Kibbutz Sasa sits one mile from Israel’s Lebanese border. Founded in 1949, it is the site of the tomb of the second-century rabbi Levi ben Sisi. It hosts groves of fruit trees and a dairy farm and has 210 members. Kibbutz Sasa is also the home of the main factory of Plasan, a company that started out making hard plastic containers like garbage cans in 1985. For four years now, American soldiers have driven more safely in Iraq and Afghanistan, thanks to Kibbutz Sasa and Plasan’s CEO, Dani Ziv.

It was Ziv who, in the 1980s, urged the company to take up the manufacture of protective ballistic vests for soldiers and police. In 1989, Plasan won its first contract to make body armor for the Israel Defense Forces, and then for IDF vehicles. When war came to Afghanistan and then Iraq, orders went through the roof, especially from the United States. Plasan’s profits soared some 1,500 percent, from $23 million in 2003 to $330 million in 2007. Today they stand at over $500 million, with 90 percent of the company’s orders coming from Europe and the United States.

Plasan specializes in a very dense plastic composite product that affords ballistic protection without significantly adding to the weight of the vehicle. “Their work is exceptional,” says a senior Israeli defense industry executive about Plasan. “To convince the U.S. military that you are a reliable outfit is no mean feat. They did it all alone, without any help from a former ambassador or defense ministry director general.”

Plasan-armored mine-resistant ambush-protected vehicles (MRAPs) have been serving in Afghanistan since August 2009, and contractor Oshkosh Company has another 8,800 on order. In 2009 Plasan even opened a factory in Bennington, Vermont, to do the work for its American contract. But while the 350 or so workers there are American, the technology is decidedly Israeli.

That applies to an even smaller company in Netanya, Israel, called Camero. Its engineers have come up with a way to use ultra-wideband wireless transmissions to see through walls—literally—and detect armed men and explosives on the other side. The Xaver 400 is barely the size of a laptop computer, but it’s dramatically shifting the odds in urban fighting in favor of the technology user, whether he’s an IDF soldier or a United States Marine. Indeed, in December 2010, one of Camero’s top clients became the Department of Defense.

What’s happening at Plasan and Camero is part of a silent revolution sweeping the defense establishments of the United States and Israel. After decades of being the Pentagon’s dependent in terms of military technology, Israel’s defense industry is now gaining a competitive advantage over its overregulated, bloated and lethargic American rival. Indeed, the United States is becoming one of its best customers. Goliath is finding shelter under the shield of David.

This situation is fraught with irony. It’s not only that America is now fighting the kind of wars Israel has been fighting for decades—small-scale, low-intensity, against an elusive terrorist enemy—and needs the skills and equipment Israel has to offer, including remote-detection devices such as unmanned drones, an area in which Israel has been on average 10 years ahead of the curve. Nor is it simply the fact that as U.S.-Israeli relations have cooled during the Obama years, Israelis are realizing that a strong and independent high-tech defense sector may be more crucial to Israel’s future than relying on U.S. help.

The Israeli way of doing defense business is changing the shape of the military-industrial complex. Smaller, nimbler, and entrepreneurial, Israel’s defense industry offers a salutary contrast to the Pentagon’s way of doing things. With the spending and budget crisis in the United States already putting immense pressure on the Pentagon, with all-but-certain declines in the percentage of the U.S. economy that will be devoted to defense in the coming decade, a second “revolution in military affairs” is going to be necessary. We are going to have to get more for less—much less. Israel points the way.

A good example coming from the more expensive end of the military-technology spectrum involving high-tech missiles is Rafael Advanced Systems. They’re the Israeli makers of the Iron Dome missile defense system, built to protect Israeli towns from mortars, rockets, and 155-millimeter artillery shells. Each Iron Dome unit fires four to eight missiles and is equipped with a Battle Management computer system designed by another Israeli company, MPrest Systems. It’s an all-weather mobile system with a range of 70 kilometers (about 43.5 miles).

For the Pentagon, developing and deploying a major new system like this can take more than a decade. By contrast, the Israel Defense Ministry gave Rafael the contract for Iron Dome in 2007, and by March 2009 the system was fully ready for testing. The first true shoot-down test had to wait until July that year. More tests followed in 2010, and by March 2011 Iron Dome was declared operational and has been deployed in towns near the Gaza strip to protect against Hamas’s attacks.

To intercept bigger ballistic missile, Israeli Aerospace Industry (IAI) developed the Arrow antimissile system in cooperation with the United States as part of Ronald Reagan’s Strategic Defense Initiative. The agreement to build Arrow came in 1989. The first missile, the Arrow 1, got its first test launch in August 1990. Less than four years later came its first test interception.

Although Arrow began as an American-Israeli joint initiative, the irony is that Israel’s interest in developing Arrow sprang from the failure of American-made Patriot antimissile batteries to intercept Scud missile attacks during the First Gulf War. Arrow relies on a coterie of Israeli companies to provide the interception system’s components. Elta, a division of Israel’s biggest private arms firm, Elbit Systems, provides the Green Pine early-warning radar. Tadiran (another Elbit division) makes the Communication, Control, and Command center. IAI devised the Hazelnut launch controls. Altogether, they have constructed one of the world’s most sophisticated defense systems. In 1995 the Arrow 1 was replaced with an even faster, more lethal version, Arrow 2, which, according to its developer, Dov Raviv, has a 90 percent probability of knocking out a ballistic missile—and can tell a warhead from a decoy.

Meanwhile, the Pentagon’s Missile Defense Agency considers itself fortunate when it gets any successful missile shoot-downs from its land-based system. The first successful test interception from the American version of Star Wars came in August 2005—more than 10 years after the Israelis had done the same thing. Now Israel is looking to sell Iron Dome in the United States. And Rafael’s American marketing partner? Raytheon, the same company that developed the Patriot.

For decades Israel has been seen as the United States’ junior partner in all matters military and strategic. American defense companies were the unquestioned leaders in developing sophisticated modern weaponry, while Israelis focused on more standard items such as small arms (the classic Uzi) or weapons built to suit their unique battle conditions (the Merkava tank). The Patriot missile deployment in the First Gulf War only reinforced the perception that Israelis needed American military technology, and American military aid, in order to survive. Now it may be Israeli technology, in the shape of Iron Dome and Arrow, that ends up defending American cities instead.

The changing situation has also affected the American attitude to technology transfers between the two allies. General Uzi Eilam, former head of the Israeli weapons research-and-development agency MAFAT, remembers that when F-15s and F-16s from the United States arrived in Israel, “they came with systems in locked boxes, which we were not allowed to open.” The rule was, the closer the Israelis were to attaining the same technical breakthrough, the more willing the United States would be to share the technology. Today the Pentagon is speeding up the cooperation process, if only to prevent Israeli advances from heading them off at the pass.

It is striking how the Israeli defense sector keeps steadily leapfrogging from one challenge to the next. This is especially true for the acid test of any strong defense industry: foreign sales. Ten years ago Israel ranked 15th. In 2007 it surpassed the United Kingdom to rank fourth, behind the United States, Russia, and France. The day when it takes France’s place is not far off.

This is a remarkable achievement for a country of some six million people that is treated as a virtual pariah by much of the world. But virtual is the mot juste—for even though Turkey virtually froze relations with Israel two years ago, it’s still among Elbit’s best customers.

Of course, it will be a long time before America’s defense establishment, with its huge government-supported research-and-development resources and armies of engineers, will be outmatched by Israel’s. It is also true that Israel’s military doesn’t use big-ticket items like aircraft carriers, stealth aircraft, and nuclear submarines that are the major money pits of Pentagon procurement; nor does it maintain the kind of global presence that requires them. Israel also spends much more of its GNP on defense (roughly 6.7 percent), and having a conscript army avoids the high personnel cost problems that are the fastest growing expense of our all-volunteer force. Nor can it be denied that much of Israel’s high-tech weapons success has come with America paying a large portion of the research-and-development bill, as with both Iron Dome and Arrow. Still, that money is looking less and less like a way to prop up a beleaguered ally, and more and more like a capital investment in future systems for ourselves.

How the Israeli defense industry, with a fraction of our capitalization and far fewer workers and engineers, has managed to move ahead at a time when our biggest defense contractors seem stalled offers some important lessons for a Pentagon beset by cost overruns and shrinking budgets. Indeed, learning from the Israeli way of doing things just might make the difference between a leaner, meaner U.S. military and hollowed-out collapse.

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Israeli defense companies owe their success to a combination of extrinsic and intrinsic factors. Having to fight for survival has always tended to focus Israeli energies and concentrate efforts. Terrorist-launched missiles raining down on civilian neighborhoods remain merely a conjectural possibility in the United States, but not in Israel. There is little margin for error in making major decisions about what kinds of weapons to develop and invest in, and even less for needlessly dragging out the timeline for the development of weapons systems that may be vital to national existence.

Another advantage is that virtually everyone working for an Israeli defense firm has served in uniform. As Dan Senor and Saul Singer note in their book Start-Up Nation, thanks to military conscription, the Israeli Defense Forces—-“particularly elite units in the air force, infantry, intelligence, and information technology arenas”—have been the spawning ground for a myriad of Israeli technological companies. And the IDF experience has also led some of Israel’s best minds toward designing and developing military technologies.

Indeed, it’s difficult to find a defense engineer or executive who doesn’t have some battlefield experience to draw upon. “We know what it means to sit in a military vehicle,” a Plasan employee told a reporter in 2008, “what it’s like to hit an explosive device or take a burst of gunfire.” It’s not unusual for a defense company engineer called up for reserve service to find himself at the controls of a weapons system he himself designed.*

Other habits from the IDF experience rub off as well. One is its bias against hierarchy. In sharp contrast to the Pentagon, junior officers enjoy more responsibility and feel free to challenge their superiors. As Senor and Singer note, that makes for a chain of command flexible enough to adapt to unexpected changes and opportunities, whether it’s on the battlefield or in the boardroom.

Another is a bias toward improvisation. Virtually every piece of equipment purchased from the United States, from F-16 fighter planes to Blackhawk helicopters, goes through immediate changes by its personnel and crews to fit Israeli battle conditions. When this happens in the American military (as when American soldiers in Iraq began self-armoring their thin-skinned Humvees), the result is confusion and panic. But accepting the reality of on-field modification means Israeli designers don’t have to worry about a weapon system that anticipates every contingency. They know the users will take care of minor problems along the way, which speeds up both development and deployment time—and gives important feedback for future improvements. It also reduces learning curves and provides unexpected opportunities for making lemonade from lemons.

A good example is the Lavi in the 1980s. Israel’s Air Force was determined to get its own attack fighter after years of modifying American or French planes. Jointly funded by the U.S. and Israeli governments, produced by defense giant IAI and nicknamed the Lavi, the plane took four years and billions of dollars to develop—until the program was cancelled in 1987, in large part because the Pentagon became worried that it was funding a plane to rival its own top export fighter, the F-16.

The cancellation sent shockwaves through the Israeli Defense Ministry: Some still say the decision was a mistake. But “the project drove the whole industry towards the cutting edge of technology,” notes defense analyst Yiftah Shapir, no fan of the Lavi. “We still sell the sub-systems that were developed [specifically] for the Lavi,” especially in computer avionics (some of them are in the unmanned airborne vehicles, or UAVs, Israel makes for customers such as India, China, and Turkey). In addition, the 1,500 engineers working on the sophisticated Lavi systems soon found jobs in other Israeli defense companies, taking their experience and expertise with them.

In short, what would have seemed a failure and giant waste of money to a risk-averse Pentagon and its congressional overseers became the springboard for still bigger advances, including, in 1988, the launching of Israel’s first communications satellite in space.

The Lavi project and the space shot set the stage for the next major step for the Israeli defense industry, its radical reorganization in the 1990s. A combination of downsizing, deregulation, and privatizing forced the country’s major defense contractors to start thinking about new ways to make money, as well as weapons, and to see the high-tech frontier as an opportunity to get the jump on big international competitors, including the United States.

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As the 1980s ended, the Israeli defense industry found itself bloated, overregulated, and too costly, like the rest of Israel’s economy. The end of the Cold War forced change. Foreign buyers had liked Israeli defense products because they had been battle-tested against the Soviet-built systems of Israel’s Arab antagonists. With the end of the Soviet threat, that marginal advantage vanished. Israeli companies saw American defense firms, flush from the success of Desert Storm, grabbing those contracts instead.

From 1985 to 1995 Israel’s defense spending fell by 37 percent. Declining global demand was matched by falling domestic demand, while a dysfunctional corporate culture made it hard for Israel’s major government-owned firms to adjust. If Israel’s ability to develop and produce its own weapons was to survive, a drastic change in how companies operated and what they made had to take place.

Major firms had to downsize their workforce and excess capacity; many smaller companies disappeared in a wave of consolidations. Elbit Systems emerged as a major contractor after absorbing smaller high-tech rivals like Elisra and Tadiran and old-line companies like Soltam Systems (founded in 1950), which made advanced artillery and mortars.

As part of a larger shift of Israel’s economy to a more deregulated model, there was also a wave of privatization of government-owned enterprises. Rafael Advanced Systems, which had been a research lab working at the behest of the Israeli Defense Ministry, spun off as a private company. Other government-owned companies like IAI were encouraged to spin off separate commercial projects from their defense units, even when the research and development had begun in those divisions. After some false starts, most of those spin-offs have done well; and as defense exports rose, the commercial exports of spin-offs rose even faster.

This was the other leg of the 1990s reorganization. It became clear that while Israel defense companies would continue to make Israel-specific weapons systems, there was a real future for the Israeli defense industry in the global marketplace, especially in the high-tech area that included retrofitting and upgrading older platforms built by the Cold War giants, Russia and the United States. Having a diversity of customers, beyond the IDF, would not only lower production costs and enhance economies of scale, it would also stimulate more technical innovation and more opportunities to sell Israeli products.

The result was a steady climb in Israeli exports, starting in 2000 and then breaking through in 2007, when Israeli arms sales abroad passed the $4 billion mark. Elbit, the maker of the Arrow, saw a 38 percent growth in revenue in that year alone. In 2009, Israel’s defense exports reached $6.9 billion; in 2010, $7.2 billion. With defense budgets declining worldwide in 2011, those numbers may be hard to surpass. But the Israeli way of doing defense business is here to stay.

Reorganization did not come cheap. In the end, Israeli taxpayers had to put up some $3 billion, the equivalent of one-third of the 2001 defense budget, to pay for the overhaul. The investment paid off. As Giora Eiland, one of Ariel Sharon’s national-security advisers, puts it, Israel found the right balance between, on the one hand, government support and oversight and, on the other, private creativity and incentive, including encouraging independent research and development. When the country needs big conventional platforms like planes and helicopters and submarines, it buys overseas and then modifies the purchases to fit IDF systems and battlefield profiles. When the IDF needs high-tech weaponry, Israelis develop it themselves with an eye toward commercializing it abroad.

That has caused some friction with Israel’s big brother. The United States views the advance of the Israeli David with some trepidation, especially when sales might mean transfers of sensitive technology. When Israel tried to sell four $250 million Phalcon early-warning systems to China, the Pentagon and Congress blocked the sale. When Israel agreed to upgrade the Harpy UAVs it had sold Beijing back in the 1990s, the United States retaliated by downgrading Israeli participation in the F-35 program.

On the other hand, American defense companies are increasingly seeing cooperation with Israel as the key to their own future. In addition to Iron Dome, Raytheon has signed on with Rafael Advanced System for development of another antimissile missile, the so-called Magic Wand or David’s Sling. A two-stage interceptor, the Magic Wand is designed to take out the long-range rocket and cruise missiles possessed by Hezbollah. To Raytheon, the Israeli technology is helpful for its own future systems; for Rafael, the deal with Raytheon is largely a way to get U.S. funding. The technology they have; it’s the money and customers they need.

One of those customers is the United States. Elbit makes 80 percent of the IDF’s UAVs and trails behind only the United States in the global marketplace for the craft we now all know as drones. Israel is not a player in the U.S. market—yet. “I don’t know why they don’t simply import UAVs,” says Elbit CEO Joseph Ackerman, including, of course, his own.

It seems a good question. And since the United States has emerged as Israel’s single biggest arms customer in the last decade, with systems like Iron Dome and David’s Sling on the way, surely drones won’t be far behind.

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So does the future of American security have “Made in Israel” stamped on it? In one sense, it already does. At the Plasan plant in Kibbutz Sasa, the hallways are covered with poster-size copies of thank-you notes from American GIs. One of them is signed by Brian, an Army sergeant serving in Afghanistan who wrote that the Plasan armor saved him from a bullet that would have blown off his head if it had gone through the door.

“American soldiers come up to us at exhibitions, and tell me that they won’t get into any vehicle that’s not been armor-protected by Plasan,” a Plasan employee says. To date, there’s not been a single soldier killed by fire while in a vehicle that we armor-protected.”

The idea of Americans protected by Israel, however, may have broader applications than vehicle armor or antimissile defense, or even weapons systems in general. It could extend to the entire way Israeli military contractors give far more bang for the buck—and all with a Defense Ministry supervisory force of fewer than 300 people. Our Pentagon, by contrast, relies on some 30,000 bureaucrats to do the same oversight—the equivalent of two full Army divisions.

Of course, Israeli companies take advantage of their niche selection and their concentration on the high-tech sector, with its relatively expensive development curve but low production costs, and ability to skip the big-ticket platforms. But can anyone doubt that if Dani Ziv or another Israeli defense contractor were asked to build the next-generation aircraft carrier, it would cost far less than the $1.3 billion currently slated—and be delivered much more quickly? With the final cost of our coming fleet of F-35 fighters approaching $1 trillion, it seems a highly relevant question.

While the number of Pentagon bureaucrats continues to grow, the number of American students graduating with engineering degrees is steadily falling to less than 5 percent of the world’s total (China graduates more than half). Right now America’s leading defense contractors spend twice as much on lawyers than they do on research. There is a very real danger that in the next decade, if they are asked to arm America for the next major strategic challenge, as they did in the 1980s and again after 9/11, U.S. defense contractors will be unable to meet it. It’s time for the Pentagon and the American defense industry to develop a new way of doing business. They must look to Israel.

* Streamlining that process is the Israeli Defense Ministry’s Talpiot unit, which targets very talented youths, some when they are in high school, for training in both high technology and military science, and on the necessary connections between them, before putting them into service with the IDF. Talpiot creates “a group unmatched anywhere in the world,” George Gilder writes in The Israel Test—with “its students designing [weapons] systems for 10 years before entering college” and with its former alumni serving as an unprecedented talent pool for Israel’s own defense companies.