JET ENGINE MAKERS DEFY THE LAW OF GRAVITY
Prices for 777 engines keep plunging. So why are manufacturers flying high?
Locked in a spirited price war to supply engines for Boeing Co.'s new 777 airliner, the industry's Big Three seem to be practically giving their biggest engines away. General Electric, Pratt & Whitney, and Rolls-Royce are selling high-thrust turbines for up to 75% below list prices--too little to earn a payback on total investments of more than $4 billion. With more expensive projects in the works, it's hard to see how anyone can make a buck.
Overall, though, the Big Three are making money--a lot of it. At General Electric Co.'s jet-engine division, operating income rose 26%, to $1.2 billion, last year. The Pratt & Whitney unit of United Technologies Corp. saw a 39% increase, to $530 million. Rolls-Royce PLC's jet-engine unit posted a 92% gain, to $269 million, including $46 million from newly acquired Allison Engine Co.
How long can they ieep up this feat of levitation? So far they've done it through rigorous cost-cutting--as well as with strong results from other, less competitive businesses, such as spare parts, maintenance, and engines for smaller aircraft, high-speed ferries, and the like. That has given them sustenance for the war over 777 orders. Each hopes to win enough volume to bring down manufacturing costs and eventually earn a return on its share of that $4 billion investment. Right now, analysts estimate the engines are selling for only about half their full cost, once development and overhead are figured in. As Charles L. Chadwell, GE's vice-president for commercial engines, dryly observes: "It's not much fun to make things and not make any money off them."
It might become even less amusing. First, the engine makers have already reduced their costs drastically, so the additional cuts they're counting on will be excruciating. Second, the ferocious competition over 777 engine orders threatens to spread to parts of the business that have been relatively sheltered. Pratt & Whitney President Karl J. Krapek worries that the rules of the once-lucrative engine game may have changed for good: "Right now the business does seem a little irrational."
POWER DESIGN. Things might have turned out differently. A year ago, it seemed that supplying 777 engines would be highly profitable for at least two of the competitors. Pratt & Whitney's PW4084 engine had won more than half of all orders for the 777. It looked as if GE would settle into second place and Rolls might disappear altogether.
But Rolls, far from packing up its slide rule, came out of nowhere with rock-bottom pricing to beat its American rivals in two significant bids, including one for longtime Pratt customer Singapore Airlines Ltd. Now, Rolls shares top billing with Pratt. GE still lacks certification from the Federal Aviation Administration for long flights over water because of early problems with parts burning up at high temperatures. While GE expects FAA clearance soon, the whole experience has been painful. It lags in 777 share despite spending the most--more than $1.5 billion in research and development. It will probably be at least 10 years before the program breaks even, Chadwell says--twice as long as GE managers thought when they committed to the project.
To cope with low prices, all three engine makers have blasted away at costs. They have pared about 40% of their workforces and shuttered millions of square feet of manufacturing and office space. GE is subcontracting more. And it is moving subassembly of fans, airfoils, and the like from Cincinnati to cheaper locations in Kansas and North Carolina. The companies have cut supplier rolls and squeezed R&D spending. Yet they must pursue still more cuts. "We have to be relentless on cost reductions to preserve position in the marketplace," says George A. David, chief executive of United Technologies.
At the same time, each company is trying to make the most of its own strengths. GE intends to turn its GE90 from a headache into an asset by using a version on future, stretched models of the Boeing 747 or Airbus A340. The GE90 is designed for more power than the older engines of Pratt and Rolls. Meanwhile, GE has combined its spare-parts and engine-overhaul businesses into a fast-growing $2 billion unit. On Mar. 22, GE announced a 10-year, $2.3 billion deal to maintain British Airways PLC's GE, Rolls, and Pratt engines.
SELLING HUSH KITS. Pratt aims to hold its position in the widebody market by trumpeting the reliability of its PW4084. Its Pratt & Whitney Canada Inc. division is doing a booming business in turboprop and turbofan engines for small commuter craft and business jets. Pratt also is trying to build a commercial space-launch business in cooperation with Russia's Energomash, using the same rockets that once powered Soviet intercontinental missiles. "Hush kits" to quiet its 1960s and 1970s engines are another good business.
For Rolls, the key to success is low price. Some analysts say Rolls's claim that it will make a profit on the Singapore 777 order may rely on projected cost savings of 40% over the next four years. Like GE and Pratt, Rolls is stepping up efforts to win international military orders--which means that profitable niche is coming under price pressure as well.
As a respite from price wars, the engine makers would dearly love more single-source deals. Being the only supplier for a given plane provides pricing power and the certainty that development costs will be spread over a large base. Sole sourcing can be good for airlines and aircraft makers, too. For the airlines, it's easier to maintain one make of engine. For aircraft manufacturers, wing struts are easier to build if they only have to accommodate one type of engine.
Both GE and Pratt were hoping to win sole-source status on McDonnell Douglas Corp.'s new MD-95 aircraft. Instead, the initial order, from discount carrier ValuJet Airlines Inc., went to a partnership of Rolls and BMW. The next major skirmish in the engine wars will be powering the so-called Asian Express--a 100-passenger jet planned by a Chinese and Korean consortium. Pratt's Krapek says his company will build the engine only if it can win a sole-source order. But that seems an unlikely outcome. Earning a return on a jet engine will be no picnic. With prices under ever-growing pressure, it will be tough to keep profits up.By Tim Smart in New Haven, with Seanna Browder in Seattle and Heidi Dawley in LondonReturn to top