Radical defence investment and SME integration has topped the political agenda in Germany since Friedrich Merz won the 23 February elections.

As Germans across the country return from voting for their new Chancellor on 23 February, a ‘day after’ plan for the looming end of the government’s special defence fund remains front and centre for the German – and European – defence industry.

Previous German Chancellor Olaf Scholz earmarked EUR100 billion for this ‘special fund’, or ‘Sondervermögen’, shortly after Russia’s full-scale invasion of Ukraine in 2022, amid ongoing accusations of Germany as a NATO spending laggard.

The Sondervermögen will run out at the end of 2026, however, with no clear strategy to replace it. As Chancellor-elect Friedrich Merz and other party leaders thresh out the composition of the new German government, defence has received a level of attention unprecedented in modern German history.

Whatever the makeup of the new administration, it will almost certainly increase Germany’s defence expenditure in line with NATO demands, according to Dr. Hans Christoph Atzpodien, Managing Director of the Federation of German Security and Defence Industries (BDSV).

“Defence spending will undoubtedly be adjusted by the next federal government in order to meet NATO’s rising requirements, which may be equivalent to at least 3% of our GDP”, Atzpodien told DSEI ahead of the election. “We expect this to happen independent of any future government’s party-composition.”

Such a pro-defence political landscape breaks with a long-held taboo around military spending in Germany, held since the Second World War.

Chancellor-elect Merz looks to “drone procurement” and “young generals”

Merz and his Christian Democratic Union (CDU) party won 28.6% of the vote in the federal elections, although this is not enough for an outright majority.

The far-right Alternative for Germany (AfD) party doubled its vote share to 20.8% in second place, followed by Olaf Scholz’ Social Democratic Party (SDP) with 16.4% in third.

Merz has confirmed he will push for a centrist coalition with the SDP rather than working alongside the AfD, which has not specified defence policies aside from reinstating compulsory military service.

Defence was a cornerstone of Merz’ election speech on 24 February, in which he said his “absolute priority will be to strengthen Europe as quickly as possible so that, step by step, we can really achieve independence from the USA”.

He warned that “this is really five minutes to midnight for Europe”, speculating “whether we will still be talking about NATO in its current form or whether we will have to establish an independent European defence capability much more quickly” before the NATO summit in June.

Before the election, Merz rejected US President Donald Trump’s calls for NATO members to spend 5% of GDP on defence – which included a direct jab at Germany. Nonetheless, he has consistently promised to increase defence expenditure. In a televised debate on 9 February, Merz floated the possibility of loosening Germany’s debt limit to finance this push “towards 3%” of GDP.

Now as Chancellor-elect, Merz has suggested he could work with mainstream parties to loosen the country’s debt brake before the 25 March deadline to form a new coalition government. He has already begun talks with the SDP over an emergency EUR200 billion defence fund, Bloomberg reported, moving hastily against a potential block on debt-brake reform by fringe parties.

A spending boost was backed up by Stefan Thumann, CEO of German small and medium-sized enterprise (SME) Donaustahl, who is involved with Merz’ election team on matters of economy, procurement, and foreign security.

“The next [CDU] federal budget plans to contain EUR300 million for drones and procurement of new defence technology”, Thumann told DSEI.

No specifics were offered on the type of defence technology, but Thumann added that “Merz will appoint a younger generation of generals more comfortable with new technology”.

Thumann’s remarks and Merz’ emergency defence fund provide some reassurance for a defence industry concerned about what happens when the Sondervermögen runs out.

Nearly EUR30 billion in funding from the Sondervermögen maintains several ongoing German defence programmes, namely the Poseidon reconnaissance and anti-submarine warfare system, F-35 Lightning II fighter aircraft, and STH heavy-lift helicopter.

When asked if the Sondervermögen has sufficiently utilised defence expenditure, the managing director of BDSV, Atzpodien, was clear.

“No, definitely not. The Sondervermögen merely addressed unfulfilled wishes of the past, as well as the most basic necessities such as ammunition”, he said. “The German Minister of Defence, Boris Pistorius, repeatedly stressed the demand for increases of the regular defence budget going forward, which was declined by the Chancellor [Scholz] and other key governmental actors”.

On the flipside, Scholz’ government and the Bundeswehr point to the record number of procurement proposals over the EUR25 billion mark approved by the Budget Committee: 97 in 2024, surpassing the previous year’s high of 55 proposals.

With Scholz expected to resign following the SDP’s electoral slump, Bundeswehr officials would not commit to any changes in policy to DSEI.

Decisions on the future of Germany’s defence spending are “purely political”, a Bundeswehr spokesperson told DSEI. “The Federal Government is committed to NATO’s 2% target, which is also set out in the Federal Government’s security strategy adopted in June 2023”.

German SMEs call for changes with Bundeswehr procurement

In the eyes of Germany’s defence industry, the guarantee of a new and improved defence budget cannot come soon enough – but only if it comes with greater investment and a more accessible procurement process.

Several German SMEs have voiced dissatisfaction at the Federal Office of Bundeswehr Equipment, Information Technology and In-Service Support (BAAINBw), the Bundeswehr’s procurement arm.

“The German defence industry does not cater to SMEs – you are expected to develop everything on your own without input from the end user, because that would exclude you from a tender”, Alexander Wüst, CEO of WARGDrones, a Hamburg-based SME which manufactures drone-based counter-improvised exploding devices and explosive ordnance disposal systems told DSEI. “[You must] be able to manufacture 10,000 pieces of something and fulfil all kinds of certifications and regulations from zero.”

Research by German trade organisation Biktom found that, for startups and SMEs, Bundeswehr processes and responsibilities are “simply unclear” and “require a lot of effort”.

To successfully apply for contracts in the Federal Ministry of Defense, for instance, it can take more than four years from project planning to awarding the contract. Processing times for general public tenders take an average of eight or nine months.

In response, a Bundeswehr spokesperson told DSEI: “interested companies can contact the Bundeswehr at any time and in particular use the contact options provided on the Internet”.

The spokesperson pointed to the Bundeswehr’s Cyber ​​Innovation Hub (CIHBw) and Agency for Innovation in Cyber ​​Security as “important interfaces between the Bundeswehr and the start-up scene”, adding that “the BAAINBw also provides interested companies with extensive information on the Bundeswehr’s procurement process”.

Neither Merz’ nor Scholz’ administrations have directly addressed the criticism for inefficient procurement practices levelled at the BAAINBw.

Wüst believes a Merz government is “absolutely not” likelier to invest in German SME integration than the current Scholz administration.

“Politicians seem to believe that VCs [venture capitals] will take care of those startups that matter, but that is a wild misconception,” Wüst continued. “As an example, even the NATO Innovation Fund (NIF) dismissed us with a copy and pasted three-liner, after which I send two more emails that have remained unanswered. These funds seem to be run by ‘VC people’, not end users – aka soldiers – so we gave up and tried other ways. Regardless, I hope and am sure that defence spending will have to increase, and we will be among the beneficiaries of that through our partners in the field”.

The NIF is a EUR1 billion venture capital fund for tech startups looking to address challenges in defence and security, backed by 24 members of the military alliance.

An NIF spokesperson would not comment to DSEI on individual SME applications, but emphasised that the fund evaluates return on investment and strategic alignment on a case-by-case basis.

To date, the NIF’s largest investment in a European defence tech company is a EUR9 million funding round for ARX Robotics, a Munich-headquartered SME, to supply uncrewed ground vehicles (UGVs) to the Ukrainian frontlines.

Deliveries to Ukrainian forces have already begun. “The deployment of the UGV fleet for Ukraine will be completed in February”, Roberta Randerath, ARX Robotics’ Head of Business Development, told DSEI. ARX Robotics also plans to build a new facility in Ukraine.

Defence experts call on new German government to cut red tape

ARX Robotics’ emerging success story demonstrates that venture capital funds like the NIF can support German SMEs on defence contracts.

For the vast majority, however, direct Bundeswehr procurement remains the primary access point into such contracts.

The elections and growing frustration among SMEs are not the only factors contributing to the ‘tipping point’ state of Germany’s defence industry.

Last year, for the first time since the end of the Cold War, Germany met NATO’s 2% of GDP spending target for defence, going against decades of political caution around military expenditure in Germany.

With this rearmament, a wave of engineering and tech companies have moved into the defence space. Many hail from the ‘Mittelstand’, or SME sector, which accounts for the largest share of Germany’s economic output and employs 60% of the country’s workers.

An example of this is Helsing, a German startup AI company now valued at EUR4.95 billion.

Helsing announced the completion of its first manufacturing site in Southern Germany on 13 February, where the startup will produce 6,000 HX-2 strike drones to Ukraine. (Helsing).

From Merz’ election team, Thumann is calling for Germany’s political and military brass to harness the ‘Mittelstand’ and “give SMEs a chance, even if they are not yet on a NATO-ready level”.

“My suggestions are to cut the processes and qualification requirements”, Thumann told DSEI. “Weapon technology (like military drones) does not need the civilian level of qualification (like an airliner). Give SMEs smaller contracts - with EUR50,000 an SME can come further than a big company with EUR5 million”.

Such analysis from an election team member of the next German Chancellor is an optimistic sign for SMEs, even if Rheinmetall, Diehl, Krauss-Maffei Wegmann and other primes are still expected to top the pecking order on Germany’s major defence programmes.

Other experts recommend collaborating between the outgoing and incoming governments to fast-track timelines for defence procurement. 

By the time the ‘Sondervermögen’ runs out at the end of 2026, “new orders will have to be placed”, according to the Managing Director of BDSV, Atzpodien.

To support this, “the outgoing government [has] prepared a major ramp-up [in procurement] by enabling parliament to push 38 high-volume approval packages through the respective parliamentary decision-making processes”, he told DSEI.

Moving forward, Atzpodien concluded that the incoming administration must “designate further means for the regular defence budgets from 2025 onwards”, “indicate binding, long-term procurement intentions to the German defence industry”, and “enable the industrial base to perform further rapid ramp-ups of capacities by introducing supportive framework legislation”, a process known as ‘Rüstungsbeschleunigungsgesetz’.

All eyes now turn to the Bundestag. Whatever composition of coalition government Merz forms between now and 25 March, officials will face immediate scrutiny from NATO allies, Ukraine, and Germany’s restless defence industry. Where will new procurement and SME integration sit on the restructured German defence agenda?