What are the profit expectations in defense R&D?

Here are some of the findings from an STTR study performed by Geoff Orazem at Federal Foundry and Gene Keselman and Kathryn Person at MIT Mission Innovation X, “DARPA’s Research and Development Automated Profit Incentive Determination RAPID.”

The DoD is using the wrong bait: The DoD uses profit to attract R&D performers and assumes that offering more profit will attract more performers. We found that this assumption is generally incorrect and that R&D companies decide whether to bid based on the opportunity to fund their commercial product development with government money and the chances of follow-on defense sales.

 

Profit negotiations are business theater: The government and performers know that the profit margin will end up being 8-10%. No vendor to our knowledge has ever walked away from an award over the profit margin.

Here are some survey responses from 55 new or infrequent government contractors: “Prioritize the factors you would consider when evaluating a DARPA R&D contract.”

And here are the results for two other survey questions related to profit for new/infrequent government contractors:

In other words, most new DoD contractors doing R&D with DARPA are not in it for large profit margins. Some small R&D-as-a-service companies who do repetitive efforts do see profit as a core aspect of their business model. But many startups and commercial companies see an initial R&D contract as a foot in the door to larger production contracts. As the author’s characterize the views:

• Government: R&D is a service. Services companies pursue profit, so if we want more engagement from R&D companies we should offer more profit.
• Everyone else: R&D is part of the product development lifecycle, not a profit center. We’ll take your money but that’s not why we’re here.

Below is a nice chart of profit expectations for different R&D performers. Both traditional primes and commercial companies want to make profits in production sales, not R&D. But commercial companies take a lot of risk in the early stages — they expect losses if the market does not adopt their products. As a result, they expect higher profitability in the later stages to compensate for that risk, but also the value they deliver.