leader appointments and, to compete with private sector renumeration levels, can accommodate individual funding arrangements on a contract basis that exceed public salary ranges.⁸⁹ However, it is unclear whether the conditions and culture within Defence will attract professionals from the fast-paced, dynamic start-up and innovation sector. Overall, there remain concerns within Australian industry that ASCA’s current model is not sufficiently different from previous Defence capability translation and innovation initiatives to improve outcomes.⁹⁰

The way Defence conceptualises how ASCA will transition innovation into Defence capability with urgency suggests it would be best placed to focus on high TRL technologies and incremental innovation. High TRL (6-9) products have a potentially shorter testing and development timeframe and can be more rapidly brought into service. The ASCA transition pathway shows a linear model where priority problems are agreed, partners selected, missions co-designed, acquisition pathway agreed, then capability acquired. Unless this model is flexible, there appears little scope to accommodate disruptive, game-changing innovation that has a non-linear pathway and is more likely to evolve over time into areas not agreed at the outset. Further, given ASCA will be led by government, it could prove better suited to identifying incremental rather than disruptive innovation. Incremental and sustaining innovation usually provides greater speed to capability rather than the search for the disruptive panacea.

Diagram provided by the Defence Science and Technology Group

The added benefit of focusing ASCA towards higher TRL technologies and safer incremental innovation is that it would clarify ASCA’s investment opportunity for the private sector. Different risk profiles motivate different investors—venture capitalists, for example, are more attracted to game-changing disruptive technology while banks and private equity prefer to place less risky bets and have a greater guarantee of return, which incremental innovation can offer. There are exceptions – when US private equity firm KKR provided venture capital raises to Australian robotics and AI company, Advanced Navigation, this was a divergence from KKR’s typical funding profile.⁹¹ But generally, different investors are drawn to projects that are either high-risk/ high-return or low-risk/ low-return and both types of investors are more effectively engaged on separate offerings. ASCA’s current intention to consider technology innovation across the spectrum and from within the same funding pool presents a mixed message for investors with different risk-appetites.

Moreover, by considering low TRL projects at all, ASCA is reducing the potential number of non-defence specific investors that might be interested. Low TRL (1-5) applications do not have a dual-use market because they are not at the commercial level; high TRL (6-9) products have already had their R&D completed and their commercialisation pathways can be made clearer to private investors.⁹² To bolster public funds with private capital and transition technologies into service faster, ASCA should focus on high TRL technologies and incremental innovation.

To attract more non-traditional industry partners and accelerate the adoption of commercial technology, Defence could also consider establishing special contracting arrangements such as an ‘Other Transactions’ (OT) mechanism. An OT authority is employed by US entities including DARPA and DIU to enter into arrangements with private companies to create prototypes without needing to go through the usual contracting or grant process.⁹³ Through adopting common business practices such as OTs, the US Government can attract non-traditional companies with technologies of interest to the Pentagon and facilitate quicker and cheaper project design.⁹⁴ A similar vehicle applied in an Australian context could benefit ASCA.

Recommendations

• At the conclusion of the 18-month start-up phase, government should sharpen ASCA’s focus to high TRL (TRL 6-9) technologies and incremental innovation to clarify the investment opportunity for the private sector
• To empower ASCA, Defence should consider new contracting mechanisms such as ‘Other Transactions’ to attract non-traditional companies and prototype faster.

‘Ghost Shark’: A public-private partnership success story with lessons for Australian SMEs

Alongside defence capability transition initiatives like ASCA, Defence is making progress in partnering with industry to develop new capabilities at speed. A standout example is Defence’s partnership with Anduril Australia. In May 2022, Defence and Anduril Australia announced the co-development of an extra-large, autonomous Anduril Australia ‘Dive-LD’ autonomous submarine in Sydney Harbour (Anduril Australia) robotic undersea vehicle, later named ‘Ghost Shark’.⁹⁵ If successful, Ghost Shark would represent a brand new capability for the Australian Navy. The vehicle would be able to remain at sea for long periods, cover long distances, and carry military payloads. Defence and Anduril Australia are contributing equally to the A$140 million co-development agreement. The intention is for three separate Ghost Shark prototypes to be operational by mid 2025.⁹⁶

Anduril Australia ‘Dive-LD’ autonomous submarine in Sydney HarbourSource: Anduril Australia

Compared with Defence’s usual contracting and development timeline, the Ghost Shark program has progressed at breakneck speed. As an example, Defence and Anduril Australia were under contract within 152 days when the typical contract process can take anywhere from 12 to 36 months.⁹⁷ Rapid progress has been further supported by DSTG scientists and engineers working alongside Anduril Australia technicians, allowing for faster Ghost Shark design, modelling and testing. In explaining Ghost Shark’s faster development, Government and industry emphasise different factors and hold differing views on how likely it will be to replicate this speed with other capabilities.

Undoubtedly, many factors came together at once to ensure Ghost Shark’s faster development. The primary reason Ghost Shark could move quickly was due to Defence and Anduril Australia being willing to accept higher levels of risk to ensure a flexible contract. Defence gave the project senior level support, deployed existing flexible contract mechanisms, and agreed to co-development. Further, the Ghost Shark project has ongoing governance that includes Defence and Anduril Australia staff supporting an Executive Steering Group, Project Management Committee and several working groups. These groups meet regularly, agree and modify ongoing work plans and allow the program to evolve as required to meet the agreed outcomes. This flexibility allows both to make core decisions throughout the project, rather than defining everything within the contract.⁹⁸

In explaining Ghost Shark’s faster development, Government and industry emphasise different factors and hold differing views on how likely it will be to replicate this speed with other capabilities.

Other factors, both at a global security level and at the interpersonal level, may have also played a role in motivating senior level stakeholders. These include Russia’s invasion of Ukraine underscoring the importance of autonomy in warfighting (Ghost Shark is seeking to be an autonomous vessel) and pre-existing relationships of trust and shared vision between Defence and Anduril Australia senior executives. From industry’s perspective, these factors – which were unique to the circumstances at the time and individuals involved – make it less likely that capabilities beyond Ghost Shark could be fast-tracked as successfully.

While some in industry hold doubts, Defence has confidence Ghost Shark’s development model can be replicated. In part, this is because Defence has already adopted aspects of this model for other projects. Defence’s intention is to employ the same flexible and agile contracting arrangements that underpin Ghost Shark for future ASCA projects.⁹⁹ Down the track, Defence is seeking to build consortia to allow SMEs and start-ups to work on ASCA’s missions independently of being contracted to a Defence Prime. If this goal is realised, there could be real benefits to Australian SMEs. In the meantime, the Ghost Shark project is supporting Australian SME growth. Anduril Australia has down selected around 15 Australian companies to fill parts of the Ghost Shark supply chain and is providing mentorship and connecting them with its VC network.¹⁰⁰

However, simply replicating the Ghost Shark approach for every Defence-industry partnership is unfortunately not possible. In several ways, Anduril Australia is a unique partner for Defence that starts with having an existing trusted relationship and shared vision.

Unlike small, stand-alone Australian companies, Anduril Australia is the subsidiary of major US company, Anduril Industries, which is valued at more than US$8 billion.¹⁰¹ Anduril Australia has access to networks, capital and commercial intelligence that many Australian SMEs lack. Anduril Australia can also afford to further develop its initial offerings to potential customers. Highlighting this approach, in April 2023 Anduril Australia CEO David Goodrich said: “Anduril doesn’t wait for government to fund its ideas and its programs; Anduril uses its own internal sources of capital to develop products ahead of a capability requirement.”¹⁰² “However, partnering with DSTG and Navy has enabled the program to achieve outcomes we would not have been able to do on our own.”¹⁰³

For small and medium Australian companies without access to financial reserves, networks, and an existing track-record with Defence, mirroring the Ghost Shark model will be challenging. Still, there are useful lessons to observe. The most pertinent for Australian SMEs is that Defence – and DSTG specifically – is embracing the practical need for innovation and partnering with industry more broadly. Other lessons are that Defence can employ flexible contracting, senior level support from Defence is critical, and faster outcomes can be achieved by having DSTG scientists working alongside private industry.

Recommendation

• Following the rapid development of a ‘Ghost Shark’ capability, Defence and other government departments should identify a shortlist of small Australian companies with promising products to employ flexible procurement contracts and co-develop capabilities side-by-side.

Incentivising Australia’s defence SMEs to upscale and the role of the university sector

To develop sovereign capability and contribute to the AUKUS partnership and beyond, Australia has a vested interest in leveraging its domestic startups and SMEs, underpinned by its research sector. Although the Australian Government almost exclusively issues procurement contracts to foreign-owned Defence Primes, there are comparative advantages to investing in sovereign Australian defence innovation, primary among them is not falling further behind global competitors.¹⁰⁴ Australia’s different-sized, structured, and positioned scientific and technological community can produce unique outcomes and its network of SMEs can be better utilised. However, encouraging Australian SMEs to grow and scale is not straightforward.

The dynamics keeping good Australian defence companies down

Two factors consistently raised by public and private actors in discussions for this report were that Australian defence SMEs lack both the desire and expertise to scale. Culturally, Australian business owners prefer to retain control and stay personally involved rather than upscale and sell to a Prime or overseas. In addition, as businesses grow, government incentives naturally dry up, creating downwards pressure on SMEs to scale. Further, while Australian defence companies boast smart product developers and excellent technologies, the quality of business management can appear highly variable. Australian businesses need expert financiers who understand capital markets and can facilitate connections into the funding ecosystem. Finally, to become a supplier to Defence, they require knowledge of how to transition their products into Defence capabilities.¹⁰⁵

Several additional factors have led to the current situation of Australian defence and technology companies remaining small and medium-sized. A primary cause is SMEs’ lack of sufficient start-up capital and difficulty securing loans from banks. One Australian bank stepping into the breach is Westpac.

In mid-2023, Westpac and Export Finance Australia (EFA) – the Australian Government’s export credit agency – struck a first-of-kind partnership to help national defence companies upscale. The EFA-Westpac initiative helps smooth the capital flow for defence SMEs, assisting them to access finance for build components, capital expenditure and bridging finance. The product is currently only available to Australian companies that have already secured a contract with a Defence Prime. The EFA and Westpac agreement is non-exclusive, meaning if they can demonstrate financial returns, the other major banks – ANZ, Commonwealth, and NAB – could strike similar deals with government. Crowding in the banks would be a gamechanger for financing Australia’s defence, especially if it promotes broader market confidence in the sector.

Recommendation

• To increase the amount of scale-up capital available to SMEs, Export Finance Australia should seek to replicate its Westpac Heads of Agreement with other major Australian banks.

There is another systemic factor keeping SMEs small - foreign-owned Defence Primes dominate the market and win 90 per cent of Australia’s defence contracts.¹⁰⁶ By virtue of being large, Defence Primes can afford to enter Defence’s procurement process and navigate its complex bureaucracy. Many Primes have employed former Defence officials in their contractual teams to fast-track the process and the Primes are also able to afford the up-front security bonds required by Defence.¹⁰⁷ The preferable position for Australian SMEs is to be a supply chain sub-contractor to a Prime. Often it is far more cost-effective for SMEs to haggle with a Prime over work share than to go through Defence’s arduous tender and contract process, which typically takes between 12-36 months or longer.¹⁰⁸

Major Defence Primes preferred for Australian Government contracts

• BAE Systems
• Boeing
• Lockheed Martin
• Northrop Grumman
• Raytheon
• Rheinmetall
• Thales

By necessity, Australian SMEs must continue working closely with these foreign Primes to win Defence contracts. However, other supporting mechanisms should be put in place to incentivise SME growth and maintain their Australian ownership and intellectual property (IP). Foreign Defence Primes will be key to this process and, although Australian Government contracts already include a requirement for local industry content, these have been insufficient in changing the underlying dynamics.

Primes can better support SMEs through appropriate licensing arrangements such as not seeking exclusive IP rights. The Primes could also provide more structured mentoring for SME executive teams to help them navigate Defence’s procurement process, regulation and compliance and identify skills gaps. The challenge for government is determining how to best incentivise Prime contractors to provide supportive licensing arrangements and business mentorship.

Recommendation

• The Defence Department should incentivise Defence Primes through the contract process to support Australian SME sub-contractors through favourable licensing arrangements and structured senior mentorship.

DARPA unmanned combat air vehiclesSource: Getty

Beyond better leveraging the Primes, Australian start-ups and SMEs could be encouraged to innovate and upscale if they had commercial customers beyond Australia’s Defence Department. The Australian market presents only one potential customer in its Defence Department. In contrast, there are several, well-financed potential customers in the United States. The United States has six Defence branches – Army, Navy, Air Force, Marine Corps, Coast Guard and Space Force – all with individual procurement streams as well as intelligence agencies and a defence-wide procurement program.¹⁰⁹ Moreover, the United States has a defence budget 16 times larger than Australia (more than US$800 billion annually¹¹⁰ compared with Australia’s US$50 billion), meaning the scale of opportunity is far greater. These factors combine to create an incentive structure geared towards Australian SMEs selling to the United States or other international markets before Australia.

A way to increase the opportunity and mitigate the financial risk for Australian SMEs would be for Australia’s Defence Department to broaden its innovation and procurement calls to open the aperture to more dual-use products. Adopting this approach, however, reveals a fundamental tension facing Defence. Previously, the DIH and NGTF had open innovation calls; their successor, ASCA, will not offer this service because Defence lacks the capacity to review and process the sheer number of unsolicited bids from Australian industry.¹¹¹ The United States has similarly reported issues and lacking value from unsolicited proposals.¹¹² Moreover, given financial and time constraints, Australia’s Defence Department is now focused on acquiring technology and innovation that are restricted in scope to solving specific and clearly articulated defence challenges at speed.

If Defence tenders become too narrow, some start-ups and SMEs will opt out given the lack of broader commercial appeal. The unintended by-product could be that Defence’s innovation calls attract a more limited number of potential suppliers, reducing the government’s capacity to capture and fertilise innovation across the Australian landscape. In addition, limiting Defence’s tenders to defence-specific capabilities greatly reduces the potential to leverage private sector financing. Dual-use products are more attractive to private sector investors, from private equity to socially conscious VC. Should Defence restrict its investment to products that only serve military purposes, there will be far fewer opportunities to attract private investment – and supplementing public funds with private capital is essential to Defence meeting its capability requirements.

Recommendation

• Where possible, Defence tenders should be flexible enough to open up dual-use opportunities so SME products have wider commercial appeal.

Should Defence restrict its investment to products that only serve military purposes, there will be far fewer opportunities to attract private investment.

To further capture innovation across Australia, a new framework to consider is an open technology and innovation competition but with a very well-defined problem-set. In the United States, DARPA runs a series of ‘Prize Challenge’ events that set a specific capability challenge and offer cash prizes. Over the last two decades, DARPA has run multiple prize challenges focused on specific areas such as autonomous vehicles, robotics, digital manufacturing, wireless communication, and pandemic forecasting.¹¹³ Cash prizes have reached up to US$3.5 million and the competition attracts talent from across the US innovation landscape.¹¹⁴ DARPA asserts that its initial autonomous vehicle Prize Challenge helped lay the foundations for future advancements in the autonomous car industry.¹¹⁵

Australia has had experience with similar competitions and innovation initiatives including the Army Innovation Day and Air Force’s Jericho Disruptive Innovation.¹¹⁶ The Army Innovation Day attracts industry and academia and seeks to unlock Australian breakthroughs in similar technology areas as DARPA’s Prize Challenges. The 2023 event focused on solutions in counter-robotics and autonomous systems. However, there are high barriers to entry for university researchers seeking to attend the Army Innovation Day, ranging from submission requirements to university approval procedures.¹¹⁷ Further, unlike DARPA’s Prize Challenge, there is no financial incentive, meaning participating researchers and companies have no financial offset or reward unless their product is acquired. Air Force’s Jericho Disruptive Innovation is also extremely limited in that it is only open to innovators drawn from within the Royal Australian Air Force.

Recommendation

• Defence should establish a ‘Prize Challenge’ event series to identify promising early-stage research, technology and innovation in the private sector and matchmake with ASCA and Defence capability managers.

Army Innovation Day 2019Source: Australian Department of Defence

In addition to Australian Army and Air Force innovation initiatives, there has been a proliferation of Australian defence industry associations, networks, conferences and forums. These serve several purposes and can be useful in terms of knowledge sharing, networking and partnership, and lobbying on behalf of business. However, lacking in the intricate latticework are forums specifically designed to attract private capital holders – VC, private equity firms, and banks.

A platform that intermingles Defence capability managers, entrepreneurs, SMEs, VC and private equity (PE) has potential to produce more public-private partnerships and create an Australian defence-finance-tech ecosystem. Where the path to procurement is clear, Defence could even play a matchmaker function to connect SMEs with private investors. For example, Defence’s Office of Defence Industry Support (ODIS) currently facilitates a ‘Meet the Primes’ initiative for SMEs: a ‘Meet the VCs and PEs’ for Australian small business on the sidelines of Defence trade events could be established to foster new commercial partnerships. Furthermore, ODIS’ business engagement initiatives and online portal systems should be more widely promoted to Australian dual-use and technology companies and internally to Defence’s own capability and program managers.¹¹⁸ Should this occur, ODIS services could be better utilised.

Recommendations

• To support strategic defence investment, government should play a matchmaker function to connect startups and SMEs with private investors where the path to procurement is clear
• Greater activism by the Australian Office of Defence Industry Support and stronger promotion of its services and portals internally within Defence, across government and to industry.

The difficulty and risks associated with Defence’s procurement process place large downward pressure on SMEs and private investors’ willingness to engage and enter into partnership. In this regard, Defence’s contracting framework could be greatly improved. Some within Australian industry assert that Defence officials lack commercial experience and are unfamiliar with the full range of contracting tools available to them, as employed by other Australian Government agencies.¹¹⁹ Understaffing and high staff turnover within Defence’s contracting and legal teams has also increased delays and eroded corporate knowledge. In addition, Defence’s contract terms place project risk almost entirely with the contractor: government contracts can be changed at any time; can be cancelled without notice; and may be terminated upon a change of government, change in technology, or change in command or capability user requirements.¹²⁰ This uncertainty is unattractive to companies and private capital alike.

Australia’s Defence Industry Minister, Pat Conroy, fully appreciates the need for Defence to take on more contract risk, as he expressed in June 2023: “…we do need to embrace more risk in defence contracting. We do need to move beyond having 70 signatures required before an authorisation goes forward. Now this places more pressure on the Department of Defence, and I’ve been frank with the Department about what our expectations are.”¹²¹ In addition, SMEs contracted to larger Defence Primes complain of receiving short-term contracts, invoicing delays and irregular payments.¹²² The increased disruption for SMEs can result in gaps in workforce and skills, lost innovation, and create the conditions where the business no longer remains viable.

The difficulty and risks associated with Defence’s procurement process place large downward pressure on SMEs and private investors’ willingness to engage and enter into partnership.

The long time taken to process tenders, including awarding contracts and notifying unsuccessful bids is another irritant. Partly, contracts can take longer to process because Defence officials lack wider knowledge of the contracting tools available to them across government. Plus, all government contracts are subject to open tender, resulting in a vast number of applications regardless of whether there are only a few companies, or only one, with the capacity to deliver. Progressing each company through the various tender stages elongates the process and creates frustration within Australian industry. Speaking again in June 2023, Defence Industry Minister Conroy said: “…what industry have told me is they are sick of wasting their time in competitions where the result is already for-ordained. They’re sick of wasting their time and resources and, quite frankly, I’m sick of wasting Defence’s time.”¹²³

In circumstances requiring specific speed to capability outcomes, Defence should receive an exemption from government to fast-track the process. Although this would require legislative change, some preliminary efforts are already underway to streamline contracting decisions. Defence is currently working across government agencies to develop a list of Australian companies that could become ‘trusted partners’ for Defence projects, specifically on AUKUS Pillar II advanced capabilities.¹²⁴ In addition, Defence has recognised the problem and is seeking to improve contracting through re-training staff and empowering them in the decision making process.¹²⁵

The United States can down select defence and technology companies at speed via its Defense Production Act (DPA). The DPA gives the President wide-ranging powers, not only to select specific defence companies but to direct them to prioritise delivery of goods to the US Government over commercial contracts. The Pentagon uses DPA authority routinely, placing around 300,000 orders per year for a variety of military equipment.¹²⁶ Although a similar Act would not fit comfortably in the Australian system, having greater flexibility to select commercial partners for Defence quickly is necessary given the strategic circumstances.

Recommendations

• Defence should continue to restructure its procurement contract process to reduce the costs for SMEs of doing business with government
• Within Defence’s contracting and legal teams there should be higher investment in staff training, recruitment and retention
• Cultural change in the Defence Department to accept greater risk through Senior Executives leading by example, ministerial-level political support, and APS reward structure
• Government should legislate change to allow Defence to shift away from a blanket prerequisite for open tenders to down selecting known and trusted Australian suppliers, SMEs and Defence Primes with a track record of delivery.

Leveraging Australia’s university sector

Another crucial piece of the puzzle is the university sector. University research is the lifeblood of scientific and technological advancements across the country. During and immediately after WWII, the US Government invested heavily in university research, underpinning decades of future advancement in defence capability. Close links between the US Defense Department and academia remain today. In contrast, Australia underutilises its academic sector in driving national security outcomes and there is significant scope to increase linkages between Defence and Australian universities. Lacking engagement is partly due to low ambition to partner on both sides. For Defence, information security on university campuses is a primary concern while, for academia, there has been little interest to support the national defence enterprise. However, there are signs the Defence Department and universities are recognising the opportunity in cooperation.

A greater number of Australian universities are applying for or interested in receiving security clearances to work on defence-related projects. In recent years, several new Defence Industry Security Program (DISP) memberships have been approved and others are in progress.¹²⁷ Collaborations, however, are impeded by the slow security clearance process for universities. Within the Defence Department, the DISP sponsors security clearances but the clearances themselves are awarded by the Australian Government Security Vetting Agency (AGSVA).

AGSVA has had a clearance backlog for some time and delays were exacerbated by technological and administrative problems associated with the rollout of the ‘myClearance’ online portal.¹²⁸ As of August 2023, AGSVA reports it is failing to meet its processing timeframe KPIs for clearance levels across the board. For example, AGSVA’s KPI for priority positive vetting is three months but AGSVA’s reported median (rather than average) processing time is around five and a half months. While DISP memberships can be processed in a relatively short time, delays with AGSVA – particularly for high-tier clearances – can extend for months and years.¹²⁹

Although this is a complex issue requiring multiple solutions, the starting point is to re-train AGSVA case officers, allowing them greater agency in decision making. Currently, AGSVA staff are encouraged to prioritise procedural requirements and not empowered to use critical thinking or informed assessment.¹³⁰ There is also broad scope to streamline the security clearance process and reduce delays and backlogs.

Security clearances exist for an important reason: to prevent top secret and sensitive information being released, undermining Australia’s national security and endangering its people. However, in failing to remove roadblocks to security clearances, Australia is making another security trade-off in the time lost to catch up with the defence and technology advancements of global competitors. Australian government officials also need to recognise that security clearance requirements are only going to tighten as Australia implements the tougher controls required by the United States as part of the AUKUS agreement.¹³¹ With a heavier uplift coming down the pipeline, the government needs to act now to address the long time taken to process security clearances.

Recommendation

• Ministerial direction to shift AGSVA from its current procedural focus to a risk-based approach and streamline the clearance process.

In failing to remove roadblocks to security clearances, Australia is making another security trade-off in the time lost to catch up with the defence and technology advancements of global competitors.

As well as security clearances, defence science and technology could be sped up by establishing secure labs and facilities on Australian university campuses. Australia lacks secure labs within universities to work on classified projects in an environment that can foster innovation. The United States has addressed this problem by creating separate laboratories for targeted defence research, such as the Johns Hopkins University Applied Physics Laboratory (APL). APL has its foundations in WWII and is credited with developing new technologies that are now integrated with modern defence systems including phased array radar, sonar arrays, and ballistic missile defence.¹³²

Beyond secure university labs, co-creation spaces offer another framework to leverage academics. The UK Ministry of Defence founded the Defence BattleLab in 2022.¹³³ BattleLab is part of the UK Government’s national strategic technology and innovation exchange program and provides a co-development space for business, academia and the UK Defence Force. There is currently no equivalent in Australia. Shared spaces can better leverage academic knowledge and know-how and stand to provide the Australian Defence Department with an edge.

Australia has an existing foundation from which to build Defence’s links with academia presented in the Australian Defence Science and Universities Network (ADSUN), which is comprised of five Australian state-sponsored defence research and innovation groups.¹³⁴ However, this network is insufficient to respond to the challenge at hand.

ADSUN identifies linkages between universities, industry, and Defence and DSTG has an embedded scientist in each of the five state-based networks. But, more than the light-touch approach of relationship building and providing advice and support, Defence’s engagement with universities needs to be directed and deliberate. Activities could include rotating Defence staff and university researchers through each other’s workplaces. Other initiatives could be encouraging Defence officials to apply for post doctorate degrees in support of Defence objectives, funded by Australian Research Council (ARC) fellowships or via the creation of an ARC Industry Fellowship specifically for Defence.

Recommendations

• Defence should work with the university sector to establish secure labs or co-creation spaces for defence science and related research
• With the aim of increased two-way mobility and skill-building in research collaboration and commercialisation, rotate university and Defence staff through each other’s workplace and pursue Australian Research. Council funded fellowship.

Connecting private capital to national defence

Traditionally, Australia’s defence bureaucracy has had little cause to connect in any systematic way with private capital markets and major Australian financial institutions. Defence budgets, acquisition processes, and innovation systems have operated in a milieu largely separate from the world of private capital. However, a more complex and dangerous strategic environment, a more assertive Australian defence posture and a transformed technological context, with closer links to commercial imperatives, call for new thinking and approaches regarding the role that private capital can play in supporting national defence.

This report has recommended the Treasurer, working with the Defence Minister, convene his high-level Investor Roundtable for a discussion on the role the private investment community could play in Australia’s military modernisation agenda. To be meaningful, this exercise should be complemented by deeper and more enduring linkages between Defence Department and sources of private capital.

Access to finance: Trends and issues

Australia’s strong, diverse and well-regulated financial sector, with one of the largest retirement savings pools in the world, provides the essential foundation for this engagement.¹³⁵ Australia’s investment landscape has continued to evolve over the past decade as a result of changes in the global economy and investors seeking greater diversification of asset classes. Some of the largest investment managers in the world have operations in Australia in recognition of the range of investment opportunities on offer across multiple asset classes.

The retail banking system is dominated by the four major banks. Together they control around 73 per cent of assets held by authorised deposit-taking institutions.¹³⁶ The stock of loans to business of the four major banks amounts to around A$1.1 trillion of a combined total loan book of A$2.9 trillion.¹³⁷

Bank lending to SMEs has continued to grow in Australia, though growth has been strongest for medium-sized enterprises in recent years. Smaller businesses face higher borrowing costs than larger businesses as they are typically riskier and subject to more volatile income flows. Modelling by major banks suggests that SMEs are around twice as likely to default on their loans compared with large corporations.¹³⁸ Around half of small business lending in Australia is collateralised with a residential mortgage.¹³⁹ There is evidence of banks pulling away from some forms of higher risk business lending, with non-banks increasing their market share. Even so, non-banks’ share of total business credit remains relatively small at about eight per cent.¹⁴⁰

In 2021, the Productivity Commission reported that while the SME market is “well covered by various lending products, there appears to be a gap for unsecured finance between $250,000 and $5 million, with few lenders willing to offer these loans.”¹⁴¹ The Commission did not identify any regulatory barriers that prevent willing borrowers and lenders from reaching a deal in this segment, noting that SMEs may be unwilling or unable to pay a sufficiently high, risk-adjusted premium for entirely unsecured finance.

Constraints on small business access to finance has remained an area of focus for policymakers in Australia. Government programs that support small business financing include the Australian Business Securitisation Fund and the Australian Business Growth Fund. The A$2 billion Securitisation Fund supports lending to SMEs by expanding the institutional funding market via investments in securitisation of loans made by SME lenders. The Australian Business Growth Fund, a private business with shareholder contributions from the Australian Government and a number of banks, provides equity finance to SMEs.¹⁴²

These financing initiatives sit alongside other programs that seek indirectly to boost financial flows into particular areas of the economy. One example is the Labor government’s newly legislated A$15 billion National Reconstruction Fund (NRF), which includes defence capability as one of seven priority areas for investment.¹⁴³ Other federal programs include the Industry Growth Program which is designed to support SMEs with expert advice and matched grant funding of A$50,000 to A$5 million for eligible projects.¹⁴⁴

While SMEs typically have access to a smaller pool of equity funding in Australia compared with larger corporates, their capacity to raise equity from sophisticated private investors (such as angel investors or venture capitalists) has grown markedly in recent years. As noted previously, Australia-focused private capital assets under management have more than doubled in the past five years, reaching an estimated A$118 billion as of September 2022, up 21 per cent from December 2021.

Private equity and VC fundraising reached record levels in 2022, even as Limited Partners (LPs) around the world grew cautious off the back of rising interest rates, recession fears and geopolitical tensions.¹⁴⁶ Aggregate capital raised by Australian-focused private equity fund managers in the first nine months of 2022 climbed to A$9 billion, more than double the A$4.3 billion in 2021. Australia-focused VC fund managers raised an estimated A$2.7 billion in over the same period, almost four times the figure for 2021. Total ‘dry power’ (the amount of capital available for investment) reached an estimated A$37 billion in the same period.¹⁴⁷

Half a dozen names – Square Peg Partners, Blackbird, AirTree Ventures, CSIRO’s Main Sequence Ventures, OneVentures and Brandon Capital Partners – dominate the VC landscape in Australia. By sector, information technology accounted for more than half of VC investment deals in Australia in 2022, supporting growth of Australian start-ups in technology sectors such as blockchain, AI and cryptocurrencies.¹⁴⁸ However, capital flows can be uneven and there still appears to be a lack of capital for the development and commercialisation of the sort of ‘deep tech’ ventures relevant to Australia’s defence enterprise.

Notably, infrastructure continues to register in investor surveys as among the most prospective asset classes in Australia for private capital.¹⁴⁹ This is a significant positive in the context of a large pipeline of planned infrastructure investment within the Defence portfolio, one that highlights opportunities for sources of patient capital such as superannuation funds. Beyond A$3.5 trillion in assets currently under management (equivalent to around 150 per cent of Australia’s GDP), the stock of Australian superannuation assets will continue to increase for decades to come. Projections are for this figure to approach A$9 billion by 2040.¹⁵⁰

For the larger Australian superannuation funds, a key trend has been increased funding commitments to private capital asset classes, with the likes of AustralianSuper, Aware Super, HESTA, and Hostplus continuing to expand funding for private equity and VC. Australia’s sovereign wealth fund, the Future Fund, has also shown increasing interest in PE and VC.

Simultaneously, there is a growing trend of more high-net-worth individuals, family offices, wealth managers, and corporate investors allocating to private capital, attracted by a range of benefits. In addition, overseas LPs have shown greater interest in Australia-based private capital funds in the past decade. Comparing the periods of 2018-22 with the period 2013- 17, for example, the percentage of active North American investors increased from 19 per cent to 25 per cent.¹⁵¹

Apart from a growing interest in alternative investments and asset classes and higher participation by foreign investors, another key trend in the Australian financial scene has been increased emphasis on ESG factors in investment decision making. Over recent years, ESG investing has become the fastest-growing segment of the asset management industry globally. Superannuation funds have played a leading role in an Australian context and Australia has around 200 signatories to the United Nations’ Principles for Responsible Investment.¹⁵²

Another key trend in the Australian financial scene has been increased emphasis on ESG factors in investment decision making.

The term ESG has become a broad catch-all for a range of investment strategies that promise to bring positive social or environmental change. The essential aim of ESG investing is to identify companies that are well-managed, have a positive impact on society and the environment, and offer a high financial return. At the same time, questions have been raised about the capacity of ESG to muddy at least two different concepts: one is an objective assessment around risk (for example, risk to business assets from climate change); the other is around values and ethics where subjectivity is inevitable.

With the rise of ESG investing, the place of defence industry including companies in defence supply chains and technology companies has received increased attention, especially given the pressures for greater defence spending by Western democracies. Russia’s invasion of Ukraine has only highlighted the complexities and contradictions in this area. In the United Kingdom, for example, government ministers have been forthright in highlighting “perverse” outcomes where financial institutions appear to be shunning or divesting from defence and security companies at a time of war in Europe. The comments followed a meeting between ministers and business executives to discuss the impact of ESG guidelines on the sector.¹⁵³ ESG standards in Australia will continue to evolve over time, with ongoing impacts for the defence enterprise as a result.

Harnessing private capital: A second step

These trends and investment dynamics such as the rise of ESG investing can no longer be of merely passing interest to defence planners and policymakers. They impact directly on Australia’s capacity to meet national defence requirements including the ability to field technically advanced capabilities. If Australia is to approach the sort of “whole-of-nation” effort called for by the DSR, the worlds of private finance and national security need to be joined up.

Beyond the recommended Investor Roundtable under the aegis of the Treasurer, the Defence Minister should look to establish an independent Private Capital Advisory Board (PCAB) to advise the Defence Department on harnessing private capital for national security purposes. The PCAB would be well placed to provide both strategic and tactical advice on capital sources, financing instruments, and talent requirements towards key lines of effort.

The first focal point is dual-use technology companies and start-ups with products and services at mid- to late-stage development. This work should essentially support the work of ASCA and the rapid development of asymmetric capabilities targeting emerging and disruptive technologies. Key issues in this setting would include how to secure adequate shared funding for the protype experimentation and refinement phase of product development, the most useful ‘crowding-in’ financial instruments, and feedback to government on financing issues fundamental to national R&D gaps and opportunities.

The second area is potential investors in defence infrastructure and infrastructure-like projects looking for stable, long-term rates of return. Some Australian superannuation funds already have experience in contracting with Defence on infrastructure projects.¹⁵⁴ The sustained growth of superannuation funds under management provides an obvious source of potential financing for major projects associated with Australia’s military modernisation.

The third area of focus is on the financial health and growth prospects of Australia’s defence sector SMEs and the degree to which improvements in government communication, support, innovation and contracting processes can help unlock greater private financing for sovereign capability. Here, there are likely a series of issues where the banking sector can assist the Department of Defence to improve contracting processes in ways that make a genuine difference to defence industry SMEs.

Board representation should include distinguished professionals with experience and expertise across the range of institutions represented on the Treasurer’s Investor Roundtable – namely, banks, VC and PE firms, superannuation funds as well as individuals with specialist expertise in particular asset classes and the defence sector. The Board and its remit could usefully be announced in conjunction with 2024 National Defence Strategy.

The Board should also become Australia’s designated hub for engagement with the burgeoning list of like-minded capital raising and investment entities (public and private) looking to invest in defence and dual-use start-ups. In the United States, leading VC firms such as Andreesen Horowitz, Founders Fund and Lux Capital have investments dedicated to critical technologies aligned with those nominated by the Pentagon. In addition, there is a growing number of corporate mission-focused funds (for example, Lockheed Martin Ventures) with the capacity to invest in companies developing cutting-edge technologies focused on national security interests. Globally, liked-minded funds include the NATO Innovation Fund, the world’s first multi-sovereign venture fund which will make direct investments in early-stage startups. This has the potential to turbocharge the nascent ecosystem being developed in Australia whereby capital raising firms such as Ellerston Capital, Bondi Partners, Beaten Zone Venture Partners, and Azcende have committed to national security investment funds.

Recommendations

• An independent Private Capital Advisory Board should be established to provide high-level guidance to the Defence Department on capital sources, financing instruments and talent requirements
  • The composition and mandate of the Board should be developed with a view to announcing it alongside the release of the National Defence Strategy in 2024
  • The Private Capital Advisory Board should become the hub for the Australian Government engagement with sources of international capital with shared security goals
  • Provide a business intelligence function for government and visibility of supply chains.

Aligning government for the task ahead

The DSR put considerable store on the importance of strong alignment across Commonwealth agencies as part of a whole-of-government approach to national defence. This will not occur automatically or without strong leadership, both at the centre and across various official institutions. Commonwealth leadership will also be required to better coordinate resources, energies and expertise across State and Territory governments and in the private sector as part of a unified, whole-of-nation defence strategy.

Deep and continuous coordination needs to be sustained across all arms of government policy and funding sources with a focus on defence capability enhancement. In the first instance, the onus is on Defence and its armed services to collaborate intensively and prioritise ruthlessly. They must also resist the temptation to layer new structures and processes on top of badly coordinated foundations, where responsibility and accountability are blurred and resources dissipated across mistaken or unclear objectives.

Making whole-of-Commonwealth coordination a reality

Across the Commonwealth as a whole, problems associated with siloed fragmentation and patch protection need to be addressed systematically. Limited resources place a premium on setting clear priorities and, where necessary, reforming structures and processes to better align with post-DSR national defence priorities.

Focused attention should be given to aligning objectives and resources across key departments, including Defence, the Department of Industry, Science and Resources (DISR), Employment and Workplace Relations, Home Affairs and Education. Prime candidates for deeper coordination include defence innovation, science and research, university research commercialisation, industry policy including supply chain resilience programs, critical technologies policy, and workforce issues. The Department of Prime Minister and Cabinet has a key role to play in supporting DSR implementation and in ensuring better coordination on national defence priorities across the Commonwealth in these and other areas.

Following consultations conducted by the Australian Government’s Chief Scientist, the Australian Government will consider a new set of National Science and Research Priorities and National Science Statement before the end of 2023. As outlined by the Office of the Chief Scientist, this exercise will be designed to reflect Australia’s strategic interests and national values, highlight competitive and comparative advantages, and help shape and align investment and funding decisions.

Traditionally, Commonwealth R&D expenditure policy has largely fallen between the industry and education portfolios, with Treasury acting as the guardian of R&D taxation arrangements.¹⁵⁵ There is a need to better define and capture the place of defence innovation, science and research activity within a national framework. A striking conclusion from a 2021 study by Industry Innovation and Science Australia (IISA) was that investments in this area are not captured as part of system-wide priorities in Australia.¹⁵⁶ This should be remedied as a matter of urgency within a new statement of national science and research priorities.

It is impossible to assess either the appropriate level or effectiveness of defence innovation, science and research expenditure outside of system-wide analysis. Other conclusions from the IISA study also need to be addressed from a national defence perspective. These include poor transparency, consistency, and independence of investment evaluations, fragmented responsibilities across departments, high turnover of investment programs, and limited coordination of investments between Commonwealth and State and Territory governments.

Recommendations

• Defence innovation, science and research investments need to be captured as part of Commonwealth system-wide priorities in the context of the Government’s forthcoming National Science and Research Priorities and National Science Statement
• Reforms to improve the evaluation and coordination of Australia’s defence related innovation, science and research investments should accompany this exercise.

The biggest whole-of-government coordination challenge lies at the intersection of departments and programs spanning industry policy, critical technologies policy, and university research commercialisation. With policy responsibilities and programs sitting across multiple government agencies, key defence related policy levers sit outside the Defence Department. While this is inevitable, it places a high premium on coordination and collaboration given government’s declared intention to deploy all elements of national power to improve Australia’s defence capabilities.

Traditionally, Australian industry policy has focused either on protecting specific manufacturing capabilities or spreading various forms of industry assistance across a broad range of sectors. Over time, the emphasis has shifted towards identifying specific manufacturing priorities, with additional steps more recently to link these priorities to a revitalised university research commercialisation agenda. The NRF signals a further policy evolution. Rather than rely predominantly on grants-based programs, the NRF is empowered to provide a range of finance options, including loans, guarantees and equity investments.

The Australian Government has nominated seven priority areas for the NRF with a view to providing finance to projects that diversify and transform Australia’s industry and economy.¹⁵⁷ The NRF Corporation will act as an independent financier with the commercial aim of delivering a positive rate of return. Investment decisions will be made independently by the Board, though guided by an investment mandate set jointly by the ministers for Industry and Science and for Finance. One of the designated priority areas is defence capability, although other priority areas – including critical enabling technologies – also have a strong bearing on the defence sector. The government has already earmarked A$8 billion of the NRF’s A$15 billion for specific areas, including A$1 billion for advanced manufacturing and A$1 billion for critical technologies.¹⁵⁸

The flagship of the Labor government’s industry policy, the NRF needs to dock seamlessly with Australia’s national defence priorities. There should be an early public statement on the governance interface between the NRF Board and Defence to ensure decisions on defence capability investments take full account of government’s highest defence priorities. A specific test is to ensure that investment decisions, as far as possible, complement ASCA’s mission directed investments. This would reflect the stated policy objective of Defence Industry Minister Pat Conroy.¹⁵⁹ To assist industry engagement with the two government bodies, protocols between Defence and DISR should provide for the ‘warm handover’ of defence and technology firms between organisations.

New institutions such as the NRF and ASCA should have their work programs integrated with the established university research commercialisation agenda administered by the Department of Education. Announced by the Morrison government in February 2022, this plan forms the backbone of Australian Government efforts to strengthen ties between academia and industry and to bridge the ‘valley of death’ that acts as an obstacle to commercialisation.

The model for ACSA, in particular, should be informed by the design and early lessons of Australia’s Economic Accelerator, the A$1.6 billion stage-gated grant program dedicated to funding translation and commercialisation of university research in national manufacturing priority areas.¹⁶⁰ Other research commercialisation initiatives with an important bearing on defence industry growth include the Trailblazer Universities program and the expanded capacity of CSIRO’s Main Sequence Ventures which backs start-up companies and helps create commercial opportunities from Australian research.¹⁶¹

Recommendations

• A public statement on the governance interface between the NRF and the Department of Defence would help guide industry engagement and ensure appropriate alignment between NRF decision making and the Government’s national defence priorities
• To assist industry engagement, protocols should be developed for seamless interaction and warm handovers between the NRF and ASCA
• The work programs of both the NRF and ASCA should be informed by the Government’s university research commercialisation agenda, with its central focus on bridging the valley of death surrounding the commercialisation of research breakthroughs.

As part of a whole-of-government coordination, Defence also needs to have direct and ongoing input into the work program of DISR’s Office of Supply Chain Resilience. DISR’s Office has a broad remit to advise the government on supply chain risks and potential actions to improve resilience. The Defence Minister should task Defence with undertaking regular reviews of defence supply chain risks, aligned to the biennial National Defence Strategy. This would see Australia mirror the work of key security partners more closely

Sitting within the purview of the Minister for Industry and Science is critical technologies policy including the development and maintenance of the standing list of critical technologies in the national interest. The government’s broad objective is to ensure Australia captures the opportunities critical technologies bring to support Australia’s economic prosperity, national security, environmental sustainability and social cohesion. It has what it describes as a balanced, whole-ofgovernment approach to critical technologies policy to ensure “all government portfolios are working together to identify and harness opportunities within the broader strategic context.”¹⁶² A Critical Technologies Hub and ‘node operating model’ has been established within DISR, supported by three nodes providing expert scientific, economic and national security advice.¹⁶³

Critical technologies policy, including both upstream and downstream elements, sits at the heart of the AUKUS Pillar II offering and ASCA. While current priorities including quantum technologies, autonomous systems, robotics and AI appear well aligned with national defence technology priorities, Defence should periodically conduct a gap analysis of government’s list of critical technologies as part of benchmarking progress on AUKUS Pillar II and ASCA.

A range of other policy areas need to form part of whole-of-government coordination on national defence. Among them are cyber protection, energy policy, and workforce and skills development as well as all arms of Australia’s international diplomatic and economic statecraft. The Labor government has promised “a methodical and comprehensive process for long-term and sustainable implementation” of its response to the DSR.¹⁶⁴ Prior to the 2024 NDS, government’s forthcoming Defence Industry Strategy is an opportunity to articulate the interface between various policy areas and funding programs with a bearing on defence industry and innovation and set expectations for coordination and alignment.

Recommendations

• To aid systemic coordination with the DISR’s Office of Supply Chain Resilience, Defence should formally review defence supply chain risks every two years, aligned with the biennial National Defence Strategy
• Defence should periodically conduct a gap analysis of government’s list of critical technologies in the national interest as part of benchmarking progress on AUKUS Pillar II and ASCA priorities
• Use the forthcoming Defence Industry Strategy to articulate the interface between various policy areas and funding programs relevant to defence industry and innovation.

Improving whole-of-nation effort and coordination

With Australia facing its most challenging strategic environment in decades, national defence is too important to be left to the existing security apparatus centred on the Defence Department. Most State and Territory governments in Australia have dedicated agencies and programs geared towards some combination of state-centric sovereign capability, defence exports or research and innovation activity. While the relative merit of state-based defence initiatives can be questioned, especially where it involves taxpayer bidding-wars for projects, the basic reality of resource constraints and skilled labour shortages suggests benefit to greater alignment and coordination across the Federation.

With a view to delivering enhanced national defence capability in the shortest possible timeframe, the Commonwealth should lead a strategy geared towards binding State and Territory defence activities more tightly around the Federal Government’s 2024 NDS. The aim would be to align State and Territory governments towards a more dynamic and innovative defence-finance-tech ecosystem at a national level.

At least once a year, the Prime Minister should convene a National Cabinet meeting dedicated solely to Australia’s national security challenge and the required mobilisation effort arising from the DSR. To support the Prime Minister, Premiers and Chief Ministers, Federal, State and Territory ministers responsible for defence industry policy in each jurisdiction should meet at least twice a year with a view to securing maximum coordination of effort across national defence tasks. This would address current precedents for ad hoc meetings of ministers responsible for defence industry.

Recommendations

• A National Cabinet meeting should be held at least once a year dedicated solely to national security issues.
• Federal, State and Territory ministers responsible for defence industry policy should meet at least twice a year with a view to securing maximum coordination of effort across national defence tasks.

Summarising thoughts

The strategic moment has arrived for a fundamental shift in the way the Australian Government approaches the development and financing of the national security enterprise. Creating an Australian defence-finance-tech ecosystem will be a complex, multi-dimensional challenge over many years and will require better coordination, attention and follow-through by public and private actors than the nation has seen previously.

This is not a challenge Australia faces in isolation; global powers like the United States and others are struggling with this challenge and continue to update and reinvent their own approaches. But if Australia fails to rise to the occasion, other countries in the international system will build on their lead and reap the security, technology, and economic benefits; in some cases, diminishing the same returns for Australia.

Australia and the region wish for a return to a more stable strategic environment but, until that time, the realities of this new era of great power competition, rapid technological advancement and rising defence costs mean Canberra needs new approaches, supported by all elements of national power. Australia has the resources, know-how, and ambition – the challenge is combining these assets to strengthen the national security position in the face of an increasingly unstable world.

Full recommendations

Responding to Australian start-up, small and medium enterprise, and university challenges

Problem: The Defence Department lacks visibility and appreciation of the nationwide defence and national security innovation ecosystem
Problem: Start-ups and SMEs can have a low understanding of how to navigate Australia’s defence innovation and financing ecosystem to transition concepts to capability and plot scale-up pathways

• To understand Australia’s defence industry and innovation ecosystem, government should conduct a mapping exercise to provide a complete visual picture of:
  
  • Defence and technology companies in Australia, their track record of engagement with government (existing security clearances), and their strengths
  • Grant and loan opportunities available to researchers, start-ups and SMEs by:
    • Size and maturity of company (identifying eligibility for funding versus co-financing)
    • Technology at different Technology Readiness Levels (TRLs)
    • Type of innovation (disruptive, incremental, or other)
    • Use and sensitivity (defence specific or dual-use)
  • Defence industry forums and networking opportunities
  • State and territory defence innovation and financing ecosystems
  • Regulation and compliance requirements
    

Problem: SMEs have insufficient start-up funds, trouble securing loans, and cash flow issues
Problem: Defence requirements being too onerous and specific, putting pressure on startups and SMEs to develop niche products that lack broader commercial appeal and export opportunity

• To increase the amount of scale-up capital available to SMEs, Export Finance Australia should seek to replicate its Westpac Heads of Agreement with other major Australian banks
  The EFA-Westpac Heads of Agreement to support Australia defence companies is non-exclusive and other major Australian banks like ANZ and the Commonwealth Bank could be interested in co-investment opportunities
• Defence should continue to restructure its procurement contract process to reduce the costs for SMEs of doing business with government
  
  • Lower the contract threshold for SMEs so they can enter defence industry
  • Government to better communicate its buying power, scale, and acceptable failure rate so banks can offer blended finance and create smoother cash flow
  • Communicate procurement decisions faster, including earlier notification of unsuccessful bids
• Where possible, Defence tenders should be flexible enough to open up dual-use opportunities so SME products have wider commercial appeal
  
  • Although Defence is targeting technology and innovation with Defence-specific outcomes, this limits the scope of bids it will receive and products it could integrate
    • If Defence tenders become too narrow in scope, some start-ups and SMEs will opt-out given the lack of broader commercial appeal
  • Dual-use products are more attractive to private sector investors, meaning Defence is more likely to leverage private finance
  • Identify which international partners, such as Japan, can become markets and development partners for Australia in strategic IP, allowing the Australian market to learn from the best in class

Problem: Difficulties for small companies navigating the large Defence bureaucracy making the engagement not commercially viable for SMEs
Problem: SMEs within the supply chains of larger Defence Primes experience short-term contracts, invoicing delays and irregular payments that create instability for SMEs

• The Defence Department should incentivise Defence Primes through the contract process to support SME sub-contractors through favourable licensing arrangements and structured senior mentorship
  
  • This could include stipulating what percentage of the contract needs to be filled by Australian SMEs
  • SMEs should continue partnering with the Defence Primes but license their Intellectual Property rather than sell and not grant Primes exclusive rights
  • Structured mentoring by Primes to provide SMEs with knowledge and tools to navigate the Defence procurement process, regulation and compliance, and identify skills gaps in SME executive teams

Problem: Proliferation of trade shows, industry and networking forums, yet absence of matchmaking initiative that intermingles entrepreneurs, SMEs, Defence capability managers, private wealth holders and VCs
Problem: Government may be missing out on exceptional breakthrough technologies and innovation within Australia’s research and start-up community as Defence has no funnel to capture and integrate it into the Services
Problem: Defence’s industry engagement initiatives and online portal systems not well known or meeting the needs of SMEs and underutilised as a result

• To support strategic defence investment, government should play a matchmaker function to connect start-ups and SMEs with private investors where the path to procurement is clear
  
  • Coordination between Austrade, Defence, State Governments and industry associations is required to better connect SMEs with private capital
  • The Office of Defence Industry Support (ODIS) currently facilitates a ‘Meet the Primes’ initiative
    • A ‘Meet the VCs and PEs’ event on the sidelines of Defence trade events could be established to foster new commercial partnerships
• Defence should establish a ‘Prize Challenge’ event series to identify promising early-stage research, technology and innovation in the private sector and matchmake with ASCA and Defence capability managers
  
  • Expanding on the Army Innovation Day and modelled off the US DARPA ‘Prize Challenge’ series, establish an annual, flagship technology and innovation competition
  • Front-load quick screening conversations before applicants apply; offer small, start-up grants to university researchers prior to competing; ensure minimal tender requirements to lower barriers to entry
  • Shoot-out or ‘Shark-tank’ style demonstrations to Defence with pull-through by the Advanced Strategic Capabilities Accelerator (ASCA)
  • Shortlisted companies invited to private, classified, follow-up days with Defence
  • Side events could include workshops that bring together researchers, industry, and Defence capability managers
  • Connect unsuccessful dual-use technology companies with the applied technology fields at the Department of Industry (e.g. for broader national solutions to deliver a clean energy economy)
• Greater activism by Australian Office of Defence Industry Support (ODIS) and stronger promotion of its services and portals internally within Defence, across government and to industry
  
  • Initiatives and activities with ODIS must be driven by a sense of urgency with a view to outcomes
  • Greater integration between ODIS and Defence capability managers and projects
    

Problem: Underutilisation of Australia’s university and academic sector by Defence and weak linkages

• Defence should work with the university sector to establish secure labs or co-creation spaces for defence science and related research
  
  
  • Defence could draw lessons from the US and UK experiences with the Johns Hopkins University Applied Physics Laboratory and the Defence BattleLab
• Ministerial direction to shift AGSVA from its current procedural focus to a risk-based approach and streamline the process
  • Allow AGSVA case officers greater agency and discretion in decision making
  • Eliminate double handling when security clearances require upgrading or reinstating
• With the aim of increased two-way mobility and skill-building in research collaboration and commercialisation, rotate university and Defence staff through each other’s workplaces and pursue Australian Research Council funded fellowships

Responding to Australian industry, private equity and venture capital challenges

Problem: Insufficient demand signal from government to businesses and the timeline/urgency of the demand resulting in low industry confidence to invest and uncertainty over Defence’s ask

• The Treasurer’s Investor Roundtable should be convened at the earliest opportunity to deepen collaboration between government and the investment community on financing Australia’s national defence priorities
  
  • To inform this discussion, Defence – working with Treasury and the Department of Finance – should undertake a detailed analysis of the Defence balance sheet, including stock and flow variables
  • Together with the Treasurer, the Minister for Defence should lead a conversation on the impact of environmental, social and governance constraints on private financing of national security capabilities
• Government should create a stronger demand signal to business by developing a clear investment pipeline for core Defence functions and enabling industries and offering co-investment
  
  • Communicating capabilities of interest through the DSR and messaging demand signals through ASCA solicitations is insufficient
  • A pipeline for infrastructure and facilities, new sovereign manufacturing capability, and logistics hubs is recommended
  • Private finance could be incentivised through the offer of low-cost, government-backed loans, loan guarantees and co-investment

Problem: Strategic imperative and scale of the challenge compelling Defence to work with non-traditional partners to finance defence capability and other requirements

• Defence should adopt a broad lens in considering the scope for greater private capital investment. Key lines of effort should include:
  • Dual-use technology companies and start-ups with products and services at mid- to late-stage development
  • Potential investors in defence infrastructure and “infrastructure-like” projects
  • Australia’s defence sector SMEs where improvements in government communication, support, innovation and contracting processes can help unlock greater private financing for sovereign capability at scale
• Defence should accelerate outreach to a wide group of private sector actors on the Advanced Strategic Capabilities Accelerator (ASCA) and AUKUS Pillar II advanced capabilities priorities
• Defence should establish an AUKUS Pillar II “trusted partner network” to advise ASCA on relevant technology issues, with additional resources devoted to fasttracking security clearances and cyber protection as a matter of urgency
• An independent Private Capital Advisory Board should be established to provide high-level guidance to the Department of Defence on capital sources, financing instruments and talent requirements
  
  • The composition and mandate of the Board should be developed with a view to announcing it alongside the release of the National Defence Strategy in 2024
  • The Private Capital Advisory Board should become the hub for the Australian Government engagement with sources of international capital with shared security goals
  • Provide a business intelligence function for government and visibility of supply chains
    
    This would not obviate the urgent need for Defence to source and develop in-house expertise in areas such as corporate finance, software engineering and data science and analysis
• Defence should establish an explicit organisational narrative to foster a shared sense of mission and help orient policy and personnel towards the goal of harnessing private finance for national security

Problem: Defence’s procurement timelines do not account for the strategic urgency and contract delays disincentivise defence industry to work with Defence
Problem: Slow development and integration of technology capabilities into service

• Government should legislate change to allow Defence to shift away from a blanket prerequisite for open tenders to down selecting known and trusted Australian suppliers, SMEs and Defence Primes with a track record of delivery
• Following the rapid development of a ‘Ghost Shark’ capability, Defence and other government departments should identify a shortlist of small Australian companies with promising products to employ flexible procurement contracts and co-develop capabilities

Responding to Australian Government challenges

Problem: Across the Commonwealth there is “siloed fragmentation” and “patch protection” that negatively impacts government investment decisions on defence capabilities and critical technology policy
Problem: Lacking coordination between key government agencies and an unclear process for Australia’s defence planners to input to the Commonwealth’s critical technology policy
Problem: State Governments are reluctant to collaborate, compete against one another, and focus on niche capabilities. Lack of coordination across the Federation results in opportunity costs and duplication of effort

• A public statement on the governance interface between the NRF and Defence would help guide industry engagement and ensure appropriate alignment between NRF decision making and government’s national defence priorities
  
  • To assist industry engagement, protocols should be developed for seamless interaction and warm handovers between the NRF and ASCA
  • The work programs of both the NRF and ASCA should be informed by the Government’s university research commercialisation agenda, with its central focus on bridging the valley of death surrounding the commercialisation of research breakthroughs
• The Australian Government’s Chief Scientist should be afforded full visibility and scope for input into defence innovation reform
• To aid systemic coordination with the DISR’s Office of Supply Chain Resilience, Defence should formally review defence supply chain risks every two years, aligned with the biennial National Defence Strategy
• Defence should periodically conduct a gap analysis of government’s list of critical technologies in the national interest as part of benchmarking progress on AUKUS Pillar II and ASCA priorities
• Use the forthcoming Defence Industry Strategy to articulate the interface between various policy areas and funding programs relevant to defence industry and innovation
• A National Cabinet meeting should be held at least once a year dedicated solely to national security issues
  
  • Federal, State and Territory ministers responsible for defence industry policy should meet at least twice a year with a view to securing maximum coordination of effort across national defence tasks
  • Meetings should focus on increasing cohesion and reducing duplication of defence SME training, grants programs, and incentives between States and Territories
• Defence innovation, science and research investments need to be captured as part of Commonwealth system-wide priorities in the context of the Government’s forthcoming National Science and Research Priorities and National Science Statement
  
  • Reforms to improve the evaluation and coordination of Australia’s defence-related innovation, science, and research investments should accompany this exercise

Problem: Defence’s Advanced Strategic Capabilities Accelerator (ASCA) has an expansive remit coupled with a short delivery timeframe, overloading its responsibilities and confusing its investment opportunity for the private sector

• At the conclusion of the 18-month start-up phase, government should sharpen ASCA’s focus to high TRL (TRL 6-9) technologies and incremental innovation to clarify the investment opportunity for the private sector
  
  • Sharpen focus from technologies across the entire Technology Readiness Level (TRL) spectrum to high-TRL (6-9) technologies that can be more quickly demonstrated to private investors
  • Focus on one type of innovation – incremental innovation, rather than disruptive – to clarify the investment risks and opportunity for the private sector
  • Once Mission program leaders are appointed, make those individuals dedicated points of contact for specific fields within industry - For example, the Mission program leader for quantum technology acts as the single point of contact for Australia’s quantum industry
  • Give the Office of Defence Industry Support clear guidance for handing off prospective dual-use companies to Mission program leaders within ASCA
• To empower ASCA, Defence should consider new contracting mechanisms such as ‘Other Transactions’ to attract non-traditional companies and prototype faster

Problem: Fast-paced developments in the defence innovation and financing models of Australia’s partner nations and adversaries mean Government may be unaware of the full range of opportunities, risks, and timelines involved

• Australia and the United States should explore a DIU-type presence in Australia to draw from US experience leveraging commercial technologies for military application - Ideally, an Australian DIU-type entity would include a US DIU embed and reciprocal Australian embed in the US DIU headquarters in Silicon Valley
• Australia should embed a Defence presence in the Pentagon’s Office of Strategic Capital to assess the most effective tools for enlisting patient, private capital investment in new and emerging technologies
• Defence should commission research on steps other countries are taking to harness private capital for advanced military capability, with a focus on the types of instruments that can best be targeted at firms developing disruptive technology capabilities
• Australia’s network of diplomatic and defence officials should be tasked with monitoring and regularly reporting on approaches partner countries are taking in this area

Problem: Fear of failure and aversion to change and risk within the Defence Department creates a weak environment for innovation and negatively impacts APS’ perception and approach towards working with the private sector
Problem: Defence contract managers lack commercial experience and broader knowledge of the contracting tools available to them across Commonwealth agencies

• Cultural change in the Defence Department to accept greater risk through Senior Executives leading by example, ministerial-level political support, and APS reward structure
  
  • Shift the cultural emphasis within Defence from the primary driver being risks associated with compliance, management of public funds, and auditing to the main focus being speed to capability
  • Ministerial-level political support for higher level risk-taking within Defence
  • Performance criteria to direct and reward staff for decision making and action that supports speed to capability
  • Foster a culture that celebrates failures, learns and adapts taking lessons from the private sector
• Within Defence’s contracting and legal teams there should be higher investment in staff training, recruitment and retention
  
  • Require current Defence officials to undertake project and business management courses or other training and apply the knowledge to their roles
  • Upskill existing Defence contract managers to have wider knowledge of the contracting tools available to them across government
  • Draw on other government departments’ knowledge and learnings in working with the private sector › Recruit contract-writers and lawyers with commercial experience
  • Acknowledging legislative restrictions, establish incentives for staff to remain in positions longer to avoid retraining