The U.S. government needs to up its investments in research and development (R&D) if it wants innovative capabilities that go beyond what the commercial sector provides, Northrop Grumman [NOC] Chief Kathy Warden said on Monday.

“So, the financing’s increasing but no doubt that the amount the government is spending on R&D compared to what commercial industry is spending has decreased over time and we are at a point where I believe it’s dangerously low,” Warden answered in response to a question from Michael O’Hanlon, a national security expert with the Brookings Institution. “If we want to be able to develop capabilities that are truly innovative, meaning they’re not available on the commercial marketplace, that give our military, intelligence and policymakers options that other nations don’t have, or even individuals operating in adversarial means don’t have, then we have to have something above commercial grade and that’s what our government has funded in the past and has enjoyed the benefits of.”

Warden spoke at a Brookings event moderated by O’Hanlon.

Earlier in the interview, Warden said that while Northrop Grumman experienced some supply chain and workforce issues in its third quarter of 2021 on production programs due to the COVID-19 pandemic, “R&D has been a real strength in the company” despite the pandemic. “And we’ve found that there’s quite a bit of capital going into the areas of R&D that we’re most interested in.”

She also said that government R&D spending has to better balance the risk and reward ratio for industry which is stuck with a relatively small customer base, mainly the Defense Department and allied and partner nation militaries, so that it can better recoup its internal investments.

“And what I have seen is as we shift too much risk onto industry, industry actually pulls back on R&D spending because the costs are too high for any one project,” Warden said. “If we want the breadth of innovation and we want to be able to move forward and take risks, and as you said that includes failure, it means that we have to count on some of those ideas that we are investing in will not generate results, then again you need the financials on the ones that do to make sense for our investor community.”

The government is “moving too rapidly” in putting all the risk on the defense industry, she said, which isn’t “healthy” for industry and doesn’t result in the “capabilities” customers want.

One problem area that Warden pointed out is the government’s use of firm-fixed-price development contracts, which puts more risk on contractors when risky development efforts end up costing more than planned. This is “very detrimental,” she said. “It shifts too much risk to early in the life-cycle and it discourages leaning far forward and taking the risk that you may fail and need to reset and move forward in a different direction. And plus, the government loses control over those decisions because they all get shifted to the industrial partner.”

Warden’s predecessor at Northrop Grumman, Wes Bush, was an advocate of bidding on firm-fixed-price development contracts when the potential long-term technology payoff outweighed the near-term risks of having to boost financial reserves for risky development work.

Warden praised the relatively recent reform of separating the Pentagon’s acquisition chief into separate positions, one focused on acquisition and the other on R&D, because of the long-term focus on R&D. She also advocated for reform that gets industry “longer-term commitment on certain technology vectors” so that successful R&D work transitions to acquisitions and then operations.

This means the DoD acquisition and R&D arms need to work “very closely together so that we don’t have things die on the vine in the research phase even if they’ve proven their effectiveness,” she said.

Asked about further industry consolidation, Warden replied that she doesn’t see much more at the “top-tier or even what I would call the middle tier of companies.” Currently, “in many areas” the industry is “at the right number” of participants “or even a little light,” she said.

Smaller companies will continue to merge and acquire one another because it helps their capital structures and scale-up, she said.

“So, we’re probably at a healthy place as we sit here today,” she said.

Warden in 2018 helped orchestrate Northrop Grumman’s acquisition of the former Orbital ATK, a deal that gave the company capabilities in rocket building and missiles. Lockheed Martin [LMT] is currently trying to acquire Aerojet Rocketdyne [AJRD], the key U.S. competitor to Northrop Grumman in the area of certain rocket motors, a deal that has been delayed amid close scrutiny by the U.S. government over potential anti-competitive concerns.