Rolls revs up: how Sir John Rose saved Rolls-Royce's aircraft business from the post-9/11 abyss

Chief Executive, The, Jan-Feb, 2005 by Richard Heller

Rolls-Royce CEO Sir John Rose likes to quote Warren Buffett's aphorism "When the tide goes out, you can see who's wearing a bathing suit." Buffett's observation, he believes, explains Rolls's success in avoiding disaster after the terrorism of 9/11, which triggered freefalling revenues and shrinking margins for airlines.

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In fact, it was a series of shrewd moves by Rose that helped hold the major engine manufacturers together while airlines were in a tailspin, ranging from a gutsy bet on engine development to no-nonsense negotiations with the company's unions.

The global airline industry is, collectively, Rose's biggest customer, but the sales relationship is complicated. Rolls-Royce usually sells civil air engines directly to aircraft manufacturers like Boeing and Airbus, but the airlines also have a say in engines. Thus, companies like Rolls, GE Aircraft Engines and Pratt & Whitney have a two-part sell--first to the airplane manufacturer and then to the airlines.

Civil aerospace propulsion units, industry speak for engines, are overwhelmingly produced for airlines, although they are also sold to power private jets. Airline and private jet-sales make up Rolls-Royce's dominant business, accounting, with after-sales activity, for almost half of total revenue.

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Deliveries of engines to the airlines fell off sharply, from 1,362 units in 2001 to 856 in 2002 and to 746 in 2003. Rolls's share price also tanked, falling from 107 pence to 28 pence [at press time, the conversion rate was $1.93 per 1 pound] in February 2003 before a reappraisal began.

But despite those numbers, Rolls hasn't really suffered all that much. The London company, which hasn't had anything to do with building cars since 1973, now owns 30 percent of the global aeroengine market, or one-third of the civil engine market. It now stands second in the sector, ahead of Pratt & Whitney (20 percent) and behind giant GE (50 percent).

There's no question that post-9/11 Rolls revenues fell off--from 6.3 billion pounds in 2001 to last year's 5.5 billion, representing a drop of 13 percent. But headline pretax profit only dropped 6 percent, from 190 million pounds to 180 million.

First-half 2004 results continued the upward trend, with after-sales revenue rising 16 percent year on year, and reaching 55 percent of total revenue. Revenue rose 6 percent, to 2.75 billion pounds. And underlying pretax profit jumped 16 percent, with 4 billion pounds in new orders booked, bringing the accumulated order book total to over 19 billion pounds.

The first major decision Rose made was to insist on continuing to invest substantially in the Trent engine series. That investment was originally initiated in the late 1980s by Rose's mentor, Sir Ralph Robbins, a former CEO and chairman who is credited with bringing Rolls back to life after its 1977 bankruptcy and subsequent nationalization. Rose took over as CEO in 1996.

Industry observers say Trent engines are more fuel-efficient than their competitors, perhaps by as much as 20 percent, and that Rolls-Royce's global after-sale servicing infrastructure functions better than Pratt & Whitney's and at least as well as GE's. "The irony of the huge success of the Trent engine is that it grew out of the RB211, the engine which led to the 1977 bankruptcy," says a long-term Rolls staffer who asked not to be identified. "There wasn't anything wrong with the RB211 except that we tried to build it with carbon fiber blades, which broke up and fell off. Titanium was the answer."

According to published reports, the company has invested, overall, some 400 million pounds in Trent-engine development. But Rolls, which has been criticized for its accounting of the Trent program, won't specify a number. (Some analysts complain that the full Trent facts should be out in the open, but Rolls says it's keeping its R & D secrets from competitors.)

Still, the tab was clearly high, and with the rewards not immediately in sight. "This is a long-term business," says Rose. "It takes years to bring an engine model from the drawing board to production. And the revenues from those models can be spread out over two decades, sometimes three."

The result, however, is that Trent engines are now a global benchmark, arguably the best jet engines in the world. Even as civil aviation flying hours have dropped, 10 to 15 percent since 2000, flying hours of Rolls-Royce engines have grown from 10 to 20 percent. That means that even as the airlines' own market shrank, the use of Rolls-Royce-powered aircraft has grown.

One salient fact: Engines account for fully one-third of the cost of an airliner, with airframe and electronic systems costs making up the rest, in roughly equal parts.

Both of the top mainframe builders, Boeing and Airbus, use and will use Rolls engines in their main models. They power Boeing's older B717 and B757 models, the big B777, and will be used on the projected B7E7 (which Rolls will share with GE). Airbus uses Rolls engines on the A321 and A330 and has chosen them, along with a GE-P & W jointly developed engine, for the huge new A380.