James gale internationalbusinessdissertation

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James gale internationalbusinessdissertation

  1. 1. AN INVESTIGATION INTO THEAEROSPACE INDUSTRY WITH SPECIFIC REFERENCE TO THE AERO-ENGINE SECTOR AND ITS ELECTRONIC ADVANCEMENTS BY JAMES GALE 2006A dissertation presented in part consideration for the degree of MSc International Business
  2. 2. AbstractThis investigation initially analyses the general trends seen within the core sectors of theaerospace industry. The external macro environment and the external industryenvironment are then assessed using the relevant models and processes that have beenpresented within the literature, with specific reference to the United Kingdom. In order todevelop a focused and detailed understanding of an aero-engine manufacturer’s internalenvironment, a case-study Rolls-Royce is incorporated. Recent technologicaldevelopments seen within the complex aero-engine are examined, with specific referenceto electronics and the integration of the processes provided by Data Systems andSolutions. The overall benefit derived from investment in these core areas is assessed andexamined in detail.
  3. 3. AcknowledgementsMany thanks to all of the people who have supported and encouraged me throughout this dissertation. James Gale
  4. 4. Table of ContentsCHAPTER 1............................................................................................................................................. 1INTRODUCTION.................................................................................................................................... 2 AEROSPACE INDUSTRY ........................................................................................................................... 2CHAPTER 2............................................................................................................................................. 8LITERATURE 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 ................................................................................................. 30CHAPTER 3........................................................................................................................................... 34HYPOTHESES....................................................................................................................................... 35 JUSTIFICATION ..................................................................................................................................... 37CHAPTER 4........................................................................................................................................... 38METHODOLOGY................................................................................................................................. 39CHAPTER 5........................................................................................................................................... 45ANALYSIS ............................................................................................................................................. 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............................................................................................................................................. 79CHAPTER 6........................................................................................................................................... 91DISCUSSION ......................................................................................................................................... 92CHAPTER 7........................................................................................................................................... 96CONCLUSION....................................................................................................................................... 97FURTHER RESEARCH........................................................................................................................ 98CHAPTER 8........................................................................................................................................... 99REFERENCES..................................................................................................................................... 100CHAPTER 9......................................................................................................................................... 109APPENDIX........................................................................................................................................... 110
  5. 5. List of FiguresFIGURE 1: MAJOR E UROPEAN AEROSPACE CROSS-HOLDINGS IN 2004 (ASD, 2003)....................................... 4FIGURE 2: CONSOLIDATION PROCESS IN THE E UROPEAN AEROSPACE INDUSTRY: 1990-2003 (ASD, 2003) .... 5FIGURE 3: PORTER’S DIAMOND MODEL (PORTER, 1990)............................................................................ 14FIGURE 4: PORTER’S FIVE FORCES MODEL (PORTER, 1980)....................................................................... 18FIGURE 5: FLAGSHIP MODEL FRAMEWORK (D’CRUZ AND RUGMAN, 1997) ................................................ 20FIGURE 6: ALLIANCES WITHIN THE AERO-ENGINE INDUSTRY (DUSSAUGE AND GARRETTE, 1995) ................ 32FIGURE 7: CIVIL AEROSPACE INDUSTRY TURNOVER - EUROPEAN UNION (ASD, 2004)............................... 48FIGURE 8: EU AEROSPACE T URNOVER PERCENTAGES - CIVIL/MILITARY (ASD, 2004)............................... 52FIGURE 9: MILITARY AEROSPACE INDUSTRY TURNOVER - EUROPEAN UNION (ASD, 2004)........................ 54FIGURE 11: DS&S DATA ANALYSIS FOR BROADBAND VIBRATION ON TWO TRENT 700 ENGINES .................. 77FIGURE 12: ENGINE SHOP VISIT - REWORK LEVEL FOR CORE ENGINE MODULES ........................................ 81FIGURE 13: EXAMPLE OF YEARLY ESCALATION VALUES FOR TOTALCARE® CONTRACTS .............................. 83
  6. 6. Chapter 1Introduction 1
  7. 7. IntroductionAerospace IndustryThe aerospace industry is a vast, complex and dynamic market which is categorised intothree core industrial sectors: systems and frames, engines, and equipment. In addition,there are also three product segments which are characterised as: aircraft, missiles andspace (European Aerospace Industry (EAI) - 2002). The main customer divisions whichare the source of demand for the products and services provided by this businessenvironment are categorised into civil aerospace and military aerospace.The foundations to the aerospace industry were originally set out around the SecondWorld War, after which it has continued to rapidly expand and develop into a successfulbusiness environment (Alfredsson and Hildingson, 2003). Throughout this time, the everincreasing demand for public air travel has driven the civil sector whilst demand forhomeland security has been the source for growth within the military sector. The tworegions that have been at the centre of this development have been the United States andthe European Union. Over time, they have come to dominate the marketplace and in 2004accounted for 84.6% of the total consolidated turnover within the industry (AeroSpace andDefence Industries Association of Europe (ASD), 2004).Due to the nature of the environment, the industry has gradually become internationalisedand increasingly competitive for the firms that operate within it. In each of the regions, aunique structure has developed whereby there are several core organisations that focus onthe manufacturing process and in turn, these are supported by an extensive supply chain ofother businesses (Alfredsson and Hildingson, 2003). For example, within the civil aircraft 2
  8. 8. business there are two core manufacturers, Airbus and Boeing, however in turn these areboth supported in all relevant areas by a wide range of other organisations. A similarsituation is also present in the aero-engine sector, with it being dominated by three corefirms: General Electric, Rolls-Royce, and Pratt and Whitney all of whom are supported byan extensive network.The market structure is also dominated by unique relationships which are formed due tothe 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 samebusiness 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 muchlarger project (de Jong, 1998).The relationships that develop over time have become an integral part of the aerospaceindustry. From these interactions, a network of strategic relationships, joint ventures,international consortia and partnership agreements have been created (ASD, 2003). Thesenot only incorporate organisations from Europe and the United States but also Asia, SouthAfrica, Australasia and the Far East (ASD, 2003). Figure 1 highlights the main cross-holdings present within the European aerospace industry in 2003. 3
  9. 9. Figure 1: Major European aerospace cross-holdings in 2004 (ASD, 2003)In order for firms to remain economically successful and competitive against national andinternational organisations, there have been numerous mergers and acquisitions. Theseprocesses enable firms to consolidate their position on the international stage which isbecoming more important in achieving the level of success required by shareholders.Figure 2 highlights the recent consolidation processes which have been undertaken withinthe European Union. 4
  10. 10. Figure 2: Consolidation process in the European Aerospace Industry: 1990-2003 (ASD, 2003) 5
  11. 11. The nature of the aerospace market and the levels of investment within research anddevelopment have placed the industry on the technology frontier (Alfredsson andHildingson, 2003). The structure of the industry and important inter-relationships whichare present are able to aid in the distribution of new innovation and technology. This inturn, gradually diffuses throughout supporting companies and industries, furtherimproving technical abilities along with capabilities and opportunities. These so called‘spill-over’ effects are valuable to any economy as it increases efficiency and the abilityfor organisations to compete on an international scale.The aerospace industry has come to play an increasingly crucial role within nationaleconomies. The growth within both civil and military sectors of the aerospace industry notonly provides potential for further national economic development, but also many otherattributable benefits. One of the most important is that of technological innovation whichprovides a base from which to develop. Companies often invest heavily within researchand development in order to remain competitive over their rivals. It has been wellresearched that there are ‘first-mover’ advantages and this has become vital within civiland military aerospace (Mueller, 1997).Due to the overall importance of aerospace organisations, a growing trend has been seenin the supporting policies which have been introduced. These are often introduced on anational level but regional policies do exist, such as those developed within the EuropeanUnion. Policies relate to issues such as research and development, funding, taxationbenefits and levels of local protectionism. The aim of such policies is to ensure thecontinued success of aerospace firms whilst ensuring their competitiveness and continuedgrowth within the sector. However, Bechat et al. (2002) emphasises that it is essential to 6
  12. 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 asuccessful business environment.In order to assess the complex aerospace market in more detail, it is important to examinethe current literature which will provide insight and understanding into the industry. Onlyafter this process has been undertaken can the analysis for this investigation commence. 7
  13. 13. Chapter 2Literature Review 8
  14. 14. Literature ReviewThe aero-engine industry consists of several organisations who dominate the market:General Electric, Rolls-Royce and Pratt and Whitney. Between them they have control ofa large proportion of the market share, with other smaller companies accounting for only asmall 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 canexist due to both strategic and also natural reasons. The natural barriers to entry aredetermined from exogenous costs, which to a great extent are outside an organisationscontrol. Costs of labour, technology, land, premises, and materials are determined by thelocal market conditions and therefore firms can have little influence upon their levels. Fora specific industry these costs, if large enough, can develop a barrier to entry. Theminimum efficient scale (MES) determines the level at which a firm looking to competewithin a specific market would have operate above. In oligopolies, the MES is high inrelation to the overall market and thus prevents an inflow of new investment (Begg andWard, 2004).The second barrier to entry, or strategic barriers, can be developed by firms within themarket. Firms are able to manipulate the overall cost nature in strategies such asadvertising and branding through which the MES is driven higher and subsequentlyprevents the development of further competition. 9
  15. 15. As a result of the barriers which develop, oligopolies often maintain the characteristic ofbeing dominated by several core organisations. Within the aero-engine market both of thepreventative characteristics are present. Firstly there are high costs associated within entryinto this high-technology market but in addition, this is developed further through thebranding and reputations of the current operators. The overall business environmentdemands extremely high levels for quality and safety of products and this has beenachieved through long-term investment and development. It is as a result of this that thefirms involved have been able to maintain and protect their hold upon large proportions ofthe market.Due to the nature of oligopolies, there is increased importance on each firm taking intoaccount the others which are present. The firms are mutually dependent upon one anotherbecause they are all affected and influenced by their rivals. Therefore, no firm can ignorethe actions and reactions of others within the industry (Sloman, 1998).Business EnvironmentThe overall competitive success of organisations is determined by the businessenvironment and the complex interactions within the external macro environment, theexternal industry environment, and the internal firm environment (Mellahi, Frynas andFinlay, 2005). Analysing and understanding these related areas enables organisations tounderstand the context within which a specific strategy needs to be developed andimplemented. 10
  16. 16. - External Macro EnvironmentPEST AnalysisThe external macro environment consists of four criteria: political, social, economic andtechnological (PEST). These provide a company with both threats and opportunitieshowever, due to the nature of the external environment these are outside the control of anybusiness. It is important therefore, that the external environment is matched to theresources and activities that a firm undertakes otherwise failure is a strong possibility.The political category is mainly dependent upon the Government policy within a particularnation. Governments have strong influences on any business trading within its borders andunderstanding their policies and objectives is crucial. Issues such as, “tax, employmentlaws, regulations, trade restrictions, tariffs, and political stability in addition tounderstanding 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 allfirms to acquire knowledge in all of these important areas as it can be extremely beneficialin the long-term performance of a business.The economic category is quantitative based, which allows for a more precise analysis. Atthe core are economic growth, exchange rates, interest rates, and inflation. Understandingthe impact of these issues and keeping track of any changes, allows a firm to be preparedand make timely decisions when they are required.The social assessment is a more subjective method which looks into the populationgrowth, demographics, and social cultures. Which areas are investigated and how thisprocess is completed is dependent on the organisation. It is based largely around the 11
  17. 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 oftechnological change which is occurring in a particular country or region. At its core theanalysis becomes infrastructure-based, as this is the platform from which furtheradvancements can arise (Schildhouse, 2006). In addition, indicators include present levelsof investment by both the Government and other organisations, along with the extent ofresearch and development activity.A firm completing a PEST analysis is able to gain a more detailed view of the businessenvironment within which it operates. However, a firm can take this further throughevaluating four criteria: Strengths, Weakness, Opportunities and Threats (SWOT).Undertaking this process allows firms to recognise the risks associated within anenvironment and is therefore a significant tool for decision making (Schildhouse, 2006).Weihrich (1982) highlights that this method can aid an organisation in changing itsposition from a reactive stance to a proactive strategy, a process which can be significantlybeneficial.The ideology behind the PEST analysis is that through the correct process, an organisationwithin a specific industry can formulate and implement suitable strategies. This will aid intaking advantage of the opportunities whilst remaining aware of the possible difficultiesthat could be faced in the future. However, it is important that the process is continuallyupdated and improved so that managers are able to utilise the framework effectively(Mellahi et al., 2005). 12
  18. 18. The understanding of the external macro environment which is developed throughutilising PEST analysis can also explain why some firms and industries within specificcountries are more successful than others. Porter (1990) takes this reasoning further andhas developed the Diamond Model which analyses the ‘national base’ as a source ofcompetitive advantage in global markets.Porter’s Diamond ModelIn order to understand how, why and where successful industries are established, one mustlook at the issues associated with national advantages. At present one of the mostrecognised and widely accepted models analysing this particular area is that presented byPorter (1990) in, ‘The Competitive Advantage of Nations’. Within this Porter developedfour core national determinants which specify why some industries succeed in a nationwhilst they fail in another. The analysis takes into account the characteristics of ‘FactorConditions’, ‘Demand Conditions’, ‘Firm Strategy, Structure and Rivalry’ and ‘Relatedand Supporting Industries’. In relation to these, the issues of ‘Government’ and ‘Hazard’are also incorporated. When encompassed together they form the Porter Diamond whichcan be seen below in figure 3. 13
  19. 19. Figure 3: Porter’s Diamond Model (Porter, 1990)Factor conditions are the first main aspect that Porter (1990) developed. This categorytakes into account the national resource base that is available to a country in the form ofhuman, material, knowledge, capital and infrastructure. These are effectively the nucleusto all markets and are required to some extent for a firm to become established andeventually succeed. In adverse instances where one or more of these are not present, a firmbecomes dependent upon innovation through which a comparative national advantage maydevelop.Demand conditions are the second category within Porter’s diamond model. This analysesthe level of home demand for the products and services of a particular industry with themain determining factors being composition, size and growth. In addition theinternationalisation process is important especially when domestic demand is limited. Thiscan reverse any negative issues into positive influences for organisations. 14
  20. 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 becomeinternationally competitive, it only aids in the overall strengthening of the system. Benefitssuch 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 industryand the firms within it are able to develop a strong national base from which they canadvance and achieve on a global scale.In addition to the four categories, it is important to recognise the importance theGovernment plays within the Diamond Model. The Government can have both a positiveand negative influence upon all four of the factors. Issues such as investment ininfrastructure, laws and regulations, taxes, education, and financial support are just someof the areas in which Governments can have an affect. Although overall competitivenessof an industry is not completely determined by the Government, its role is significant andmust therefore be taken into consideration.Hazard is the final issue associated with Porter’s diamond model and takes into accountfinancial fluctuations, political unrest and technological breakthroughs. Again these arerecognised as potentially having either a positive or negative influence upon an industryand are often dependent upon how a nation or industry deals with each issue. Porterhighlights that when a more favourable diamond is present, there is increased potential fordeveloping a competitive advantage from any hazard that may arise. 15
  21. 21. It is important to understand that all of the categories influence on another and are to somedegree 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 basewhich develops provides the relevant businesses with a base for innovation, which in turncan lead to global success (Mellahi et al., 2005).Porter (1990) recognises that there are other criteria that determine the success of firms ona national and international level, such as management styles and organisationalstructures. However, within industries these are known to converge over time and thusdifferentiation becomes increasingly difficult. Globalisation has spread resources andknowledge across the world and therefore, the four non-controllable factors of thediamond model become the determinants for the development of a competitive advantage(Mellahi et al., 2005)Overall therefore, understanding the conditions highlighted by Porter (1990) enablesnations and also the organisations within them to develop and become successful. Theycan focus on areas and industries that are sufficiently supported whilst also working toachieve improvement in those areas that do not reach the desired standards.These processes and models of analysing the external macro environment will enable adetailed analysis of the aero-industry, with more specific examination of Rolls-Royce asthe core case-study for the aero-engine organisations. 16
  22. 22. - External Industry EnvironmentThe external industry environment is another important area associated with the success oforganisations. It consists of all the factors stemming from actions undertaken by suppliers,buyers, competitors and others which directly influence the level of competitive successwithin a specific industry (Mellahi et al., 2005). It is important that a firm understandsthese issues and is able to relate them back to their own business. In doing so they canensure that resources and the subsequent activities are matched. In addition, Porter (1980;1985) suggests that a firm must also understand the underlying economic and technicalcharacteristics of an industry in which they operate.Porter’s Five Forces ModelPorter’s Five Forces model (1980; 1985), as seen in figure 4, takes into consideration twofundamental issues which drive the success and therefore profitability of an organisation:industry attractiveness and competitiveness. These are themselves determined by five coreforces: ‘rivalry among existing competitors’, ‘threat of new entrants’, ‘threat ofsubstitutes’, ‘bargaining power of suppliers’, and ‘bargaining power of buyers’.Understanding these five forces enables firms to develop greater knowledge on theirexternal industrial environment which can therefore aid them in becoming more successfulover time. 17
  23. 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 andMichaels, 1998), have been issued to the Five Forces model, it is still recognised as animportant organisational tool. Porter himself has stated that industries can and do changein unpredictable ways and that no type of model can forecast such fundamentalfluctuations. However, for the majority of established industries, the external environmentis one which sees only gradual change and development over time and can therefore beunderstood further through incorporating such models.In order to analyse the evolution of an industry, Vernon (1966) developed the Product LifeCycle which aids in understanding the evolution of a product through its four life stages: 18
  24. 24. introduction, growth, maturity and finally decline. This research was taken further byVernon (1966) and later Wells (1968), in the International Product Life Cycle Modelwhich developed five stages of development, from home country introduction through toexport by developing nations. Such models aim to produce a general trend that themajority of products are expected to proceed through as they pass through their life.Although globalisation has produced a significant shift in product development, thesemodels are still able to provide managers with a level of insight which can be utilised.Flagship ModelThe Flagship Model, figure 5, introduced by D’Cruz and Rugman (1997) goes against thetraditional competition theories which depict arm’s length relationships as seen in the FiveForces Model (Porter, 1980). Instead of analysis on a short-term basis the Flagship Modelproposes a long-term competitive system which aims to outperform competition within theindustry. The system is dominated by one main flagship firm which has the resources andcapabilities to attain the level of financial success that is required by all those involved.This firm subsequently provides the important leadership, direction, strategies, anddecisions. 19
  25. 25. Figure 5: Flagship Model Framework (D’Cruz and Rugman, 1997)In conjunction with the presence of one main flagship firm, another major characteristic isthe establishment of strong relationships. These are often developed over time with themain consumers, suppliers, and select competitors. They are all initiated by the flagship inorder to perform functions more effectively which in turn improves the overall system. Inaddition, flagship firms often develop important relationships with non-businessinfrastructure including Governments, non-trade service sectors, educational institutions,research centres, trade unions, and trade associations to enable yet further businessadvancement. With these relationships the flagship system develops a vertically integratedchain of organisations which in turn creates a complex business network in the pursuit oflong-term economic success. 20
  26. 26. Competition is driven between flagship firms, but in some instances co-operation betweenthem in term of joint ventures does occur when risk and revenues are too high for anindividual 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 marketintelligence, intellectual property, knowledge, and technologies occurs in order to achievesuccess for the whole business network. Each individual organisation understands whatthey desire and expect from the business relationships and in the long-term they worktogether in order to maximise success, which in turn benefits each of the individualsinvolved.The analysis models utilised for the understanding of the external industry environmentprovide the opportunity to further develop a complete picture of a particular market.Through implementing these processes in relation to the aero-industry it will providefurther insight into the present situation and aid further in the understanding of thisparticular business sector.- Internal Firm EnvironmentKnowledge bases have always been, and will always remain, a core internal determinantto the success of a business organisation. Knowledge bases are a collection of informationthat pertains to a specific area within an organisation that enables them to be successfulthrough criteria such as product development and innovation. They are resourcesintegrated into the dynamic framework of a business, which need to evolve over time asthe firm progresses through its own stages of development. 21
  27. 27. Pavitt (1986) emphasises that industry leaders have managed to retain knowledge basesdue to their ability of creating opportunities. The capacity to retain this is dependent uponlearning from experience, accumulated expertise and the capacity for integration. Withoutthese there can be no learning and therefore a reduction in the ability to re-createopportunities.At the core of knowledge bases is the ideology of knowledge itself. However, the currentunderstanding of knowledge on an organisational and industrial level has developedseveral concepts within the literature.Implementation of the neo-classical understanding of knowledge is possible, and evensuccessful, when it is sufficient to have simple representations of simple systems. This isachievable in industries of mono-technological systems with low regional intensity whichdo not develop complex networks and inter-relationships (Paoli and Prencipe, 1999). Inthese situations knowledge develops the characteristics of perfect explicitability, perfectdecomposability, perfect transferability, indistinguishability of the process from theproduct and finally distinguishability between scientific and technological knowledge(Paoli and Prencipe, 1999). This allows all types of knowledge to be reduced to their mostsimplistic form, information.This neo-classical understanding has been linked to the virtual corporation model that wasdeveloped by Byrne, Brandt and Port (1993) and has since continued to be extensivelyrevised and developed. The virtual corporation model uses technology to link people,assets, and ideas within a temporary organisation. Core differentiation, soft integration andvirtual realisation are the three core factors which provide the potential for a firm to 22
  28. 28. become successful (Scholz, 2000). In addition, empirical evidence from Scholz (2000)highlights that firms which have integrated such methodologies have been able to developsignificant economic benefits as a result. However, a negative implication of this system isthat 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 uponeconomic determinants and the lack of reference to other significant issues reduces thecompatibility with the neo-classical definition. In these industries there are differentproduct characteristics, innovation dynamics, and strategic and management optionswhich consequently limit the overall applicability (Paoli and Prencipe, 1999).In the literature, knowledge in complex product systems can be correlated to theevolutionary theory. This method considers knowledge as a system of processes deeplyrooted 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 knowledgecan be reduced to the smallest level, information, so therefore organisations must maintaina degree of understanding and integration capacity.In these complex environments there can be a degree of networked innovative activitiesand a use of external sources for development and manufacturing. This is clearly seenwithin aero-engine producers who have a high level of external agreements, in terms ofboth activity and scope (Paoli and Prencipe, 1999). However, in these instances, systemintegrators maintain their importance for the success of an organisation. It is crucial that 23
  29. 29. the firm maintains knowledge bases along with their generative contexts (Paoli andPrencipe, 1999).Core CompetenciesIn order for a firm to operate effectively and efficiently within an industry it must beaware 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 amarket. This advantage and ultimately the degree of success are often determined by thecore competencies found within a firm (Mellahi et al, 2005). Core competencies aretechnologies and production skills which underlie a company’s product lines and areregarded 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, competitivenessstems from the ability to build on these core competencies as they govern the, “collectivelearning in the organization, especially on how to coordinate diverse production skills andintegrate multiple streams of technologies”.Core competencies can be identified using the VRIO framework (Barney, 1997) whichlooks at whether resources and capabilities are valuable, rare, costly to imitate, andexploited by the organisation. Managers can use this information to further enhance thefirm and ensure that they possess a competitive advantage. However, Prencipe (1997)states “rules of competition change over time, in that core competencies considered to bekey for a business sector may eventually become trivial, and vice versa”. Therefore, themanagement decisions on issues such as this have become of crucial importance for afirms long-term survival. 24
  30. 30. Value Creating IndustriesDue to globalisation and the rate of economic growth on a world-wide scale there has beenincreasing levels of demand for businesses to obtain value-creating activities from a wholerange of sources. There has been a general trend for utilising opportunities outside theinternal firm environment for developing the essential value-creating activities (Mellahi etal., 2005). Financial success is at the core of almost all organisations and thus the need tominimise 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 servicesfrom external sources.The use of external sources in the manner discussed by Insinga and Werle (2000) isstrongly related to economic issues. Managers should utilise external sources when thecost of undertaking the task is cheaper than completing it internally. This criterion is alsothe main determinant when a firm must decide on whether to incorporate domestic orforeign sources. It is however vital that a firm does not reduce its ability to compete ordevelop an advantage over rivals within the market when adapting such strategies. Also, itis important that other issues such as intellectual property rights are taken intoconsideration. Due to their importance managers, must understand these issues as they cansignificantly affect a firm’s business plan and long-term success. The concepts of valueadded, value chain, and value system analysis are all methods which can be utilised inorder to aid in such business decisions. 25
  31. 31. - Business RelationshipsProduct systems are characterised by interactions across whole organisational structuresand at all levels including component, subsystem, and system (Prencipe, 1997). There area high number of interdependencies upon each of these levels which in turn, categorise thedegree of performance which is achievable. Such product systems are subject to technicalchange at any level through modular, architectural and radical innovation (Henderson andClark, 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 dueto the forty thousand individual components which vary in technological value and need tosuccessfully integrate them. Undertaking the integration of a product of this naturegenerates a situation where development, production, change and innovation cannot beundertaken solely within the boundaries of one organisation. For this reason, anorganisation involved within such a market needs to utilise external sources.Due to the extensive product environment within the aero-engine industry, there are vastarrays 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 evaluateeach of these competencies. Through this process, a firm can retain those practices whichare most vital whilst contracting out those which are not.Within the literature there are currently two main business strategies that are incorporatedby 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. 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 thefirm by independent suppliers (Kotabe, 1992). However, the literature has contradictingview points on the most suitable method that should be employed by firms to increase theprobability of success.Porter (1980) highlights that there are many benefits to a firm incorporating a verticallyintegrated strategy. The majority of these are economic in nature, with the ability to raisebarriers to entry, offset bargaining power, generate a higher return on business and alsodefend against foreclosure which can ultimately restrict an organisation. In addition, firmscan become more stable through understanding demand whilst also reducing qualityissues, uncertainty, and costs.Porter (1980) highlights that the technological knowledge that is derived from verticalintegration is considered a benefit, as organisations can gain from the use or understandingof it. However, full integration not only provides its own difficulties but also increases thedegree of risk. This is derived as a firm must accept complete responsibility fordeveloping its own technological capabilities rather than utilising the distinctivecompetencies that had previously been developed by others.Although Porter (1980) highlights some risk associated with vertical integration, empiricalevidence from studies completed by Prahalad and Hamel (1990) and Stalk, Evans andShulman (1992), suggest that developing competencies through such actions is a necessityto 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. 33. interactions between research and development, product and process engineering, and alsomanufacturing activities. The inter-relationships enable firms to generate and managetechnological change, an issue which has become essential due to the difficulties that arisewhen attempting to transfer knowledge. Therefore, retaining these core processes isessential to a firm’s survival.Monteverde and Teece (1982) highlight that vertical integration can be correlated toefficiency considerations. Through research it was discovered that undertaking such astrategy can increase coordination of production and also reduce the level of exposure toopportunism from suppliers. However, Prencipe (1997) states that it is also a matter ofmastering evolutionary dynamics. Without these, an organisation loses the ability tointroduce innovation which minimises the sustainability of generating competitiveness.Stuckey and White (1993) relate vertical integration to market structure and state that asone 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 verticalmarket may fail. Organisations must therefore adapt their strategies in order to take suchknowledge into account. In opposition to this, Prencipe (1997) states that due to thefeatures of technological knowledge such methods are deemed inappropriate and are notfeasible within markets of complex-product systems.From the perspective of outsourcing, there are also many potential benefits. One of themost 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. 34. deciding upon vertical integration. One of the main drivers behind this is the promotion ofcompetition between suppliers which reduces costs, whilst increasing the level of quality.Outsourcing provides access to proprietary knowledge through the suppliers, which canthen be utilised by the organisation. In most instances this would have otherwise not beenavailable. Other benefits include a degree of flexibility as suppliers can be changed overtime as new technologies, practices and processes become available and the needs of thebusiness evolve. Finally, outsourcing also provides the ability to focus upon core areas ofthe business instead of inefficiently utilising important resources.There are however, risks associated with the outsourcing process. One of the mostsignificant that can arise is agreement failure. Dun and Bradstreet (2000) reported that halfof all outsourcing agreements fail within five years due to issues of culture, costs, andservice. When agreement failures occur they can be extremely costly to organisations andprove difficult to overcome.Prencipe (1997) emphasises that outsourcing of any technologies deemed not relevant toan organisation may damage a firms ‘change-generating capacity’ along with its ‘contextof 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 removedfrom the internal business environment. In addition, extensive outsourcing can also lead toa ‘hollow’ firm by which the reliance upon external sources becomes too great andultimately results in failure (Mellahi et al., 2005). 29
  35. 35. Overall therefore, there are both advantages and disadvantages to vertical integration andoutsourcing. Due to this, business decisions on which method to incorporate into thecorporate strategy have become major issues for firms. Economic factors have becomecentral to many decisions however, from the review of current literature it is clear thatwhen making a decision of this nature other factors must be considered and taken intoaccount.- Strategic Alliances/Joint VenturesThe use of strategic alliances and joint ventures is one method incorporated byorganisations in an attempt to develop, expand and improve (Dussauage and Garrette,1995). A joint venture involves two or more individuals or companies engaged in asolitary business deal, which has been arranged in order to generate profits. Although themanagement of joint ventures can be difficult, long-term success can be extremelybeneficial to organisations (Lorange and Roos, 1992). Such business relationships are amore recent occurrence in many industries but have been present in the aerospace sectorsince the 1960’s.In recent years, there has been a general shift from the use of international joint venturesto strategic alliances. The main difference between the two is that strategic alliances are amore long-term and diverse process often undertaken between competitors within thesame market. The two driving forces behind this change have been globalisation andtechnology. The process of globalisation is making global business markets increasinglyuncertain, mainly as a result of higher levels of competition. Due to this, it is nowemphasised in the current business literature that being a strong multinational with suitablestrategy based on competition, is not enough to ensure a sustainable competitive 30
  36. 36. advantage. In addition, with ever improving technology in all areas of the businessenvironment, firms are seeing shorter product life cycles, faster obsolescence, rising costsand the rising demand for new technology. Technological change is fragmenting globalmarkets and emphasis is placed on organisations to develop a clear product strategy thattakes into account these factors (Hayes, Pisano, Upton, and Wheelwright, 2005). Erhornand Stark (1994) stated, “world-class product development is the key to competitiveadvantage within global markets and so organisations need to be proficient at this coreactivity”. Strategic alliances offer organisations the possibility to achieve these coreobjectives.A strategic alliance is defined by Gulati and Singh (1998) as, “any voluntarily initiatedcooperative 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 ofstrategic alliances being formed across the globe. This trend has reversed the morecommon ideology of firms being independent entities that use internal skills andknowledge, to establish themselves as market leaders. The development of alliancesenables the achievement of strategically significant objectives, that are mutually beneficialand beyond what a single firm could attain (Mellahi et al, 2005).Porter and Fuller (1986) state that strategic alliances blur the distinction betweencompetition and cooperation and therefore, can lead to significant management issues.However, strategic alliances have successfully been incorporated into many industries andare 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. 37. significant proportion of the total number of partnerships set up in manufacturingindustries world-wide (Hartley and Martin, 1990). One of the main processes is the Riskand Revenue Sharing Partnerships (RRSP’s) that enable all firms involved to develop acomparative advantage from the relationship. Figure 6 shows some examples of theextensive international strategic alliances that have been initiated for the development ofseveral 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 ofreduced R&D costs and access to intangible assets, such as skills and knowledge, at a ratethat is both quicker and cheaper than competitors. The integration of competencies andcapabilities of two or more organisations can subsequently increase the levels ofcompetitiveness within a specific business environment.However, as Mellahi et al. (2005) highlight, it is vital that the correct partner is selectedand 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. 38. compatibility, commitment, and control when the selection of a partner is made. If all ofthese conditions are not achieved then failure is a much greater possibility.Jordan and Lowe (2004) draw attention to the dilemma that strategic alliances develop fororganisations. They highlight that, “on the one hand, alliance success is associated withhigh 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 toopportunistic moves by alliance partners”. As a result, the fundamental ‘learning’ and‘knowledge’ paradoxes arise, in that “to gain the greatest benefits an organisation mustexchange information and knowledge with external parties yet, at the same time, theymust protect themselves against knowledge appropriation” (Larrson, Bengtsson,Henricksson and Sparks, 1998). If protection is not considered, the resulting loss ofknowledge and competencies can be significantly detrimental to any organisation.In the aerospace sector, the issues discussed appear more acute as a result of the politicalimperatives which strongly influence partner choice and the fact that collaborators areoften strong rivals in other contexts (Jordan and Lowe, 2004). This emphasises theimportance of partner selection and the crucial role of management in the overall successof strategic alliances. 33
  39. 39. Chapter 3Hypotheses 34
  40. 40. HypothesesHypothesis 1:Alternative Hypothesis (H0):Data trends show potential for continued growth throughout the core sectors of theaerospace industry.Null Hypothesis (H1):Data trends show no potential for continued growth throughout the core sectors of theaerospace industry.Hypothesis 2:Alternative Hypothesis (H0):The business environment for the aerospace sector in the United Kingdom is currently in astrong 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 forthe associated organisations is limited. 35
  41. 41. Hypothesis 3:Alternative Hypothesis (H0):The aero-engine manufacturer, Rolls-Royce, significantly improved their overall businesswhen they incorporate technological advancements, with specific reference to DataSystems and Solutions.Null Hypothesis (H1):The aero-engine manufacturer, Rolls-Royce, develops no additional benefit fromincorporating technological advancements such as those associated with Data Systems andSolutions. 36
  42. 42. JustificationThe hypotheses presented above aim to develop questions which will further improve thecurrent understanding of the aerospace industry, with specific reference to the aero-enginesector 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 thisfirm has become crucial and so has the complex network of supporting firms andindustries which have developed.This investigation will develop a clear insight into global market trends that have beenseen and also those which are predicted for the future. In addition, the study will focus onthe present situation found within the United Kingdoms aerospace industry. A clear andcomplete presentation of the aerospace environment is not available within the currentliterature 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 continuallydevelop and advance the products and services provided. In recent years the main changehas involved the integration of electronics. These have subsequently become integral toany aero-engine and many ensuing advancements to the products have focused on thisarea. Rolls-Royce has become a market leader and now utilises the technology in all of itsnew engines. However, there is currently limited information in the present literature onthese systems and the benefits which arise from their incorporation. Therefore, Rolls-Royce will be examined in detail to analyse these issues. In addition, the businessrelationship between Rolls-Royce and Data Systems and Solutions (DS&S) will beexplored as a case-study to highlight the specific advantages which have been generatedfrom advancements of this nature. 37
  43. 43. Chapter 4Methodology 38
  44. 44. MethodologyResearch is a process of ‘knowledge production’ (Marshall and Rossman, 1999), throughwhich one seeks a greater understanding or discovery of new information on a particularsubject matter. In order for this to be accomplished, the process of data collection and thendata analysis needs to be completed.In this investigation, the methodology that has been set out has been undertaken todetermine the validity of the hypotheses presented above. The analysis that is going to beundertaken will be looking at the aerospace industry. The aero-engine sector of this vastmarket plays a crucial role and it is this which will be researched in further detail. In orderto develop a critical insight into the core aero-engine market Rolls-Royce will be theorganisation investigated. Rolls-Royce is the second largest aero-engine manufacturer inthe 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 marketwill be performed in order to establish a detailed understanding of the industry. It isimportant to generate a comprehension of these factors in order to establish the potentialmarket movements for the future. The overall trends have influence upon all organisationsinvolved within the industry so therefore this analysis is crucial to the investigation andwill allow the first hypothesis to be assessed.In order to gain a full understanding of the complex industry and to assess the secondproposed 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. 45. environment. These four PEST analysis factors are the core issues within all marketsacross the globe and developing an understanding of these is crucial. This knowledge willallow a comprehension of the current market and the position that UK organisationscurrently occupy. To develop the analysis further, Porter’s Diamond Model (1990) willalso be applied. This will highlight whether the national advantage required for an industryto be successful within a nation was present for the aerospace industry in the UnitedKingdom.To gain an understanding of the external industry environment, Porter’s Five ForcesModel (1980) will be utilised along with the Flagship Theory introduced by D’Cruz andRugman (1997). Through performing these examinations, one can develop a morecomplete comprehension and deeper level of knowledge of the issues within the aerospaceindustry.The study is looking to understand the benefits of relationships developed bymanufacturers and external organisations within the aero-engine sector. One of the mostimportant is the understanding of interactions with electronics firms. The present day aero-engine has become strongly integrated with electronics and the technology surroundingsuch systems. In relation to these developments, Rolls-Royce has made some key strategicdecisions. 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 marketand firm advancements, the benefits of technological progression, along with providing ananalysis of the internal firm environment. Through analysing all of these factors it will bepossible to fully assess the third hypothesis which has been presented. 40
  46. 46. Incorporating a case-study enables a researcher to obtain information that will directlyrelate to the hypotheses being investigated. One of the primary advantages is that an entireorganisation can be studied in detail with greater attention to detail (Zikmund, 2000). Acase-study on a single firm has been completed in this instance as it allows in-depthresearch into a particular theory. It must be recognised that this process does not provide awhole market analysis, however for this specific investigation broad and wide-ranginginformation is not a core requirement. This single case-study on Rolls-Royce has beendeemed sufficient to provide the necessary understanding required to assess thehypotheses presented.In order to gain access to primary data for the aero-engine industry, two semi-structuredinterviews were undertaken with employees from Rolls-Royce. This type of primaryresearch enables a way of collecting and analysing specific research information. It mustbe emphasised however, that interviews only provide a limited degree of knowledge. Thislimit is dependent upon the level of knowledge the interviewee possess and also, thequantity that they are willing to divulge (Cassel and Symon, 2004). Although interviewscan provide useful information and data, the factors mentioned above must be taken intoconsideration. The interview must therefore be approached in a manner that allowsmaximum benefit to the investigation.When using the semi-structured method, pre-set questions are developed however, there isa degree of flexibility which allows for a less autocratic interview process. This methodensures the interviewee remains focused on the issues being presented, but is free toprovide other potentially useful information (Cassel and Symon, 2004). In thisinvestigation, the semi-structure technique was utilised as the conditions meant that it had 41
  47. 47. the possibility of providing the most significant results. In relation to this decision, it wasfelt 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 informationrequired 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 sessionsallowed for greater interaction between both parties involved.The interviews which were arranged by a third party contact, were undertaken to gain aninsight into the business environment, develop further knowledge not currently in presentliterature, and also attempt to acquire specific data for the desired research topic.However, during the interviews, both persons involved expressed concern over thepossibility of releasing confidential information and for this reason requested that theinterview was not recorded and that they remain anonymous.The first interview with Contact A (2006), was completed on the 4th August 2006, with theinterviewee being a manager within a specific business team. This employee of Rolls-Royce had previously spent several years overseas again working within the aerospaceindustry. Throughout the interviewee’s career, a full understanding of many aero-enginemodels and their integrated systems had been developed. The interviewee’s currentposition required this knowledge in order to allow effective management of specificbusiness issues. This diverse knowledge subsequently proved very useful to thisinvestigation. 42
  48. 48. The second interview with Contact B (2006), took place on the 7th August 2006. Theinterviewee (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 operationsin relation to Rolls-Royce engines. Within the organisation, information from this divisionis 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 itplays within the aero-engine sector of Rolls-Royce.In order to further support the investigation, secondary data is also going to beincorporated into the analysis. Secondary sources represent information that has beencollected 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 takeinto consideration the overall relevance of this type of data to an investigation. Data of thisnature may have been collected and/or analysed incorrectly, may have become outdatedsince 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 canprovide a much wider scope and depth of information than primary data collection whilstallowing for a much greater understanding of industrial or market trends (Hyman, 1987).For this investigation, secondary data from related research topics within the currentliterature will be utilised. In addition, documents in the form of reports, publications andacademic 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 amethod which will permit the most accurate conclusions. 43
  49. 49. This particular methodology has been developed to provide the most significant analysisand results to the overall study. The techniques stated have been incorporated into manyacademic research articles which analyse specific areas within an industry. In relation tothe aerospace market, the literature highlights the use of empirical analysis which is oftenlinked to anecdotal evidence from interviews and a subsequent case-study of a specificorganisation (Bonaccorsi, Giuri, and Pierotti, 2001; Prencipe,1997). This technique hasbeen used in the examination of many research fields including the direct analysis theaero-engine sector (Prencipe, 2004). The literature concludes that this type of analysisprocess can be extremely useful and successful when undertaken to evaluate a specificinvestigation.Overall therefore, this methodology is appropriate for developing accurate conclusions tothe hypotheses that have been generated for this investigation. All of the data collectedduring the study and the resulting analysis will allow for a clearer understanding of theissues raised. 44
  50. 50. Chapter 5 Analysis 45
  51. 51. AnalysisIn order to complete an accurate and detailed analysis of the aerospace industry, it isimportant to look at the recent trends which have been seen. Understanding the past trendsplaces the current situation into perspective and also provides the opportunity to predictwhat the future potentially holds, a factor which is crucial for all organisations involvedwithin this market.Market TrendsIn 2005, the turnover value for the world aerospace industry was valued by the AeroSpaceand 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 anaverage rate of 4% per annum. Utilising these predictions it can be estimated that theaerospace market in 2006 will be worth over €210 billion, with a continuing growth trendafter this period.Within the aerospace industry there are two core markets. The largest is that of the UnitedStates which has long been the frontrunner. In 2000 the country accounted for 49.3% ofthe market (ASD, 2000). By 2004 this value had fallen slightly to 45.2%, or just over €88billion (ASD, 2004), but the United States still dominates. The main determinant of thismassive market share is the sheer size of the domestic market, with over half the world’sair traffic being conducted within this single nation (House of Commons - Trade andIndustry Committee, 2005). 46
  52. 52. The second largest aerospace market is the European Union (EU) which accounts forseventeen national aerospace industries. In 2004, the EU accounted for 39.4% of the worldmarket, up on 2000 by 5.6%. However, this region is dominated by several core nationswhich are the United Kingdom, France and Germany.Currently, the aerospace markets are dominated by organisations within the moreeconomically advanced nations such as those presented above, but there is increasingactivity in many of the emerging economies around the globe. Although at present theseare recognised as, “indigenous to their national aerospace industries”, it is expect that inthe near future they will have a major influence upon the international market (House ofCommons - Trade and Industry Committee, 2005).- Civil AerospaceThe civil aerospace industry can be strongly correlated to trends seen within the airlinesector, 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 isgenerated from within the global population. In addition, organisations involved within aircargo are another key component within the civil aerospace market. The air cargo sector isgoverned by the same rules and regulations of passenger airlines and the products andservices utilised are almost identical.Like many markets around the globe, civil aerospace is cyclical in nature. This hasdeveloped 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. 53. within the global economic environment, with financial implications recognised as one ofthe central determinants (House of Commons - Trade and Industry Committee, 2005).Figure 7 highlights the recent turnover levels of the civil aerospace industry within theEuropean Union. The trends seen within the EU were also present across the globalaerospace market as all are strongly influenced by the same determinants.From 1980 to 1992, the business environment was undergoing a period of strong andcontinuous growth, with turnover rising by just over 170% (ASD, 2004). However, theindustry followed its cyclical nature from 1992 to 1995 where turnover within Europecollapsed by 31.3%. The main cause of the trend reversal was the overall slow down in theglobal economic environment. However, after the three years of decline the markets againrecovered 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. 54. In 2001, the world economies were performing at ever increasing levels, with the marketsand organisations reaping the benefits. This is represented in the analysis of the Europeancivil 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 €56.4billion in 2001 (European Aerospace Industry (EAI, 2000: 2001: 2002), a trend that waspredicted to continue across the global market.However, in 2001 the civil aerospace market entered into a period of sudden recession. Asthe cyclical model referenced above highlights, the main determinant of this change wasthe rapid and unpredictable decline in the world economy. The main causes of theproblems seen were several high profile events including the outbreak of SARS (SevereAcute Respiratory Syndrome), conflict across the Middle-East, increasing oil prices andalso the terrorist attacks in the United States. The combination of all these incidents led toa downturn in the global economy with all industries being adversely affected. Inparticular, the civil aerospace market was significantly influenced due to the use of aircraftin 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 TransportAssociation (IATA, 2006) recorded an all-time high of passenger travel in 2000 withnearly 1.7 billion. However, for 2001 this value fell by 100 million passengers, resulting ina drastic negative impact upon the airline industry and subsequently the civil aerospaceindustry. 49
  55. 55. In 2001, the airline industry alone saw net losses of $13 billion. In contrast the sameindustry was making a net profit of $8.5 billion in 1999, highlighting the impact that theevents of 2001 had upon business. A consequence of this was the collapse in the value ofthe civil aerospace market. Data from the ASD (2004) highlights that European civilaerospace industry fell in value by 9.6% in 2001-2002, followed by a further reduction in2002-2003 of 3.5%. This degree of change in such a short period of time emphasises theunpredictable nature of the industry. It is therefore crucial for businesses to be aware ofthese potential changes and take into account the risks of similar fluctuations in theirfuture business strategies.Although the events seen throughout 2001 had a drastic influence upon the civil aerospacemarkets, the trend reversed in 2004 with growth of 3.5%. Even though the threat ofterrorist activity still remains, conflict is still commonplace, oil prices remain high, andmany global threats are still a possibility, the aerospace industry has still continued todevelop. These issues, especially that of terrorism, have gradually integrated themselvesinto present-day ideologies and become another part of modern society. The shock of 2001massively 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 havebecome accustomed to the issues that they represent.The result of these changes has been the return to rising passenger levels and increasingdemand for domestic and international flights. After 2001, passenger numbers began torecover with strong and steady growth. Over the period 2003-2005, passenger numbersrose by almost 25% to over two billion. This trend can be correlated to the ever increasingpassenger demand and also to stronger than expected economic performance in the United 50
  56. 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 isexpected to continue. However, even though positive trends are being seen it must berecognised that the airline sector is still undergoing recovery. Net losses of $3.2 billionwere still present in 2005, sustained mainly by the ever increasing cost of oil which nowaccounts for 22% of total operating costs (IATA, 2006). It is predicted that it will takemany more years before net profits are again viable within this industry. However, inAugust 2006 the potential for further terrorist attacks was realised when plots to destroytrans-Atlantic airlines between the United Kingdom and the United States were thwarted.This instability highlights the issues which modern businesses, especially those involvedin the aerospace markets, have to overcome.In conjunction with passenger travel, air-cargo levels also fell with a decline in operatinglevels of 7.7% from 2000 to 2001. This sector also endured a prolonged struggle torecover as sale volumes remained at their depleted levels 2001-2003. Although the cargoindustry is not as valuable as passenger travel, the financial implications for all theassociated industries were severe. However, freight levels eventually began to recoverwith 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 presentlyin a period of growth. Currently this is predicted to continue (ASD, 2004) however, thecyclical trends of the industry are difficult to predict and therefore, organisations must beprepared for any eventualities that may arise in the future. 51
  57. 57. - Military AerospaceThe military sector is a vital and important division within the aerospace market. In theearly 1980’s turnover attributed to military sources accounted for over 67% of the totalEuropean market and was therefore, a key factor in the early growth and development ofthe industry.As figure 8 highlights, the significance of the military sector in economic terms hasgradually reduced since the 1980’s and was overtaken by the civil sector in 1990. By 2004military 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 beensome 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 andwill 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) 52
  58. 58. With Europe being the second largest aerospace market, demand for the products andservices developed in the region not only comes from internal Government sources butalso 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 militaryexpenditure.Figure 9 shows the value of turnover from military sources from 1980 to 2004. Althoughfluctuations 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 economicperformance, but is dependent upon defence budgets and the procurement policies ofGovernments. These in turn are influenced by the geopolitical developments and thechanging 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 totallevels within Europe reaching highs of nearly €35 billion. This trend was seen due to theissues over the cold war. Political tension between the Soviet Union and the United Statesspread and the result was an increase in defence budgets as nations attempted to protectthemselves through military development. When this era finally came to an end in the late1980’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 fluctuatedhowever, on average it has remained at around €24 billion. The variations that arehighlighted in figure 9 have been determined by political unrest and other internationalissues. The recent rise has been attributed to terrorist activities and the rising demand forhomeland security. 53
  59. 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 UnitedKingdom, stated that defence budgets in many European nations, including the UnitedKingdom, were set to enter a phase of decline. However, between 2005 - 2009 the UnitedStates defence budget is expected to increase by approximately 30% (DTI, 2006). Theconsequence of such changes will have an impact on many of the organisations within thisbusiness environment, so it is important for organisations to be prepared. There are manycommonalities between the civil and military segments of the market and it is essential forthe industry to have a degree of predictability and stability in both areas. Having suchinformation allows for firms to, “make best use of the knowledge bases, to optimisetechnical, human and financial resources, and to iron out fluctuations in demand wheneither segment encounters periodic difficulties” (Bechat et al., 2002). 54
  60. 60. - Aero-Engine IndustryThe aero-engine industry within Europe accounts for 9% of the total consolidated turnoveror, nearly €7 billion. This value is dependent upon both the trends seen within the civil andmilitary aerospace industry across the globe. The sales of engines are correlated to the saleof aircraft, whether for commercial, personal or military use. However, with general trendswithin the United States and the United Kingdom highlighting growth in all enginesectors, 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 thebusiness 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 ofbusinesses which supply and support these international organisations. The relationshipsthat are developed and the subsequent high-technology products which are produced arebecoming an increasingly significant industry.Within the United Kingdom the Aerospace Industry (UKAI) is realised as one of the mostimportant manufacturing industries. It provides £17 billion to the economy whilst alsoproviding the ‘spill-over’ effects to many other business sectors (House of Commons -Trade and Industry Committee, 2005). At present, the Society for British AerospaceCompanies (SBAC, 2006) estimates that in the UK there are over 3,000 companiesintegrated into the aerospace industry. Currently the most successful of these firms isRolls-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 alreadyordered for forthcoming years stood at £20.7 billion, driven by the increasing sales of 55
  61. 61. aircraft. Such figures show that the business is currently in a period of success and thistrend is predicted to continue for the foreseeable future.In conclusion, all of the sectors within the current aerospace industry have been throughtheir recent problems and difficulties but they have been able to overcome these anddevelop into more successful business environments. The firms which operate within themnow have the potential to take advantage of this situation and become increasinglysuccessful.More specifically however, the aero-engine sector plays a crucial role within the aerospaceindustry across the globe. For this reason, it is important to understand the environmentwithin which they operate and also how the firms involved have continued to remaincompetitive and successful in an ever-changing market. The following analysis willattempt to further understand these issues and allow for the second and third hypothesespresented for this study to be assessed.Business Environment- External Macro EnvironmentIn order to provide a detailed analysis of the aero-engine market, the external macroenvironment and external industry environment of the aerospace industry will be initiallyinvestigated, followed by an analysis of the internal environment. This will provide adetailed insight into the present situation within this vital market segment. In order to gainthis knowledge numerous models and techniques will now be applied which will allow fora comprehensive insight and enable a thorough investigation to be completed. 56
  62. 62. Specifically, the United Kingdom will be focused upon due to the importance of thisindustry 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 largestaero-engine manufacturer, Rolls-Royce, will be utilised. A case-study based analysisenables a detailed approach to the investigation, upon which specific data can be gathered.PEST AnalysisA PEST analysis can be used in order to analyse all areas of an industry and theenvironment within which businesses operate. This type of analysis takes intoconsideration the political, economic, social, and technological issues. It provides anoverview of the current situation within a particular market and can be extremely usefulfor firms operating within the sector.A PEST analysis will now be completed for the aero-engine industry in order to highlightthe present situation for this particular market. It will provide some backgroundknowledge whilst also showing the future trends that the firms may face. Utilising thismethod in relation to the Rolls-Royce case-study, enables a core from which the integralfactors can be more clearly depicted.Within the aero-engine industry there is a strong political influence upon the nature of thebusiness environment. Not only are Governments a source of demand for militaryproducts and services, but they also have a strong influence upon critical marketcharacteristics. 57

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