The Scale of the Problem
The federal government recorded $773.68 billion in FY2024 federal contract awards, distributed across 108,899 companies. The Department of Defense accounted for roughly 60% of that total, approximately $445 billion in contract obligations flowing to defense contractors in a single fiscal year. For terminology, see USDG’s explainers on federal contracting and contract obligations.
These are not abstract numbers. They represent the largest single buyer in the world purchasing everything from aircraft carriers to cybersecurity software, from satellite systems to training simulators. And the spending is accelerating: GAO reported approximately $793 billion in FY2025 federal contract commitments, while GovSpend’s broader OT-inclusive count reached $833.83 billion. Depending on methodology, federal contract volume has grown from approximately $442 billion in FY2015 to roughly $800 billion-plus in FY2025.
Yet behind these headline figures, the defense industrial base that supports this spending is quietly contracting, consolidating, and becoming structurally less competitive. The companies best positioned to bring next-generation capabilities to the warfighter, small and mid-size technology firms, are leaving the market faster than they are entering it.
The question is not whether the money is there. The question is whether the system that allocates it can sustain the innovation base it depends on.
A Shrinking Industrial Base
In 1993, the defense industry had 51 prime contractors. Today it has five: Lockheed Martin, Boeing, RTX, General Dynamics, and Northrop Grumman. Those five firms are prime contractors on over 74% of DoD’s major defense acquisition programs. In FY2024, they collectively received $132.9 billion in defense contracts, roughly 30% of total DoD spending.
The consolidation at the top is well known. What is less discussed is the erosion happening below.
The defense industrial base declined from 76,700 companies in 2017 to under 60,000 by 2021. More than 17,000 companies left the DIB over five years, with a net loss of 3,300 in FY2021 alone. DoD vendor counts have dropped 27.6% over the past decade. The Pentagon’s own assessment warns it could lose an additional 15,000 small business partners over the next decade.
The sector-level numbers are even more alarming. Tactical missile suppliers went from 13 to 3. Fixed-wing aircraft suppliers went from 8 to 3. Satellite suppliers went from 8 to 4. In the submarine industrial base, the supplier count has declined roughly 80% from Cold War peaks, and approximately 70% of remaining critical submarine suppliers are sole-source.
CSIS analysis found that defense-specialist firms now account for 61% of DoD’s major programs by value, up from just 6% when the Berlin Wall fell. The defense industrial base has become structurally isolated from the broader American economy.
The Small Business Squeeze
On the surface, small business participation in federal contracting looks healthy. In FY2024, small businesses received $183.27 billion, or 28.78%, of federal contracts, exceeding the statutory 23% goal for the fourth consecutive year.
Look closer, and the picture changes.
The number of active small business federal contractors has dropped from approximately 149,000 in 2009 to roughly 85,000 by 2022. Firms receiving prime contracts were cut nearly in half over the same period, from about 121,000 to about 63,000. New entrants to the federal marketplace have dropped roughly 80% over the past 15 years.
In FY2023, just 1.4% of total obligated dollars went to businesses that had never before received a prime award. More than 92% of contract awards go to established vendors. The first-time bidder win rate is approximately 3%.
This is not a market that rewards new entrants. It is a market that entrenches incumbents.
The Valley of Death
The defense innovation ecosystem has a well-documented structural flaw known as the “valley of death,” the gap between prototype development and production contracts where promising technologies go to die.
The data confirms the problem. Air Force SBIR Phase II-to-Phase III transition rates sit at roughly 8.8%. Only about 16% of DoD SBIR-funded companies received Phase III contracts over the past decade. Companies must independently bridge 18 to 36 months between prototype delivery and production contracts, burning through capital with no guaranteed path to revenue.
The SBIR program itself has structural issues. Twenty-five companies, just 0.5% of recipients, captured 18% of Pentagon SBIR funding over the past decade, approximately $2.3 billion. Sixteen of those 25 derived more than half their DoD contracting revenue from SBIR awards rather than production contracts, suggesting the program funds research performers rather than companies that will scale.
Acquisition Dysfunction
The federal acquisition process compounds the problem.
DoD contracts over $50 million have seen procurement lead times increase by 70 days between FY2019 and FY2022. Major defense acquisition programs now take almost 12 years to deliver initial capability, up 18 months from the prior year and three years longer than originally planned. Total cost growth across major programs since inception has reached $628 billion, a 54% overrun.
The regulatory burden is staggering. The Federal Acquisition Regulation spans over 2,000 pages across 53 parts, with DFARS adding 53 more. The Section 809 Panel, convened to study the problem, produced 2,000 pages of proposed fixes and recommended eliminating 165 contract clauses, 13 acquisition offices, and 20 reporting requirements.
For small businesses, the cost of participation is often prohibitive. Proposal development typically runs 1 to 3% of contract value, meaning a $10 million opportunity requires $150,000 to $300,000 in bid and proposal investment. CMMC Level 2 certification costs small organizations $100,000 to $300,000 in the first year, with three-year total cost of ownership reaching nearly $500,000. NDIA estimates that 33,000 to 44,000 companies may exit the defense market by 2027 due to compliance burden alone.
Meanwhile, 66% of defense companies say dealing with DoD is “very difficult” or “somewhat difficult”. Only 9% say the same about private sector customers.
Why the Traditional Advisory Model Fails
The conventional approach to helping companies enter or grow in defense contracting is the traditional advisory model: consultants, capture managers, and proposal shops, all billing by the hour.
Senior capture managers command $200 to $250+ per hour. CMMC consultants bill $250 to $400 per hour. A mid-sized proposal engagement runs $40,000 to $75,000 in external fees, not counting internal staff time. Major recompetes on contracts exceeding $50 million require $100,000 to $500,000+ in capture investment over 18 to 24 months.
This model works for established defense contractors with dedicated capture teams and sufficient contract revenue to absorb advisory costs. It does not work for the dual-use technology companies, early-stage defense startups, and commercial firms that the Pentagon is actively trying to attract.
Small government contractors average roughly 8% profit margins, compared to 24% for large contractors. Sixty percent of small business contract winners earn less than $100,000 per year from government work. For these companies, a $75,000 proposal engagement or a $300,000 CMMC certification represents an existential bet, not a cost of doing business.
The structural result is predictable: the companies that most need help entering the defense market are the ones least able to afford traditional advisory services. The traditional model selects for incumbency, not innovation.
What Innovation Looks Like
The good news is that the defense innovation ecosystem is growing, unevenly and imperfectly, but with real momentum.
The Defense Innovation Unit awarded 90 prototype contracts worth $298 million in FY2023, working with 389 unique vendors since its founding. Its budget surged to $983 million in FY2024. AFWERX has awarded over 10,400 contracts worth more than $7.24 billion since 2019, with 470 companies transitioning to Phase III contracts totaling $1.44 billion in FY2024 alone.
Private capital is pouring into defense technology. VC investment in defense tech grew from $2.7 billion in 2023 to $3 billion in 2024, then surged to $7.7 billion in 2025. Nearly 8% of all global VC funding now flows into defense technology ventures. Anduril’s trajectory from founding to $61 billion valuation demonstrates that the capital markets believe defense technology is a generational investment category.
Other Transaction Authorities (OTAs), the streamlined procurement pathway that bypasses much of the FAR, have grown from $1.8 billion in FY2016 to over $18 billion in FY2024. In April 2025, an executive order established OTAs as the preferred contracting method, signaling a potential structural shift in how the Pentagon buys.
The Case for a New Operating Model
The data points toward a clear conclusion: the defense industrial base needs an operating model that reduces barriers to entry for innovative companies, rather than one that charges them by the hour to navigate barriers that should not exist.
That model has several defining characteristics.
Platform over practice. Traditional advisory is bespoke and unscalable. A platform approach, AI-powered contracting intelligence, automated compliance workflows, shared security infrastructure, reduces the marginal cost of each new company entering the market. Second Front Systems demonstrated this with Game Warden, cutting ATO timelines from 12 to 18 months down to as little as 90 days by providing inheritable security controls as a platform rather than a consulting engagement.
Aligned incentives. The hourly billing model creates a structural misalignment: the advisor profits regardless of whether the client wins the contract. An equity-aligned or contingency-based model ties the advisor’s return to the company’s success, filtering for serious commitment on both sides.
Embedded operators, not outside advisors. The venture studio model emerging in defense embeds experienced operators from day one rather than offering periodic strategic guidance. In a market defined by relationships, clearance requirements, and institutional knowledge, the difference between an embedded operator and a visiting consultant is often the difference between a contract win and a form letter rejection.
Automation of the administrative burden. The acquisition process generates enormous volumes of structured data: solicitations, modification histories, award records, FPDS entries, SAM registrations. AI-powered tools can automate opportunity discovery, competitor analysis, and compliance monitoring at a fraction of the cost of manual processes. The question is no longer whether AI can accelerate defense contracting but how quickly the industry adopts it.
Shared infrastructure for market entry. CMMC certification, facility clearances, ITAR registration, CUI handling: these are table-stakes requirements that every defense entrant must satisfy independently. A platform model can amortize these costs across a portfolio of companies, reducing the per-company burden from hundreds of thousands of dollars to a manageable investment.
What Comes Next
The defense industrial base is not going to fix itself. The consolidation trends, the regulatory complexity, and the cost barriers are structural, not cyclical. They require structural solutions.
The Pentagon recognizes this. The National Defense Industrial Strategy, published in January 2024, calls for resilient supply chains, workforce development, and improved access for nontraditional contractors. The Defense Innovation Board published its “Scaling Nontraditional Defense Innovation” report in January 2025, recommending “focused organizational structure, cultural optimization, and dedicated capital.”
But government reform moves slowly. The companies that will define the next generation of defense capability do not have the luxury of waiting for procurement reform to reach them.
They need operating partners who understand both the technology and the bureaucracy. They need platforms that reduce the cost of compliance and market entry. They need aligned capital that shares in the outcome rather than billing for the attempt.
The $773 billion question is not whether the defense market is large enough to support innovation. It is whether the ecosystem that connects innovative companies to defense missions can evolve fast enough to sustain the industrial base the nation depends on.
The operating model needs to change. The companies building that new model are the ones worth watching.
US Defense Group is a defense-focused operating platform that partners with technology companies to accelerate defense market entry. Through GovSeek, an AI-powered contracting intelligence platform, and Launcher Station, a contingency-based accelerator, USDG provides the infrastructure, intelligence, and operational support that traditional advisory models cannot.