Risk and Reward: sustaining a higher value-added economy - Business and Enterprise Committee Contents


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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