Israel has a number of military and political problems. One of its most severe strategic and tactical problems is that it is a very small nation with no strategic depth. This has the well-known effect of forcing Israel to treat any conflict as an existential one, but has another more straightforward technical effect as well - namely, it is easy to reach large populated areas of Israel with very cheap bombardment rockets.
Although artillery - especially mobile and short-range artillery such as mortars - has always played a part in Israeli wars starting with the 1948 War for Independence, Israel's suppression of its nation-state neighbors has driven the use of indirect fire into the arsenals of organizations such as Hamas and Hezbollah. Unable to wield high-quality artillery due to the proximity and overwhelming firepower of Israeli counterbattery fire, they have embraced the mortar and the cheap and concealable unguided rocket as a way to do attritive and terror damage to Israel. The Qassam and Grad rockets, fired from Lebanon and the Gaza Strip, have rained down on Israeli targets for several years. Following Operation Cast Lead (The Gaza War) in 2008, when Israeli forces entered Gaza for three weeks, rocket attacks on Israel have climbed steadily. The Gazan-built Qassam series of rockets which first saw use following the 2001 intifada have been joined by larger and more sophisticated weapons. In 2008, the Grad was first used - a 122-mm rocket built by Iran and smuggled into Gaza. WIth a 20-km range, it threatens the Israeli town of Ashkelon. Another 122-mm rocket, the WS-1E which may be Chinese built originally, has also reached Gaza via Iran. It has a 45-km range, which threatens Ashdod, Qiryat Gat and Beersheba from Gazan territory and carries a warhead of more than 20 kilograms of high explosive.
Operation Cast Lead was Israel's last attempt (following the 2006 Lebanese invasion) of interrupting rocket bombardments with troops, and it doesn't seem to have worked all that well. Rocket attacks continued to grow in frequency and firepower after 2001; doubling in frequency after the Lebanese war and continuing to scale up. The IDF counted over 3,000 rocket hits within Israel in 2008. Something else needed to be done.
Israel is one of the first nations to have direct experience with missile defenses. Although their effectiveness was later debunked, American PATRIOT missiles were emplaced in Israel during the first Gulf War. They raised morale through their claimed interception of Iraqi Scud missiles fired at Israel. During and immediately after the Second Lebanese War of 2006, over 4,000 rockets were fired at Israel, killing over 40 civilians and causing widespread if random damage. The Israeli government decided to fund a domestically-built missile defense system for use against bombardment rockets and mortar shells. The Defense Minister selected the Iron Dome proposal in February of 2007.
Iron Dome is built by several Israeli companies, with Rafael (an Israeli aerospace firm) as lead contractor for the IDF. Radars, battle systems and missiles are all built domestically. The system was projected to cost around US$210 million. Israel funded the system development out of existing budgets; however, in May 2010 President Barack Obama proposed that the U.S. spend $205 million to buy Israel additional batteries of Iron Dome to increase defensive coverage. U.S. firm Raytheon is also now working with Rafael to market Iron Dome to foreign customers.
Progress was swift. In 2008, Rafael successfully tested the interceptor it had designed for the system, the $40,000 Tamir missile. In 2009, the system successfully intercepted simulated Qassam and Grad rockets, and the first batteries were deployed in southern Israel near Gaza and along the northern border with Lebanon. Through 2010, testing continued; the system was declared operational in early 2011. On April 7, 2011 Iron Dome intercepted two Gazan rockets before they could strike their targets.
Although commentators worried that Iron Dome would be ineffective because the attackers could force Israel to expend $40-50,000 rockets by firing ~$800 weapons, the system was set up to only intercept those rockets which its radars predict will land on populated areas. With a very large dataset of trajectories and impact points over the past decade, along with multiple radars to quickly track incoming weapons, Iron Dome has successfully discriminated between on-target attacks and those which it predicted would fall in open areas, ignoring the latter. Since the bombardment rockets are not very accurate, the large majority of attacks can be ignored.
It's difficult to determine, at this point, how effective Iron Dome is either technically or operationally. Although several intercepts have been claimed, the first Gulf War proved that it can be very hard to quickly and accurately determine if your intercepts are actually preventing or lessening damage (most of the Scuds intercepted by Patriot nevertheless dropped their warheads which successfully detonated on the ground, regardless of whether the incoming missile was damaged or destroyed; in most cases, it was later determined, the Scuds had in fact been several meters in front of the Patriot intercept points due to software problems and fuse designs on the Patriot which was originally intended to intercept much slower aircraft). A recent attack proved able to saturate Iron Dome's defenses with seven or so simultaneous launches, in which one or two reached defended areas and detonated.
Operationally, however, the story is brighter. Rocket launches, especially immediately following visible Iron Dome interceptions, have dropped in frequency. Despite the successful saturation attack, coordinated launches are very difficult for Hezbollah fighters and make the launching personnel and sites extremely vulnerable to Israeli attack. The local governments of communities in the threatened areas have begun loudly petitioning the Israeli military and government for additional Iron Dome coverage. Time will tell if this is an effective short-range missile defense, but early results look promising.