Palantir: The Government's Darling (Part 1)
Pivoting towards a new age of public-private partnerships
Ever watched the movie War Dogs? In the movie, a couple of guys from Miami put together an operation to buy up arms contracts from the military, find suppliers, and get them delivered to the field. This movie was just one example, but was indicative of a larger narrative. Regular guys everywhere could just pick up small government contracts and making a quick buck.
While easy for small businesses, breaking into the defense industry at a large scale was almost impossible. Lockheed Martin, General Dynamics, and Northrop Grumman have been around since World War 2. Sure, there are a few other players - but for the most part - the past has only seen consolidation, not addition. Here’s how the defense industry has basically been since the turn of the century.
King, David. (2019). Validating Stock Market Reactions to Acquisition Announcements. 1. 1.
These companies are legacy manufacturers. Even in the general space of govtech, there really has not been much movement in terms of contracts or public-private partnerships at scale (“-tech” is just a suffix nowadays). Honestly, it’s hard to blame anyone for shying away from winning government contracts. For one, the government is so fractured, and each layer has its own political headache.
After the federal government, we’ve got 50 state` governments, 3,000 counties—which play different roles in different parts of the country—and 20,000 municipalities.
The list continues. Bureaucracy, security clearance, and confusing registration guidelines have plagued the industry over the last few years (we’ll get into this soon). Ironically, one company completely out of radar was able to break into the government sector not only once, but twice. PayPal. We all know that Elon Musk went on to create SpaceX, which launches everything from rockets to satellites for the government. And, Peter Thiel went on to found Palantir - the topic of today’s story.
The Makings Of Palantir
In the early 2000s, the integration of finance in the internet was still quite nascent. PayPal was still just establishing itself as the pioneer of payments on the internet. With any emerging technology, the internet brought both early adopters and bad actors.
PayPal especially faced this firsthand since it was the gateway for internet payments. In 2000, PayPal was losing more than $10 million each month due to credit card fraud. The team had to create a robust algorithm to overcome the fraudsters - a tough challenge in yesterday’s world. After some iteration, Max Levchin (CEO) and team created a dual-pronged approach where computer algorithms would flag suspicious transactions and humans would either approve or deny them. PayPal finally posted their first quarterly profit in Q1 2002, with almost all of the credit going to this algorithm.
Thiel immediately recognized the opportunity here. PayPal didn’t just figure out how to turn cash-flow positive, they created a system that better empowered humans to detect red flags - for practically any use case! To add to the party, the FBI already identified a use case that was heavily topical at the time. Identifying terrorist networks.
And surely, on May 6th, 2003, Thiel and his law school buddy Alex Karp (current CEO) founded Palantir. Honestly, I didn’t know what “a palantir” was but it's apparently a reference to an indestructible crystal ball in Lord of The Rings - sorry LOTR fans. Thiel’s VC Founders Fund as well as the CIA’s venture investing arm (In-Q-Tel) invested a total of $32 million to get the company up and running towards their first product.
It was all quite patriotic. Palantir spun up the algorithm soon after 9/11, set up ties with the government through the FBI and CIA, and created the product that is known today as Gotham. Within no time, the government and Palantir were synonymous. CIA, FBI, NHS, HHS, and ICE all used Palantir systems to analyze data streams real time for detection of red flags and fraud. Get this - Palantir even developed the platform to help locate Osama bin Laden!
Shaping The Future Of The Government
There’s this concept in the government space referred to as the Valley of Death. Essentially, its the period of time in between when a vendor approaches the government with a prototype and when that prototype becomes a contract. Typically, many companies run out of funding and go belly up just waiting to hear back from the government. Well, Palantir was able to cross this chasm. Today, Palantir generates 43% of its revenue from US government contracts. Solely the US Government. That’s more than a billion dollars of revenue coming from the government for a software as a service business. Within 20 years, Palantir changed the landscape of how startups interact with public agencies in the United States.
Again, “govtech” was not a thing in the early 2000s. The primes - Lockheed, Northrup, Raytheon, and a few others monopolized all contracts. In order for Palantir to win, they had to successfully break past every layer of friction in the government. Forge through useless bureaucrats and comply with the stringent requirements that vary between different state and federal agencies. They had to play politics.
And that's exactly what they did. Palantir used their early ties with the CIA to learn how the game is played. A few years later, they loaded up on the nation’s best lobbying firms and brought in top politicians to lobby for funding for intelligence analysis tools and defense appropriations bills.
Palantir was completely aware that in addition to playing politics, they had to deliver like the big guys. Successful lobbying efforts and perfect execution meant more contracts with the Army, Marine Corps, Defense Intelligence Agency, DoJ, FBI, Homeland Security and anything else related to US defense.
Structurally, the only way for Palantir to break in, deliver value, and build a business was through the creation of vertically integrated products that could be delivered as complete, opinionated, end-to-end solutions, just like the primes.
The earlier graph outlined consolidation in the defense industry over the past 50+ years. This one shows how Palantir shifted the tide for new entrants. Palantir’s lobbying efforts paved the way for Anduril, Saronic, HawkEye, Epirus and many more. From the looks of it, they are just getting started. Also, their massive government contracts used to mobilize the government tech stack also unlocked a key point of value enabling them to move into the next generation of their company. Data. Tune in for next week’s post to learn more.
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