ALEXANDER CAMPBELL / LONDON
Next week's Farnborough 2002 is the UK's chance to shine on the world aerospace stage. But how are the UK's aerospace heavyweights performing in an industry where international joint ventures are increasingly important? Flight International profiles some of the biggest players
David Marshall, director general of the Society of British Aerospace Companies (SBAC), tells of being asked by a taxi driver what business he was in. "I run the trade organisation for the British aerospace industry," he replied proudly. "Is there any industry left to run?" was the driver's deflating response. His view reflects a common perception that the UK aerospace sector is a shadow of its post-war glory when it set the pace with aircraft such as the Comet, Harrier and Concorde (with a little help from the French). The axeing last year of the UK's last remaining indigenous aircraft programme, BAE Systems' Avro RJX regional jet, was portrayed by many in the media as being the final nail in a once-great industry's coffin.
Yet, while next week's Farnborough 2002 will not play host to a single wholly UK-built aircraft, the UK's aerospace industry is the second largest in the world in terms of numbers employed and has ridden out the worst effects of the post-11 September downturn. According to Gordon Page, SBAC president and chairman of Cobham, "continued capital investment" and a willingness to reduce workforces to realistic levels after the terror attacks has left the UK fitter than many of its continental European rivals, which have chosen to resist making redundancies. "It's why British companies won so much of the [Lockheed Martin] F-35 [Joint Strike Fighter]," he says.
There are only 10 UK companies in the latest Flight International Aerospace Top 100 ranking of companies by sales (Flight International, 21-27 August, 2001) and just two - BAE Systems and Rolls-Royce - in the top 20. But the UK - thanks to a pool of educated workers and flexible labour laws - is a major recipient of inward investment. The industry employed 147,090 people in 2001, according to the latest SBAC figures, more than any country outside the USA. Employment fell by just 2.5% last year. And that was the result, says the SBAC, of improved productivity rather than the impact of 11 September. Total sales were £18.4 billion ($27.4 billion), down just 1.5% on 2000, but operating margins were up 1% to 7%.
While these figures represent the value of aerospace goods manufactured in the UK by foreign as well as UK-owned companies, UK businesses are also increasing their investment overseas, led largely by an acquisitive BAE Systems determined to boost its US portfolio to benefit from research and development funds and compete for Department of Defense procurement awards as a prime contractor (see below). Turnover of UK-owned assets overseas increased in 2001 to £7.21 billion - equivalent to the world's sixth largest aerospace industry - with numbers of employees growing by one-third to almost 61,000.
UK aerospace companies have, like everywhere else, been hit by the post 11-September downturn, with those more reliant on the civil market worst affected. At the end of last year, the SBAC reckoned 20,000 jobs would go directly as a result of the crisis in air transport, plus a further 20,000 indirect jobs. The organisation has not altered that forecast despite the gradual recovery in airline traffic now apparent. Rolls-Royce, for instance, which saw orders for its RB211 and Trent engines plunge on the back of delivery cancellations, has announced 5,000 job losses - more than one-tenth of its workforce.
The outlook for UK companies in the defence sector is brighter, although there has not yet been any groundswell in orders. BAE still complains it is denied prime contractor status in the USA while having to compete in its home market for government business. BAE is a shareholder in two major current European fighter programmes - with 35% of the Saab Gripen and 33% of the Eurofighter Typhoon - and is among several UK companies, including Martin Baker, Rolls-Royce and Smiths Aerospace - that are team members in the Lockheed Martin's F-35 JSF.
In an industry where international partnerships are playing an increasing role, the SBAC sees the future of the UK aerospace industry as being in leveraging its intellectual capital to wring value from large-scale aircraft programmes, from JSF to the Airbus A380, building components and supplying know-how rather than fighting over the right to have completed aircraft emerge from their factories.
BAE Systems
BAE has its chequebook open and is hunting for acquisitions that would take it closer to its ambition of being a US prime contractor. The world's fourth biggest aerospace company - with sales in 2001 of £13.1 billion, up 7.8%, and pre-tax profits up 26% to £1.08 billion - BAE sees US defence as its biggest potential market and wants to be leading teams competing for major US contracts alongside Boeing, Lockheed Martin and Northrop Grumman. "How much bigger could we get in Europe?" asks new chief executive Mike Turner. "The USA is the number one market for defence. European defence spending is fairly limited. We need a bigger presence in the USA."
BAE increased its North American sales by 54% to £2.6 billion last year. This represented 18% of group sales and a quarter of the company's total non-commercial aerospace sales, but Turner wants the majority of turnover to come from the USA. This can only be achieved by making acquisitions. Although it has bought four US companies since January 2000, including Lockheed Martin Control Systems and Electronic Systems for a combined $2.18 billion, it was outbid by Northrop Grumman for TRW last month. Turner acknowledges the US company would have been an ideal fit.
"TRW was exactly in line with our strategy - a US company, a prime contractor for the Department of Defense, with a lot of leading-edge technology." But BAE was warned off by the price - Northrop Grumman has agreed to pay $7.8 billion - and the associated debt. "There are a lot more companies on our list," promises Turner, although he concedes none would offer the instant scale of TRW.
One of the advantages of being regarded as a US prime is that it unlocks research dollars and delivers better returns on investment. "The US government believes that companies should make a healthy profit from defence," Turner says. One of his biggest gripes is that BAE is forced to compete for defence business in the UK. By awarding major contracts to foreign contractors, he argues, the government risks losing the industry's technical expertise and turning its defence companies into suppliers to the big US primes. Turner says the UK Ministry of Defence's approach to procurement creates "an adversarial relationship from day one".
Another plus in dealing with the US DoD is that it is a single customer. With the increasing number of European joint efforts, such as the Airbus Military A400M tactical transport, come the problems and political wrangling of dealing with different governments. "A400M is a real opportunity for Europe," Turner says. "The opposition from the USA shows it's a good project. It fills a gap and is real value for money...if only the Germans would decide to buy it."
While metal-bashing may have gone out of fashion for BAE, Turner insists the company has to remain a versatile manufacturer rather than simply a systems integrator, handling as much as possible in house rather than putting together teams of system suppliers. "With the Marconi take-over [in 1999] and the Lockheed Martin acquisitions, we became more vertically integrated. We see it as a strength to have some core subsystems capabilities, but we have sold some not seen as core. The core is a prime systems company [focused on] C4ISR [command, control, communications, computers, intelligence, surveillance and reconnaissance] and precision weapons," he says.
Turner disagrees with those who say that delegating systems assembly work to subcontractors makes sense as it spreads the risk along the supply chain. "The risk of taking a prime contract and purchasing key subsystems is greater than the risk associated with being vertically integrated," he says.
The importance of the US market to BAE is illustrated by the fact that the company's systems and equipment content on the F-35 is forecast to be worth $8.5 billion, compared to $5.5 billion on the Eurofighter, while its content on other US fighter programmes is expected to be worth around $6 billion. While the start of Eurofighter production will help boost sales in BAE's Programmes sector to almost £3.5 billion by 2004, the company's share of the F-35 system development and demonstration phase is alone worth around £1.9 billion.
On the civil side, through its 20% stake in Airbus, BAE has been hit by the collapse in airliner orders. "We were on the verge of significant profitability for the company. We have had to defer our ambitions for a year or two," Turner says. But the A380's launch means he is optimistic about prospects and firmly rules out any suggestion that BAE will get rid of its Airbus shareholding.
"There's a huge amount of value to be released from Airbus to our shareholders," he says. The company has been hit in other areas by the airline crisis. BAE's avionics and aerostructures businesses have dropped and, in December, it abandoned the RJX programme, ending more than half a century of civil jet production in the UK. "September 11 finished off our regional-jet manufacturing business," says Turner.
Rolls-Royce
Engine manufacturer Rolls-Royce is the UK's second largest aerospace company, and ranked 11th in last year's Top 100. The company saw sales increase 8% last year, to £6.3 billion, while its pre-tax profit was up 9% to £475 million. With over 50% of its business in civil aero-engines, Rolls-Royce was quick to react to the impact of the events of 11 September on the air transport market, downsizing rapidly to reduce costs by £250 million a year.
So far, business is tracking the guidance Rolls-Royce issued last October: that engine deliveries would be down 30% this year and remain depressed in 2003; while aftermarket sales would be flat, with growth to return next year. The impact of the airline crisis will be substantial: operating profit at the company's civil aerospace business is expected to be down by about half this year. Rolls-Royce is forecasting a recovering beginning in 2003, with the aftermarket picking up first.
"A lot of the orders have gone backward rather than being cancelled. We have had relatively few cancelled contracts," says executive vice-president airlines Charles Cuddington. But the recovery is expected to be slow. "The recovery will be driven by traffic. We're not back yet to pre-September 11 levels, but we are on course to meet our predictions, based on the after-effects of the Gulf War as the basic model," he says. "Airlines won't be back into profit for probably two years, and a few years after that they will start to order in volume - probably at least in 2006."
Until then, Rolls-Royce will have to rely on its diversification to weather the downturn. In addition to civil turbofans, the company produces military and marine engines as well as gas turbines for power generation. With the defence and marine markets remaining stable, and civil "developing as expected", Rolls-Royce believes it is positioned for profit growth in 2003. Most of the growth in defence and aftermarket business will be from the international partnerships and joint ventures in which Rolls-Royce, in common with the rest of the UK industry, finds itself increasingly involved.
The defence business will be boosted by the ramping up of production of the Eurofighter and its EurojetEJ200 engine, in which Rolls-Royce has a 33% stake. The UK company also has a substantial stake in the JSF programme, working with General Electric on development of the F136 engine as well as providing the lift system for the F-35, whether powered by the baseline Pratt & Whitney F135 or GE's alternate powerplant. The JSF programme also involves the UK and US arms of the company.
While Rolls-Royce has invested heavily to grow aggressively on the civil side of its business, mainly by winning new applications and customers for its Trent series of engines, the company is increasingly spreading the risk among its suppliers. About 30-40% of the cost of its latest civil engine programmes have been given to revenue-sharing partners, many of them "long-term strategic partners which we try to work with on most large projects", Cuddington says. "We do it because we need a way to share the risk and the development investment."
Like other aerospace companies, Rolls-Royce has noted the tendency of suppliers to move up the supply chain and supports it - up to a point. "We would encourage it in terms of engine subsystems," says Cuddington. "We would prefer to give a subsystem to someone who can take on more responsibility for production, but there are certain core areas where we intend to maintain core skills. Someone already supplies the complete gearbox... but we would have to think carefully about the high-pressure turbine [and] there are no plans to do that at the moment."
Smiths Aerospace
Like many manufacturers, Smiths Aerospace has seen its revenues see-saw in the wake of 11 September, with defence business up but civil trade down. While managing director John Ferrie expects the overall aerospace market to increase 4-5% annually over the next decade, the defence "markets we address will grow 5% and some segments 9-10% a year". But Ferrie is not quite celebrating a victory; rather a lucky escape. Military spending, he says, is "helping to largely, but not completely, offset the civil market downturn".
Smiths Aerospace - the largest business within the London-based healthcare-to-ventilation conglomerate Smiths - produces hydraulic actuators, health and usage monitoring systems and engine and airframe components. Last year, the division's sales of £1.33 billion and profits of £210 million were up, although part of the increase was due to the acquisitions of Fairchild Defense for £75 million and of Barringer Technologies, which makes machines for detecting explosives and drugs, for £39 million. The fourth largest UK aerospace company after GKN, Smiths ranked 33rd in last year's Top 100.
The company is benefiting from its contracts to supply equipment for the Eurofighter and Boeing F/A-18E/F Super Hornet. But the growth of spending on Homeland Defence in the USA has also been important. The addition of Barringer has helped push Smiths Aerospace's detection business - which also includes military chemical and biological weapon detectors - to 15% of its overall sales. The rest is 50% defence and 35% civil.
While the Barringer and Fairchild Defense acquisitions have broadened Smiths' product range, strategy director William Mawer believes there is room to expand the company's capabilities further up and down the supply chain by exploiting the fall in stock prices and taking over component companies. The component sector is "somewhat less consolidated" than systems manufacturers further up the supply chain, he says. This would enhance Smiths' chances of assembling entire systems for primes rather than simply supplying components. "Systems companies are outsourcing a lot of production. We've grown our engine component business from primes outsourcing their subsystem integration work to their suppliers," he says.
This marks an important and permanent change in the aerospace industry, Ferrie believes. "Primes do a lot of second and third tier work - they are traditionally very vertically integrated," he says. "But they are now starting to concentrate on a few core skills and move out of other areas." This will allow Smiths and its peers to move up the supply chain, starting to supply full systems to the prime contractors rather than components. This means sharing more risk with primes, but the upside, says Ferrie, is closer links with prime contractors, a more efficient supply chain and higher added-value work on future contracts.
The USA will remain Smiths' largest single market - last year it represented 46% of the group's total turnover. "We have no problems forming supply relationships," in the USA, says Ferrie: "We can be what the market wants us to be." Europe also has the potential to be a valuable market, especially in defence, but "it must address its budget issue and must rationalise its military market", says Ferrie. "European military [spending] is underperforming relative to the USA." But this is a long-term issue: in the short term, US and European spending on tankers and transports to support expeditionary warfare will be more important for Smiths, which manufactures the air-to-air refuelling system for the Boeing 767 tanker that will soon begin to replace the US Air Force's ageing Boeing KC-135 fleet.
Cobham
Despite a heritage which included a key role in the 1948 Berlin airlift, Cobham is one of the companies David Marshall's London taxi driver would probably not have heard about. Based in Wimborne, Dorset, the company largely makes equipment for prime contractors. Its line-up includes flight-refuelling equipment, communications antennas and microwave systems.
Ranked 43 in the Top 100 with a turnover in 2001 of £722 million, up 27%, and pre-tax profit of £103 million, up 14.7%, the company has been in acquisitive mood, completing eight take-overs at a total cost of more than £60 million in 2001 and taking its debt up to £200 million. Most of the purchases were aimed at increasing its product range in the defence sector where, after years of stagnation, the outlook is now "the best for a decade", says chief executive Allan Cook. "Increased defence spending [in the USA] is certainly an opportunity for us."
The company is looking strongly at the "transformation" air forces will begin to make to unmanned air vehicles (UAV), stand-off weapons, advanced communications and sensors, and long-range strike tactics. "Microwave communications are essential for transformation, to allow mobile secure communications as well as UAV handover," says Cook.
Executive chairman Gordon Page believes the willingness of prime contractors to take on large parts of production themselves is waning. As a result, manufacturers such as Cobham will increasingly move from supplying components to providing entire systems. "Wherever we can, we're looking to move up the supply levels," he says. The strategy brings its challenges. "Full system development means learning to interface with other systems," says financial director Giles Irwin. "We may also move into our existing customers' market."
Despite Cobham's acquisition spree, they agree that growth opportunities are limited. "We are framed by what is possible. Nothing will convince us to bulk up," says Irwin. Cook agrees: "There is no prospect of us becoming a £5-6 billion company in the next two to three years."
The future
Cancelling the RJX cost over 1,000 jobs at BAE Systems and a £370 million charge in its 2001 accounts. Otherwise, the end of commercial aircraft final assembly in the UK is not viewed as a tremendous blow to the UK industry. "It's not about what we build. It's about the intellectual property held by UK companies. We retain world-class capabilities in a small number of areas," says SBAC marketing director David Norriss.
Paul Edwards of aerospace investment bank Quarterdeck agrees: "The UK industry is composed of globally successful primes such as BAE and Rolls-Royce, very successful Tier 1 suppliers like Smiths and Cobham, and some globally successful privately owned niche companies like Martin-Baker. None of these have owed their success to the RJX or any other indigenous commercial aircraft programme."
Aerospace analyst Graziano Freschi of PriceWaterhouseCoopers disagrees: "Having the final assembly, flight testing and delivery centre for an airliner is a value-adding factor for the country concerned...You only need to see what Airbus has done to Toulouse and the French aerospace industry in general to prove the point." Freschi says UK suppliers have difficulty in penetrating Airbus's operations outside the UK, with French or German suppliers selected even when they are not the most efficient. "I do not agree with the SBAC's view - on the contrary, it will contribute to an eventual erosion of the supply base," he says.
Whether the UK holds on to its second place in the aerospace industry league table will depend on the extent to which companies take up the challenges presented by the primes' increasing willingness to subcontract larger pieces of their programmes. If the smaller companies making up the rest of the UK industry do not take on the added risk and responsibility, an erosion of the supplier base and decline in the workforce could be a reality.
Source: Flight International
