This document appears to be a dissertation investigating the aerospace industry, specifically focusing on the aero-engine sector and its electronic advancements. The dissertation includes chapters on literature review, hypotheses, methodology, analysis, discussion, conclusion and references. The analysis chapter will examine market trends in civil and military aerospace and the aero-engine industry. It will also analyze the business environment using models like PEST, Porter's Diamond and Five Forces, and examine Rolls-Royce's internal environment and the benefits of its investment in electronic data systems. The dissertation aims to provide a detailed understanding of an aero-engine manufacturer's internal and external environments.
1. AN INVESTIGATION INTO THE
AEROSPACE INDUSTRY WITH SPECIFIC
REFERENCE TO THE AERO-ENGINE
SECTOR AND ITS ELECTRONIC
ADVANCEMENTS
BY
JAMES GALE
2006
A dissertation presented in part consideration for the
degree of MSc International Business
2. Abstract
This investigation initially analyses the general trends seen within the core sectors of the
aerospace industry. The external macro environment and the external industry
environment are then assessed using the relevant models and processes that have been
presented within the literature, with specific reference to the United Kingdom. In order to
develop a focused and detailed understanding of an aero-engine manufacturer’s internal
environment, a case-study Rolls-Royce is incorporated. Recent technological
developments seen within the complex aero-engine are examined, with specific reference
to electronics and the integration of the processes provided by Data Systems and
Solutions. The overall benefit derived from investment in these core areas is assessed and
examined in detail.
3. Acknowledgements
Many thanks to all of the people who have supported and encouraged me throughout this
dissertation.
James Gale
4. Table of Contents
CHAPTER 1............................................................................................................................................. 1
INTRODUCTION.................................................................................................................................... 2
AEROSPACE INDUSTRY ........................................................................................................................... 2
CHAPTER 2............................................................................................................................................. 8
LITERATURE REVIEW ........................................................................................................................ 9
BUSINESS ENVIRONMENT ..................................................................................................................... 10
- External Macro Environment ........................................................................................................ 11
PEST Analysis............................................................................................................................................ 11
Porter’s Diamond Model ............................................................................................................................ 13
- External Industry Environment...................................................................................................... 17
Porter’s Five Forces Model........................................................................................................................ 17
Flagship Model .......................................................................................................................................... 19
- Internal Firm Environment............................................................................................................ 21
Core Competencies .................................................................................................................................... 24
Value Creating Industries ........................................................................................................................... 25
- Business Relationships .................................................................................................................. 26
- Strategic Alliances/Joint Ventures ................................................................................................. 30
CHAPTER 3........................................................................................................................................... 34
HYPOTHESES....................................................................................................................................... 35
JUSTIFICATION ..................................................................................................................................... 37
CHAPTER 4........................................................................................................................................... 38
METHODOLOGY................................................................................................................................. 39
CHAPTER 5........................................................................................................................................... 45
ANALYSIS ............................................................................................................................................. 46
MARKET TRENDS ................................................................................................................................. 46
- Civil Aerospace............................................................................................................................. 47
- Military Aerospace........................................................................................................................ 52
- Aero-Engine Industry .................................................................................................................... 55
BUSINESS ENVIRONMENT ..................................................................................................................... 56
- External Macro Environment ........................................................................................................ 56
PEST Analysis............................................................................................................................................ 57
Porter’s Diamond Model ............................................................................................................................ 63
External Industry Environment ........................................................................................................ 66
Porter’s Five Forces Model........................................................................................................................ 66
Flagship Theory ......................................................................................................................................... 69
- Internal Environment .................................................................................................................... 70
Business Relationships - Rolls-Royce .......................................................................................................... 70
Data Analysis............................................................................................................................................. 79
CHAPTER 6........................................................................................................................................... 91
DISCUSSION ......................................................................................................................................... 92
CHAPTER 7........................................................................................................................................... 96
CONCLUSION....................................................................................................................................... 97
FURTHER RESEARCH........................................................................................................................ 98
CHAPTER 8........................................................................................................................................... 99
REFERENCES..................................................................................................................................... 100
CHAPTER 9......................................................................................................................................... 109
APPENDIX........................................................................................................................................... 110
5. List of Figures
FIGURE 1: MAJOR E UROPEAN AEROSPACE CROSS-HOLDINGS IN 2004 (ASD, 2003)....................................... 4
FIGURE 2: CONSOLIDATION PROCESS IN THE E UROPEAN AEROSPACE INDUSTRY: 1990-2003 (ASD, 2003) .... 5
FIGURE 3: PORTER’S DIAMOND MODEL (PORTER, 1990)............................................................................ 14
FIGURE 4: PORTER’S FIVE FORCES MODEL (PORTER, 1980)....................................................................... 18
FIGURE 5: FLAGSHIP MODEL FRAMEWORK (D’CRUZ AND RUGMAN, 1997) ................................................ 20
FIGURE 6: ALLIANCES WITHIN THE AERO-ENGINE INDUSTRY (DUSSAUGE AND GARRETTE, 1995) ................ 32
FIGURE 7: CIVIL AEROSPACE INDUSTRY TURNOVER - EUROPEAN UNION (ASD, 2004)............................... 48
FIGURE 8: EU AEROSPACE T URNOVER PERCENTAGES - CIVIL/MILITARY (ASD, 2004)............................... 52
FIGURE 9: MILITARY AEROSPACE INDUSTRY TURNOVER - EUROPEAN UNION (ASD, 2004)........................ 54
FIGURE 11: DS&S DATA ANALYSIS FOR BROADBAND VIBRATION ON TWO TRENT 700 ENGINES .................. 77
FIGURE 12: ENGINE SHOP VISIT - REWORK LEVEL FOR CORE ENGINE MODULES ........................................ 81
FIGURE 13: EXAMPLE OF YEARLY ESCALATION VALUES FOR TOTALCARE® CONTRACTS .............................. 83
7. Introduction
Aerospace Industry
The aerospace industry is a vast, complex and dynamic market which is categorised into
three core industrial sectors: systems and frames, engines, and equipment. In addition,
there are also three product segments which are characterised as: aircraft, missiles and
space (European Aerospace Industry (EAI) - 2002). The main customer divisions which
are the source of demand for the products and services provided by this business
environment are categorised into civil aerospace and military aerospace.
The foundations to the aerospace industry were originally set out around the Second
World War, after which it has continued to rapidly expand and develop into a successful
business environment (Alfredsson and Hildingson, 2003). Throughout this time, the ever
increasing demand for public air travel has driven the civil sector whilst demand for
homeland security has been the source for growth within the military sector. The two
regions that have been at the centre of this development have been the United States and
the European Union. Over time, they have come to dominate the marketplace and in 2004
accounted for 84.6% of the total consolidated turnover within the industry (AeroSpace and
Defence Industries Association of Europe (ASD), 2004).
Due to the nature of the environment, the industry has gradually become internationalised
and increasingly competitive for the firms that operate within it. In each of the regions, a
unique structure has developed whereby there are several core organisations that focus on
the manufacturing process and in turn, these are supported by an extensive supply chain of
other businesses (Alfredsson and Hildingson, 2003). For example, within the civil aircraft
2
8. business there are two core manufacturers, Airbus and Boeing, however in turn these are
both supported in all relevant areas by a wide range of other organisations. A similar
situation is also present in the aero-engine sector, with it being dominated by three core
firms: General Electric, Rolls-Royce, and Pratt and Whitney all of whom are supported by
an extensive network.
The market structure is also dominated by unique relationships which are formed due to
the high cost barriers present in producing products such as airframes and aero-engines.
As a result, organisations can become both partners and competitors within the same
business environment as they strive to remain competitive in the market. In relation to this,
smaller companies often operate within their own specialised role which is part of a much
larger project (de Jong, 1998).
The relationships that develop over time have become an integral part of the aerospace
industry. From these interactions, a network of strategic relationships, joint ventures,
international consortia and partnership agreements have been created (ASD, 2003). These
not only incorporate organisations from Europe and the United States but also Asia, South
Africa, Australasia and the Far East (ASD, 2003). Figure 1 highlights the main cross-
holdings present within the European aerospace industry in 2003.
3
9. Figure 1: Major European aerospace cross-holdings in 2004 (ASD, 2003)
In order for firms to remain economically successful and competitive against national and
international organisations, there have been numerous mergers and acquisitions. These
processes enable firms to consolidate their position on the international stage which is
becoming more important in achieving the level of success required by shareholders.
Figure 2 highlights the recent consolidation processes which have been undertaken within
the European Union.
4
11. The nature of the aerospace market and the levels of investment within research and
development have placed the industry on the technology frontier (Alfredsson and
Hildingson, 2003). The structure of the industry and important inter-relationships which
are present are able to aid in the distribution of new innovation and technology. This in
turn, gradually diffuses throughout supporting companies and industries, further
improving technical abilities along with capabilities and opportunities. These so called
‘spill-over’ effects are valuable to any economy as it increases efficiency and the ability
for organisations to compete on an international scale.
The aerospace industry has come to play an increasingly crucial role within national
economies. The growth within both civil and military sectors of the aerospace industry not
only provides potential for further national economic development, but also many other
attributable benefits. One of the most important is that of technological innovation which
provides a base from which to develop. Companies often invest heavily within research
and development in order to remain competitive over their rivals. It has been well
researched that there are ‘first-mover’ advantages and this has become vital within civil
and military aerospace (Mueller, 1997).
Due to the overall importance of aerospace organisations, a growing trend has been seen
in the supporting policies which have been introduced. These are often introduced on a
national level but regional policies do exist, such as those developed within the European
Union. Policies relate to issues such as research and development, funding, taxation
benefits and levels of local protectionism. The aim of such policies is to ensure the
continued success of aerospace firms whilst ensuring their competitiveness and continued
growth within the sector. However, Bechat et al. (2002) emphasises that it is essential to
6
12. balance such issues on an international scale in order to ensure a level ‘playing field’.
Ensuring this will allow for the industry as a whole to develop and grow further into a
successful business environment.
In order to assess the complex aerospace market in more detail, it is important to examine
the current literature which will provide insight and understanding into the industry. Only
after this process has been undertaken can the analysis for this investigation commence.
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14. Literature Review
The aero-engine industry consists of several organisations who dominate the market:
General Electric, Rolls-Royce and Pratt and Whitney. Between them they have control of
a large proportion of the market share, with other smaller companies accounting for only a
small percentage of overall sales. Due to the dominance of just several firms, the aero-
engine industry currently displays the characteristics of an oligopoly.
One of the major features of oligopolies is the existence of barriers to entry, which can
exist due to both strategic and also natural reasons. The natural barriers to entry are
determined from exogenous costs, which to a great extent are outside an organisations
control. Costs of labour, technology, land, premises, and materials are determined by the
local market conditions and therefore firms can have little influence upon their levels. For
a specific industry these costs, if large enough, can develop a barrier to entry. The
minimum efficient scale (MES) determines the level at which a firm looking to compete
within a specific market would have operate above. In oligopolies, the MES is high in
relation to the overall market and thus prevents an inflow of new investment (Begg and
Ward, 2004).
The second barrier to entry, or strategic barriers, can be developed by firms within the
market. Firms are able to manipulate the overall cost nature in strategies such as
advertising and branding through which the MES is driven higher and subsequently
prevents the development of further competition.
9
15. As a result of the barriers which develop, oligopolies often maintain the characteristic of
being dominated by several core organisations. Within the aero-engine market both of the
preventative characteristics are present. Firstly there are high costs associated within entry
into this high-technology market but in addition, this is developed further through the
branding and reputations of the current operators. The overall business environment
demands extremely high levels for quality and safety of products and this has been
achieved through long-term investment and development. It is as a result of this that the
firms involved have been able to maintain and protect their hold upon large proportions of
the market.
Due to the nature of oligopolies, there is increased importance on each firm taking into
account the others which are present. The firms are mutually dependent upon one another
because they are all affected and influenced by their rivals. Therefore, no firm can ignore
the actions and reactions of others within the industry (Sloman, 1998).
Business Environment
The overall competitive success of organisations is determined by the business
environment and the complex interactions within the external macro environment, the
external industry environment, and the internal firm environment (Mellahi, Frynas and
Finlay, 2005). Analysing and understanding these related areas enables organisations to
understand the context within which a specific strategy needs to be developed and
implemented.
10
16. - External Macro Environment
PEST Analysis
The external macro environment consists of four criteria: political, social, economic and
technological (PEST). These provide a company with both threats and opportunities
however, due to the nature of the external environment these are outside the control of any
business. It is important therefore, that the external environment is matched to the
resources and activities that a firm undertakes otherwise failure is a strong possibility.
The political category is mainly dependent upon the Government policy within a particular
nation. Governments have strong influences on any business trading within its borders and
understanding their policies and objectives is crucial. Issues such as, “tax, employment
laws, regulations, trade restrictions, tariffs, and political stability in addition to
understanding and assessing the availability of raw materials and supplier development”
(Schildhouse, 2006) are just some of the wide ranging factors. There is a desire by all
firms to acquire knowledge in all of these important areas as it can be extremely beneficial
in the long-term performance of a business.
The economic category is quantitative based, which allows for a more precise analysis. At
the core are economic growth, exchange rates, interest rates, and inflation. Understanding
the impact of these issues and keeping track of any changes, allows a firm to be prepared
and make timely decisions when they are required.
The social assessment is a more subjective method which looks into the population
growth, demographics, and social cultures. Which areas are investigated and how this
process is completed is dependent on the organisation. It is based largely around the
11
17. individual however, it can also be correlated back to the economic factors (Schildhouse,
2006).
The final category is that of technology. This is assessed through looking at the rate of
technological change which is occurring in a particular country or region. At its core the
analysis becomes infrastructure-based, as this is the platform from which further
advancements can arise (Schildhouse, 2006). In addition, indicators include present levels
of investment by both the Government and other organisations, along with the extent of
research and development activity.
A firm completing a PEST analysis is able to gain a more detailed view of the business
environment within which it operates. However, a firm can take this further through
evaluating four criteria: Strengths, Weakness, Opportunities and Threats (SWOT).
Undertaking this process allows firms to recognise the risks associated within an
environment and is therefore a significant tool for decision making (Schildhouse, 2006).
Weihrich (1982) highlights that this method can aid an organisation in changing its
position from a reactive stance to a proactive strategy, a process which can be significantly
beneficial.
The ideology behind the PEST analysis is that through the correct process, an organisation
within a specific industry can formulate and implement suitable strategies. This will aid in
taking advantage of the opportunities whilst remaining aware of the possible difficulties
that could be faced in the future. However, it is important that the process is continually
updated and improved so that managers are able to utilise the framework effectively
(Mellahi et al., 2005).
12
18. The understanding of the external macro environment which is developed through
utilising PEST analysis can also explain why some firms and industries within specific
countries are more successful than others. Porter (1990) takes this reasoning further and
has developed the Diamond Model which analyses the ‘national base’ as a source of
competitive advantage in global markets.
Porter’s Diamond Model
In order to understand how, why and where successful industries are established, one must
look at the issues associated with national advantages. At present one of the most
recognised and widely accepted models analysing this particular area is that presented by
Porter (1990) in, ‘The Competitive Advantage of Nations’. Within this Porter developed
four core national determinants which specify why some industries succeed in a nation
whilst they fail in another. The analysis takes into account the characteristics of ‘Factor
Conditions’, ‘Demand Conditions’, ‘Firm Strategy, Structure and Rivalry’ and ‘Related
and Supporting Industries’. In relation to these, the issues of ‘Government’ and ‘Hazard’
are also incorporated. When encompassed together they form the Porter Diamond which
can be seen below in figure 3.
13
19. Figure 3: Porter’s Diamond Model (Porter, 1990)
Factor conditions are the first main aspect that Porter (1990) developed. This category
takes into account the national resource base that is available to a country in the form of
human, material, knowledge, capital and infrastructure. These are effectively the nucleus
to all markets and are required to some extent for a firm to become established and
eventually succeed. In adverse instances where one or more of these are not present, a firm
becomes dependent upon innovation through which a comparative national advantage may
develop.
Demand conditions are the second category within Porter’s diamond model. This analyses
the level of home demand for the products and services of a particular industry with the
main determining factors being composition, size and growth. In addition the
internationalisation process is important especially when domestic demand is limited. This
can reverse any negative issues into positive influences for organisations.
14
20. The third category Porter places emphasis on is the related and supporting industries.
These two areas are essential and when firms present within these categories become
internationally competitive, it only aids in the overall strengthening of the system. Benefits
such as innovation and efficiency are developed that in turn support the national base.
The fourth category within Porter’s model is that of firm strategy, structure and rivalry.
When the correct combination of these three areas is incorporated into a national industry,
there is the increased probability of a firm being internationally successful. An industry
and the firms within it are able to develop a strong national base from which they can
advance and achieve on a global scale.
In addition to the four categories, it is important to recognise the importance the
Government plays within the Diamond Model. The Government can have both a positive
and negative influence upon all four of the factors. Issues such as investment in
infrastructure, laws and regulations, taxes, education, and financial support are just some
of the areas in which Governments can have an affect. Although overall competitiveness
of an industry is not completely determined by the Government, its role is significant and
must therefore be taken into consideration.
Hazard is the final issue associated with Porter’s diamond model and takes into account
financial fluctuations, political unrest and technological breakthroughs. Again these are
recognised as potentially having either a positive or negative influence upon an industry
and are often dependent upon how a nation or industry deals with each issue. Porter
highlights that when a more favourable diamond is present, there is increased potential for
developing a competitive advantage from any hazard that may arise.
15
21. It is important to understand that all of the categories influence on another and are to some
degree interdependent. Changes in one area will subsequently have an impact on another.
Also, these factors can change over time and so therefore must be taken into consideration.
When the correct combination of positive factors is present then the strong home base
which develops provides the relevant businesses with a base for innovation, which in turn
can lead to global success (Mellahi et al., 2005).
Porter (1990) recognises that there are other criteria that determine the success of firms on
a national and international level, such as management styles and organisational
structures. However, within industries these are known to converge over time and thus
differentiation becomes increasingly difficult. Globalisation has spread resources and
knowledge across the world and therefore, the four non-controllable factors of the
diamond model become the determinants for the development of a competitive advantage
(Mellahi et al., 2005)
Overall therefore, understanding the conditions highlighted by Porter (1990) enables
nations and also the organisations within them to develop and become successful. They
can focus on areas and industries that are sufficiently supported whilst also working to
achieve improvement in those areas that do not reach the desired standards.
These processes and models of analysing the external macro environment will enable a
detailed analysis of the aero-industry, with more specific examination of Rolls-Royce as
the core case-study for the aero-engine organisations.
16
22. - External Industry Environment
The external industry environment is another important area associated with the success of
organisations. It consists of all the factors stemming from actions undertaken by suppliers,
buyers, competitors and others which directly influence the level of competitive success
within a specific industry (Mellahi et al., 2005). It is important that a firm understands
these issues and is able to relate them back to their own business. In doing so they can
ensure that resources and the subsequent activities are matched. In addition, Porter (1980;
1985) suggests that a firm must also understand the underlying economic and technical
characteristics of an industry in which they operate.
Porter’s Five Forces Model
Porter’s Five Forces model (1980; 1985), as seen in figure 4, takes into consideration two
fundamental issues which drive the success and therefore profitability of an organisation:
industry attractiveness and competitiveness. These are themselves determined by five core
forces: ‘rivalry among existing competitors’, ‘threat of new entrants’, ‘threat of
substitutes’, ‘bargaining power of suppliers’, and ‘bargaining power of buyers’.
Understanding these five forces enables firms to develop greater knowledge on their
external industrial environment which can therefore aid them in becoming more successful
over time.
17
23. Figure 4: Porter’s Five Forces Model (Porter, 1980)
Although some criticism, in the form of understanding change (D’Aveni, 1994; Harvey,
Novicevic and Kiessling, 2001) and level of profitability (Rumelt, 1991; Mauri and
Michaels, 1998), have been issued to the Five Forces model, it is still recognised as an
important organisational tool. Porter himself has stated that industries can and do change
in unpredictable ways and that no type of model can forecast such fundamental
fluctuations. However, for the majority of established industries, the external environment
is one which sees only gradual change and development over time and can therefore be
understood further through incorporating such models.
In order to analyse the evolution of an industry, Vernon (1966) developed the Product Life
Cycle which aids in understanding the evolution of a product through its four life stages:
18
24. introduction, growth, maturity and finally decline. This research was taken further by
Vernon (1966) and later Wells (1968), in the International Product Life Cycle Model
which developed five stages of development, from home country introduction through to
export by developing nations. Such models aim to produce a general trend that the
majority of products are expected to proceed through as they pass through their life.
Although globalisation has produced a significant shift in product development, these
models are still able to provide managers with a level of insight which can be utilised.
Flagship Model
The Flagship Model, figure 5, introduced by D’Cruz and Rugman (1997) goes against the
traditional competition theories which depict arm’s length relationships as seen in the Five
Forces Model (Porter, 1980). Instead of analysis on a short-term basis the Flagship Model
proposes a long-term competitive system which aims to outperform competition within the
industry. The system is dominated by one main flagship firm which has the resources and
capabilities to attain the level of financial success that is required by all those involved.
This firm subsequently provides the important leadership, direction, strategies, and
decisions.
19
25. Figure 5: Flagship Model Framework (D’Cruz and Rugman, 1997)
In conjunction with the presence of one main flagship firm, another major characteristic is
the establishment of strong relationships. These are often developed over time with the
main consumers, suppliers, and select competitors. They are all initiated by the flagship in
order to perform functions more effectively which in turn improves the overall system. In
addition, flagship firms often develop important relationships with non-business
infrastructure including Governments, non-trade service sectors, educational institutions,
research centres, trade unions, and trade associations to enable yet further business
advancement. With these relationships the flagship system develops a vertically integrated
chain of organisations which in turn creates a complex business network in the pursuit of
long-term economic success.
20
26. Competition is driven between flagship firms, but in some instances co-operation between
them in term of joint ventures does occur when risk and revenues are too high for an
individual to pursue alone. This enables flagships to advance technology and research,
further improving the products and services which they are able to provide.
The partnerships between all members develops a situation where sharing of market
intelligence, intellectual property, knowledge, and technologies occurs in order to achieve
success for the whole business network. Each individual organisation understands what
they desire and expect from the business relationships and in the long-term they work
together in order to maximise success, which in turn benefits each of the individuals
involved.
The analysis models utilised for the understanding of the external industry environment
provide the opportunity to further develop a complete picture of a particular market.
Through implementing these processes in relation to the aero-industry it will provide
further insight into the present situation and aid further in the understanding of this
particular business sector.
- Internal Firm Environment
Knowledge bases have always been, and will always remain, a core internal determinant
to the success of a business organisation. Knowledge bases are a collection of information
that pertains to a specific area within an organisation that enables them to be successful
through criteria such as product development and innovation. They are resources
integrated into the dynamic framework of a business, which need to evolve over time as
the firm progresses through its own stages of development.
21
27. Pavitt (1986) emphasises that industry leaders have managed to retain knowledge bases
due to their ability of creating opportunities. The capacity to retain this is dependent upon
learning from experience, accumulated expertise and the capacity for integration. Without
these there can be no learning and therefore a reduction in the ability to re-create
opportunities.
At the core of knowledge bases is the ideology of knowledge itself. However, the current
understanding of knowledge on an organisational and industrial level has developed
several concepts within the literature.
Implementation of the neo-classical understanding of knowledge is possible, and even
successful, when it is sufficient to have simple representations of simple systems. This is
achievable in industries of mono-technological systems with low regional intensity which
do not develop complex networks and inter-relationships (Paoli and Prencipe, 1999). In
these situations knowledge develops the characteristics of perfect explicitability, perfect
decomposability, perfect transferability, indistinguishability of the process from the
product and finally distinguishability between scientific and technological knowledge
(Paoli and Prencipe, 1999). This allows all types of knowledge to be reduced to their most
simplistic form, information.
This neo-classical understanding has been linked to the virtual corporation model that was
developed by Byrne, Brandt and Port (1993) and has since continued to be extensively
revised and developed. The virtual corporation model uses technology to link people,
assets, and ideas within a temporary organisation. Core differentiation, soft integration and
virtual realisation are the three core factors which provide the potential for a firm to
22
28. become successful (Scholz, 2000). In addition, empirical evidence from Scholz (2000)
highlights that firms which have integrated such methodologies have been able to develop
significant economic benefits as a result. However, a negative implication of this system is
that economics becomes the dominant force and therefore any organisational operation,
such as the viability of outsourcing, becomes solely dependent on this factor.
In more complex product systems, such as in the aero-engine, the complete reliance upon
economic determinants and the lack of reference to other significant issues reduces the
compatibility with the neo-classical definition. In these industries there are different
product characteristics, innovation dynamics, and strategic and management options
which consequently limit the overall applicability (Paoli and Prencipe, 1999).
In the literature, knowledge in complex product systems can be correlated to the
evolutionary theory. This method considers knowledge as a system of processes deeply
rooted in their contexts of production while there is a high degree of tacitness and non-
decomposability (Paoli and Prencipe, 1999). The result of this is that not all knowledge
can be reduced to the smallest level, information, so therefore organisations must maintain
a degree of understanding and integration capacity.
In these complex environments there can be a degree of networked innovative activities
and a use of external sources for development and manufacturing. This is clearly seen
within aero-engine producers who have a high level of external agreements, in terms of
both activity and scope (Paoli and Prencipe, 1999). However, in these instances, system
integrators maintain their importance for the success of an organisation. It is crucial that
23
29. the firm maintains knowledge bases along with their generative contexts (Paoli and
Prencipe, 1999).
Core Competencies
In order for a firm to operate effectively and efficiently within an industry it must be
aware of its resources and capabilities. These enable a firm to operate within an industry,
however they do not always enable a firm to develop a competitive advantage within a
market. This advantage and ultimately the degree of success are often determined by the
core competencies found within a firm (Mellahi et al, 2005). Core competencies are
technologies and production skills which underlie a company’s product lines and are
regarded by many within the literature as one of the critical areas within an organisation
(Tampoe, 1994). Prahalad and Hamel (1990) explain that in the long run, competitiveness
stems from the ability to build on these core competencies as they govern the, “collective
learning in the organization, especially on how to coordinate diverse production skills and
integrate multiple streams of technologies”.
Core competencies can be identified using the VRIO framework (Barney, 1997) which
looks at whether resources and capabilities are valuable, rare, costly to imitate, and
exploited by the organisation. Managers can use this information to further enhance the
firm and ensure that they possess a competitive advantage. However, Prencipe (1997)
states “rules of competition change over time, in that core competencies considered to be
key for a business sector may eventually become trivial, and vice versa”. Therefore, the
management decisions on issues such as this have become of crucial importance for a
firms long-term survival.
24
30. Value Creating Industries
Due to globalisation and the rate of economic growth on a world-wide scale there has been
increasing levels of demand for businesses to obtain value-creating activities from a whole
range of sources. There has been a general trend for utilising opportunities outside the
internal firm environment for developing the essential value-creating activities (Mellahi et
al., 2005). Financial success is at the core of almost all organisations and thus the need to
minimise costs whilst elevating revenues is a constant requirement. Insinga and Werle
(2000) state that this trend has led to the proliferation of international strategic alliances,
or simply the outsourcing of certain business functions, by buying goods and services
from external sources.
The use of external sources in the manner discussed by Insinga and Werle (2000) is
strongly related to economic issues. Managers should utilise external sources when the
cost of undertaking the task is cheaper than completing it internally. This criterion is also
the main determinant when a firm must decide on whether to incorporate domestic or
foreign sources. It is however vital that a firm does not reduce its ability to compete or
develop an advantage over rivals within the market when adapting such strategies. Also, it
is important that other issues such as intellectual property rights are taken into
consideration. Due to their importance managers, must understand these issues as they can
significantly affect a firm’s business plan and long-term success. The concepts of value
added, value chain, and value system analysis are all methods which can be utilised in
order to aid in such business decisions.
25
31. - Business Relationships
Product systems are characterised by interactions across whole organisational structures
and at all levels including component, subsystem, and system (Prencipe, 1997). There are
a high number of interdependencies upon each of these levels which in turn, categorise the
degree of performance which is achievable. Such product systems are subject to technical
change at any level through modular, architectural and radical innovation (Henderson and
Clark, 1990).
The aero-industry is described within the literature as multi-technology and multi-
component in nature. The engines produced are classified as complex product systems due
to the forty thousand individual components which vary in technological value and need to
successfully integrate them. Undertaking the integration of a product of this nature
generates a situation where development, production, change and innovation cannot be
undertaken solely within the boundaries of one organisation. For this reason, an
organisation involved within such a market needs to utilise external sources.
Due to the extensive product environment within the aero-engine industry, there are vast
arrays of competencies that can be developed within a firm. However, as Prencipe (1997)
explains, a firm’s success is often dependent upon whether it is able to correctly evaluate
each of these competencies. Through this process, a firm can retain those practices which
are most vital whilst contracting out those which are not.
Within the literature there are currently two main business strategies that are incorporated
by organisations to deal with the additional processes that cannot be completed internally:
vertical integration and outsourcing. Vertical integration represents the expansion of a
26
32. firm’s activities to include processes carried out by suppliers or customers (Mellahi et al.,
2005), whereas, outsourcing utilises inputs that have been produced and delivered to the
firm by independent suppliers (Kotabe, 1992). However, the literature has contradicting
view points on the most suitable method that should be employed by firms to increase the
probability of success.
Porter (1980) highlights that there are many benefits to a firm incorporating a vertically
integrated strategy. The majority of these are economic in nature, with the ability to raise
barriers to entry, offset bargaining power, generate a higher return on business and also
defend against foreclosure which can ultimately restrict an organisation. In addition, firms
can become more stable through understanding demand whilst also reducing quality
issues, uncertainty, and costs.
Porter (1980) highlights that the technological knowledge that is derived from vertical
integration is considered a benefit, as organisations can gain from the use or understanding
of it. However, full integration not only provides its own difficulties but also increases the
degree of risk. This is derived as a firm must accept complete responsibility for
developing its own technological capabilities rather than utilising the distinctive
competencies that had previously been developed by others.
Although Porter (1980) highlights some risk associated with vertical integration, empirical
evidence from studies completed by Prahalad and Hamel (1990) and Stalk, Evans and
Shulman (1992), suggest that developing competencies through such actions is a necessity
to remain competitive over rivals within a market. Research by Bell and Pavitt (1993)
supports this ideology and emphasise that technological capabilities are developed from
27
33. interactions between research and development, product and process engineering, and also
manufacturing activities. The inter-relationships enable firms to generate and manage
technological change, an issue which has become essential due to the difficulties that arise
when attempting to transfer knowledge. Therefore, retaining these core processes is
essential to a firm’s survival.
Monteverde and Teece (1982) highlight that vertical integration can be correlated to
efficiency considerations. Through research it was discovered that undertaking such a
strategy can increase coordination of production and also reduce the level of exposure to
opportunism from suppliers. However, Prencipe (1997) states that it is also a matter of
mastering evolutionary dynamics. Without these, an organisation loses the ability to
introduce innovation which minimises the sustainability of generating competitiveness.
Stuckey and White (1993) relate vertical integration to market structure and state that as
one changes the other should follow. If there are a small number of buyers and sellers,
high asset specificity, durability and intensity, and frequent transactions, then a vertical
market may fail. Organisations must therefore adapt their strategies in order to take such
knowledge into account. In opposition to this, Prencipe (1997) states that due to the
features of technological knowledge such methods are deemed inappropriate and are not
feasible within markets of complex-product systems.
From the perspective of outsourcing, there are also many potential benefits. One of the
most significant is that of cost saving. Research undertaken by Gilley and Rasheed (2000)
shows that firms undertaking outsourcing achieve high cost advantages relative to those
28
34. deciding upon vertical integration. One of the main drivers behind this is the promotion of
competition between suppliers which reduces costs, whilst increasing the level of quality.
Outsourcing provides access to proprietary knowledge through the suppliers, which can
then be utilised by the organisation. In most instances this would have otherwise not been
available. Other benefits include a degree of flexibility as suppliers can be changed over
time as new technologies, practices and processes become available and the needs of the
business evolve. Finally, outsourcing also provides the ability to focus upon core areas of
the business instead of inefficiently utilising important resources.
There are however, risks associated with the outsourcing process. One of the most
significant that can arise is agreement failure. Dun and Bradstreet (2000) reported that half
of all outsourcing agreements fail within five years due to issues of culture, costs, and
service. When agreement failures occur they can be extremely costly to organisations and
prove difficult to overcome.
Prencipe (1997) emphasises that outsourcing of any technologies deemed not relevant to
an organisation may damage a firms ‘change-generating capacity’ along with its ‘context
of learning’, and therefore the ability to master the evolutionary dynamics of product-
systems. Contexts provide the base for new knowledge and thus should not be removed
from the internal business environment. In addition, extensive outsourcing can also lead to
a ‘hollow’ firm by which the reliance upon external sources becomes too great and
ultimately results in failure (Mellahi et al., 2005).
29
35. Overall therefore, there are both advantages and disadvantages to vertical integration and
outsourcing. Due to this, business decisions on which method to incorporate into the
corporate strategy have become major issues for firms. Economic factors have become
central to many decisions however, from the review of current literature it is clear that
when making a decision of this nature other factors must be considered and taken into
account.
- Strategic Alliances/Joint Ventures
The use of strategic alliances and joint ventures is one method incorporated by
organisations in an attempt to develop, expand and improve (Dussauage and Garrette,
1995). A joint venture involves two or more individuals or companies engaged in a
solitary business deal, which has been arranged in order to generate profits. Although the
management of joint ventures can be difficult, long-term success can be extremely
beneficial to organisations (Lorange and Roos, 1992). Such business relationships are a
more recent occurrence in many industries but have been present in the aerospace sector
since the 1960’s.
In recent years, there has been a general shift from the use of international joint ventures
to strategic alliances. The main difference between the two is that strategic alliances are a
more long-term and diverse process often undertaken between competitors within the
same market. The two driving forces behind this change have been globalisation and
technology. The process of globalisation is making global business markets increasingly
uncertain, mainly as a result of higher levels of competition. Due to this, it is now
emphasised in the current business literature that being a strong multinational with suitable
strategy based on competition, is not enough to ensure a sustainable competitive
30
36. advantage. In addition, with ever improving technology in all areas of the business
environment, firms are seeing shorter product life cycles, faster obsolescence, rising costs
and the rising demand for new technology. Technological change is fragmenting global
markets and emphasis is placed on organisations to develop a clear product strategy that
takes into account these factors (Hayes, Pisano, Upton, and Wheelwright, 2005). Erhorn
and Stark (1994) stated, “world-class product development is the key to competitive
advantage within global markets and so organisations need to be proficient at this core
activity”. Strategic alliances offer organisations the possibility to achieve these core
objectives.
A strategic alliance is defined by Gulati and Singh (1998) as, “any voluntarily initiated
cooperative agreement between firms that involves exchanges, sharing, or co-
development, and includes contributions by partners of capital, technology, or firm-
specific assets”. Over recent years there has been a rapid increase in the number of
strategic alliances being formed across the globe. This trend has reversed the more
common ideology of firms being independent entities that use internal skills and
knowledge, to establish themselves as market leaders. The development of alliances
enables the achievement of strategically significant objectives, that are mutually beneficial
and beyond what a single firm could attain (Mellahi et al, 2005).
Porter and Fuller (1986) state that strategic alliances blur the distinction between
competition and cooperation and therefore, can lead to significant management issues.
However, strategic alliances have successfully been incorporated into many industries and
are gradually becoming more integrated into the business environment. At present, cross-
border alliances between competing firms in the aerospace industry account for a
31
37. significant proportion of the total number of partnerships set up in manufacturing
industries world-wide (Hartley and Martin, 1990). One of the main processes is the Risk
and Revenue Sharing Partnerships (RRSP’s) that enable all firms involved to develop a
comparative advantage from the relationship. Figure 6 shows some examples of the
extensive international strategic alliances that have been initiated for the development of
several aero-engine models.
Engine Model Strategic Alliance Partner Firms
Olympus 593 Rolls-Royce, Snecma
CFM-56 General Electric, Snecma
EJ-200 Rolls-Royce, MTU, Fiat Aviazione, ITP
MTR 390 MTU, Turbomeca, Rolls-Royce
RTM 322 Rolls-Royce, Turbomeca
Adour Rolls-Royce, Turbomeca
Larzac Snecma, Turbomeca, MTU, KHD
RB-199 Rolls-Royce, MTU, Fiat Aviazione
BMW-RR BMW, Rolls-Royce
SST-Engine Rolls-Royce, Snecma
GE 90 General Electric, Snecma
V-2500 (IAE) Rolls-Royce, Pratt and Whitney, MTU, Fiat, JAEC
Figure 6: Alliances within the aero-engine industry (Dussauge and Garrette, 1995)
In the aerospace industry, the motives for utilising strategic alliances lies in the form of
reduced R&D costs and access to intangible assets, such as skills and knowledge, at a rate
that is both quicker and cheaper than competitors. The integration of competencies and
capabilities of two or more organisations can subsequently increase the levels of
competitiveness within a specific business environment.
However, as Mellahi et al. (2005) highlight, it is vital that the correct partner is selected
and that they achieve the appropriate strategic, operational and cultural fit. Medcof (1997)
suggests that management should take into account four key criteria: capability,
32
38. compatibility, commitment, and control when the selection of a partner is made. If all of
these conditions are not achieved then failure is a much greater possibility.
Jordan and Lowe (2004) draw attention to the dilemma that strategic alliances develop for
organisations. They highlight that, “on the one hand, alliance success is associated with
high levels of interaction and co-operation between partners however, full and open co-
operation exposes a firm’s distinctive knowledge and skills and makes it vulnerable to
opportunistic moves by alliance partners”. As a result, the fundamental ‘learning’ and
‘knowledge’ paradoxes arise, in that “to gain the greatest benefits an organisation must
exchange information and knowledge with external parties yet, at the same time, they
must protect themselves against knowledge appropriation” (Larrson, Bengtsson,
Henricksson and Sparks, 1998). If protection is not considered, the resulting loss of
knowledge and competencies can be significantly detrimental to any organisation.
In the aerospace sector, the issues discussed appear more acute as a result of the political
imperatives which strongly influence partner choice and the fact that collaborators are
often strong rivals in other contexts (Jordan and Lowe, 2004). This emphasises the
importance of partner selection and the crucial role of management in the overall success
of strategic alliances.
33
40. Hypotheses
Hypothesis 1:
Alternative Hypothesis (H0):
Data trends show potential for continued growth throughout the core sectors of the
aerospace industry.
Null Hypothesis (H1):
Data trends show no potential for continued growth throughout the core sectors of the
aerospace industry.
Hypothesis 2:
Alternative Hypothesis (H0):
The business environment for the aerospace sector in the United Kingdom is currently in a
strong position and this trend looks set to continue.
Null Hypothesis (H1):
The aero-engine industry within the United Kingdom is in a poor state and the future for
the associated organisations is limited.
35
41. Hypothesis 3:
Alternative Hypothesis (H0):
The aero-engine manufacturer, Rolls-Royce, significantly improved their overall business
when they incorporate technological advancements, with specific reference to Data
Systems and Solutions.
Null Hypothesis (H1):
The aero-engine manufacturer, Rolls-Royce, develops no additional benefit from
incorporating technological advancements such as those associated with Data Systems and
Solutions.
36
42. Justification
The hypotheses presented above aim to develop questions which will further improve the
current understanding of the aerospace industry, with specific reference to the aero-engine
sector within the United Kingdom. The UK currently has a successful aerospace industry,
however it is dominated by one major organisation - Rolls-Royce. The importance of this
firm has become crucial and so has the complex network of supporting firms and
industries which have developed.
This investigation will develop a clear insight into global market trends that have been
seen and also those which are predicted for the future. In addition, the study will focus on
the present situation found within the United Kingdoms aerospace industry. A clear and
complete presentation of the aerospace environment is not available within the current
literature and therefore it is important to provide a complete insight into this sector.
In relation to the aero-engine industry, there is the constant requirement to continually
develop and advance the products and services provided. In recent years the main change
has involved the integration of electronics. These have subsequently become integral to
any aero-engine and many ensuing advancements to the products have focused on this
area. Rolls-Royce has become a market leader and now utilises the technology in all of its
new engines. However, there is currently limited information in the present literature on
these systems and the benefits which arise from their incorporation. Therefore, Rolls-
Royce will be examined in detail to analyse these issues. In addition, the business
relationship between Rolls-Royce and Data Systems and Solutions (DS&S) will be
explored as a case-study to highlight the specific advantages which have been generated
from advancements of this nature.
37
44. Methodology
Research is a process of ‘knowledge production’ (Marshall and Rossman, 1999), through
which one seeks a greater understanding or discovery of new information on a particular
subject matter. In order for this to be accomplished, the process of data collection and then
data analysis needs to be completed.
In this investigation, the methodology that has been set out has been undertaken to
determine the validity of the hypotheses presented above. The analysis that is going to be
undertaken will be looking at the aerospace industry. The aero-engine sector of this vast
market plays a crucial role and it is this which will be researched in further detail. In order
to develop a critical insight into the core aero-engine market Rolls-Royce will be the
organisation investigated. Rolls-Royce is the second largest aero-engine manufacturer in
the world and one of the United Kingdom’s most important high-technology industries.
A complete analysis of the recent trends within the core sectors of the aerospace market
will be performed in order to establish a detailed understanding of the industry. It is
important to generate a comprehension of these factors in order to establish the potential
market movements for the future. The overall trends have influence upon all organisations
involved within the industry so therefore this analysis is crucial to the investigation and
will allow the first hypothesis to be assessed.
In order to gain a full understanding of the complex industry and to assess the second
proposed hypothesis there will initially be an analysis of the political, economic, social,
and technological (PEST) criteria which will provide an insight into the external macro
39
45. environment. These four PEST analysis factors are the core issues within all markets
across the globe and developing an understanding of these is crucial. This knowledge will
allow a comprehension of the current market and the position that UK organisations
currently occupy. To develop the analysis further, Porter’s Diamond Model (1990) will
also be applied. This will highlight whether the national advantage required for an industry
to be successful within a nation was present for the aerospace industry in the United
Kingdom.
To gain an understanding of the external industry environment, Porter’s Five Forces
Model (1980) will be utilised along with the Flagship Theory introduced by D’Cruz and
Rugman (1997). Through performing these examinations, one can develop a more
complete comprehension and deeper level of knowledge of the issues within the aerospace
industry.
The study is looking to understand the benefits of relationships developed by
manufacturers and external organisations within the aero-engine sector. One of the most
important is the understanding of interactions with electronics firms. The present day aero-
engine has become strongly integrated with electronics and the technology surrounding
such systems. In relation to these developments, Rolls-Royce has made some key strategic
decisions. One of these involved the development of Data Systems and Solutions (DS&S)
in a joint venture. This particular case-study attempts to highlight the impact of market
and firm advancements, the benefits of technological progression, along with providing an
analysis of the internal firm environment. Through analysing all of these factors it will be
possible to fully assess the third hypothesis which has been presented.
40
46. Incorporating a case-study enables a researcher to obtain information that will directly
relate to the hypotheses being investigated. One of the primary advantages is that an entire
organisation can be studied in detail with greater attention to detail (Zikmund, 2000). A
case-study on a single firm has been completed in this instance as it allows in-depth
research into a particular theory. It must be recognised that this process does not provide a
whole market analysis, however for this specific investigation broad and wide-ranging
information is not a core requirement. This single case-study on Rolls-Royce has been
deemed sufficient to provide the necessary understanding required to assess the
hypotheses presented.
In order to gain access to primary data for the aero-engine industry, two semi-structured
interviews were undertaken with employees from Rolls-Royce. This type of primary
research enables a way of collecting and analysing specific research information. It must
be emphasised however, that interviews only provide a limited degree of knowledge. This
limit is dependent upon the level of knowledge the interviewee possess and also, the
quantity that they are willing to divulge (Cassel and Symon, 2004). Although interviews
can provide useful information and data, the factors mentioned above must be taken into
consideration. The interview must therefore be approached in a manner that allows
maximum benefit to the investigation.
When using the semi-structured method, pre-set questions are developed however, there is
a degree of flexibility which allows for a less autocratic interview process. This method
ensures the interviewee remains focused on the issues being presented, but is free to
provide other potentially useful information (Cassel and Symon, 2004). In this
investigation, the semi-structure technique was utilised as the conditions meant that it had
41
47. the possibility of providing the most significant results. In relation to this decision, it was
felt that a structured interview would be too rigid and not allow for a flowing session,
whilst an unstructured method may not provide the scope and detail of information
required to complete a successful analysis.
Both of the interviews undertaken for this project were completed in private and on a one-
to-one personal basis which lasted approximately 25-30 minutes. These private sessions
allowed for greater interaction between both parties involved.
The interviews which were arranged by a third party contact, were undertaken to gain an
insight into the business environment, develop further knowledge not currently in present
literature, and also attempt to acquire specific data for the desired research topic.
However, during the interviews, both persons involved expressed concern over the
possibility of releasing confidential information and for this reason requested that the
interview was not recorded and that they remain anonymous.
The first interview with Contact A (2006), was completed on the 4th August 2006, with the
interviewee being a manager within a specific business team. This employee of Rolls-
Royce had previously spent several years overseas again working within the aerospace
industry. Throughout the interviewee’s career, a full understanding of many aero-engine
models and their integrated systems had been developed. The interviewee’s current
position required this knowledge in order to allow effective management of specific
business issues. This diverse knowledge subsequently proved very useful to this
investigation.
42
48. The second interview with Contact B (2006), took place on the 7th August 2006. The
interviewee (Contact B, 2006), supported the Data Systems and Solutions (DS&S)
division of Rolls-Royce. The interviewee had a facing role involved in DS&S operations
in relation to Rolls-Royce engines. Within the organisation, information from this division
is analysed and delivered to the relevant personnel involved within engine management.
This interviewee was able to provide useful information about DS&S and the role which it
plays within the aero-engine sector of Rolls-Royce.
In order to further support the investigation, secondary data is also going to be
incorporated into the analysis. Secondary sources represent information that has been
collected for other investigations. As this data has already been collected by a third party,
there is a reduction in both cost and time. It is important however, to understand and take
into consideration the overall relevance of this type of data to an investigation. Data of this
nature may have been collected and/or analysed incorrectly, may have become outdated
since publication, or may not correlate to the present research (Cassel and Symon, 2004).
Secondary data however, can prove to be an extremely useful tool for analysis. It can
provide a much wider scope and depth of information than primary data collection whilst
allowing for a much greater understanding of industrial or market trends (Hyman, 1987).
For this investigation, secondary data from related research topics within the current
literature will be utilised. In addition, documents in the form of reports, publications and
academic journals will be incorporated in order to further develop the level of analysis.
This will allow for the hypotheses presented to be fully understood and analysed in a
method which will permit the most accurate conclusions.
43
49. This particular methodology has been developed to provide the most significant analysis
and results to the overall study. The techniques stated have been incorporated into many
academic research articles which analyse specific areas within an industry. In relation to
the aerospace market, the literature highlights the use of empirical analysis which is often
linked to anecdotal evidence from interviews and a subsequent case-study of a specific
organisation (Bonaccorsi, Giuri, and Pierotti, 2001; Prencipe,1997). This technique has
been used in the examination of many research fields including the direct analysis the
aero-engine sector (Prencipe, 2004). The literature concludes that this type of analysis
process can be extremely useful and successful when undertaken to evaluate a specific
investigation.
Overall therefore, this methodology is appropriate for developing accurate conclusions to
the hypotheses that have been generated for this investigation. All of the data collected
during the study and the resulting analysis will allow for a clearer understanding of the
issues raised.
44
51. Analysis
In order to complete an accurate and detailed analysis of the aerospace industry, it is
important to look at the recent trends which have been seen. Understanding the past trends
places the current situation into perspective and also provides the opportunity to predict
what the future potentially holds, a factor which is crucial for all organisations involved
within this market.
Market Trends
In 2005, the turnover value for the world aerospace industry was valued by the AeroSpace
and Defence Industries Association of Europe (ASD, 2004) at €203 billion. Datamonitor
(2006) has estimated that global aerospace markets will grow in the following years at an
average rate of 4% per annum. Utilising these predictions it can be estimated that the
aerospace market in 2006 will be worth over €210 billion, with a continuing growth trend
after this period.
Within the aerospace industry there are two core markets. The largest is that of the United
States which has long been the frontrunner. In 2000 the country accounted for 49.3% of
the market (ASD, 2000). By 2004 this value had fallen slightly to 45.2%, or just over €88
billion (ASD, 2004), but the United States still dominates. The main determinant of this
massive market share is the sheer size of the domestic market, with over half the world’s
air traffic being conducted within this single nation (House of Commons - Trade and
Industry Committee, 2005).
46
52. The second largest aerospace market is the European Union (EU) which accounts for
seventeen national aerospace industries. In 2004, the EU accounted for 39.4% of the world
market, up on 2000 by 5.6%. However, this region is dominated by several core nations
which are the United Kingdom, France and Germany.
Currently, the aerospace markets are dominated by organisations within the more
economically advanced nations such as those presented above, but there is increasing
activity in many of the emerging economies around the globe. Although at present these
are recognised as, “indigenous to their national aerospace industries”, it is expect that in
the near future they will have a major influence upon the international market (House of
Commons - Trade and Industry Committee, 2005).
- Civil Aerospace
The civil aerospace industry can be strongly correlated to trends seen within the airline
sector, as these organisations are the main customers of the products and services. In turn,
the airlines themselves are heavily influenced by the demand for air travel that is
generated from within the global population. In addition, organisations involved within air
cargo are another key component within the civil aerospace market. The air cargo sector is
governed by the same rules and regulations of passenger airlines and the products and
services utilised are almost identical.
Like many markets around the globe, civil aerospace is cyclical in nature. This has
developed due to the inter-relationships that are present between aerospace firms, airlines,
and the general public. The trends that result can be closely related to characteristics
47
53. within the global economic environment, with financial implications recognised as one of
the central determinants (House of Commons - Trade and Industry Committee, 2005).
Figure 7 highlights the recent turnover levels of the civil aerospace industry within the
European Union. The trends seen within the EU were also present across the global
aerospace market as all are strongly influenced by the same determinants.
From 1980 to 1992, the business environment was undergoing a period of strong and
continuous growth, with turnover rising by just over 170% (ASD, 2004). However, the
industry followed its cyclical nature from 1992 to 1995 where turnover within Europe
collapsed by 31.3%. The main cause of the trend reversal was the overall slow down in the
global economic environment. However, after the three years of decline the markets again
recovered with further growth of 113% between 1995 and 2001.
Civil Aerospace Industry Turnover - European Union
60
50
40
Turnover (€bn)
30
20
10
0
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
Year
Figure 7: Civil Aerospace Industry Turnover - European Union (ASD, 2004)
48
54. In 2001, the world economies were performing at ever increasing levels, with the markets
and organisations reaping the benefits. This is represented in the analysis of the European
civil aerospace industry, which from 1999-2000 and 2000-2001 saw growth rates of 11%
and 8.8%, respectively. These levels saw turnover rise from €46.7 billion in 1999 to €56.4
billion in 2001 (European Aerospace Industry (EAI, 2000: 2001: 2002), a trend that was
predicted to continue across the global market.
However, in 2001 the civil aerospace market entered into a period of sudden recession. As
the cyclical model referenced above highlights, the main determinant of this change was
the rapid and unpredictable decline in the world economy. The main causes of the
problems seen were several high profile events including the outbreak of SARS (Severe
Acute Respiratory Syndrome), conflict across the Middle-East, increasing oil prices and
also the terrorist attacks in the United States. The combination of all these incidents led to
a downturn in the global economy with all industries being adversely affected. In
particular, the civil aerospace market was significantly influenced due to the use of aircraft
in the terrorist attacks on the 11th September 2001.
The potential threat for further activities of this nature was widespread and as a result,
there was a massive collapse in the demand for air travel. The International Air Transport
Association (IATA, 2006) recorded an all-time high of passenger travel in 2000 with
nearly 1.7 billion. However, for 2001 this value fell by 100 million passengers, resulting in
a drastic negative impact upon the airline industry and subsequently the civil aerospace
industry.
49
55. In 2001, the airline industry alone saw net losses of $13 billion. In contrast the same
industry was making a net profit of $8.5 billion in 1999, highlighting the impact that the
events of 2001 had upon business. A consequence of this was the collapse in the value of
the civil aerospace market. Data from the ASD (2004) highlights that European civil
aerospace industry fell in value by 9.6% in 2001-2002, followed by a further reduction in
2002-2003 of 3.5%. This degree of change in such a short period of time emphasises the
unpredictable nature of the industry. It is therefore crucial for businesses to be aware of
these potential changes and take into account the risks of similar fluctuations in their
future business strategies.
Although the events seen throughout 2001 had a drastic influence upon the civil aerospace
markets, the trend reversed in 2004 with growth of 3.5%. Even though the threat of
terrorist activity still remains, conflict is still commonplace, oil prices remain high, and
many global threats are still a possibility, the aerospace industry has still continued to
develop. These issues, especially that of terrorism, have gradually integrated themselves
into present-day ideologies and become another part of modern society. The shock of 2001
massively influenced the global economies as it was the first major incident of its type.
However, the economic impacts have now been overturned and the general public have
become accustomed to the issues that they represent.
The result of these changes has been the return to rising passenger levels and increasing
demand for domestic and international flights. After 2001, passenger numbers began to
recover with strong and steady growth. Over the period 2003-2005, passenger numbers
rose by almost 25% to over two billion. This trend can be correlated to the ever increasing
passenger demand and also to stronger than expected economic performance in the United
50
56. Kingdom, Japan and many other emerging economies (IATA, 2006). For 2006, IATA
(2006) predicts that passenger numbers will rise to 2.2 billion and the growth trend is
expected to continue. However, even though positive trends are being seen it must be
recognised that the airline sector is still undergoing recovery. Net losses of $3.2 billion
were still present in 2005, sustained mainly by the ever increasing cost of oil which now
accounts for 22% of total operating costs (IATA, 2006). It is predicted that it will take
many more years before net profits are again viable within this industry. However, in
August 2006 the potential for further terrorist attacks was realised when plots to destroy
trans-Atlantic airlines between the United Kingdom and the United States were thwarted.
This instability highlights the issues which modern businesses, especially those involved
in the aerospace markets, have to overcome.
In conjunction with passenger travel, air-cargo levels also fell with a decline in operating
levels of 7.7% from 2000 to 2001. This sector also endured a prolonged struggle to
recover as sale volumes remained at their depleted levels 2001-2003. Although the cargo
industry is not as valuable as passenger travel, the financial implications for all the
associated industries were severe. However, freight levels eventually began to recover
with sales rising by over 27%, from 29 million tonnes to nearly 37 million tonnes,
between 2003 and 2005 (IATA, 2006). This positive trend is expected to continue at 7%
per annum, driven by the ever increasing levels of international trade (IATA, 2006).
Overall therefore, the civil market has overcome the issues of recent years and is presently
in a period of growth. Currently this is predicted to continue (ASD, 2004) however, the
cyclical trends of the industry are difficult to predict and therefore, organisations must be
prepared for any eventualities that may arise in the future.
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57. - Military Aerospace
The military sector is a vital and important division within the aerospace market. In the
early 1980’s turnover attributed to military sources accounted for over 67% of the total
European market and was therefore, a key factor in the early growth and development of
the industry.
As figure 8 highlights, the significance of the military sector in economic terms has
gradually reduced since the 1980’s and was overtaken by the civil sector in 1990. By 2004
military turnover accounted for only 35.6% of the aerospace market, worth €27.4 billion.
During 2000 military levels reached an all time low of 29.1% and although there has been
some recovery as a result of recent global issues, the divergence is predicted to continue
(ASD, 2004). Even though this is the case, the military market is substantial in value and
will therefore remain a very significant world market.
EU Aerospace Industry Turnover Percentage - Civil/Military
100
90
80
70
Turnover (%)
60
50
40
30
20
10
0
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
Year
Civil Military
Figure 8: EU Aerospace Turnover Percentages - Civil/Military (ASD, 2004)
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58. With Europe being the second largest aerospace market, demand for the products and
services developed in the region not only comes from internal Government sources but
also from other nations across the world, classified as military exports. As a consequence,
the turnover trends that are presented provide a general global trend for military
expenditure.
Figure 9 shows the value of turnover from military sources from 1980 to 2004. Although
fluctuations are present, these are much less severe than those seen in civil aerospace.
There are no clear patterns or cycles as change is not determined by world-wide economic
performance, but is dependent upon defence budgets and the procurement policies of
Governments. These in turn are influenced by the geopolitical developments and the
changing perception of threats across the globe (Bechat et al., 2002).
From 1980 to the 1987 the military turnover saw a trend of general increase, with total
levels within Europe reaching highs of nearly €35 billion. This trend was seen due to the
issues over the cold war. Political tension between the Soviet Union and the United States
spread and the result was an increase in defence budgets as nations attempted to protect
themselves through military development. When this era finally came to an end in the late
1980’s defence budgets subsequently, and EU turnover dropped to €22 billion per annum.
From the mid-1990’s onwards, the military turnover within Europe has fluctuated
however, on average it has remained at around €24 billion. The variations that are
highlighted in figure 9 have been determined by political unrest and other international
issues. The recent rise has been attributed to terrorist activities and the rising demand for
homeland security.
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59. Military Aerospace Industry Turnover - European Union
40
35
30
Turnover (€bn)
25
20
15
10
5
0
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
Year
Figure 9: Military Aerospace Industry Turnover - European Union (ASD, 2004)
Over the forthcoming years the Department for Trade and Industry (DTI) for the United
Kingdom, stated that defence budgets in many European nations, including the United
Kingdom, were set to enter a phase of decline. However, between 2005 - 2009 the United
States defence budget is expected to increase by approximately 30% (DTI, 2006). The
consequence of such changes will have an impact on many of the organisations within this
business environment, so it is important for organisations to be prepared. There are many
commonalities between the civil and military segments of the market and it is essential for
the industry to have a degree of predictability and stability in both areas. Having such
information allows for firms to, “make best use of the knowledge bases, to optimise
technical, human and financial resources, and to iron out fluctuations in demand when
either segment encounters periodic difficulties” (Bechat et al., 2002).
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60. - Aero-Engine Industry
The aero-engine industry within Europe accounts for 9% of the total consolidated turnover
or, nearly €7 billion. This value is dependent upon both the trends seen within the civil and
military aerospace industry across the globe. The sales of engines are correlated to the sale
of aircraft, whether for commercial, personal or military use. However, with general trends
within the United States and the United Kingdom highlighting growth in all engine
sectors, the industry is currently in a strong economic position (House of Commons -
Trade and Industry Committee, 2005; AIA, 2005)
Across the globe there are three main aero-engine manufacturers that dominate the
business sector: General Electric (US), Rolls-Royce (UK), and Pratt and Whitney (US).
Although these firms develop the final product, there is a vast and complex network of
businesses which supply and support these international organisations. The relationships
that are developed and the subsequent high-technology products which are produced are
becoming an increasingly significant industry.
Within the United Kingdom the Aerospace Industry (UKAI) is realised as one of the most
important manufacturing industries. It provides £17 billion to the economy whilst also
providing the ‘spill-over’ effects to many other business sectors (House of Commons -
Trade and Industry Committee, 2005). At present, the Society for British Aerospace
Companies (SBAC, 2006) estimates that in the UK there are over 3,000 companies
integrated into the aerospace industry. Currently the most successful of these firms is
Rolls-Royce. In 2005 revenue that was attributable to the civil and defence sectors stood at
£4.9 billion. (Rolls-Royce, 2006a). In addition, the total book value for engines already
ordered for forthcoming years stood at £20.7 billion, driven by the increasing sales of
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61. aircraft. Such figures show that the business is currently in a period of success and this
trend is predicted to continue for the foreseeable future.
In conclusion, all of the sectors within the current aerospace industry have been through
their recent problems and difficulties but they have been able to overcome these and
develop into more successful business environments. The firms which operate within them
now have the potential to take advantage of this situation and become increasingly
successful.
More specifically however, the aero-engine sector plays a crucial role within the aerospace
industry across the globe. For this reason, it is important to understand the environment
within which they operate and also how the firms involved have continued to remain
competitive and successful in an ever-changing market. The following analysis will
attempt to further understand these issues and allow for the second and third hypotheses
presented for this study to be assessed.
Business Environment
- External Macro Environment
In order to provide a detailed analysis of the aero-engine market, the external macro
environment and external industry environment of the aerospace industry will be initially
investigated, followed by an analysis of the internal environment. This will provide a
detailed insight into the present situation within this vital market segment. In order to gain
this knowledge numerous models and techniques will now be applied which will allow for
a comprehensive insight and enable a thorough investigation to be completed.
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62. Specifically, the United Kingdom will be focused upon due to the importance of this
industry and its influence upon the economic and technological aspects within the nation.
As a case-study, the core organisation within the United Kingdom and the second largest
aero-engine manufacturer, Rolls-Royce, will be utilised. A case-study based analysis
enables a detailed approach to the investigation, upon which specific data can be gathered.
PEST Analysis
A PEST analysis can be used in order to analyse all areas of an industry and the
environment within which businesses operate. This type of analysis takes into
consideration the political, economic, social, and technological issues. It provides an
overview of the current situation within a particular market and can be extremely useful
for firms operating within the sector.
A PEST analysis will now be completed for the aero-engine industry in order to highlight
the present situation for this particular market. It will provide some background
knowledge whilst also showing the future trends that the firms may face. Utilising this
method in relation to the Rolls-Royce case-study, enables a core from which the integral
factors can be more clearly depicted.
Within the aero-engine industry there is a strong political influence upon the nature of the
business environment. Not only are Governments a source of demand for military
products and services, but they also have a strong influence upon critical market
characteristics.
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63. From a non-financial perspective, the development of the Society of British Aerospace
Companies (SBAC) within the United Kingdom has been critical. This is the main
governing body and representative organisation within United Kingdom and has strong
influence both within the industry and Government. Having this over-riding body
improves the functioning of the aerospace firms which is extremely beneficial.
In addition, two further politically based bodies which have been developed have become
central to the UK aerospace industry: Aerospace Innovation and Growth Team (AeIGT)
and the National Defence and Aerospace Systems Panel (NDASP). The AeIGT was
launched in 2002 and includes representatives from the Government, industry and other
stakeholders. Its main aim is to secure agreement between the Government and industry
on shared vision and strategy for the future (SBAC, 2006). The NDASP also formed in
2002 incorporates key personnel from the Government, academia, industry, and trade
associations, to ensure that the sector is prepared for future challenges. It drives to acquire
development and funding, and has set up National Advisory Committees that bring
together experts in advisory roles.
Support for the aerospace industry in the United Kingdom is taken further with high levels
of financial funding from numerous bodies. The Government is one of the core sources,
with Department for Trade and Industry (DTI) taking responsibility for these issues. The
Government has stated its intent and desire to continue the support which it offers the
aerospace industry companies. The procurement policies that are in place aim to support
the firms’ development, as this sector has been highlighted for its crucial role that it plays
within the United Kingdom’s economy.
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64. Since 1997, nearly €1.4 billion has been invested in Airbus and Rolls-Royce with the
indirect benefits subsequently filtering into other firms associated with these industries. In
2005-2006, the funding from the DTI stood at over €500 million (DTI, 2006) However, in
addition to this there were extra financial sources such as the science budget which stood
at €145 million last year (DTI, 2006). This funding has been put in place to stimulate
innovation and knowledge transfer, whilst also enhancing the nations overall
competitiveness on an international scale.
Due to the long-term vision of the UK Government and its desire to ensure the success of
this industry, there have been many other forms of support which have arisen. These all
aim to improve the business sector, from extra funding to the development of new
technologies:
• SBAC Competitiveness Challenge
• National Research Support (NRS)
• Aeronautics Research Programme (ARP)
• Defence Science and Technology Laboratory (DSTL)
• Engineering and Physical Sciences Research Council (EPSRC)
• Defence Aerospace and Research Partnerships (DARPS)
• QinetiQ
Not all of the funding in the United Kingdom is directly linked to Rolls-Royce however,
with the company being the largest firm in the aerospace sector, it does benefit from much
of the support. Rolls-Royce can take advantage of this and utilise it in order to remain a
focal organisation within the aerospace sector.
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