At first glance, it appears that the term “innovation” is used too freely in aerospace—every incremental improvement in a product, process or service is trumpeted as such. Where are the discoveries and breakthroughs that marked the first century of aviation?

They are there, is the answer, but not where they once were to be found. Aerospace and defense contractors can no longer afford standing armies of scientists, so they are forging close relationships with universities and acquiring innovative small companies as they cast their net wider for new ideas.

Invention has become a global endeavor, as instantaneous communications ensure that ideas have no boundaries, making it more difficult to protect a competitive edge. Meanwhile, even as global issues like climate change and cyber-security challenge the aerospace and defense industry, a terrorist with few resources can out-innovate the most-powerful, best-funded military forces.

“Research and innovation are becoming more and more dynamic. Ideas fly around the world at the speed of light,” says Jean Botti, EADS chief technology officer. “The world of research and technology is expanding, but at the same time getting smaller as everybody communicates more. Open innovation is happening.”

A number of issues contribute to the perception that the aerospace and defense industry’s ability to innovate is broken. Cost overruns and schedule delays have become chronic on large development programs, such as the VH-71 presidential helicopter, 787 Dreamliner, National Reconnaissance Office’s Future Imagery Architecture and Europe’s A400M military transport. And the negative perception is reinforced because many of today’s large A&D contractors are not optimally organized to innovate and are having a harder time attracting the best and brightest innovators, who are also being sought by newer industries such as computer software.

Yet a four-month examination by the global consulting firm Charles River Associates (CRA), undertaken in collaboration with Aviation Week, concludes that there is no “crisis” in A&D innovation. The CRA findings are detailed in a white paper posted online at AviationWeek.com/innovate.

“The perception may be widespread that this is an industry that is too fat, dumb and happy to recognize it is in decline,” says Steven C. Grundman, a CRA vice president and the Boston-based director of the firm’s aerospace, defense and transportation practice. “But we detect at least as many indicators of risk-taking, innovative achievement and adaptation to the new rules of the A&D innovation game.” The white paper also found that, despite last year’s meltdown of the global credit markets, there remain sources of private capital willing to invest in small, innovative A&D companies.

That is not to say all is well. CRA’s findings, based on engagement with more than 50 senior industry executives, emphasize the industry must adapt to a new era in which companies will have to finance more of their own innovation efforts as government funding declines. Jacob Markish, a principal in CRA’s London office, notes that as government customers continue shifting the priority of acquisition programs away from clean-sheet designs—where customers paid all development costs—they increasingly are calling on industry to provide capabilities and leaving it to contractors to figure out how to deliver them.

“Companies are going to have to become more adept at attracting or simply deploying private capital that finances the realization of innovations,” says Grundman. “They are going to have to figure out how to explain to shareholders the employment of capital with risk offset by long-term—not short-term—promise, adapt technology developed in commercial businesses to solve aerospace customers’ needs, and develop relationships with small private companies that are often better at fostering innovations.”

But many large A&D companies are not organized to promote long-term innovation. While Wall Street generally rewards organizations for paying close attention to shareholder value, the flip side of that equation is they are unwilling to make investments in innovation that are not cash-flow positive within three years. “Many companies have devolved responsibility for planning innovation to their business units, where attention tends to be focused on annual profit and loss,” says Grundman. “So there is often too little incentive to make long-term investments, and innovation suffers.”