The Department Needs a Secondary Market for Contracts
To realize innovation, enable new entrants to buy contracts from existing performers
The stock market is a secondary market for ownership in a company. Stubhub is a secondary market for event tickets. A thrift shop is a secondary market for clothing. A vibrant secondary market in defense contracts would allow America to leverage her greatest twin strengths, software exceptionalism and deep capital markets, to drive adoption of innovation in the Department of Defense. The primary market in defense are the contracts the Department awards directly to performers. A secondary market in defense would be contracts that companies buy from existing contract performers.
Joe Larson recently shared the story of Andrew Higgins, bootlegger turned boat builder who made “the boat that won the war.” This innovation was not welcome with open arms by the Navy - it was rejected at every turn. First, it was excluded from competition. After another attempt Higgins won the competition, but the Navy procured none of his design. Instead they stole his design to incorporate into a program that failed. After that he was blocked from participating in a subsequent bake off because it was non-compliant.1 But for the courage of Marine Lieutenant Viktor Krulak and a hardheaded American entrepreneur, the Pacific theater in WWII could have turned out very differently.
The DOD needs to reform its 60-year-old PPBE system, which will enable greater speed, agility, and innovation in acquisition. The DOD’s requirements process is another enterprise transformation that is needed to enable innovation adoption. Fixing these enterprise processes will take energy, perseverance, and time, which we don’t have a lot of in this great power competition. These problems have existed for at least 100 years and are more the consequence of human nature than broken process. Andrew Higgins’ pain would be immediately understood by every defense entrepreneur today.
The Defense Tech community needs a PACE (Primary, Alternative, Contingency, Emergency) plan for communicating its innovations to the Department. Let’s say that fixing acquisition and Terraforming the Valley of Death is Primary. Our Alternative should not depend on the DOD fixing itself, but instead on American ingenuity — on bootlegger capitalism.
The DOD Market lacks a robust secondary market for contracts post award. Creating and supporting this mechanism would enable new entrants to leverage America’s deep capital markets to buy contracts2 from existing performers with government support to deliver in innovative ways when the technology is ready instead of waiting for when the acquisition is ready. In the “P” part of the PACE plan, folks are focusing on making tech insertions and more frequent competitions to increase opportunities for new entrants. In the best case scenario, that takes months, but more often years. By flipping the model on its head with a secondary market, the latency is reduced to zero. It also enables our primes, who are going through a difficult time with Firm Fixed Price (FFP) contracts they are unable to execute on profitably, to benefit, and all in a way that leaves the U.S. taxpayer better off.
Example
The promise of innovation is that you can do things better, faster, and cheaper. And if there is an innovation to leverage in the underlying technology, software approach, production technique, or supply chain, it is likely that a better capability, developed at private expense with commercial R&D, can be delivered more quickly at lower cost. If the entrant is able to make that case, and the prime is interested in selling it, the government could agree to novate the contract as part of the three party transaction between the buyer, seller, and government.
The interested buyer (almost certainly a non-traditional contractor, but it could theoretically be another prime) would then engage in a government-mediated negotiation with the seller. If there are multiple interested buyers, then bidding would ensue until there is a company willing to pay more than another company. Importantly, the government maintains leverage as a party in negotiations. For example, if the government is reluctant to bring on a new performer, they may require a discount on the face value of the contract; this would create a mechanism for the government to capture price-performance improvements from better technology and new performers. Alternately, if the government is eager to bring on a new performer for an albatross of a program, they may not require a discount and would simply want an innovative performer to begin ASAP.
Let’s say there is a $100M / 5 year contract that has been awarded to deliver X-wings.
The existing traditional performer likely has 10% operating margins, so this contract will result in $10M of EBITDA over 5 years.3 At a 5%-15% discount rate, that means the contract has a net present value of $6.7M-$8.7M — that’s what this $100M contract is worth to the existing performer in purely financial terms today. The other $90M is the cost for the traditional performer to deliver on the contract.
Assume the traditional performer is willing to sell the contract for a lump-sum, upfront cash payment of $15 million, which is ~2x more NPV (i.e. profit) than the original contract to them.
In this scenario, there are several parties interested in taking over the contract even at a reduced value, and the government wants to capture price-performance improvements from better technology. The government therefore applies a 10% discount, reducing the face value of the contract from $100 million to $90 million over five years. This represents a $10 million savings to the government.
The buyer would then have $75 million (the new contract value of $90 million less the $15 million they’re paying the seller) to execute the contract. The buyer’s investors would underwrite the business case to do this at 30-80% margins (depending on the mix of hardware and software; the below chart shows a notional 40% margin). This margin profile is required and expected of a modern technology company that privately funds its own R&D.
The government would have a face saving way to adopt innovation without changing acquisition wholesale. Private investors would shoulder innovation risk — and gladly do so as that is the business they are in. The U.S. government will have a mechanism to insert modern technologies into production, from novel manufacturing techniques to improved software, revitalizing the American industrial base with innovation.

Contract Mills
A common push back on the concept is that it would create a class of companies that are only good at winning contracts and managing regulations and compliance.4 First, these rentiers already exist. Second, this would simply be the market responding to the demand signal from the monopsonist buyer. Per the “Primary” in PACE, Congress and the Department can change how they acquire things to avoid outcomes like the Kafka-esque $600 roll of tape (see Mike Benitez and
’s interview with Norm Augustine). In parallel, we can and should develop a strategy to deliver innovation and drive adoption that assumes the same factors that blocked Higgins still exist today.New Entrants
The secondary market is a mechanism to bring dynamism back into the development of critical national security capabilities. We have $100 billion of venture capital investment into defense tech, but these companies have not achieved scale. There were no new defense companies added to the S&P 500 in the last 45 years that were formed standalone (i.e., not from a merger or spinout). By market cap, Palantir is the only publicly traded, top 10 defense company that is founder-led, and it is the only company founded in the 21st century. The first, but not the last. There is untapped American exceptionalism among non-traditional performers with a different risk profile than the primes.
Conclusion
The Department would no longer find itself as the roadblock to innovation but instead would be leveraging American ingenuity and aggressive capital formation to attack its hardest problems. The primes would have a graceful way to rebalance their portfolios to higher margin work and generate more capital to invest in their innovation.5 Program Managers would have a face saving way of managing their programs and innovation post award. The American capital class will be unleashed completely through the implements of American entrepreneurs working on problems in the national interest. Most importantly, our warfighters will be substantially more lethal.
If the procurement/evaluation process excludes the technology that ultimately became the boat that won the war, we are definitely in need of remembering that there is no process, only content.
Technically the buyer would be purchasing a specially created subsidiary from the seller with the relevant assets and liabilities, including the relevant contract.
Operating Margins:
RTX Trailing 12 Months (TTM) 8.98% (as of Feb 2024)
LMT TTM 12.29% (as of Jan 2024)
NOC TTM 14.59% (as of Jan 2024)
GD TTM 10.24% (as of Jan 2024)
LHX TTM 5.32% (as of Jan 2024)
BA TTM -6.35% (as of Jan 2024)
There is an analogue to large Pharma companies here. They have specialized in managing regulatory approvals and commercialization. The innovation most often comes from smaller biotechs where they license the drugs, platforms, and technology (see the BioNTech and Pfizer relationship). The entire market is organized around this.
The Primes today believe they are in a zero sum competition. The thinking goes something like: the Defense Budget is fixed and not going to grow that much. Share of the pie is everything. Primes deeply believe their stock can’t trade at more than 1-2x revenue multiple. Defense Tech has a positive sum view — specifically that they will have tech multiples of 5-20x. Helping the Primes rotate their business to much higher margin work will enable them to have less revenue but be more valuable (i.e., see stock price appreciation).