Business Model Interrogation & Development

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Business model interrogation & development
Rolls Royce Group Plc
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Contents
Introduction………………………………………………………………………2
Background……………………………………………………………………….2
Strategy……………………………………………………………………………..2
Product Market…………………………………………………………………..3
Internal Architecture………………………………………………………….6
Capital Market……………………………………………………………………8
Conclusion and Recommendations………………………………………9
References………………………………………………………………………..10
Introduction
This study will question Rolls Royce current business model evaluating its interaction between the product market and the capital market. It will do so by analysing the profitability of its product/service portfolio and the strategies used to achieve a competitive advantage over their competitors. A close examination into their internal architecture will determine if its current organizational systems and processes can withstand the need to innovate and sustain technology advancements from the market, as well as an analysis of the main financial indicators providing an assessment of their current bottom line situation. Based on the analysis, the study will go on to provide a viable strategic recommendation for the future of Rolls Royce.
Background
Rolls Royce Group PLC is a provider of power systems and services for use on land, at sea and in the air, operating in four segments: civil aerospace, defence aerospace, marine and energy. (Thompson Reuters, 2013). Founded in 1906 as Rolls Royce Limited, it fell into bankruptcy developing the RB211 for the Lockheed L1-011jumbo jet in 1971. Nonetheless, as a nationalised company under the Labour and Tory governments it sustained its investments for the RB211 and in 1987 it was privatised, where it has been operating as a public limited company until nowadays. (Lazonick, 2002).
Strategy
Since privatised, Rolls Royce has turned into one of the biggest providers of power systems and services along GE Aviation and Pratt & Whitney. It succeeded due to the gathering of knowledge, resources and capabilities through takeovers and mergers. It started with the merger in 1989 with Northern Engineering Industries, which started the company on a diversification strategy of gas turbine technology to energy and marine uses. (Lazonick, 2002). The 1990’s were a time of great change in Rolls Royce operations; it formed a joint venture with BMW named BMW Rolls-Royce to develop the civil aerospace sector, acquired Allison in 1995 to support the defence aerospace sector, took control of its joint venture Cooper Rolls in 1999 and in the same year acquired National Airmotive and Vickers plc. (BBC, 2003). Most recently, in 2011, Rolls Royce acquired engine-maker Tognum in a joint venture with Daimler. (Bloomberg, 2011). These mergers and acquisitions are an essential part in Rolls Royce strategy as enables to maintain and develop new technologies, vital to attract new customers.
Additionally, as part of their long-term strategy, Rolls Royce invests heavily in research and development, having spent over £7.5bn in the past 10 years. To acquire technology, it operates a centralised research and technology centre having partnerships with several universities and research centres. (Rolls Royce plc, 2012). Furthermore, 2/3 of the investment in research and development are aimed to improve the environmental performance of the engines, promoting fuel efficiency and low emissions to appeal customers, improving the social responsibility image portrait to the community. This is extremely important as Rolls Royce will only start production once they received an order from a customer, operating in an order book base.
Product market
To evaluate Rolls Royce product market, the Product Life Cycle presents a useful model as it demonstrates the growth of products through sales (through orders received in the case of Rolls Royce), enabling predictions for future performance. According to Levitt, the PLC is composed of four stages: market development, growth, maturity, and decline. (Levitt, 1964). Rolls Royce has reached the maturity stage as there are no steep increases in orders. But, as the growth rate maintains rising, (uncharacterised from the maturity stage) resulted by innovating their products, demonstrates in fact that Rolls Royce is in the proliferation stage. (Enis, Garce and Prell, 1977).
Source: Rolls Royce Group PLC. (2011). Annual Report 2007 – 2011. London.
To analyse Rolls Royce strengths and weakness the BCG matrix presents a useful tool as it maps the products in terms of their profitability and likely cash flows. (Ioana, Mirea and Balescu, 2009). Rolls Royce segments, civil and defence aerospace, can be considered cash cow’s as they are already established in the market and are having an increase in orders; in 2011, Rolls Royce signed an exclusive contract to develop a new engine for Airbus, (Financial Times, 2011) and in the defence aerospace they have signed a £62 contract with the US Air force (London Evening Standard, 2013). The energy segment can be classified as a star, as they are signing promising deals and have predictions of a booming demand; Signed a $110 energy contract around the world in 2010 and have estimates that in 20 years the market will be worth $750bn. (Rolls-Royce PLC, 2011). Classified as a question mark is the marine segment as orders level drop 8% in 2011, (Bloomberg, 2012) but, with a forecast demand of $340bn in the next 20 years, it has the potential of becoming a star instead of a dog. (Rolls-Royce PLC, 2011)
Boston matrix for Rolls Royce PLC
High
Low
High
Star
Energy
Question mark
Marine
Low
Cash Cow
Civil aerospace
Defence Aerospace
Dog
Market share
Market growth
Supporting these classifications is the trend on revenue by segment; Civil and Defence aerospace maintain a constant growth, the Energy segment up until 2010 had a steady growth and is predicted to continue in 2012, and as shown, the future of the Marine segment seems uncertain with revenue levels going down.
Source: Rolls Royce Group PLC. (2011). Annual Report 2007 – 2011. London.
Theoretically, it is important to analyse revenue by region as it demonstrates the location of their main customers and helps explain their business model. North America and Europe represent Rolls Royce main revenue stream, powering airplanes from renowned companies like Airbus and Boeing. Additionally, Rolls Royce strategic direction passes through the Asian market that is expected to have a fast growth, (IStockAnalist, 2010) and are securing it by winning a $1.8bn contract from Air China, (BBC, 2010)
Source: Rolls Royce Group PLC. (2011), Annual Report 2011. London.
Internal architecture
After analysing the product market it is imperative to examine the internal architecture, looking at performance measures, reward/ punishment and partition decision rights, as it describes the key aspects of the firm. (Smith and Clifford, 2001)
A key indicator of performance measure is ROCE, as it measures the effectiveness of the firm on using its resources. By analysing the graph below we can perceive that Rolls Royce is operating effectively, deduce they manage costs efficiently and have a healthy bottom line.
Source: Rolls Royce Group PLC. (2011), Annual Report 2011. London.
Another indicator to analyse the performance of a firm is the amount of dividends given to shareholders; typically a firm that is performing well is capable to pay high dividends to its shareholders. By having a high ROCE it is expected that Rolls Royce enables capital to reward shareholders for the money invested in their businesses. This is the case in Rolls Royce as we can observe a rise in dividend per share regardless of the drastic change in dividend growth.
Source: Rolls Royce Group PLC. (2011), Annual Report 2011. London.
Despite the increasing levels of ROCE and dividends paid, when comparing the efficiency of their operations with their main competitors, Pratt & Whitney and General Electric, it is evident that they are not managing their resources effectively due to the variance of their operating margin. This may have resulted due to numerous problems like the engine failure in the Quantas A380 in 2009 (BBC, 2009) that affected Rolls Royce reputation, to the radical measures of 80000 job’s cut in 2008. (Financial Times, 2008)
Source: Morningstar (2012)
Even though Rolls Royce operating margin is far from perfect, the fact is, Rolls Royce continues to increase its order book and revenues due to its technological innovation in the industry, making the Research and Development centres its main competitive advantage. This has its rewards as they won the deal to power Boeing’s conceptual widebody instead of the favourite, GE. (Flight Global, 2012)
In light of success we can see that Rolls Royce rewards senior management through great increases in their salaries. In 1987 the highest paid executive had a salary 9 times higher than the average of all employees while the executive director was 6.1, by 2002 these figures where 28.9 for the executives and 18.2 for the executive directors (Lazonick, 2002). These figures don’t seem reasonable since nowadays Rolls Royce is cutting 320 jobs in Britain (Thompson Reuters, 2013), a sign of disrespect for Rolls Royce workforce. But as was stated, Rolls Royce develops partnerships with a diversified number of employees, for the entry of new engineers and managers to the firm.
Understanding the supply chain of Rolls Royce is fundamental as 70% of the values of the parts that comprise the engine come from other manufacturers (Rolls Royce, 2012) and many of its operations are outsourced to countries like Singapore and Germany. Currently, the strategy of Rolls Royce is to have dual sources of manufacturing supplies (Jeffery’s, 2010) having 660 preferred suppliers and a total of over 8000 suppliers around the world (Rolls Royce, 2012). This creates an assurance to not delay any projects and enables Rolls Royce to complete all of its orders on time.
The government also possesses an influential role as they own “golden shares” preventing any hostile takeover for Rolls Royce. Additional they exercise a great influence on taxes, legislations, trade agreements and policies concerning Rolls Royce.
Capital Market
In correlation with the product market and the internal architecture, it is not a surprise that Rolls Royce manages to have low levels of debt. In fact, it is visible, that Rolls Royce debt ratio is considerably lower than the industry and sector they operate in. Having said that, it shows that the managers are not willing to risk borrowing a lot of capital, (which could bring greater profits), since they are already well rewarded compared to the average employees.
Rolls Royce
Company
Industry
Sector
LT Debt to equity
25.93
308.95
51.26
Total debt to equity
26
373.48
74.9
Source: Reuters UK, Rolls Royce PLC
Furthermore, looking at their share price, it consolidates the arguments stated above, as currently Rolls Royce is performing exceptionally well in the capital market. Additionally, it is clear the increase of share price over the index, demonstrating they are performing above the market expectations. For shareholders these statistics bring comfort as it demonstrates the rise in value of the company which in their interest will bring more dividends
Rolls Royce Stock Exchange
Source: Reuters UK, Rolls Royce PLC
Conclusion and Recommendations
Assessing all the aspects of Rolls Royce business model I conclude that throughout history managers were able to give the right past for the strategic direction of Rolls Royce. Nowadays, Rolls Royce is an established company in the aerospace industry and is able to compete with the top performers of the market. Predicted to increase its order book in the following years, joined with an increase in revenues, Rolls Royce seems to be in the right path, but, in my view, there is still plenty of room for improvement. First, there should be a greater effort in entering the Asian market as China, India and Japan are becoming leading economies, and are in the need to upgrade their technological resources to sustain the rapid growth. Secondly, Rolls Royce should take advantage of it current debt ratio by borrowing more money to invest in technology so that they can upgrade their product portfolio before it gets saturated by the market. This extra risk would also make investors invest more as they would expect a greater dividend for the increase of risk in the stock. Thirdly, there should be a greater control over the operations and suppliers in order to create greater efficiency. A final idea would be to vertically integrate with a main supplier, exercising control over them to apply a lean production scheme, for example Just-in-Time, to promote control, efficiency and a reduction in operating costs.
References
Bbc.co.uk (2004) BBC – Derby – Around Derby – Rolls-Royce Centenary. [online] Available at: http://www.bbc.co.uk/derby/features/2004/05/rolls_royce_centenary/timeline.shtml [Accessed: 14 Feb 2013].
BBC News (2010) Rolls isolates A380 engine fault. [online] Available at: http://www.bbc.co.uk/news/business-11740915 [Accessed: 14 Feb 2013].
BBC News (2010) Rolls-Royce wins $1.8bn contract. [online] Available at: http://www.bbc.co.uk/news/business-11808623 [Accessed: 14 Feb 2013
Bloomberg (2013) Daimler, Rolls-Royce Clinch $4.8 Billion Tognum Takeover With Higher Offer. [online] Available at: http://www.bloomberg.com/news/2011-05-16/tognum-accepts-increased-rolls-royce-daimler-offer-valued-at-4-8-billion.html [Accessed: 14 Feb 2013].
Financial Times (2008) More than 80,000 jobs cut in just five days – FT.com. [online] Available at: http://www.ft.com/cms/s/0/c08dcf20-b7f3-11dd-ac6d-0000779fd18c.html#axzz2KqyHvwVc [Accessed: 14 Feb 2013].
Financial Times (2008) Rolls-Royce hopes to ride out market storm as orders surge – FT.com. [online] Available at: http://www.ft.com/cms/s/0/84f3fb5c-5951-11dd-90f8-000077b07658.html#axzz2KkAqfwbP [Accessed: 14 Feb 2013].
Financial Times (2011) Rolls-Royce wins exclusivity on Airbus engine – FT.com. [online] Available at: http://www.ft.com/cms/s/0/125a3abe-9c21-11e0-acbc-00144feabdc0.html#axzz2KiA5P3hN [Accessed: 14 Feb 2013].
Flightglobal.com (2012) Rolls-Royce pushes new engine concept for 777X. [online] Available at: http://www.flightglobal.com/news/articles/rolls-royce-pushes-new-engine-concept-for-777x-369294/ [Accessed: 14 Feb 2013].
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