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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Early orders are already arriving for both the B7E7 and the A380 from "launch customers" for the aircraft. Singapore Airlines' choice of the Trent 900 engine for its big order of A380s has actually made the Rolls-Royce product the leading propulsion unit for the aircraft. And All Nippon Airways, the launch customer for Boeing's B7E7 (50 aircraft ordered for a total of a billion dollars) has chosen the Trent 1000 as its engine of choice.

Seeing the Trent series as high-quality and adaptable, Rose has focused on diversifying the use of those and other Rolls engines into, variously, defense aviation (26 percent of 2003 turnover), marine propulsion (17 percent) and energy (10 percent). But one way to rouse Rose's ire is to call Rolls a diversified business. "We are a unitary business selling in diversified markets," he says. "The overlap, the synergies, are tremendous. A Trent engine used for marine purposes has a 60 percent similarity to one used in an airplane."

Rolls's defense aeroengine initiative may well be its most impressive. Before becoming CEO, Rose, then head of the company's Aerospace Division, had spearheaded the 1995 $525 million purchase of America's Allison from private equity specialists Clayton, Dubilier & Rice, coming over to run Allison during the initial period of ownership. The acquisition provided an entree into the clubby world of U.S. aerospace procurement.

Rose's defense commitment has paid off handsomely. The U.S. Defense Department is Rolls-Royce's largest individual customer. According to Defense News, an industry magazine, Rolls stood 18th in its ranking of sector suppliers, with 1.45 billion pounds of defense sales. Rolls is the biggest engine supplier for the Joint Strike Fighter. And in direct contrast to the situation in civil engines, Rolls-Royce's post 9/11 defense industry engine deliveries bounced 32 percent, to 237 in 2002, up from 179 in 2001, and up 7 percent last year, to 253.

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Rolls-Royce's second largest business, marine propulsion, also has fared very well over the past decade under Rose's direction. It boasts a strong product range and claims "full systems integration capability," meaning the production and maintenance systems used with aerospace engines can be adapted to the maritime sector as well.

Ironically, Rose's major buy as CEO was not even in the aerospace field. In 1998, he bought Vickers for 576 million pounds, an acquisition that implanted Rolls firmly in the energy generation field. Although there were big technical problems in 1999-2001 with the company's key energy product, a generator based on the jet engine that powers Boeing's 777 wide-body airliners, they have been overcome. John Cheffins, Rose's COO, believes Rolls-Royce's energy generation market opportunity is somewhere between one-half and two-thirds of its civil aerospace market, or somewhere between 1.35 billion and 1.80 billion pounds using last year's civil aviation figures. "There's a huge future for us in energy," says Rose, "and the beauty is in the synergies. Our Trent technology has been very successfully adapted."

Perhaps the largest factor in Rolls's continuing success in the face of adversity is its after-sales business, a passion of Rose's. Engine service and sales of spare parts to replace worn components make up more than 50 percent of turnover. This is oil in the ground, and Rose's eyes gleam as he contemplates potential revenues from the company's 13,500 installed engines around the world. "It's long arc income," says Rose. For example, the engine on the 757 was invented in 1979, and the last such engine will probably be sold in 2030 or 50 years later. "We realized we had to take back control of after-sales," he says. "Much of it had been given over to third parties. But we knew if we were to build a global organization we had to represent ourselves in that area. And, of course, the synergies help with profitability.

A last piece of Rose's puzzle was internal. Faced with a 1.2 billion pound shortfall in the Rolls-Royce pension plan, Rose and his team last year managed an enviable settlement. "We'd been talking to the unions for over a year," he recounts. "We'd sat down with them, given them all the figures and our thinking and invited their suggestions. In the end, an accommodation was reached, a happier one than some of the solutions developed in other places."

Proving Critics Wrong

Rose says the pension settlement was not so much a financial but a people issue, and it reflected an ongoing consensual trend. "In dealing with post-9/11, we were very open with the work force and the union leadership," says Rose. "After six weeks of appraising the 9/11 impact, we sat down with our people, showed them our data, and engaged them in a discussion. And we said, 'Look, this is what we have to do, but if you can think of other solutions, we're ready to listen.'" The result was an 18 percent work-force reduction--from 42,500 to 35,000--over a two-year period.

Despite his successes, Rose, a former banker himself, has not been a favorite in London financial circles. "John Rose may not be an arrogant so and so, but that is frequently the impression he gives," says one analyst, who insists on anonymity. "He's impatient with people who are slow studies, and he has a tendency to denigrate questioners who are operating from premises other than his own. I know that shouldn't influence analysts, but of course it does."

The antipathy of the markets may have had something to do with the dramatic slide of the Rolls-Royce share price after 9/11. Today, the price is around 250 pence. "The truth is that he was right and we were wrong," the analyst adds. "A lot of people are saying he wasn't telling us what we needed to know. My view is that most of us just weren't listening."

In some respects, Rose doesn't seem to fit the profile for leading Britain's second biggest defense contractor. For one thing, he's not a local boy. Rose was born in 1952 at Blantyre, in what was the British protectorate of Nyasaland, now Malawi, returning to England to attend Charterhouse, one of the great British public schools. After that, he earned a master's degree in psychology at St. Andrews University.

Rose is basically a generalist with a financial background who now finds himself amid a crowd of engineers. His pre-Rolls background in London was with First National Bank of Chicago, though his specialization was in aircraft finance. After joining Rolls in 1984, one of his early positions was as treasurer.

He is, in fact, the first Rolls CEO to lack an engineering background--ironic given how many CEOs across the industry have training in engineering (see "Route to the Top," page 20). When Rose tries to explain a point about Rolls-Royce's vaunted Trent engine series in an interview, his COO, John Cheffins, who is an engineer, looks on with affectionate amusement, now and then quietly correcting the boss.

Rose is a very private and very big man, perhaps 6-foot-4 and 225 pounds. He has the look of a former rugby player. His corporate bio lists two current sports hobbies, scuba diving and skiing, neither of which is really group-oriented, despite his insistence that Rolls management is essentially a team sport.

But his adventurous lifestyle keeps him in shape for an intensely challenging job running Rolls-Royce, a company that until very recently was considered by many a takeover target, with GE and UTC being the potentially interested parties. Rolls is one of the few bright spots in Britain's declining heavy-industry sector. And Rose, at 52, appears solidly entrenched in his job. He is quoted as once having said, in a reference to analysts' opinion of him, "I'm entirely happy with being boring."

Complicated he may be. But boring, he is not.

RELATED ARTICLE: A Balanced Business

Total revenues for 2003 were spread across four distinct segments ...

Defense               [pounds sterling]1,398 million
Marine                  [pounds sterling]927 million
Energy                  [pounds sterling]584 million
Civil                 [pounds sterling]2,694 million

Note: Table made from pie chart.

... of which aftermarket services has become a huge slice.

Defense                 [pounds sterling]609 million
Marine                  [pounds sterling]598 million
Energy                  [pounds sterling]340 million
Aftermarket Services      [pounds sterling]2.8 billion
Civil                 [pounds sterling]1,255 million

2003 sales--[pounds sterling] 5.6 billion

Note: Table made from pie chart.