Examination of Witnesses (Questions 79-99)
ROLLS-ROYCE
GROUP
21 FEBRUARY 2008
Q79 Chairman: Gentlemen, welcome to this
evidence session, the second session of the Committee's inquiry
into creating a higher value-added economy. As I was saying to
Sir John just before the session began, you are actually one of
the reasons we are doing this inquiry because I have been reading
your comments on this subject for some years now. I am particularly
grateful to you for making time in a very busy schedule for coming
to talk to us. We would like to talk to you today obviously about
Rolls-Royce and the decisions it is taking but also set them in
a more general context about UK manufacturing in the broader perspective.
As we always do before we begin, having thanked you for coming
in, can I ask you to introduce yourself and your colleagues for
the record?
Sir John Rose: I am Sir John Rose
and I am Chief Executive of Rolls-Royce. On my left is Mike Terrett,
who is our Chief Operating Officer. On my right is Charles Blundell,
who is our Director of Public Affairs.
Q80 Chairman: Can I invite you perhaps
first of all, before we go into Rolls-Royce specifically, to give
your perspective on how you see Britain's future in the globalised
economy, particularly with respect to manufacturing, what our
prospects actually are?
Sir John Rose: I think it is very
difficult to put that into a very narrow context. Speaking for
Rolls-Royce, I think our prospects are very good. As you have
seen in the last decade or so, our ability to access the global
markets that are now available to us, and there has been a huge
change in the geographic spread of our activity over the last
ten or 15 years as the world has opened up, has been demonstrated
with growth in the order book and the range of customers that
we now have geographically. We are advantaged by the fact that
we have as our technological base technologies and products that
are not widely available and therefore we access a lot of these
countries because they do not have a domestic competitor. So we
are a high value-added industrial company, we are a very high
barrier to entry and we provide a product that creates a lot of
value.
Q81 Chairman: That does not say much
about the broader competitive environment though. Give me your
perspective on that, particularly perhaps what you make of the
development of the emerging BRIC economies, particularly say India
and China. What is Britain's correct reaction to that development?
I do not want to lead you too much.
Sir John Rose: I think you have
to see these new economies as both an opportunity and a challenge,
as with all the countries with which we deal, and it is not just
the emerging economies that we have to consider. We have to recognise
what our competitive strengths and disadvantages are. We need
to look at that in the context of ... It is a very general question.
Let me step back. We will only access these markets if we have
something that they value and they think is world class. They
also aspire to do the things that we do. They are actively setting
out their stall to be competitors across a whole range of activities
and technologies. That has always been the case. Most of the countries
with whom we compete have a few of the sort of economic structure
they want and they make decisions based on that view, so whether
it is the United States or Canada or Germany or India or China
or Singapore or Russia or Brazil, they have an economic agenda
for their country which they actively support as governments and
try and create an environment that allows them to be competitive.
We will be attractive to them either as providers of technology
or of products if we are perceived to be world-class. The challenge
for us is to recognise what world-class is in that context and
that has essentially been the thesis that I have been focusing
on for a decade now, I suppose.
Q82 Chairman: British business is
aware of that challenge, I think. Do you think the wider population
of the United Kingdom properly understand the challenges we face?
Sir John Rose: I think it is clear
that the population is understanding is going to be defined by
the sort of language that government and others use and, as I
have said in the past, if we use a language that tends to define
the country in terms of being a post-industrial service economy
which has somehow created some new paradigm for economic success,
then that is what the population will believe. I am not sure I
believe it, and I think that it is harmful that we have consistently
taken that approach. It is not consistent with the approach that
is taken by most of the countries that we see as our potential
competitors, so I am not sure among the BRIC countries you talked
about that you will find any of them talking about being post-industrial
countries. They will be talking about being high value-added manufacturing
countries because they see that as being the best economic way
forward for them, so they will play to their strengths. They will
not all have the same objectives in detail but, if you go and
talk to governments in China or India or Brazil or Russia or Singapore
or Vietnam, you will find that they are articulating a vision
of their economy of which high value-added manufacturing is a
significant part.
Q83 Chairman: The United States?
Sir John Rose: I was talking about
the BRICs, the United States, Canada—the list is very long.
Q84 Chairman: Exactly. Let us move
slightly more into Rolls-Royce because you have given me the cue
there with your reference to post-industrial paradigms and service
sector economies. 53% of your revenues now come from after-market
services and I was very struck with something the CBI told us
last year; I quote: "Production itself is becoming less important
as a defining factor for manufacturing companies, many instead
opting to focus on R&D or service provision." What has
happened to R&D in Rolls-Royce's operating environment over
the last ten years in this respect? How has your business changed?
Sir John Rose: There again, that
is a multi-faceted question. Let me start by explaining services.
What we do is service our product because we own the intellectual
property and therefore we are best placed to add value to the
customer, and our ability to do that is dependent on our ability
to design and manufacture. We are providing engineered solutions,
so "services" is a useful descriptor of that part of
our business in the sense that we are providing services that
are ancillary to and post the original equipment sale. The services
are fundamentally enabled by the fact that we do the research
and technology in the first place, that we develop the product,
that we certify it, that we understand its operation in service,
that we have the skills and capability to monitor it, that we
can view the use of our product across geographies and applications,
and that we can therefore act with the customer in a way that
improves their business and improves the operation of our product
in service, which is very meaningful to them, because for most
of our customers our product has a significant impact on the success
or otherwise of their business. It is not that we are going around
and saying we happen to understand the civil market or the defence
market or the energy market and we can do some service things
because of that; it is fundamentally to do with the fact that
we own the intellectual property and the relationship with the
customer.
Q85 Chairman: How has that changed
over ten or 20 years?
Sir John Rose: It has not changed,
frankly, as a business model at all. All that has changed is the
quantum, and the reason that has changed is that we have invested
heavily in new product, we have gained market share, the volume
of products that we have in operation is greater and therefore
the revenues associated with the operation of those products is
greater as a consequence. If you go back to 1995, we had 20,000-odd
engines in service; we now have 54,000 engines in service. It
is therefore unsurprising that our service component of our revenues
grows. You asked a question about R&T. Our R&T has continued
to grow. We spend more now than we ever did in absolute terms
and it is more widely spread geographically. We do it globally
because we try and access the most efficient place for doing that
research and technology work.
Q86 Chairman: We will ask you some
more questions in detail later on. Before I hand over to my colleague,
can I just ask you what is the definition of manufacturing in
the modern economy? Some people have suggested to me that if a
company is based in the UK, designs its products here, services
them here, markets them from here, organises the logistics from
here but actually they are all made somewhere else, it is still
a manufacturing company, a British manufacturing company, in spite
of the fact that virtually nothing is made here. Would you go
along with that definition? Do you think it actually has to be
made here too?
Sir John Rose: If it is going
to be important to the economy, you have to look where the value
is added and therefore I am sure you can define manufacturing
in those terms and, clearly, a successful global business needs
to have brand technology and route to market and clearly you can
do that without necessarily doing the actual manufacturing in
the UK. You could do your research here and get everything made
offshore. Whether that is the right answer for the UK in that
that would create, if it is a high-value activity, a lot of the
high value-added activity in a different geography and therefore
the benefit here would be some employment and some remittance
of the profits. Whether that is the right answer for the UK I
rather doubt. There is no reason to assume that we cannot do high
value-added manufacturing in the UK. There is a lot of reason
to assume that we cannot do low value-added manufacturing in the
UK and we should not aspire to do it.
Q87 Mr Clapham: Sir John, you said
a little earlier that one of the developments that had influenced
Rolls-Royce was the fact that, as you become globalised, you are
looking at countries that have an economic agenda that is competitive.
Would it be true to say that that has been the most influential
factor on the way in which Rolls-Royce's performance has developed
over recent years?
Sir John Rose: We have certainly
had an opportunity to change the footprint of the company over
the last 20 years as we have become more successful. If you go
back to when we were floated, we were a substantially UK-based
company and probably a third of our revenue came from the UK,
but certainly most of R&T work, R&D work, our product
development, our people, our manufacturing and indeed our supply
chain was UK-based. Over time, as we have expanded our portfolio
and had increasing success in global markets, we have had the
opportunity to access other jurisdictions for R&T, R&D,
manufacturing and supply chain. That is a rational thing to do.
We are a global business now; 90% of our revenue comes from places
other than the UK, 50% of our product is developed outside the
UK, close to 50% of R&T is done outside the UK. Some of that
is a natural consequence of being global; some of it is a consequence
of finding places that are simply more competitive—they
have a different attitude to manufacturing, they have a different
attitude to our industry, they have a different attitude to R&T
funding and that makes them attractive places to be in their own
right. So we are not going there because we think that we will
get peculiarly good market access in that geography; we are going
there because we think we can access skills and funding in a way
that is not available necessarily in the UK.
Q88 Mr Clapham: Coming back to the
Chairman's question on manufacturing, given the globalisation
of a company like Rolls-Royce, is it your view that, in that very
changed situation, the kind of links that have anchored a company
like Rolls-Royce in the UK are broken and therefore the linkage
could be elsewhere in the world? For example, we tend to see R&D
in manufacturing as being one of the anchors that links a particular
company to that location but, given the changes that you have
described, do you think that the linkage of a company like Rolls-Royce
to the UK is completely broken and that Rolls-Royce could well
find its location based elsewhere?
Sir John Rose: Clearly, it could
but the issue for me is not as you articulate it. There is a strong
link to the UK. It is still the single biggest location of people
and R&D activity and product development in the world, and
that is likely to persist. Indeed, we disproportionately spent
our capital over the last five years in the UK relative to the
geographic balance of the business. I think there is a strong
disposition for a company that has historically always been located
in the UK to remain located in the UK. However, I think the key
is that a business such as ours has choice and we have to exercise
choice in the best interests of the company and the employees
and the shareholders and, if the UK is a less attractive choice
on individual decisions, progressively those choices will end
up defining the shape of the business. So the shape of the business
today is a consequence of choices made ten, 15 years ago, and
five years ago, and the shape in the future will be defined by
the next set of choices and therefore ensuring that the UK recognises
who the competition is and what is different about them and why
they might represent good choices for Rolls-Royce is really important.
Q89 Mr Clapham: In actually evaluating
those choices, what role do the respective values of differing
currencies have? For example, has the weak dollar had an impact
on your strategic thinking?
Sir John Rose: We are a very long-term
business and we tend not to make decisions solely on the basis
of short periods of currency strength or weakness. Currencies
over time are reasonably volatile, which is one of the reasons
we hedge, and we try to take decisions with a recognition of a
long-term trend. So it is not the absolute volatility. The fact
is that we are an industry where a large part of the revenue is
in dollars and therefore having a mismatch with your cost base
and your revenue base adds an element of risk to the business
that does not necessarily exist for our competitors and therefore
you have to take steps to try and neutralise that. You can do
that partly by changing your cost base, partly by hedging and
partly by ensuring that, through investment and productivity,
you put yourself in the best possible position to deal with that
volatility. We use a combination of all three. You will have seen
that we made a recent decision to site an assembly and test facility
in the US but we also made a decision to site an assembly and
test facility in Singapore. Singapore is not a dollar economy
though it does peg itself against a basket of currencies but what
it is is extremely productive, and that and a range of other factors
meant that we felt that it was a good location for that facility,
even though it was not dollar-based.
Q90 Mr Clapham: Given the choices,
given the challenges, given the opportunities and the fact that
Rolls-Royce is now expanding overseas, is Rolls-Royce gravitating
to any particular region? For example, where could Rolls-Royce
now build an engine from design through to its actual manufacture?
Sir John Rose: We can do that
in three places now. We can do it in the US, we can do it in the
UK and we can do it in Germany.
Q91 Mr Clapham: Given that Germany
has perhaps a stronger manufacturing base, could it be that Rolls-Royce
is gravitating towards Germany?
Sir John Rose: We have, I think,
about 2,500 full-time employees in Germany. It is one of the centres
for our small engine activity. We split that between the US and
Germany. We have 20,000 people in the UK. The UK is the centre
for our large engine business. We do not do large engine development
in any other geography but we will be doing large engine assembly
in Singapore. If I am understanding the nature of your question,
which is about gravitation, is the centre of gravity likely to
be in Germany? Probably not. Is it going to be less clear where
the centre of gravity is over time? Probably. You are likely over
time, given globalisation, for it to be less obvious where your
centre is. That is going to be the nature of global companies,
and we are more global than most today. If you look at where our
revenues come from, we satisfy all the normal criteria of a global
company, more so than many companies that are perceived to be
global. We are much more global, for instance, than a GE in terms
of the normal definitions. One of the strengths of the business
will be whether or not we learn how to be a very effective global
company. How do you manage yourself as a global company? How do
you continue to behave in the same way as you did when the whole
of the management was on one corridor when the management is dispersed
around the world? That will actually be the differentiating skill
if you can achieve it.
Chairman: Some of the implications of
that change Mr Hoyle would like to explore.
Q92 Mr Hoyle: Obviously, if we can
just talk about some of the announcement of redundancies: 2,300
jobs to go worldwide obviously has a major implication for Bootle.
Is it the right time to be cutting jobs as you are on the up,
things are really taking off? Excuse the pun.
Sir John Rose: I think that as
you grow it is really important that you do that in an efficient
way. Growing inefficiently is very expensive. There are two elements
you raised. One was the 2,300 jobs worldwide. Let us put it in
context. We recruited about 2,500 people last year. We are continuing
to recruit graduates and apprentices and direct employees, i.e.
people who are closely involved in the actual production and development
of our product. What we are reducing is the number of people in
the overhead, so we are trying to sustain the productivity improvements
that we have talked about and we have been achieving over the
last decade. We have probably been achieving improvements of roughly
7% a year for over a decade and the rebalancing of the business
between overhead and directs will continue to allow us to sustain
that productivity improvement as we grow, and it is really important
that we do that, otherwise we cannot afford to grow. So I think
it is the sensible thing for us to be doing as we grow and it
is enabled by the very large investments we have made in IT and
capital over the past years. If you look at what we have spent
on capital, IT, training, R&D, and R&T over the last decade,
we have spent about £11 billion, and part of the pay-off
for that is that you are able to do things more efficiently. In
the specific case of Bootle—and we are pleased to say that
we have reached agreement with the workforce now on the way forward
towards closure—we did a very careful evaluation of whether
or not it was appropriate to sustain that facility, and the conclusion
was that it was not, because we have the capacity to achieve the
output we need in a single site in the US because of the investments
we have made and the flexibility that we have there. As we know,
capital equipment has elements of lumpiness and the advantages
of being on one site with all the ancillary services located around
it as opposed to in a satellite site were significant and it was
the right thing for us to do for the company as a whole. It is
clearly a great disappointment for Bootle but the original rationale
for the site, which was established when that business was not
owned by Rolls-Royce, was not powerful enough in today's circumstances
to justify it being kept open.
Q93 Mr Hoyle: Would it be fair to
say that Rolls-Royce, a UK name, is a global manufacturer but
with a commitment to the UK?
Sir John Rose: Absolutely. The
reason that I have spent so much time making the case for manufacturing
is that I think it is important for the UK and I think it is important
for Rolls-Royce. One of the disadvantages of a reduced manufacturing
footprint in the UK is that your pipeline for skills and professions
shrinks because we do not have the hinterland, the cluster, that
is developing those skills and therefore when we want to go and
find them, they are not there.
Q94 Mr Hoyle: I am glad we can agree
on that because it is that commitment I would just like to look
at a bit more deeply. If I were to say to you that the case for
Bootle has been thoroughly looked at by Rolls-Royce, there has
been very good evidence from the union but what about if we were
to say that something has been overlooked? Would you consider
re-looking at it?
Sir John Rose: I think we have
come to the end of the process.
Q95 Mr Hoyle: But if there was something
that was significant, that would make a real difference, would
Rolls-Royce keep their eyes closed and go deaf on the public of
Bootle? If we were to say there was something, would it be possible
to say "Yes, we will look at it"?
Sir John Rose: I think it would
be absolutely absurd for us not to consider a material fact. However—
Q96 Mr Hoyle: Can I then push it
a little bit further forward. I am pleased to hear that. I think
that something did not come out, that I have been told about since
our meeting, that you were offered a new site in Liverpool, that
if you were to close the American site, that would be new work
coming into Liverpool on a brand new facility with capability
of single site manufacturing, with actually the attraction of
full grant because it will be the transfer of work into the UK.
That will give you not only an added advantage but it would also
give you a brand new facility in which to go forward. It would
be part of that commitment that could be re-looked at. I do not
believe it would take a long time; I believe it could be something
that can be done very quickly but the RDA feel that they were
not listened to. I have spoken to them. That commitment is there.
They wish to do that and I just wish to see that this very loyal
workforce ... A UK facility is actually available to be continued
on that brand new facility, just on the last point, and this huge
plant that you are building is next door to the port and not inland
in Mount Vernon.
Sir John Rose: Can I just put
it in perspective?
Q97 Mr Hoyle: Of course.
Sir John Rose: We have come to
a conclusion. Your arguments are interesting but do not recognise
the fact, I think, that we also have a large number of loyal,
committed employees in Mount Vernon.
Q98 Mr Hoyle: Which do you value
most?
Sir John Rose: I have more in
Mount Vernon with a far broader range of capabilities. It is a
more capable site in terms of the total activity. It is the headquarters
of our energy business globally. If we were to have a competition
for a new site for our energy business, we would have to open
it up to the sites in the US, elsewhere in the world, as well
as Liverpool because we would have to see which is the best location
for energy if we were prepared to do something as radical as changing
from a very substantial site in Mount Vernon. I think that is
what you have to put in perspective. We are a global business
making global choices. We have a predisposition, which is well
evidenced by the money that we have spent in the UK over the last
decade—in the last five years 80% of our capital has been
spent in the UK, which is actually disproportionate to the footprint
of our business. I think our commitment to the UK is unquestioned
and you have to put yourself, when thinking about issues like
this, into the shoes of a company that has a global footprint
and where we owe equal loyalty to all our employees everywhere
in the world.
Q99 Mr Hoyle: It is just that some
are valued a little bit more than others.
Sir John Rose: No. They are all
valued in the same way.
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