Innovation needs Customers, not Capital.

In this return of great power competition, it is clear that we need to continue to innovate to provide deterrence from conflict. This requires military superiority and continuous technological innovation. When Palantir was founded there was no path to working with the Defense Department. Not a difficult path, no path. And there was exactly one path to working with the Intelligence Community, In-Q-Tel.  

In-Q-Tel is a venture capital firm that invests in commercial technologies that are relevant to national security. But this headline confuses that actual value proposition. America has plenty of capital for quality companies. A start up that can’t raise money is probably not a very good startup. It is one of America’s strengths - a deep and wide venture ecosystem. What In-Q-Tel provides that is a game changer is customers. The capital invested is often de minimis to the companies even if it is extremely valuable validation. The customer contracts, clearances, and commitments that In-Q-Tel furnishes are the fuel for innovation.  

Not enough is said about the US Govt as Customer and too much has been said and overstated about the US Govt as R&D financier. It is broadly acknowledged that in the present era the USG cannot outspend industry in R&D, acknowledging that it very much did in the early cold war. But perhaps that spending was never the key enabler outside of basic research.

Chris Miller’s Chip Wars covers the history of the semiconductor industry. In 1965, Military and Space applications where 95% of the chip market. Bob Noyce, then Co-Founder/CEO of Fairchild and future Co-founder/CEO of Intel, always envisioned a broader market than the military which meant he had to manage his R&D priorities (and he was of course right: the first Integrated Circuit for consumers was used in Zenith hearing aid that was initially designed for a NASA satellite). He declined most military R&D contracts (despite these customers representing 95% of his revenue) so he could stay in control of his R&D roadmap. He never let more than 4% of this R&D budget come from Govt contracts. So 96% of his R&D was self-financed from investors and profits.  

In Noyce’s own words “..there are very few research directors anywhere in the world who are really adequate to the job at assessing Fairchild’s work and they are not often career officers.” Noyce complained about the time spent writing progress reports for the bureaucracy for any of this government funded R&D. Now Fairchild had the unique luxury of being funded by the 1950’s equivalent of a billionaire so they could treat the military as the customer for their products rather than as their boss of their R&D from day one. 

Because of the difficulty of achieving scaled procurement in US Govt it is unfortunately still true that a uniquely hard head and patient sort of mission-driven capital is still required today. SpaceX, Palantir, Anduril all have billionaire founders whose commitment to the cause was required to survive the various valleys of death and incredibly long acquisition cycles. Notably 2 of the 3 had to sue the Govt to ensure the Govt didn’t de facto compete against industry.

Even in Noyce’s era, the Pentagon was more comfortable working with big bureaucracies than nimble startups, and as a result underestimated the speed by which Fairchild would transform the industry. DoD assessment praised RCA for having the best microsystems electronics miniaturization program while dismissively noting that Fairchild only have 2 scientists working on it internally while Lockheed had 50, implying that Lockheed was far ahead. Of course it was Fairchild’s R&D team that made the breakthroughs. 

Defense contractors thought of chips as the final product. Noyce and Moore were already dreaming of computers and phones. Noyce slashed prices to access the broader vision and market. Cost plus government contracting would never have created the price performance the USG needed to create the incredible military deterrence capability. And of course all that commercial innovation led to a semiconductor revolution that created vast American prosperity, the underpinning of our national security. 

We see a very different story with Drones. General Atomics invented the modern drone in the 1990s with the Predator. A Noycian figure would have seen the vast potential for not only commercial drone applications but also the consumer market. Instead for decades that vast R&D focus of these platforms was locked by Govt R&D programs. And with great effect. But without any American prosperity that should have followed GA owning or spinning out a Commercial subsidiary that should have been the DJI of America. Instead the vacuum let DJI fill it to serve CCP civil-military fusion aims. Now the hobbyist consumer’s drone purchase funds CCP R&D against America.

The root problem is that the acquisition system is unintentionally communist (Bill Greenwalt noticed the same). Profits are capped at a very low number on contracts. While the law says the government should favor fixed priced contracts in practice these acquisitions happen cost plus. This means the only way to make more money as a contractor is to find a way to spend more money in your costs. That won’t work. Noyce made MORE money as he lowered the cost with even greater the profit margins. He had the commercial incentive to do that and that benefited every customer, including Uncle Sam. Noyce could not have done that rationally if he was a government contractor - lowering the price would have been lower profit with government regulated profit margins. The reason we lost the market with Drones is that China executed with true capitalism with DJI while, ironically, America pursued communism.

“Selling R&D to the government is like taking your venture capital and putting it into a savings account. Venturing is venturing. You want to take the risk.” - Robert Noyce

Noyce ultimately left Fairchild, a company he co-founded and ran, because the billionaire financier of Fairchild didn’t think anyone but he should have equity in the company. Ironically at the time equity for employees was viewed as creeping socialism. So the talent left. Noyce and Moore left to found Intel. Remember that Moore’s Law is not actually a law at all. It is a goal. To the extent Intel achieved it, and they did for many decades, it is the consequence of incredible hard work in search of equally incredible reward — monetary and metaphysical.  

The problem with defense contracting is not the popular narrative that contractors make too much money, it is actually that they make too little money. The sums are large but the current system only incentivizes spending more money to drive up the fixed percentage of profit the communist procurement policies deem reasonable. Fairchild’s financier thought it was reasonable Noyce earned a salary and had no equity. So Fairchild lost and Intel and a family of ex-Fairchild companies flourished. The USG should focus on price, not profit. If innovators can provide capability for less money, why does the government care what the profit margin is? Innovators will need outsized profits to motivate progress.  

Bill Perry and his Assault Breaker program was only possible because of the commercial success of chips. He needed a 100-fold improvement in performance to deliver that capability. Perry complained that his critics were luddites, favoring DARPA’s continued spend on its own advanced chips... but it was the commercial chips that delivered the capability.

And in the modern era, for today’s great power competition, commercial technologies will be what delivers the future of warfare. We need look no further than the battlefield in Ukraine to see that.