Rolls Royce1

Introduction

High above the Pacific, passengers sleep during an intercontinental flight. Suddenly, a lightening
crosses the skies. Those who woke up with the noise quickly fell asleep again. However, in
Derby (UK), Rolls Royce's engineers are suddenly busy!

On average, for each flight hour a plane is struck by two rays. In general, the fact that a lightning
hits an airplane has no consequences. But it can, in fact, sometimes, cause an engine to stop. If
this happens, the plane can land safely with one engine. However, even if the engine does not
suffer a stop, it may need a general inspection as soon as it lands. This type of inspection would
be perfectly normal, but would delay the return flight with implications for tens or hundreds of
passengers.

Shortly after being struck by lightning, the aircraft sends a large amount of information traveling
to Derby! All these data are visible on screen and quickly transformed into useful information
for engineers, come to them almost instantly and are discussed even before the plane lands.

The headquarters of Rolls Royce in Derby works 24 hours a day. Its appearance, with several
monitors showing the data and clocks set for different time zones, reminds us a financial center
and not the headquarters of a company producing engines! In fact, the operations center of
Derby is the "heart" of Rolls Royce.

Over the past 20 years, Rolls Royce went from a company on the brink of bankruptcy to the
second largest producer of aircraft engines, having blurred the line between "doing things" and
"offering services".

A financial engine

In the last decade, Rolls Royce's turnover has doubled, with 85% coming from international
sales. About 50% of the large aircrafts (wide-bodied) and 25% of the average sized aircrafts
(single-aisle) produced in the world use engines from Rolls Royce. The remaining aircraft use
Pratt & Whitney and GE, the two major competitors of Rolls Royce.

Rolls Royce has also remarkable growth in other markets. On the one hand, the Rolls Royce
engines currently fit over 30,000 vessels. Second, in mid-2009, benefiting from the past
experience and knowledge acquired in the construction of nuclear submarines, Rolls Royce
entered the field of nuclear energy for civilian purposes. Currently representing 20% of its
revenues, and with the aim of reaching $75bn by 2023, this diversification strategy will enable
Rolls Royce to deal with fluctuations in demand for aircraft engines, which represent most of
their turnover.

1 Developed based on information available about the Organisation and its sector.

This case was prepared as a basis for class discussion and not to illustrate the effective or ineffective handling of a management
problem.
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©José Bento da Silva e Sandra Pereira
In order to understand the success of Rolls Royce in the field of aircraft engines, it is important
to review the technological challenges associated with them.

Some of the most important parts in the engine of an airplane are the turbine blades (not the ones
that are visible, but the ones located inside the engine). Each of these blades can cost about
US$10,000. The difficulty in producing these parts is in the fact that they have to withstand large
temperature variations while the engine is running: the blades are exposed to temperatures of
1600°C when the melting point of the metal they are made of is 1200°C. The secret to overcome
this phenomenon is the cooling system of the blades.

Despite the difficulties inherent in the production of the blades and cooling system, this
knowledge represents no more than the "entry ticket" in the field of aircraft engines. Any
competitor of Rolls Royce is able to produce these two components of an engine. On average, in
the field of aircraft engines, a technological advance introduced by a company takes a maximum
of 10 years to be replicated by competitors.

Rolls Royce is not known for having introduced an engine slightly better than the competition,
taking advantage of the temporary advantages of this innovation. In fact, this company designed
a completely new engine. This allowed the company to thrive in an industry that, in the 1960s,
was dominated by Pratt & Whitney with 90% market share. From a commercial standpoint, the
strategy of Rolls Royce was to first enter the European market. Later, given the importance of
the U.S. market, Rolls Royce developed for that market the first engines for long-haul aircrafts.

In the development of its Rolls Royce engine the company bet on two technological innovations.
The first was the production of turbine blades (those that are visible) in carbon. The main
advantage of carbon alloys is the lighter weight. The second innovation was the change in the
fundamental architecture of aircraft engines, which began using three axes instead of two. Both
technologies have proven to be quite expensive and harder to implement than originally
anticipated. The blades in carbon showed less resistance to collisions with birds and were
abandoned to the detriment of composed metal alloys. This setback, coupled with delays in the
development of new engines, led to a poor financial performance, and Rolls Royce was
eventually nationalized by the British government in 1971.

Despite these facts, innovation in architecture led to the production of a family of engines much
more efficient in terms of fuel consumption and more reliable than the competitions. In addition
to these two advantages, the Rolls Royce engine can be adapted to any aircraft, regardless of
their size. Thus, Rolls Royce does not have to design an engine each time a new aircraft is
introduced, allowing it to compete across a broader range of models than their competitors. Rolls
Royce is the only aircraft engines producer which has designs to equip the Boeing 787
Dreamliner, the Airbus A380 and the new version of the Airbus A350.

However, this family of engines is much more complex in terms of design, production and
maintenance than competitive engines. Rolls Royce equips the planes of 45 of the 50 largest
airlines in the world. But, as for example in the business of razor blades, the highest margins in
the industry of airplane engines are not in the sale of engines, but in the maintenance and
replacement parts sales. As a shaver, a motor has a residual profit margin. The higher margins
are associated with the sale of blades in the case of the shaver, and the sale of maintenance
services and replacement parts, for aircraft engines. In 2007, about 50% of Rolls Royce sales
revenues was coming from post-sales. The market for replacement parts for aircraft engines is
very competitive and has attracted several companies that produce certified parts and / or
provide maintenance services. In addition, engine manufacturers produce parts compatible with
the engines of the competition, and provide maintenance services for them. This means that in
many cases, parts produced by other manufacturers can cost 1/3 the price of replacement parts.

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©José Bento da Silva e Sandra Pereira
Rolls Royce has therefore decided to offer its customers a differentiated offering, combining
technology with services. So instead of selling engines, parts and service, Rolls Royce has
decided to sell their customers' flight-hours: Rolls Royce's customers pay an amount for each
hour of operation of the engines. In exchange for this monthly fee, Rolls Royce ensures engine
maintenance, the exchange of any piece, and even the replacement of an engine if necessary.

The two biggest competitors now offer the same type of service, but Rolls Royce has managed
to gain advantage over the competition. Offering this product for over 10 years, Rolls Royce has
more than 50% of their engines covered by that type of service contract. The proof of the success
lies in the fact that 80% of new engine orders are done in these terms.

Produce, sell and serve

The fact that companies in this sector are offering services might suggest that these are what
companies should focus on, gradually outsourcing production. However, the case of Rolls Royce
seems to demonstrate that it is difficult to provide quality services without being capable of
producing quality engines.

Derby operations center monitors over 3.500 engines, producing a body of data whose
possession constitutes a barrier to entry for any company interested in servicing Rolls Royce
engines. The data collected in Derby allow Rolls Royce to predict the likelihood of faults, which
allows customers to schedule maintenance services efficiently. This means less emergency
maintenance and less unsatisfied passengers.

These data are also very valuable to Rolls Royce. The timely detection of problems allows the
design and production of more reliable engines and continuous improvement of existing engines.
Currently, the Rolls Royce engines are more energy efficient and have a lifetime between large
repairs of more than 10 years.

Workshop Resolution Proposal (minimum required)*.

1. Perform a strategic analysis properly identifying Rolls Royce resources and capabilities.

2. Are those resources and/or capabilities dynamic? Explain why.

3. Identify and analyse Rolls Royce resources and/or capabilities that might provide
sustainable competitive advantage on the basis of their Value, Rarity, Inimitability and
Organisational Support (VRIO).

4. Diagnose Rolls Royce resources and capabilities and environment by means of a SWOT
analysis.

*The use of other lectured contents in the analysis of this case will be a plus.

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©José Bento da Silva e Sandra Pereira