A sector in transformation
The defence industry is experiencing unprecedented technological transformation driven by digitalisation, autonomisation, and disruptive innovation. This is being accelerated by geopolitical tensions, particularly the war in Ukraine, and rising defence spending across European countries. The sector faces a fundamental challenge: traditional military capabilities are being revolutionised by digital transformation and autonomous systems, while disruptive innovations from the civilian technology sector are finding their way into security-related applications.
The scale of this transformation is evident in how modern conflicts demonstrate the power of accessible technologies to undermine traditional armaments. A striking example is how an improvised small drone worth just a few hundred euros can now destroy a battle tank worth millions, fundamentally challenging traditional procurement strategies. This underlines that innovation is not merely desirable but absolutely necessary for maintaining defensive capabilities in a dynamic security environment.
Cyber security: the foundation of modern defence
Cyber vulnerability has emerged as one of the greatest threats to modern armed forces and military systems. As a result, cyber security is critical to securing military IT infrastructure and communication networks and protecting sensitive weapon control systems, making it a basic requirement for operational capability.
The European Union recognises this criticality, providing targeted funding through the European Defence Fund (EDF), with approximately €7.9 billion available for critical defence technologies up to 2027, including cyber, AI, military cloud, and other key areas.
For defence companies, this technological shift means that partnerships with cyber experts, particularly specialised software companies, are becoming increasingly important to make their systems robust and 'hack-proof'. The integration of cyber security capabilities is no longer optional but essential for maintaining competitive advantage and operational effectiveness.
Drone technology: transforming military operations
Unmanned aerial and ground vehicles have dramatically changed military operations in recent years, with applications ranging from reconnaissance drones providing real-time situational awareness to armed drone swarms. The transformative impact of drone technology is perhaps most starkly illustrated by recent conflicts, particularly in Ukraine, where commercially available drones have demonstrated significant military effectiveness.
The economic implications are profound given that an inexpensive and readily available drone can take out expensive and specialised military equipment, completely overturning the cost-benefit calculation of conventional weapon systems. This dramatic shift in military economics is driving fundamental changes in defence procurement and strategy.
Europe has a vibrant drone technology ecosystem, with start-ups such as Quantum Systems (Germany) and Tekever (Portugal) developing advanced drones for reconnaissance and missions, often in cooperation with established players. Quantum Systems exemplifies the dual-use nature of this technology, having originally begun with civilian applications in agriculture before now supplying reconnaissance drones to Ukrainian armed forces.
The dual-use nature of drone technology presents both opportunities and challenges for defence companies, which are increasingly examining investments in drone start-ups or acquiring them outright to secure access to proven technology before competitors.
Artificial Intelligence: the next generation of defence systems
AI is considered a key technology for the next generation of defence systems, with applications spanning from intelligent sensor fusion and target recognition to decision support in command posts and autonomously operating weapon systems. The strategic importance of AI in defence is reflected in the substantial investments being made in this sector.
European defence start-ups such as Helsing (Germany) exemplify the rapid growth and high expectations in this field, having raised €600 million in funding with a valuation of approximately €12 billion, making it the most valuable start-up in Germany. This valuation serves as an indicator of the enormous expectations for AI-powered defence solutions and the willingness of investors to back such technologies.
The practical application of AI in defence is already being demonstrated through collaborations between traditional defence players and AI specialists. For example, Airbus Defence and Space is working with Helsing to integrate AI into future unmanned Wingman drones for fighter aircraft. This collaboration illustrates how established defence companies are partnering with AI specialists to advance autonomous capabilities.
The European Union is also targeting AI research for defence through EDF funding, with projects for "critical defence technologies" such as military AI and semiconductors being co-financed. This institutional support demonstrates the strategic priority placed on AI development for defence applications.
The innovation imperative
The rapid pace of technological progress and the growing number of new suppliers are creating increasing pressure for cooperation among traditional defence companies. No single large corporation can develop all relevant technologies in-house simultaneously, as the fields are too diverse and innovation cycles too short.
Established defence companies, often described by industry experts as cumbersome "supertankers" face competition from agile start-ups with cutting-edge technology. These start-ups are supported by well-known investors and, in some cases, state innovation funds, creating a dynamic ecosystem where fresh capital accelerates the development of new military technologies. For more on the M&A environment in the defence sector, read our article.
The software-defined defence revolution
A critical shift occurring in the defence sector is the move towards Software Defined Defence (SDD), which significantly changes conception and planning of defence projects focussing on software instead of traditional hardware. This transformation makes intellectual property a vital strategic asset and has profound implications for how defence capabilities are developed, deployed, and maintained. It also means shortening innovation cycles, and making rapid integration of new software capabilities create a critical competitive advantage. This effect is reinforced by the growing importance of AI as part of weapon systems and supporting infrastructure for command processes.
Regulatory and legal complexities
The integration of new technologies into the defence sector brings significant regulatory challenges. Investment control mechanisms, particularly Foreign Direct Investment (FDI) screening, subject security-relevant companies to strict controls. In Germany, for example, the Foreign Trade and Payments Act requires mandatory official approval review if a non-German investor acquires at least 10% of shares in a company in the defence or IT security sector.
Export control regulations, particularly US ITAR (International Traffic in Arms Regulations) and EAR (Export Administration Regulations), create additional complexity. These regulations can stipulate that when acquiring an ITAR-registered company, the new foreign owner must carry out its own registration, and the transfer of certain technologies to non-US persons is only permitted with US authorisation.
Actions
In this period of intense technological development and an active investment and M&A market, there are a number of areas on which defence businesses should focus.
Traditional defence companies
- Technology strategy development: defence companies must review their technology roadmaps and identify key areas where gaps exist, such as AI for reconnaissance data analysis, autonomous drones, and cyber defence. The concept of SDD should play a central role.
For technology start-ups
- Strategic defence focus: young technology companies should decide early whether and to what extent they want to engage with the defence sector. The market offers enormous opportunities with high budgets and strategic investors, but requires particular trustworthiness. Start-ups developing dual-use technologies should consider obtaining certification or fulfilling certain security standards to be attractive to defence companies.
- Intellectual property protection: start-ups should have their intellectual property properly organised before major partnerships develop. Patent applications for core technologies, robust secrecy protection concepts, and secure IT infrastructures increase company value. In the defence sector, companies often resort to alternative protection mechanisms such as trade secrets and confidentiality agreements rather than traditional patents, which require publication.
- Compliance as competitive advantage: early implementation of compliance processes pays dividends. An internal export control concept, including classification of products according to dual-use or weapons lists, signals professionalism to potential buyers and reduces liability risk. IT security audits and ISO certifications, such as ISO 27001 for information security, are sensible investments for standing up to large defence partners.
- Strategic networking: technology companies should actively seek partnerships with established industry players, not just at exit but during the growth phase. Programmes such as Airbus Ventures or incubators in the defence sector can provide access, while maintaining negotiating position through pilot projects with multiple larger partners.
Outlook and implications
The transformation of the defence industry through cyber security, AI, and drone technologies represents more than technological evolution - it is a fundamental shift in how military capabilities are conceived, developed, and deployed. The move towards Software Defined Defence, the democratisation of military capabilities through accessible technologies, and the acceleration of innovation cycles all point to a future where agility and technological integration become as important as traditional military assets.
For businesses operating in this space, success will depend on their ability to navigate the complex regulatory environment while rapidly integrating new capabilities. The companies that can effectively bridge the gap between innovative technology and operational military requirements, while maintaining compliance with increasingly complex regulatory frameworks, will be best positioned to succeed in this transformed landscape.
The substantial public and private investment flowing into defence technology, combined with the urgent operational requirements driven by current geopolitical tensions, create an environment where technological innovation can rapidly translate into operational capability and commercial success. However, this opportunity comes with the responsibility to ensure that such innovations are developed and deployed in ways that enhance rather than compromise security and stability.
The convergence of civilian and military technologies, exemplified by the dual-use nature of AI, cyber security, and drone technologies, suggests that the future defence industry will be characterised by closer integration with the broader technology ecosystem. This integration brings both opportunities for rapid innovation and challenges in maintaining the security and reliability that military applications demand.
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