THE COMPETITIVENESS OF THE UK INDUSTRY Derek Lindsay Braddon, Keith Hartley

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Derek Lindsay Braddon, Keith Hartley. THE COMPETITIVENESS OF THE UK AEROSPACE INDUSTRY. Applied Economics, Taylor & Francis (Routledge), 2007, 39 (06), pp.715-726. ￿10.1080/00036840500448391￿. ￿hal-00581926￿

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THE COMPETITIVENESS OF THE UK AEROSPACE INDUSTRY

Journal: Applied Economics

Manuscript ID: APE-05-0188.R1

Journal Selection: Applied Economics

Date Submitted by the 20-Sep-2005 Author:

JEL Code: L93 - Air Transportation <

Keywords: Aerospace Industry, Competitiveness

Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Page 1 of 59 Submitted Manuscript Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 4 5 6 7 8 9 10 THE COMPETITIVENESS OF THE UK 11 AEROSPACE INDUSTRY 12 13 14 15 16 17 18 19 20 21 For Peer Review 22 23 24 25 26 27 28 29 Abstract 30 31 The aerospace industry is often regarded as one of Britain’s last remaining 32 world class, high technology manufacturing industries and this paper 33 34 assesses its international competitiveness. Various statistical indicators are 35 used to measure competitiveness, based on published data at the industry 36 and firm level, supplemented with information derived from company 37 interviews. Indicators include productivity, output, firm size, development 38 time-scales, labour hoarding, exports and profitability. The empirical 39 results of this paper suggest that, over the period 1980-2000, the UK 40 41 aerospace industry improved its competitiveness compared with the USA 42 and the EU. 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

1 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript Page 2 of 59 Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 Introduction 4 5 6 The UK aerospace industry is often regarded as one of “Britain’s last remaining 7 8 world class, high technology manufacturing industries” (SBAC, 2000, p3; IGT, 9 10 2003). This paper assesses the international competitiveness of the industry. 11 12 13 Competitiveness is determined by, and reflected in, price-cost factors and non- 14 15 price factors. Price-cost factors reflect industry and company efficiency (eg. 16 17 18 factor productivity; lean manufacturing), the opportunities for achieving 19 20 economies of scale, scope and learning and the extent of rivalry. Non-price 21 For Peer Review 22 factors include research and development (R&D), development time-scales, 23 24 25 delivery schedules, export finance, reliability and the provision of spares and 26 27 support over the life-cycle. A related taxonomy is that competitiveness is 28 29 embodied in five competitive forces comprising threats from new entrants and 30 31 32 substitute products and services, the bargaining power of buyers and suppliers and 33 34 rivalry amongst existing competitors. These five competitive forces are a function 35 36 37 of industry structure and determine long-run industry profitability (Porter, 1990, 38 39 p35). 40 41 The five competitive forces provide an analytical framework for assessing the UK 42 43 44 aerospace industry’s competitiveness. Various statistical indicators are used to 45 46 measure competitiveness, based on published data at the industry and firm level. 47 48 The indicators include productivity, output, firm size, development time-scales, 49 50 51 labour hoarding, exports and profitability. 52 53 54 55 56 57 58 59 60

2 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Page 3 of 59 Submitted Manuscript Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 The UK aerospace industry 4 5 6 The UK aerospace industry comprises firms involved in the design, development, 7 8 manufacture and support of , helicopters, missiles and space systems (eg. 9 10 satellites). It includes aircraft and systems, engines, equipment and maintenance, 11 12 13 repair and overhaul companies supplying military and civil markets in both the 14 15 UK and overseas. 16 17 18 Government is central to understanding aerospace industries in the UK and 19 20 elsewhere. Governments are major buyers of aerospace equipment for their 21 For Peer Review 22 armed forces and they can use their buying power to influence the size, structure, 23 24 25 conduct and performance of their national industries. Government also influences 26 27 the civil aircraft market through its allocation of national landing and over-flying 28 29 rights, its provision of financial support for civil aircraft development 30 31 32 programmes and exports, and its ownership and support for national airlines. In 33 34 the UK, both the aerospace industry and its airlines are privately-owned. 35 36 37 Table 1 shows some of the UK aerospace industry’s stylised facts. Over the 38 39 period 1980-2002, real sales and export shares increased whilst employment 40 41 declined substantially. Also, the relative contributions of military and civil 42 43 44 markets changed markedly, reflecting the disarmament following the end of the 45 46 Cold War. The R&D-intensity of the industry is reflected in some 10% of sales 47 48 devoted to R&D. Even these simple descriptive statistics showing rising trends in 49 50 51 export shares and a high proportion of output exported suggest that this is a 52 53 competitive industry. This position is reinforced by the fact that in 2002, about 54 55 two-thirds of UK civil aerospace sales were exported. 56 57 58 59 60

3 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript Page 4 of 59 Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 Table 1 here 4 5 6 7 8 The UK aerospace industry is highly imperfect comprising domestic monopolies 9 10 in military and civil aircraft (BAE Systems), helicopters (Agusta Westland), and 11 12 13 engines (Rolls-Royce), a duopoly in missiles (MBDA; Thales: Racal and Shorts 14 15 Missile Systems) and oligopoly in the equipment sector (BAE Avionics; Thales; 16 17 18 Smiths; ). The major UK aerospace firms are also partners in European 19 20 collaborative programmes. BAE is involved in (UK; 21 For Peer Review 22 ; ; Spain), (wings, representing 20% of the Airbus company) 23 24 25 and missiles (MBDA); AgustaWestland in joint European helicopter programmes 26 27 and Rolls-Royce is a partner in associated European collaborative engine projects. 28 29 BAE dominates the UK aerospace industry, accounting for some 75% of the 30 31 32 industry’s sales in 2002. BAE also dominates the UK defence market with its 33 34 involvement as a major supplier of air, land and sea systems as well as defence 35 36 37 electronics. 38 39 The UK aerospace industry has considerable development and manufacturing 40 41 assets overseas, especially in the USA. For example, BAE owns US avionics 42 43 44 firms and Rolls-Royce owns the US Allison engine company. In 2002, total 45 46 employment in the USA of UK aerospace industry assets was almost 26,000 47 48 personnel. Similarly, many overseas companies have either located in the UK or 49 50 51 purchased UK aerospace companies (eg. Goodrich; Thales). 52 53 Since the end of the Cold War, the UK, European and US aerospace industries 54 55 have experienced substantial consolidation. In the UK, major mergers and take- 56 57 58 overs led to the creation of BAE Systems (British Aerospace and GEC Marconi 59 60 Electronics), AgustaWestland (helicopters: a merger between Agusta/Italy and

4 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Page 5 of 59 Submitted Manuscript Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 Westland/UK, with the UK interest sold to Agusta in 2004) and the Thales 4 5 6 acquisition of Racal and Shorts Missile Systems. In Europe, EADS represented a 7 8 merger of Aerospatiale (France), Daimler Chrysler (Germany) and CASA 9 10 (Spain). US mergers and take-overs resulted in a smaller number of major 11 12 13 aerospace companies, forming a major competitive threat to UK and European 14 15 firms. acquired Rockwell and McDonnell Douglas; 16 17 18 acquired General Dynamics Aircraft, a merger of Lockheed and Martin Marietta 19 20 and the acquisition of Loral; Northrop acquired LTV Aircraft, then merged with 21 For Peer Review 22 Grumman followed by the acquisitions of Litton and Newport News Shipbuilding; 23 24 25 and Raytheon acquired Beech Aircraft, BAe Business Jet, TI Defence and Hughes 26 27 Aerospace and Defence. 28 29 30 31 32 A comparative assessment 33 34 The UK aerospace industry’s position in the world market can be assessed by 35 36 37 comparing it with the USA, the EU and other rivals. The US aerospace industry 38 39 dominates the world market. In 2000/02 and on the basis of sales and 40 41 employment, the US industry was some four times larger than the UK industry; 42 43 44 and if size indicates the opportunities for achieving economies of scale, learning 45 46 and scope, then the US industry has a competitive advantage over the rest of the 47 48 world. Outside the EU, other major rivals include Canada and Japan (Table 2). 49 50 51 Within the EU, the UK aerospace industry is the largest employer followed by 52 53 France, Germany and Italy. 54 55 56 57 58 Table 2 here 59 60

5 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript Page 6 of 59 Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 The five competitive forces 4 5 6 Assessing the industry using Porter’s five competitive forces model requires a 7 8 distinction between military and civil aerospace markets. In the UK military 9 10 market, the Government is a major buyer and funder of development programmes 11 12 13 and can use its buying power to regulate profits. Government also determines 14 15 entry and exit and typically UK defence contracts are subject to competitive 16 17 18 procurement allowing foreign firms to bid for such contracts. Usually, there is 19 20 significant rivalry between existing competitors, mainly European (EADS; 21 For Peer Review 22 Dassault; Saab) and US firms (Boeing; Lockheed Martin; Northrop Grumman; 23 24 25 Raytheon). Oligopoly in the world market results in close substitutes with rivalry 26 27 in combat aircraft and military helicopters. 28 29 However, the threat of new entry is limited, mainly because of high entry barriers 30 31 32 and costs due to the need for costly and fixed R&D expenditure which on defence 33 34 work is usually borne by government. Also, further entry barriers arise from 35 36 37 economies of scale and learning. Nonetheless, large defence electronics 38 39 companies provide an entry threat. Substitutes for an effective combat aircraft 40 41 take many years to develop (eg. 10+ years) and whilst buyers are budget- 42 43 44 constrained, they are not price-sensitive. Rivalry tends to be based on non-price 45 46 factors, especially R&D which determines the technical features of military 47 48 aircraft (eg. speed; range; weapons capability). 49 50 51 Civil markets are different, especially on the demand side, where governments are 52 53 not major buyers. UK airlines form a privately-owned oligopsony, dominated by 54 55 British Airways. Within the world market, there are large numbers of state-and 56 57 58 privately-owned airlines demanding large and . There are 59 60 also large numbers of buyers for business jets and for light aircraft for pleasure

6 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Page 7 of 59 Submitted Manuscript Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 use. On the supply side within the world market, there are duopolies in large jet 4 5 6 airliners (Airbus, Europe; Boeing, USA) and regional jet airliners (Bombardier, 7 8 Canada; Embraer, Brazil). The large jet industry is characterised by high 9 10 entry barriers, reflecting high R&D costs and scale and learning economies. 11 12 13 However, duopoly results in close substitutes for both regional and large civil 14 15 aircraft. Nonetheless, substitutes for a commercially-successful large jet airliner 16 17 18 might take some 6 years to develop with break-even occurring some 10-15 years 19 20 into production and pay-back periods extending a further 20 years or more. Even 21 For Peer Review 22 on regional jet airliners, orders for 40-60 aircraft are the minimum required for a 23 24 25 commercial launch. These unique economic characteristics of civil aircraft 26 27 development mean that this is not a market offering short-term profitability. 28 29 30 31 32 Duopoly prime contractors can use their buying power on major new programmes 33 34 to obtain favourable deals with their major suppliers, especially the engine 35 36 37 companies. The world aero-engine market is an oligopoly comprising Pratt and 38 39 Whitney (United Technologies, USA); General Electric, USA; Rolls-Royce, UK; 40 41 and Snecma, France. These companies compete vigorously for their engines to be 42 43 44 used on new civil aircraft programmes (eg. Airbus 380; Boeing 7E7). There is 45 46 similar rivalry between a small number of major equipment companies for a share 47 48 of such new projects. 49 50 51 52 53 Both the large and regional jet airliner industry has been characterised by exits. In 54 55 2003, the UK, as a prime contractor, exited from the regional jet airliner market 56 57 58 (similar exits occurred for , Netherlands and Fairchild Dornier, Germany). 59 60 However, a number of nations are seeking to enter the industry

7 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript Page 8 of 59 Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 (eg. China; Indonesia; Spain). For both existing and new entrants, Government is 4 5 6 involved in the civil aircraft market through the provision of state financial 7 8 support for new aircraft programmes. The UK Government provides a risk 9 10 sharing, repayable investment in the form of launch investment with repayments 11 12 13 through a levy on sales. Studies of international financial supports show that 14 15 “there is a very large imbalance in the absolute levels of support provided by other 16 17 18 governments to their civil aerospace industries, particularly the USA, and a 19 20 material imbalance with the rest of Europe”(IGT, 2003). Estimates show that the 21 For Peer Review 22 US support may be at least seven times and possibly as high as twelve times 23 24 25 greater than the level of support available in Europe. Despite the lower levels of 26 27 state support available, the UK industry has achieved significant success in 28 29 creating world-class competitors. However, nations are in a prisoner’s dilemma 30 31 32 subsidy war which extends to include local and regional government (eg. with 33 34 regions in various nations offering competitive subsidies to attract aerospace 35 36 37 firms, especially suppliers). 38 39 40 41 In the Porter model, industries in which the pressure from one or more of the five 42 43 44 competitive forces is intense are ones where few firms are very profitable for long 45 46 periods (Porter, 1990, p35). The UK aerospace industry has at least three intense 47 48 competitive forces, namely, powerful buyers in both military (government) and 49 50 51 civil markets (prime contractors), fierce competitive rivalry and substitute 52 53 products: hence the prediction that UK aerospace will have few firms which are 54 55 very profitable for long periods. The remainder of this paper assesses the UK 56 57 58 aerospace industry competitiveness using various statistical indicators mostly for 59 60 the period 1980 to 2000. Inevitably, there is no single ‘best’ indicator of

8 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Page 9 of 59 Submitted Manuscript Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 performance, so that a balanced assessment requires several performance 4 5 6 measures. 7 8 9 10 11 Assessing the Competitiveness of the UK Aerospace Industry 12 13 (i) Labour productivity 14 15 Productivity is one of the determinants of competitiveness. This section focuses 16 17 18 on industry labour productivity based on sales per employee, since this is the 19 20 measure for which international data are readily available. The UK aerospace 21 For Peer Review 22 industry’s labour productivity relative to the USA and the EU improved over the 23 24 25 period 1980 to 2000. The 1980 productivity gap between the UK on the one hand 26 27 and the EU and USA industries on the other was reduced substantially by 2000 28 29 (Table 3). 30 31 32 33 34 Table 3 here 35 36 37 38 39 The DTI publishes an annual Value Added Scoreboard which provides data for a 40 41 sample of UK and European companies (first published in 2002). These show 42 43 44 value added productivity defined as value added per employee and value adding 45 46 efficiency or wealth creation which is value added divided by input costs of 47 48 labour and equipment depreciation. For the combined sample of UK and 49 50 51 European companies, the rank correlation between VA per employee and VA 52 53 efficiency was r = 0.22; that between VA per employee and profitability was r = 54 55 0.174; and that between VA per employee and VA share of sales was r = 0.043, 56 57 58 none of which were significant. 59 60

9 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript Page 10 of 59 Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 Table 4 here 4 5 6 7 8 Table 4 shows that for aerospace and defence companies, the European average 9 10 for value added per employee was some 20% higher than the corresponding figure 11 12 13 for the UK. The high value added productivity companies comprised Dassault 14 15 Aviation, EADS and SAAB; and the lowest value added productivity company 16 17 18 was Bombardier (formerly Shorts, Belfast) whose productivity was 65% and 55% 19 20 of the UK and European averages, respectively. Comparing firms in similar 21 For Peer Review 22 markets, Dassault’s value added productivity was almost 90% higher than that for 23 24 25 BAE Systems; EADS productivity was some 40% higher than Airbus UK; but 26 27 Rolls-Royce productivity was some 15% higher than its French rival, Snecma. 28 29 Dassault scores highly on all the criteria shown in Table 4: value added 30 31 32 efficiency; a higher current value added efficiency than its four year average; a 33 34 middle position on vertical integration; and a high profit margin. However, the 35 36 37 rankings are sensitive to the choice of performance indicator. Using value added 38 39 efficiency (wealth creation), its four year average and profit margins, the UK 40 41 averages are slightly higher than those for Europe, with the UK also showing a 42 43 44 higher degree of vertical integration. A higher value added efficiency for the 45 46 average of UK companies compared with the European average reflects their 47 48 higher efficiency in creating wealth. 49 50 51 52 53 (ii) Output 54 55 Output is a major determinant of unit costs and hence competitiveness in the 56 57 58 aerospace industry. Larger output allows the greater ‘spreading’ of fixed R&D 59 60 costs and also results in learning economies which lead to rising productivity as

10 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Page 11 of 59 Submitted Manuscript Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 output increases. A limited interview survey of UK firms (reported in Braddon 4 5 6 and Hartley, 2002) found that learning remained important but it has been affected 7 8 by modern manufacturing techniques, new materials and business practices. The 9 10 interviews suggested that whilst learning is still relevant, “the curve might now be 11 12 13 steeper than it used to be”, that it has been affected by lean methods and supply 14 15 chain changes and that “on the Joint Strike Fighter, BAE is comparable to 16 17 18 Lockheed Martin.” Three further comments were made on learning economies. 19 20 First, that scale differences between the USA and the UK are not as important as 21 For Peer Review 22 they used to be. Second, that UK labour costs are lower. Third, that more capital- 23 24 25 intensive methods are now used since greater precision is needed for modern 26 27 aircraft manufacture which results in fewer opportunities for labour learning. 28 29 Overall, the consensus view was that UK aerospace unit cost curves were lower 30 31 32 than US unit cost curves. 33 34 35 36 37 There is also evidence of a major change in UK aerospace learning curves. 38 39 Between the 1950s and 1970s, UK learning curves tended to ‘flatten-out’ at about 40 41 100 units, reflecting the small-scale of UK aircraft output. For example, on eight 42 43 44 UK civil aircraft projects, average output was 143 units ranging from 53 units 45 46 ((VC10) to 440 units (Viscount). In contrast, US learning curves of that period 47 48 showed continuous learning (eg. up to 5000 units on the Phantom combat 49 50 51 aircraft). On eight large US jet airliners, average output by end-1974 was 525 52 53 units ranging from 100 units (Lockheed Tristar) to 1088 units (Boeing 727). 54 55 Currently, for some projects, UK learning curves now show continuous learning 56 57 58 reflecting a larger scale of output. 59 60

11 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript Page 12 of 59 Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 A distinction needs to be made between military and civil aircraft. Industry 4 5 6 performance on civil aircraft is probably a more accurate indicator of market 7 8 competitiveness: civil aircraft markets are less subject to state protection and 9 10 military projects are greatly affected by government procurement policies, 11 12 13 including export licensing regimes. On civil aircraft, the European Airbus is 14 15 achieving US scales of output. For example, on the , total 16 17 18 output exceeded 2100 units by end-2003. Here, it has to be remembered that 19 20 Airbus was a new entrant to the large jet airliner market as recently as 1970, when 21 For Peer Review 22 the market was dominated by US companies, namely, Boeing, McDonnell 23 24 25 Douglas and Lockheed. In 2004, there is an industry duopoly comprising Airbus 26 27 and Boeing. 28 29 30 31 32 Airbus is distinctive in being an example of a competitive and hence successful 33 34 European international collaborative organisation. It provides a ‘model’ for other 35 36 37 collaborative arrangements, especially for European military aerospace projects 38 39 (cf. Eurofighter Typhoon). Using scale of output, market penetration and market 40 41 share criteria, Airbus is a successful and competitive organisation (but the costs of 42 43 44 achieving this market position would need to be included in any economic 45 46 evaluation). Airbus differs from other European collaborations in at least three 47 48 ways. First, as a single company (now an integrated company), it represents a 49 50 51 different form of collaboration (cf. European collaborations 52 53 which are project-specific with the partner companies retaining their identity). 54 55 Second, Airbus is not constrained by the commitment to raise the technological 56 57 58 capability of the partner nations (eg. as occurred on collaborative military aircraft 59 60 projects). Indeed, Airbus is less constrained by juste retour: in fact, it is claimed

12 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Page 13 of 59 Submitted Manuscript Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 that the juste retour used by Airbus has been beneficial in creating areas of 4 5 6 technical expertise and specialisation (eg. BAE focus on wing technology for 7 8 Airbus: ITC, 2001). Third, to survive Airbus has to be competitive in responding 9 10 to the varied and changing demands of the world civil aircraft market. Unlike 11 12 13 military collaborations, there is no guaranteed market for Airbus aircraft (cf. the 14 15 partner nations on Eurofighter Typhoon which fund its R&D costs and provided 16 17 18 firm production orders for the aircraft). 19 20 21 For Peer Review 22 On military aircraft, the US aerospace industry has the benefit of a large protected 23 24 25 home market. The US Joint Strike Fighter (JSF, now the Lockheed Martin F-35) 26 27 illustrates the scale differences between the UK, other European nations and the 28 29 USA. The original planned requirement was 2852 JSF aircraft for the US Forces 30 31 32 compared with a UK requirement for 150 aircraft. Faced with such scale 33 34 differences in military markets, the UK can respond by reducing unit costs 35 36 37 compared with the USA; by exporting; and by international collaboration (eg. UK 38 39 involvement in Eurofighter Typhoon and JSF). On exports, the UK Hawk is a 40 41 good example achieving both high output levels (over 800 aircraft) and a high 42 43 44 proportion of output exported (almost 80% exported). Similarly, Eurofighter 45 46 shows how European collaboration results in output levels closer to those in the 47 48 USA and considerably greater than European national scales of output. For 49 50 51 example, the partner nation’s planned order for Eurofighter is 620 units, 52 53 comprising 232 units for the UK, 180 for Germany, 121 for Italy and 87 for 54 55 Spain. However, collaboration departs from the ‘ideal case’ leading to 56 57 58 inefficiencies associated with complex international management and monitoring 59 60 arrangements and restrictive work sharing requirements. UK estimates suggest

13 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript Page 14 of 59 Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 that the total development costs on the four nation Eurofighter were almost twice 4 5 6 as high as an alternative national aircraft; but typically, the UKs cost share 7 8 equates to one third of total development costs. Similarly, the scale economies 9 10 achieved on collaborative production programmes are in the region of half those 11 12 13 on national programmes; and delays on collaborative programmes average almost 14 15 one year (NAO, 2001). 16 17 18 19 20 (iii) Size of firms 21 For Peer Review 22 The US competitive advantage in the scale of output, especially for military 23 24 25 aircraft, is also reflected in its advantage in firm size. Large firms are able to 26 27 obtain economies of scale and scope and in recent years there has been 28 29 considerable merger activity creating larger aerospace firms. US firms dominate 30 31 32 the world’s top 10 aerospace firms, accounting for 7 out of the top 10 in 1996, 33 34 2000 and 2002. BAE Systems was the only UK aerospace company in the top 10 35 36 37 in 1996, 2000 and 2002, ranking fourth in each year. In contrast, the newly- 38 39 created EADS ranked third in 2000 and second in 2002 . 40 41 42 43 44 Table 5 shows the top 15 aerospace companies between 1996 and 2002. 45 46 Interestingly, 9 of the top 15 companies remain unchanged throughout the period 47 48 (including BAE Systems and Thales/Thomson-CSF). Comparisons with Boeing 49 50 51 for 2002 show the scale advantage of the US company: based on sales, EADS was 52 53 53% and BAE was 34% of the size of Boeing. Similarly, in aero-engines in 2002, 54 55 Rolls-Royce was 55% of the size of General Electric. Within the top 15, between 56 57 58 1996 and 2002, the UK and European firms have not achieved any substantial 59 60 increase in their average size in relation to the top US firms. This suggests that

14 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Page 15 of 59 Submitted Manuscript Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 the US aerospace mergers after 1996 have been more successful in creating 4 5 6 relatively larger firms. Also, over this period, UK industry mergers have created 7 8 relatively larger aerospace firms than in Europe. 9 10 11 12 13 Table 5 here 14 15 16 (iv) Development time-scales 17 18 19 The time taken to develop an aircraft from start to delivery is a further indicator of 20 21 competitiveness.For Traditionally, Peer the US Reviewaerospace industry developed both civil 22 23 and military aircraft faster than the UK and European industries. For example, 24 25 26 between 1945 and 1969, the average UK development times for military aircraft 27 28 were 8 years 4 months compared with 6 years 3 months for the USA; and for civil 29 30 31 aircraft, the average development times were 4 years and 4 months and 3 years 32 33 and 7 months, respectively (Elstub, 1969). 34 35 36 37 38 Since 1980, the position has changed. On large jet airliners, Airbus is now 39 40 competitive with Boeing on development times (where Airbus involves a UK 41 42 component on the wings, engines and other equipment). Table 6 shows 43 44 45 development times for a similar group of Airbus and Boeing civil aircraft, with 46 47 similarity defined by their characteristics. Airbus aircraft were developed some 4- 48 49 50 7% faster, with Airbus being faster from start to first flight, but slightly slower 51 52 from first flight to Certificate of Airworthiness. Interestingly, this evidence 53 54 confirms that European collaboration in civil aircraft has created a competitive 55 56 57 industrial organisation. Regression analysis of various measures of development 58 59 time against aircraft characteristics, a time-trend and a country of manufacture 60

15 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript Page 16 of 59 Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 dummy variable gave a significant and negative coefficient for the time-trend 4 5 6 only. As expected, the country of manufacture dummy was not significant. 7 8 9 10 11 Table 6 here 12 13 14 15 The traditional competitive advantage of the US industry in development times 16 17 18 for military combat aircraft is shown in the following regression equation. This 19 20 allows for combat aircraft characteristics: 21 For Peer Review 22 23 24 25 TCS = 143.71 – 0.12S + 2.32W* + 0.02R + 54.40CM + 0.39T 26 (1.97) (1.99) (2.69) (1.26) (2.36) (0.26) 27 _ 28 R2 = 0.70 29 30 31 32 where TCS = total time from contract start to service (months); 33 S = speed; W = weight; R = range; CM = a dummy variable for USA = 0 and rest 34 of world = 1; and T = a time-trend based on date of first flight. 35 The equation was based on a sample of 11 US, European, Russian and Japanese 36 37 modern combat aircraft (see also notes to Table 7). 38 39 40 41 The equation shows a significant and predicted positive impact of weight on 42 43 44 development times; but surprisingly, other aircraft characteristics, namely, speed 45 46 and range were not significant. The country of manufacture dummy is almost 47 48 significant, showing a substantial US advantage in development times (some 4.5 49 50 51 years). 52 53 54 55 On current generations of combat aircraft, development times are similar between 56 57 58 Europe and the USA, confirming that the US no longer has a competitive 59 60 advantage in this aspect of industry performance. On three current generation

16 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Page 17 of 59 Submitted Manuscript Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 European combat aircraft (Gripen; Rafale; Typhoon) average development times 4 5 6 were 181 months compared with an average of 209 months for two US combat 7 8 aircraft (F-22 and JSF, neither of which have yet entered service). Since the end of 9 10 the Cold War, development times have been ‘stretched’ reflecting defence budget 11 12 13 problems and less urgency due to a reduced threat. Using pairwise comparisons, 14 15 the European collaborative Typhoon has been developed in a considerably shorter 16 17 18 time, namely, 214 months, than the US F-22 aircraft which is due in service in late 19 20 2005 (231 months). Admittedly, the US F-22 is a more complex, high- 21 For Peer Review 22 performance aircraft which is more advanced than any of the current European 23 24 25 combat aircraft. Overall, the evidence shows that the traditional US competitive 26 27 advantage on development times for civil and military combat aircraft no longer 28 29 applies. 30 31 32 33 34 v) Labour hoarding 35 36 37 The speed at which firms vary their labour force in response to changes in output 38 39 is another indicator of their competitiveness. A slow response suggests labour 40 41 hoarding and labour retention policies. Once again, the US ‘model’ is of an 42 43 44 aerospace industry which adjusts its labour force quickly to variations in output. 45 46 The statistical evidence suggests that since 1980, the UK aerospace industry’s 47 48 employment has become more responsive to variations in output (cf Table 7: 49 50 51 equations (2) and (3)). Also, the UK industry’s employment responsiveness to 52 53 changes in output is considerably higher than for the French aerospace industry 54 55 and similar to that for the EU industry (Table 7: equations (1), (4) and (6)). 56 57 58 Moreover, whilst the UK industry’s employment responsiveness remains below 59 60

17 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript Page 18 of 59 Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 that for the US aerospace industry, there was evidence of it approaching US 4 5 6 levels. 7 8 9 10 11 Table 7 here. 12 13 14 15 Exports 16 17 18 Exports and market shares are often used as major indicators of competitiveness. 19 20 In 2000, civil and military exports accounted for 60% of the UK aerospace 21 For Peer Review 22 industry’s turnover. Civil aerospace sales accounted for almost 55% of the UK 23 24 25 industry’s turnover in 2000; and some two-thirds of this civil business was 26 27 exported with civil aerospace exports accounting for 36% of total UK industry 28 29 sales (SBAC, 2000). On civil aircraft, the UK industry designs and manufactures 30 31 32 the wings for Airbus; and UK firms are also suppliers of engines and equipment to 33 34 Airbus, Boeing and to the regional aircraft manufacturers. These exports reflect 35 36 37 the fact that the UK is a world leader in wings, aero-engines and equipment some 38 39 of which are represented on Airbus civil aircraft. 40 41 42 43 44 Airbus was a new entrant to the large jet airliner industry with its first deliveries 45 46 in 1974 to a market which had been dominated by US firms (Boeing; Lockheed; 47 48 McDonnell Douglas in the early 1970s). Since then Airbus has increased its share 49 50 51 of the world market for large civil aircraft, achieving a 38% share in 2000 with the 52 53 market changing from a US-dominated oligopoly to a European-US duopoly. 54 55 Table 8 shows the trends in Airbus penetration of the world market. Two points 56 57 58 can be made about entry time and costs. First, it took Airbus 21 years to achieve a 59 60 market share of over 30%. Second, Airbus entry involved substantial costs for

18 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Page 19 of 59 Submitted Manuscript Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 European taxpayers, especially in France and Germany and particularly for the 4 5 6 and A310. By December 2003, Airbus had delivered 780 A300/310 7 8 aircraft compared with 2109 units of the A320 family which is similar to Boeing 9 10 scale of output for its successful airliners. 11 12 13 14 15 Table 8 here. 16 17 18 19 20 The military-civil sales ratio has changed substantially since 1980 when military 21 For Peer Review 22 sales accounted for about 65% of the UK aerospace industry’s sales and civil sales 23 24 25 the remaining 35%. In 2000, military sales accounted for 46% of the UK 26 27 aerospace industry’s sales, shared equally between domestic and export customers 28 29 (SBAC, 2001). In comparison, the military-civil ratios of sales for the EU and 30 31 32 the US aerospace industries were 30/70 and 40/60, respectively. 33 34 35 36 37 Military aerospace exports dominated UK defence equipment exports over the 38 39 period 1980 to 2000, especially in the 1990s with sales to the Middle East. 40 41 However, defence exports are determined by both economic and political factors 42 43 44 which makes it difficult to assess competitiveness. Even standard competitiveness 45 46 measures such as equipment prices are misleading, since they can reflect different 47 48 national subsidies to producers, differences in national preferential purchasing, 49 50 51 various financial support arrangements (eg state export credits), offsets, a 52 53 willingness by the supplying nation to waive R&D levies and the provision of 54 55 gifts-in-kind (eg equipment and training free of charge). Equipment prices can 56 57 58 also be for the basic equipment or might include various amounts of spares, 59 60 training and support services. Political factors are also important, especially the

19 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript Page 20 of 59 Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 supplying nations views on the political and military importance of the buying 4 5 6 country (eg. allies and friends; ethical criteria; willingness of rival nations to 7 8 supply). 9 10 11 12 13 Table 9 shows examples of the unit prices of various military aircraft. Amongst 14 15 trainers, the UK Hawk appears to be competitive on price. This is confirmed by its 16 17 18 status as a world leader for subsonic combat aircraft with 27% share of the world 19 20 market compared with a 26% share for the USA over the period 1986 to 1997 21 For Peer Review 22 (based on volume data: DoS, 2000). For both trainers and combat aircraft, some 23 24 25 of the price data are for aircraft in the early stages of development whilst others 26 27 are for aircraft in-service (eg.in-service aircraft at 2000 included Hawk, Gripen, F- 28 29 15, F-16, Harrier and SU-27). Amongst combat aircraft, the F-16, Gripen and 30 31 32 SU-27 are relatively cheap, whilst the US F-15E and F-22 are costly aircraft, but 33 34 technically advanced. The collaborative Eurofighter Typhoon (with the UK as a 35 36 37 partner) is cheaper than the US F-15 and F-22 but more expensive than Rafale. If 38 39 the Lockheed Martin JSF is successful and its estimated costs are achieved 40 41 (major assumptions), it will be a competitive aircraft and a major threat to 42 43 44 Typhoon and Rafale. 45 46 47 48 Table 9 here. 49 50 51 52 53 Statistical analysis of the determinants of UK aerospace exports was constrained 54 55 by the available data. Some limited, exploratory equations were estimated and 56 57 58 examples are shown in Table 10. The time-trend variable gave the expected 59 60 significant and positive coefficient for civil exports; but a surprising negative

20 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Page 21 of 59 Submitted Manuscript Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 coefficient for total exports. The end of the Cold War resulted in a negative 4 5 6 impact on total and military exports. Passenger miles gave an expected positive 7 8 impact on total exports, but a surprising negative coefficient for civil exports. 9 10 There was no evidence of a ‘crowding-out’ effect from UK military equipment 11 12 13 spending. Military equipment imports were positively associated with total UK 14 15 military exports, which might reflect the general level of demand in world 16 17 18 military markets. 19 20 21 For Peer Review 22 Table 10 here. 23 24 25 26 27 A relatively new feature of the UK aerospace industry is its global dimension with 28 29 both inward and outward foreign direct investment. The UK industry has 30 31 32 considerable aerospace manufacturing assets overseas. In 2000, these subsidiaries 33 34 recorded sales of £5.55 billion and employed 47,000 personnel outside the UK. 35 36 37 Some 60% of these overseas sales and employment were located in the USA ( UK 38 39 firms with US subsidiaries included BAE, Rolls-Royce and Smiths), so allowing 40 41 UK firms to achieve entry into the US market, especially its defence market. 42 43 44 Similarly, some overseas companies have located in the UK or acquired UK 45 46 aerospace companies (eg. Bombardier/Shorts; Agusta-Westland; TRW; Thales). 47 48 As a result, the UK aerospace industry now comprises both UK and foreign- 49 50 51 owned companies located in the UK. 52 53 54 55 56 57 58 59 60

21 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript Page 22 of 59 Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 Profitability 4 5 6 In competitive markets, profitability can be regarded as the final indicator of 7 8 industry performance and competitiveness. Over the period 1985 to 2000, the UK 9 10 aerospace industry achieved the highest median profit rate on sales, exceeding 11 12 13 both the EU and the USA. The UK industry’s annual profitability exceeded that 14 15 of the EU in twelve of the sixteen years and exceeded that of the USA in ten of 16 17 18 the sixteen years. The data are shown in Table 11. It is, however, recognised that 19 20 national aerospace markets are imperfect: the EU and US markets are 21 For Peer Review 22 characterised by national monopolies and oligopolies, respectively, and both have 23 24 25 national preferential purchasing policies (eg Buy America Act). In principle, the 26 27 UK market is different with its competitive procurement policy for military 28 29 equipment, so that its profitability record is a more accurate reflection of 30 31 32 international competitiveness. Moreover, the UK industry’s profitability record 33 34 was achieved despite the US industry’s advantage with its larger scale output and 35 36 37 larger firms. 38 39 40 41 Table 11 here 42 43 44 45 46 Profitability data are also available at the company level and these are shown in 47 48 Table 12, based on the year 2000. There are two features of this Table. First, the 49 50 51 profitability of the two UK major aerospace firms, BAE and Rolls-Royce, 52 53 generally exceeded that of their major and much larger US rivals, namely, Boeing 54 55 and Lockheed Martin. Second, the profitability of some of the UK equipment 56 57 58 suppliers exceeded that of the much larger UK and US companies (BAE; RR; 59 60 Boeing; Lockheed Martin).

22 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Page 23 of 59 Submitted Manuscript Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 Conclusion 4 5 6 The UK aerospace industry is the largest in the EU. The USA is the UK 7 8 industry’s major rival and provides the ‘benchmark’ for assessing its performance. 9 10 On this basis and using the indicators reviewed in this paper, the UK industry 11 12 13 improved its competitiveness over the period 1980 to 2000. There were 14 15 improvements in labour productivity, output levels, development times, 16 17 18 employment responsiveness and export performance. The results are summarised 19 20 in Table 12. 21 For Peer Review 22 23 24 25 Table 12 here 26 27 28 29 Statistical indicators confirm past and current performance and competitiveness 30 31 32 but do not guarantee future successful competitiveness. The main problems 33 34 facing the UK aerospace industry arise from the lack of new R&D programmes to 35 36 37 provide the next generation of projects. Some of this new R&D will require 38 39 government funding (IGT, 2003). Technical change is also a challenge to the 40 41 future UK aerospace firm. The possible emergence of unmanned combat air 42 43 44 vehicles (UCAVs) could revolutionise air warfare and lead to the end of manned 45 46 combat aircraft and an increased emphasis on electronics and electronic warfare. 47 48 For civil aircraft, the UK’s future looks to be through an involvement in 49 50 51 collaborative Airbus programmes. Also, the future absence of any UK-designed 52 53 military and civil aircraft will mean the increasing importance of its equipment 54 55 suppliers. 56 57 58 59 60

23 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript Page 24 of 59 Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 Benchmarking against the US aerospace industry and continued competition with 4 5 6 its US rivals will provide a major competitive stimulus for the UK aerospace 7 8 industry. Evidence suggests that “the more a given manufacturing industry is 9 10 exposed to the world’s best practice high productivity industry, the higher its 11 12 13 relative productivity (the closer it is to the leader). Competition with the 14 15 productivity leader encourages higher productivity” (Bailey and Solow, 2001). 16 17 18 On this basis, part of an industry’s productivity disadvantage reflects 19 20 organisational slack and/or reluctance to change and innovate. Failure by the UK 21 For Peer Review 22 aerospace industry to adjust to change will mean more exits and the loss of its 23 24 25 world leader companies. 26 27 28 29 30 31 REFERENCES 32 33 AECMA (200; 2002). The European Aerospace Industry: Facts and Figures, 34 AECMA, Brussels. 35 36 37 Bailey, M.N. and Solow, R.M. (2001). International productivity comparisons 38 built from the firm level, Journal of Economic Perspectives, 15, 3, Summer, pp 39 .151-172. 40 41 Braddon, D. and Hartley, K. (2002), UK Aerospace Competitiveness Study. 42 Department of Trade and Industry, July. 43 44 45 DTI (2004). The Value Added Scoreboard, 2004, DTI, London. 46 47 DoS (2000). World Military Expenditures and Arms Transfers, 1998, US 48 Department of State, US Government Printing Office, Washington DC. 49 50 51 Elstub (1969). Productivity of the National Aircraft Effort, HMSO, London 52 53 Flight (1997; 2002; 2003). Aerospace Top 100, August, , 54 . 55 56 57 Janes (2001). Jane’s All the World’s Aircraft, Jane’s Information Group, 58 Coulsdon, Surrey. 59 60 ICT (2001). Competitive Assessment of US Large Civil Aerostructures Industry, US International Trade Commission, Washington DC, June.

24 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Page 25 of 59 Submitted Manuscript Document converted by PDFMoto freeware version The competitiveness of the UK aerospace industry 1 2 3 4 5 IGT (2003). An Independent Report on the Future of the UK Aerospace 6 Industry, Aerospace Innovation and Growth Team, DTI, London, June. 7 8 NAO (2001). Maximising the Benefits of Defence Equipment Co-operation, 9 National Audit Office, The Stationery Office, London. 10 11 12 Porter, M.E. (1990). The Competitive Advantage of Nations, Macmillan, 13 London. 14 15 SBAC (2000; 2002). UK Aerospace Facts and Figures, SBAC, London 16 17 18 19 20 21 For Peer Review 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

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1 2 3 Table 1. UK Aerospace Industry, 1980-2002 4 5 6 1980 2000 2002 7 Sales (£ billion, 12.90 18.85 16.14 8 2002 prices) 9 Employment 241,997 150,,651 117,256 10 11 R&D share of sales Na 10.0 10.8 12 (%) 13 Exports as share of 47 60 63 14 sales (%) 15 Civil share of sales 36 54 55 16 17 (%) 18 Military share of 64 46 45 19 sales (%) 20 For Peer Review 21 Note: Sales are unconsolidated sales which is the sum of each company’s total 22 23 aerospace turnover. 24 25 Source: SBAC (2002) 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

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1 2 3 Table 2. The World’s Aerospace Industries 4 5 6 Sales Sales Employment Employment 7 2000 2002 2000 2002 8 (Euro (Euro (000) (000) 9 billion, billion, 10 11 current current 12 prices) prices) 13 USA 105.6 102.7 595.9 531.9 14 EU 72.3 74.6 429.1 407.8 15 Japan 13.4 11.4 33.0 31.0 16 17 Canada 13.6 14.5 91.5 78.8 18 Others 9.4 9.0 70.0 103.0 19 Total 214.2 212.2 1219.5 1152.5 20 For Peer Review 21 Notes: 22 23 (i) USA and EU turnover is for consolidated turnover. For the EU, 24 consolidated turnover represents all sales to end-user customers and to 25 aerospace firms outside the EU. Employment figures at year end and are 26 based on direct employment. EU figures include the UK. 27 28 29 (ii) Others is an estimate excluding China and CIS 30 31 Source: AECMA (2000; 2002) 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

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1 2 3 Table 3 Labour Productivity (Aerospace), 1980 - 2000 4 5 6 UK EU USA 7 1980 Index 77 99 100 8 (US = 100) 9 2000 10 11 Sales per employee 12 Index (US=100) £96,183 £102,698 £108,012 13 (89) (95) (100) 14 15 Note: All sales figures are consolidated sales. US figures are based on AECMA 16 17 estimates. 18 Source: AECMA (2002) 19 20 21 For Peer Review 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

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1 2 3 4 5 Table 4. Value added Productivity: UK and European Companies, 2004 6 7 Company Value Value Value Value Operating 8 added per added added added profit as 9 employee efficiency efficiency: share of share of 10 11 (£000) (%) 4 year sales sales 12 average (%) (%) 13 (%) 14 All UK 44.7 143.4 149 30.1 4.4 15 Companies 16 17 All UK Aerospace 45.0 118.1 125 39.9 2.5 18 and Defence 19 BAE Systems 45.7 105.4 119 39.3 na 20 Rolls-Royce For 51.4 Peer 115.9 Review 121 34.8 3.4 21 Smiths 47.4 139.8 143 48.7 12.4 22 23 Airbus 49.1 120.9 na 26.5 4.6 24 Cobham 47.5 147.6 146 51.2 14.7 25 Bombardier 29.6 113.5 124 48.8 1.8 26 54.5 134.9 147 50.2 8.4 27 28 Dunlop Standard 50.1 152.9 163 43.9 14.5 29 Aerospace 30 49.1 140.8 141 45.2 11.4 31 EUROPE: 54.1 116.2 120 38.1 2.3 32 All European 33 34 Aerospace and 35 Defence 36 companies 37 EADS 67.7 112.4 109 33.4 0.3 38 Thales (F) 51.0 110.9 112 39.5 2.1 39 40 Finnmeccanica(It) 47.5 123.6 128 40.1 5.8 41 Snecma (F) 45.2 116.2 129 39.4 4.0 42 Dassault Aviation 85.2 155.7 147 43.1 14.6 43 (F) 44 SAAB (Sweden) 54.9 117.5 121 57.5 7.0 45 46 47 Notes: 48 49 (i) Value added (VA) efficiency is VA divided by labour costs and depreciation. The 50 DTI Scoreboard refers to this measure as wealth creation. 51 52 (ii) VA efficiency 4 year average shows that a company is becoming more efficient if 53 its current VA efficiency is higher than its 4 year average. 54 (iii) A high VA sales ratio shows a high degree of vertical integration. 55 (iv) The UK sample is based on the top 800 UK companies; and the European sample 56 is based on the top 600 European companies, including UK companies. 57 58 59 Source: DTI (2004) 60

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1 2 3 4 5 Table 5. Top 15 Aerospace Firms 6 7 2002 2000 1996 8 Firm Aerospace Firm Aerospace Firm Aerospace 9 Ranking Sales Ranking Sales Ranking Sales 10 11 ($m) ($m) ($m) 12 Boeing 53,344 Boeing 51,407 Lockheed 26,068 13 Martin 14 EADS (E) 28,182 Lockheed 23,977 Boeing 22,681 15 Martin 16 17 Lockheed 26,562 EADS 23,336 McDonnell 13,447 18 Martin Douglas 19 BAE 18,236 BAE 19,661 British 11,635 20 Systems For PeerSystems Review Aerospace 21 Northrop 18,126 Raytheon 15,443 Aerospatiale 9,948 22 23 Grumman (F) 24 Raytheon 17,449 United 12,358 United 8,852 25 Technologies Technologies 26 United 13,216 General 10,779 DASA (G) 8,636 27 Technologies Electric 28 29 General 11,141 Honeywell 9,988 Hughes 8,314 30 Electric Electronics 31 Honeywell 8,855 Northrop 7,782 Northrop 8,071 32 International Grumman Grumman 33 Thales (F) 8,035 Bombardier 7,112 Raytheon 7,769 34 35 Bombardier 7,194 Rolls-Royce 6,890 General 6,302 36 ( C ) Electric 37 General 6,970 TRW 6,237 Thomson- 6,264 38 Dynamics CSF (F) 39 40 Rolls-Royce 6,179 Thales 5,977 Allied Signal 5,714 41 Snecma (F) 6,130 Snecma 5,204 GEC (UK) 5,653 42 Finmeccanica 5,041 Mitsubishi 4,841 Rolls-Royce 4,616 43 (Italy) Heavy 44 Industries (J) 45 46 Average size: 47 UK v USA 63% 77% 61% 48 Average size: 49 Europe v 61% 67% 70% 50 USA 51 52 Average size: 53 EU v UK 97% 87% 113% 54 55 Notes: i) Sales figures are in current prices and are for aerospace sales only. Most 56 companies have other sales, but total sales figures are not reported here. 57 58 ii) C = Canada; E = Europe; F = France; G = Germany. 59 iii) Average size of firm is based on firms in the top 15. 60 Sources: Flight (1997; 2002; 2003)

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1 2 3 4 5 Table 6. Average Development Times for Civil Aircraft 6 7 Development Times Aircraft Characteristics 8 Aircraft (months) 9 Start to First Total Speed Weight Passengers Range 10 11 first flight Time (mph) (lbs) (miles) 12 flight to CoA 13 Airbus 14 (n=7) 43.4 13 56.4 595 325,179 252 4653 15 Airbus 16 17 (n=6) 43.8 11 54.8 602 318,748 250 4716 18 Boeing 19 (n=7) 48.9 9.9 58.7 606 388,078 240 4516 20 For Peer Review 21 Notes: 22 23 i. Airbus n=7 sample: A300;A310; A320; A319; A321; A340; A330. The sample 24 n=6 excluded the A300 with a first flight in 1972. All other Airbus airliners had a 25 first flight date of 1982-95. 26 ii. Boeing n=7 sample: B737 Next Generation; B747-400; B757; B767; BMD11; 27 B717-200, all with first flight dates of 1981-98. 28 iii. Weight is maximum take-off weight; months are rounded to nearest month; CoA 29 30 is award of Certificate of Airworthiness. 31 32 Source: Janes (2001) 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

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1 2 3 Table 7. Employment Equations 4 5 6 Dependent Coefficients of: _ 7 variable Constant Log t Log ,1 ,11 8 R2 d 8 Q Lt-1 9 1) LogLt 3.59* 0.38** -0.04** 0.42** 0.38 0.65 0.58 0.980 2.1 10 (UK) (2.35) (5.02) (4.74) (3.45) 11 12 2) LogLt 0.87 0.35** -0.02** 0.69* 0.35 1.14 0.31 0.968 1.3 13 (UK) (1.97) (5.64) (6.62) (15.12) 14 3) LogLt -2.65 0.65** -0.02* 0.69** 0.65 2.1 0.31 0.961 1.7 15 (UK) (1.21) (4.26) (2.75) (5.35) 16 4) LogLt 3.90** 0.41** -0.02** 0.39** 0.41 0.67 0.61 0.988 2.1 17 (EU) (4.55) (5.28) (3.34) (4.00) 18 5) LogLt 2.80** 0.42** -0.003 0.46** 0.42 0.77 0.54 0.985 2.4 19 (USA) (3.88) (5.19) (1.14) (8.17) 20 6) LogLt 4.21** 0.16* -0.01* 0.51** 0.16 0.33 0.49 0.96 2.0 21 For Peer Review (FR) (3.91) (2.35) (2.34) (5.26) 22 23 24 Notes: 25 26 i) All equations are log linear: logLt = log a + bt + c logQ + d log Lt-1 where ,1= c; 27 11 28 , = c/ 8; d = 1 - 8 where 8 = lagged adjustment of actual to desired employment. 29 30 ii) Lt = employment; t = an exponential time trend representing technology and the 31 capital stock; Q = value of turnover in constant 1999 prices (US $ millions); Lt-1 = 32 lagged dependent variable. 33 34 35 iii) Equations (1) and (3) included a dummy variable for end of Cold War (not 36 significant); equation (4) included a dummy for end of Cold War in 1991 37 (significant); equation (5) included slope shift dummies for mergers and dummies for 38 end of Cold War (none were significant); equation (6) also included a dummy for end 39 of the Cold War (not significant). 40 41 42 iv) Equations (1), (3), (5) and (6) based on 1980–2000; equation (2) based on 1948- 43 2000; equation (4) based on 1980-1999. Equations (1), (4) and (6) use consolidated 44 turnover; equations (2) and (3) use unconsolidated turnover. 45 46 2 47 v) t-ratios in brackets; R is adjusted for degrees of freedom; d = Durbin Watson 48 statistic; * significant at 5% level; ** significant at 1% level. 49 50 51 52 53 54 55 56 57 58 59 60

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1 2 3 Table 8. Airbus and Boeing Sales, 1974 - 2000 4 5 6 Gross 1974 1980 1985 1990 1995 2000 7 deliveries 8 (units) 9 Airbus 5 38 42 95 124 311 10 11 Boeing 12 (incldg 284 363 282 527 261 504 13 McDonnell 14 Douglas) 15 Airbus 16 17 share 1.7 9.5 13.0 15.3 32.2 38.2 18 (%) 19 20 Source: DTI (2002).For Peer Review 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

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1 2 3 Table 9. Military Aircraft Unit Prices 4 5 6 Aircraft Unit Price 7 (US$ millions) 8 Trainers 9 Hawk (UK) 18-21 10 11 MAKO (EADS) 22-25 12 KTX-2 (S. Korea) 18-20 13 Combat Aircraft 14 Eurofighter Typhhon 68 15 16 Rafale (France) 58 17 Gripen (Sweden) 35 18 F-15E (USA) 75 19 F-16 (USA) 24-25 20 F-18 E/F (USA) 50 21 For Peer Review 22 F-22 (USA) 183 23 Joint Strike Fighter (JSF:USA) 31-38 (different versions) 24 Harrier AV8B (UK-US) 36 25 Mitsubishi F-2 (Japan) 115 26 27 SU-27 (Russia) 35 28 29 Sources: Variuos aviation and defence magazines (eg Defense News; Aviation 30 Week; Janes Defence Weekly; Flight; Fug Revue; Air Forces Monthly). All data are 31 for 1999, 2000 or 2001. 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

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1 2 3 Table 10. UK Aerospace Exports. 4 5 6 Dependent Constant Coefficients of: _ 2 7 Variable t Cold PASM DSP MIMP R d 8 War 9 Dummy 10 1) TEXP -6.95 -0.64** -1.66* 0.02** 0.0002 0.20 0.93 2.1 11 (1.89) (3.36) (2.72) (5.45) (0.55) (0.11) 12 2) TMX 4518.4 67.09 -1661.6* -0.23 2.53* 0.79 1.7 13 (1.78) (0.66) (2.48) (1.21) (2.14) 14 15 3) TCX 8417.7* 711.55** -207.5 -16.33** -0.12 0.85 1.9 16 (2.28) (3.54) (0.32) (4.69) (0.73) 17 Notes: 18 i) TEXP = total UK aerospace exports; TMX = total UK military aerospace exports; 19 TCX = total UK civil aerospace exports. All value data in £ billions, 1999 prices. 20 Equations (1) and (2) are based on 1980-1998; equation (3) based on 1980-2000. All 21 For Peer Review 22 equations are linear. 23 24 ii) t = time-trend; dummy variable (1,0) for the end of the Cold War was based on 25 either 1991 or 1992; PASM = world passenger miles (billions); DSP = UK military 26 equipment spending; MIMP = UK military equipment imports lagged one year. 27 28 29 iii) Other details as in Table 7. 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

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1 2 3 Table 11. Industry Profitability [Profit as percentage of sales (%)] 4 5 6 Aerospace Industry 7 Year 8 UK EU USA 9 10 11 1985 5.5 5.2 3.1 12 1986 5.0 4.2 2.8 13 1987 4.4 3.5 4.1 14 1988 3.4 3.8 4.3 15 1989 4.2 3.2 3.3 16 17 1990 2.8 2.4 3.4 18 1991 2.2 2.4 1.8 19 1992 -1.2 -0.6 -1.4 20 1993 2.2 0.7 3.6 21 For Peer Review 22 1994 0.5 0.0 4.7 23 1995 5.4 0.0 3.8 24 1996 4.8 2.2 5.6 25 1997 6.2 3.9 5.2 26 27 1998 6.9 6.7 5.0 28 1999 6.4 6.8 6.5 29 2000 6.4 4.9 4.7 30 Median 4.6 3.4 4.0 31 32 33 Sources: AECMA; SBAC; USAIA 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

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1 2 3 Table 12. Competitiveness Indicators, 1980-2000 4 5 6 Indicator UK industry performance relative to 7 USA 8 1. Labour productivity Improving 9 2. Output (a) Civil Airbus achieving US scales of output 10 11 (b) Military UK/JSF = US scales of output 12 Eurofighter = higher output 13 3. Development times US no longer has competitive advantage 14 4. Labour hoarding UK employment responsiveness has 15 improved and is approaching US 16 17 levels. 18 5. Exports a. Military aerospace exports dominated 19 UK defence exports; 20 For Peer Reviewb. World leader for subsonic combat 21 aircraft; 22 23 c. Airbus: rising share of world market 24 6. Industry profitability Higher than USA 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

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1 2 3 THE COMPETITIVENESS OF THE UK AEROSPACE INDUSTRY 4 5 a b 6 Derek Braddon and Keith Hartley 7 8 9 Authors affiliation: 10 11 aSchool of Economics, Business School, University of the West of England, Bristol, 12 BS16 1QY e-mail: [email protected] 13

14 b 15 Centre for Defence Economics, University of York, Heslington, York, YO1 5DD e-mail: 16 [email protected] 17 18 19 Abstract 20 For Peer Review 21 Porter’s five competitive forces model provides an analytical framework for assessing 22 the UK aerospace industry’s competitiveness in this paper. Various statistical 23 indicators are used to measure competitiveness, based on published data at the industry 24 and firm level, supplemented with information from company interviews. The 25 26 indicators include productivity, output, firm size, development time-scales, labour 27 hoarding, exports and profitability. The empirical results of this paper suggest that, 28 over the period 1980-2000, the UK aerospace industry improved its competitiveness 29 compared with the USA and the EU. 30 31 32 33 34 Introduction 35 36 The UK aerospace industry is often regarded as one of “Britain’s last remaining world 37 class, high technology manufacturing industries” (SBAC, 2000, p3; IGT, 2003; TIC, 38 2005). This paper assesses the international competitiveness of the industry. 39 Competitiveness is determined by, and reflected in, price-cost factors and non-price 40 41 factors. Price-cost factors reflect industry and company efficiency (eg. factor 42 productivity; lean manufacturing), the opportunities for achieving economies of scale, 43 scope and learning and the extent of rivalry. Non-price factors include research and 44 development (R&D), development time-scales, delivery schedules, export finance, 45 reliability and the provision of spares and support over the life-cycle (for further 46 47 discussion on the meaurement of international competitiveness, see Manzur et al, 48 1999 and Kambhampati U.S., 2000). A related taxonomy is that competitiveness is 49 embodied in five competitive forces comprising threats from new entrants and 50 substitute products and services, the bargaining power of buyers and suppliers and 51 rivalry amongst existing competitors. These five competitive forces are a function of 52 industry structure and determine long-run industry profitability (Porter, 1990, p35). 53 54 55 The five competitive forces provide an analytical framework for assessing the UK 56 aerospace industry’s competitiveness. Various statistical indicators are used to 57 measure competitiveness, based on published data at the industry and firm level. The 58 indicators include productivity, output, firm size, development time-scales, labour 59 60 hoarding, exports and profitability.

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1 2 3 The UK aerospace industry 4 5 6 The UK aerospace industry comprises firms involved in the design, development, 7 manufacture and support of aircraft, helicopters, missiles and space systems (eg. 8 satellites). It includes aircraft and systems, engines, equipment and maintenance, 9 repair and overhaul companies supplying military and civil markets in both the UK 10 and overseas. 11 12 13 Government is central to understanding aerospace and similar industries in the UK 14 and elsewhere (see, for example, Bonte, 2003). Governments are major buyers of 15 aerospace equipment for their armed forces and they can use their buying power to 16 influence the size, structure, conduct and performance of their national industries. 17 18 Government also influences the civil aircraft market through its allocation of national 19 landing and over-flying rights, its provision of financial support for civil aircraft 20 development programmes and exports, and its ownership and support for national 21 airlines. In the UK,For both the aerospacePeer industry Review and its airlines are privately-owned. 22 23 Table 1 shows some of the UK aerospace industry’s stylised facts. Over the period 24 25 1980-2002, real sales and export shares increased whilst employment declined 26 substantially. Also, the relative contributions of military and civil markets changed 27 markedly, reflecting the disarmament following end of the Cold War. The R&D- 28 intensity of the industry is reflected in some 10% of sales devoted to R&D. Even 29 these simple descriptive statistics showing rising trends in export shares and a high 30 31 proportion of output exported suggest that this is a competitive industry. This position 32 is reinforced by the fact that in 2002, about two-thirds of UK civil aerospace sales 33 were exported. 34 35 Table 1. UK Aerospace Industry, 1980-2002 36 37 38 1980 2000 2002 39 Sales (£ billion, 12.90 18.85 16.14 40 2002 prices) 41 Employment 241997 150651 117256 42 43 R&D share of sales Na 10.0 10.8 44 (%) 45 Exports as share of 47 60 63 46 sales (%) 47 Civil share of sales 36 54 55 48 49 (%) 50 Military share of 64 46 45 51 sales (%) 52 53 Note: Sales are unconsolidated sales which is the sum of each company’s total 54 55 aerospace turnover. 56 57 Source: SBAC (2002) 58 59 The UK aerospace industry is highly imperfect comprising domestic monopolies in 60 military and civil aircraft (BAE Systems), helicopters (AgustaWestland), and engines (Rolls-Royce), a duopoly in missiles (MBDA; Thales: Racal and Shorts Missile

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1 2 3 Systems) and oligopoly in the equipment sector (BAE Avionics; Thales; Smiths; 4 5 Cobham). The major UK aerospace firms are also partners in European collaborative 6 programmes (see Bishop, 2003). BAE is involved in Eurofighter Typhoon (UK; 7 Germany; Italy; Spain), Airbus (wings representing 20% of the Airbus company) and 8 missiles (MBDA); AgustaWestland in joint European helicopter programmes and 9 Rolls-Royce is a partner in associated European collaborative engine projects. BAE 10 dominates the UK aerospace industry, accounting for some 75% of the industry’s 11 12 sales in 2002. BAE also dominates the UK defence market with its involvement as a 13 major supplier of air, land and sea systems as well as defence electronics. 14 15 The UK aerospace industry has considerable development and manufacturing assets 16 overseas, especially in the USA. For example, BAE owns US avionics firms and 17 18 Rolls-Royce owns the US Allison engine company. In 2002, total employment in the 19 USA of UK aerospace industry assets was almost 26,000 personnel. Similarly, many 20 overseas companies have either located in the UK or purchased UK aerospace 21 companies (eg. Goodrich;For Thales). Peer Review 22 23 Since the end of the Cold War, the UK, European and US aerospace industries have 24 25 experienced substantial consolidation (for a discussion of the welfare effects of 26 increased industrial concentration in manufacturing industries, see Gopinath et al, 27 2004). In the UK, major mergers and take-overs led to the creation of BAE Systems 28 (British Aerospace and GEC Marconi Electronics), AgustaWestland (helicopters: a 29 merger between Agusta/Italy and Westland/UK, with the UK interest sold to 30 31 Finmeccanica in 2004) and the Thales acquisition of Racal and Shorts Missile 32 Systems. In Europe, EADS represented a merger of Aerospatiale Matra (France), 33 Daimler Chrysler (Germany) and CASA (Spain). US mergers and take-overs resulted 34 in a smaller number of major aerospace companies, forming a major competitive 35 threat to UK and European firms. Boeing acquired Rockwell and McDonnell 36 37 Douglas; Lockheed Martin acquired General Dynamics Aircraft, a merger of 38 Lockheed and Martin Marietta and the acquisition of Loral; Northrop acquired LTV 39 Aircraft, then merged with Grumman followed by the acquisitions of Litton and 40 Newport News Shipbuilding; and Raytheon acquired Beech Aircraft, BAe Business 41 Jet, TI Defence and Hughes Aerospace and Defence. 42 43 44 A comparative assessment 45 46 The UK aerospace industry’s position in the world market can be assessed by 47 comparing it with the USA, the EU and other rivals. The US aerospace industry 48 dominates the world market. In 2000/02 and on the basis of sales and employment, 49 50 the US industry was some four times larger than the UK industry; and if size indicates 51 the opportunities for achieving economies of scale, learning and scope, then the US 52 industry has a competitive advantage over the rest of the world. Outside the EU, 53 other major rivals include Canada and Japan (Table 2). Within the EU, the UK 54 aerospace industry is the largest employer followed by France, Germany and Italy. 55 56 57 58 59 60

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1 2 3 Table 2. The World’s Aerospace Industries 4 5 6 Sales Sales Employment Employment 7 2000 2002 2000 2002 8 (Euro (Euro (000) (000) 9 billion, billion, 10 11 current current 12 prices) prices) 13 USA 105.6 102.7 595.9 531.9 14 EU 72.3 74.6 429.1 407.8 15 Japan 13.4 11.4 33.0 31.0 16 17 Canada 13.6 14.5 91.5 78.8 18 Others 9.4 9.0 70.0 103.0 19 Total 214.2 212.2 1219.5 1152.5 20 For Peer Review 21 Notes: 22 23 (i) USA and EU turnover is for consolidated turnover. For the EU, 24 consolidated turnover represents all sales to end-user customers and to 25 aerospace firms outside the EU. Employment figures at year end and are 26 based on direct employment. EU figures include the UK. 27 28 29 (ii) Others is an estimate excluding China and CIS 30 31 Source: AECMA (2000; 2002) 32 33 The five competitive forces 34 35 36 Assessing the industry using Porter’s five competitive forces requires a distinction 37 between military and civil aerospace markets. In the UK military market, the 38 Government is a major buyer and funder of development programmes and can use its 39 buying power to regulate profits. Government also determines entry and exit and 40 typically UK defence contracts are subject to competitive procurement allowing 41 42 foreign firms to bid for such contracts. Usually, there is significant rivalry between 43 existing foreign competitors, mainly European (EADS; Dassault; Saab) and US firms 44 (Boeing; Lockheed Martin; Northrop Grumman; Raytheon). Oligopoly in the world 45 market results in close substitutes with rivalry in combat aircraft and military 46 helicopters. However, the threat of new entry is limited, mainly because of high entry 47 barriers and costs due to the need for costly and fixed R&D expenditure which on 48 49 defence work is usually borne by government. Also, further entry barriers arise from 50 economies of scale and learning. Nonetheless, large defence electronics companies 51 provide an entry threat. Substitutes for an effective combat aircraft take many years 52 to develop (eg. 10+ years) and whilst buyers are budget-constrained, they are not 53 generally price-sensitive. Rivalry tends to be based on non-price factors, especially 54 55 R&D which determines the technical features of military aircraft (eg. speed; range; 56 weapons capability). 57 58 Civil markets are different, especially on the demand side, where governments are not 59 major buyers. UK airlines form a privately-owned oligopsony, dominated by British 60 Airways. Within the world market, there are large numbers of state-and privately- owned airlines demanding large and regional jet airliners. There are also large

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1 2 3 numbers of buyers for business jets and for light aircraft for pleasure use. On the 4 5 supply side within the world market, there are duopolies in large jet airliners (Airbus, 6 Europe; Boeing, USA) and regional jet airliners (Bombardier, Canada; Embraer, 7 Brazil). The large jet airliner industry is characterised by high entry barriers, 8 reflecting high R&D costs and scale and learning economies (Graham, 2001). 9 However, duopoly results in close substitutes for both regional and large civil aircraft. 10 Nonetheless, substitutes for a commercially-successful large jet airliner might take 11 12 some 6 years to develop with break-even occurring some 10-15 years into production 13 and pay-back periods extending a further 20 years or more. Even on regional jet 14 airliners, orders for 40-60 aircraft are the minimum required for a commercial launch. 15 These unique economic characteristics of civil aircraft development mean that this is 16 not a market offering short-term profitability. 17 18 19 Duopoly prime contractors can use their buying power on major new programmes to 20 obtain favourable deals with their major suppliers, especially the engine companies. 21 The world aero-engineFor market Peer is an oligopoly Review comprising Pratt and Whitney (United 22 Technologies, USA; General Electric, USA; Rolls-Royce, UK; and Snecma, France). 23 These companies compete vigorously for their engines to be used on new civil aircraft 24 25 programmes (eg. Airbus 380; Boeing 7E7). There is similar rivalry between a small 26 number of major equipment companies for a share of such new projects. 27 28 Both the large and regional jet airliner industry has been characterised by exits. In 29 2003, the UK as a prime contractor, exited from the regional jet airliner market 30 31 (similar exits occurred for Fokker, Netherlands and Fairchild Dornier, Germany). 32 However, a number of nations are seeking to enter the regional airliner industry (eg. 33 China; Indonesia; Spain). For both existing and new entrants, Government is 34 involved in the civil aircraft market through the provision of state financial support 35 for new aircraft programmes. The UK Government provides a risk sharing, repayable 36 37 investment in the form of launch investment with repayments through a levy on sales. 38 Studies of international financial supports show that “there is a very large imbalance 39 in the absolute levels of support provided by other governments to their civil 40 aerospace industries, particularly the USA, and a material imbalance with the rest of 41 Europe”(IGT, 2003). Estimates show that the US support may be at least seven times 42 and possibly as high as twelve times greater than the level of support available in 43 44 Europe. Despite the lower levels of state support available, the UK industry has 45 achieved significant success in creating world-class competitors. However, nations 46 are in a prisoner’s dilemma subsidy war which extends to include local and regional 47 government (eg. with regions in various nations offering competitive subsidies to 48 attract aerospace firms, especially suppliers). 49 50 51 In the Porter model, industries in which the pressure from one or more of the five 52 competitive forces is intense are ones where few firms are very profitable for long 53 periods (Porter, 1990, p35). The UK aerospace industry has at least three intense 54 competitive forces, namely, powerful buyers in both military (government) and civil 55 markets (prime contractors), fierce competitive rivalry and substitute products: hence 56 57 the prediction that UK aerospace will have few firms which are very profitable for 58 long periods. The remainder of this paper assesses the UK aerospace industry 59 competitiveness using various statistical indicators mostly for the period 1980 to 60 2000. Inevitably, there is no single ‘best’ indicator of performance, so that a balanced assessment requires several performance measures.

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1 2 3 4 5 Assessing the Competitiveness of the UK Aerospace Industry 6 7 (i) Labour productivity 8 9 Productivity is one of the determinants of competitiveness. This section focuses on 10 industry labour productivity based on sales per employee, since this is the measure for 11 12 which international data are readily available. The UK aerospace industry’s labour 13 productivity relative to the USA and the EU improved over the period 1980 to 2000. 14 The 1980 productivity gap between the UK on the one hand and the EU and USA 15 industries on the other was reduced substantially by 2000 (Table 3). 16 17 18 Table 3 Labour Productivity, 1980 - 2000 19 20 For UKPeer Review EU USA 21 1980 Index 77 99 100 22 (US = 100) 23 24 2000 25 Sales per employee 26 Index (US=100) £96183 £102698 £108012 27 (89) (95) (100) 28 29 30 Note: All sales figures are consolidated sales. US figures are based on AECMA 31 estimates. 32 Source: AECMA (2002) 33 34 35 36 The DTI publishes an annual Value Added Scoreboard which provides data for a 37 sample of UK and European companies (first published in 2002). These show value 38 added productivity defined as value added per employee and value adding efficiency 39 or wealth creation which is value added divided by input costs of labour and 40 equipment depreciation. For the combined sample of UK and European aerospace 41 companies, the rank correlation between VA per employee and VA efficiency was r = 42 43 0.22; that between VA per employee and profitability was r = 0.174; and that between 44 VA per employee and VA share of sales was r = 0.043, none of which were 45 significant. 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

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1 2 3 4 5 Table 4. Value added Productivity: UK and European Companies, 2004 6 7 Company Value Value Value Value Operating 8 added per added added added profit as 9 employee efficiency efficiency: share of share of 10 11 (£000) (%) 4 year sales sales 12 average (%) (%) 13 (%) 14 All UK 44.7 143.4 149 30.1 4.4 15 Companies 16 17 All UK Aerospace 45.0 118.1 125 39.9 2.5 18 and Defence 19 BAE Systems 45.7 105.4 119 39.3 Na 20 Rolls-Royce For 51.4 Peer 115.9 Review 121 34.8 3.4 21 Smiths 47.4 139.8 143 48.7 12.4 22 23 Airbus 49.1 120.9 na 26.5 4.6 24 Cobham 47.5 147.6 146 51.2 14.7 25 Bombardier 29.6 113.5 124 48.8 1.8 26 Meggitt 54.5 134.9 147 50.2 8.4 27 28 Dunlop Standard 50.1 152.9 163 43.9 14.5 29 Aerospace 30 Ultra Electronics 49.1 140.8 141 45.2 11.4 31 EUROPE: 54.1 116.2 120 38.1 2.3 32 All European 33 34 Aerospace and 35 Defence 36 companies 37 EADS 67.7 112.4 109 33.4 0.3 38 Thales (F) 51.0 110.9 112 39.5 2.1 39 40 Finnmeccanica(It) 47.5 123.6 128 40.1 5.8 41 Snecma (F) 45.2 116.2 129 39.4 4.0 42 Dassault Aviation 85.2 155.7 147 43.1 14.6 43 (F) 44 SAAB (Sweden) 54.9 117.5 121 57.5 7.0 45 46 Notes: 47 (i) Value added (VA) efficiency is VA divided by labour costs and depreciation. The 48 DTI Scoreboard refers to this measure as wealth creation. 49 (ii) VA efficiency 4 year average shows that a company is becoming more efficient if 50 its current VA efficiency is higher than its 4 year average. 51 52 (iii) A high VA sales ratio shows a high degree of vertical integration. 53 (iv) The UK sample is based on the top 800 UK companies; and the European sample 54 is based on the top 600 European companies, including UK companies. 55 56 Source: DTI (2004) 57 58 59 Table 4 shows that for aerospace and defence companies, the European average for 60 value added per employee was some 20% higher than the corresponding figure for the UK. The high value added productivity companies comprised Dassault Aviation,

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1 2 3 EADS and SAAB; and the lowest value added productivity company was Bombardier 4 5 (formerly Shorts, Belfast) whose productivity was 65% and 55% of the UK and 6 European averages, respectively. Comparing firms in similar markets, Dassault’s 7 value added productivity was almost 90% higher than that for BAE Systems; EADS 8 productivity was some 40% higher than Airbus UK; but Rolls-Royce productivity was 9 some 15% higher than its French rival, Snecma. Dassault scores highly on all the 10 criteria shown in Table 4: value added efficiency; a higher current value added 11 12 efficiency than its four year average; a middle position on vertical integration; and a 13 high profit margin. However, the rankings are sensitive to the choice of performance 14 indicator. Using value added efficiency (wealth creation), its four year average and 15 profit margins, the UK averages are slightly higher than those for Europe, with the 16 UK also showing a higher degree of vertical integration. A higher value added 17 18 efficiency for the average of UK companies compared with the European average 19 reflects their higher efficiency in creating wealth. 20 21 (ii) Output For Peer Review 22 23 Output is a major determinant of unit costs and hence competitiveness in the 24 25 aerospace industry. Larger output allows the greater ‘spreading’ of fixed R&D costs 26 and also results in learning economies which lead to rising productivity as output 27 increases (see Frantzen D, 1998). A limited interview survey of UK firms 28 (undertaken in 2001/02) found that learning remained important but it has been 29 affected by modern manufacturing techniques, new materials and business practices. 30 31 The interviews suggested that whilst learning is still relevant, “the curve might now 32 be steeper than it used to be,” that it has been affected by lean methods and supply 33 chain changes and that “on the Joint Strike Fighter, BAE is comparable to Lockheed 34 Martin.” (Braddon and Hartley, 2002). Three further comments were made on 35 learning economies. First, that scale differences between the USA and the UK are not 36 37 as important as they used to be. Second, that UK labour costs are lower. Third, that 38 more capital-intensive methods are now used since greater precision is needed for 39 modern aircraft manufacture which results in fewer opportunities for labour learning. 40 Overall, the consensus view was that UK aerospace unit cost curves were lower than 41 US unit cost curves. 42 43 44 There is also evidence of a major change in UK aerospace learning curves. Between 45 the 1950s and 1970s, UK learning curves tended to ‘flatten-out’ at about 100 units, 46 reflecting the small-scale of UK aircraft output. For example, on eight UK civil 47 aircraft projects, average output was 143 units ranging from 53 units ((VC10) to 440 48 units (Viscount). In contrast, US learning curves of that period showed continuous 49 50 learning (eg. up to 5000 units on the Phantom combat aircraft). On eight large US jet 51 airliners, average output by end-1974 was 525 units ranging from 100 units 52 (Lockheed Tristar) to 1088 units (Boeing 727). Currently, for some projects, UK 53 learning curves now show continuous learning reflecting a larger scale of output (for a 54 wider discussion of learning curves in a related industry, see Chung, 2001). 55 56 57 A distinction needs to be made between military and civil aircraft. Industry 58 performance on civil aircraft is probably a more accurate indicator of market 59 competitiveness: civil aircraft markets are less subject to state protection and military 60 projects are greatly affected by government procurement policies, including export licensing regimes. On civil aircraft, the European Airbus is achieving US scales of

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1 2 3 output. For example, on the Airbus A320 family, total output exceeded 2100 units by 4 5 end-2003. Here, it has to be remembered that Airbus was a new entrant to the large 6 jet airliner market as recently as 1970, when the market was dominated by US 7 companies, namely, Boeing, McDonnell Douglas and Lockheed. In 2004, there is an 8 industry duopoly comprising Airbus and Boeing. 9 10 Airbus is distinctive in being an example of a competitive and hence successful 11 12 European international collaborative organisation. It provides a ‘model’ for other 13 collaborative arrangements, especially for European military aerospace projects (cf. 14 Eurofighter Typhoon). Using scale of output, market penetration and market share 15 criteria, Airbus is a successful and competitive organisation (but the costs of 16 achieving this market position would need to be included in any economic 17 18 evaluation). Airbus differs from other European collaborations in at least three ways. 19 First, as a single company (now an integrated company), it represents a different form 20 of collaboration (cf. European military aircraft collaborations which are project- 21 specific with the partnerFor companies Peer retaining Review their identity). Second, Airbus is not 22 constrained by the commitment to raise the technological capability of the partner 23 nations (eg. as occurred on collaborative military aircraft projects). Indeed, Airbus is 24 25 less constrained by juste retour: in fact, it is claimed that the juste retour used by 26 Airbus has been beneficial in creating areas of technical expertise and specialisation 27 (eg. BAE focus on wing technology for Airbus: ITC, 2001). Third, to survive Airbus 28 has to be competitive in responding to the varied and changing demands of the world 29 civil aircraft market. Unlike military collaborations, there is no guaranteed market for 30 31 Airbus aircraft (cf. the partner nations on Eurofighter Typhoon which fund its R&D 32 costs and provided firm production orders for the aircraft). 33 34 On military aircraft, the US aerospace industry has the benefit of a large protected 35 home market. The US Joint Strike Fighter (JSF, now the Lockheed Martin F-35) 36 37 illustrates the scale differences between the UK, other European nations and the USA. 38 The original planned requirement was 2852 JSF aircraft for the US Forces compared 39 with a UK requirement for 150 aircraft. Faced with such scale differences in military 40 markets, the UK can respond by reducing unit costs compared with the USA; by 41 exporting; and by international collaboration (eg. UK involvement in Eurofighter 42 Typhoon and JSF). On exports, the UK Hawk is a good example achieving both high 43 44 output levels (over 800 aircraft) and a high proportion of output exported (almost 80% 45 exported). Similarly, Eurofighter shows how European collaboration results in 46 output levels closer to those in the USA and considerably greater than European 47 national scales of output. For example, the partner nation’s planned order for 48 Eurofighter is 620 units, comprising 232 units for the UK, 180 for Germany, 121 for 49 50 Italy and 87 for Spain. However, collaboration departs from the ‘ideal case’ leading 51 to inefficiencies associated with complex international management and monitoring 52 arrangements and restrictive work sharing requirements. UK estimates suggest that 53 the total development costs on the four nation Eurofighter were almost twice as high 54 as an alternative national aircraft; but typically, the UKs cost share equates to one 55 third of total development costs. Similarly, the scale economies achieved on 56 57 collaborative production programmes are in the region of half those on national 58 programmes; and delays on collaborative programmes average almost one year 59 (NAO, 2001). 60

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1 2 3 4 5 6 (iii) Size of firms 7 8 The US competitive advantage in the scale of output, especially for military aircraft, 9 is also reflected in its advantage in firm size. Large firms are able to obtain 10 economies of scale and scope and in recent years there has been considerable merger 11 12 activity creating larger aerospace firms. US firms dominate the world’s top 10 13 aerospace firms, accounting for 7 out of the top 10 in 1996, 2000 and 2002. BAE 14 Systems was the only UK aerospace company in the top 10 in 1996, 2000 and 2002, 15 ranking fourth in each year. In contrast, the newly-created EADS ranked third in 16 2000 and second in 2002 . 17 18 19 Table 5 shows the top 15 aerospace companies between 1996 and 2002. Interestingly, 20 9 of the top 15 companies remain unchanged throughout the period (including BAE 21 Systems and Thales/ThomsonFor -PeerCSF). Comparisons Review with Boeing for 2002 show the 22 scale advantage of the US company: EADS was 53% and BAE was 34% of the size of 23 Boeing. Similarly, in aero-engines in 2002, Rolls-Royce was 55% of the size of 24 25 General Electric. Within the top 15, between 1996 and 2002, the UK and European 26 firms have not achieved any substantial increase in their average size in relation to the 27 top US firms. This suggests that the US aerospace mergers after 1996 have been 28 more successful in creating relatively larger firms. Also, over this period, the UKs 29 mergers have created relatively larger aerospace firms than in Europe. 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

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1 2 3 4 5 6 Table 5. Top 15 Aerospace Firms 7 8 2002 2000 1996 9 Firm Aerospace Firm Aerospace Firm Aerospace 10 11 Ranking Sales Ranking Sales Ranking Sales 12 ($m) ($m) ($m) 13 Boeing 53,344 Boeing 51,407 Lockheed 26,068 14 Martin 15 EADS (E) 28,182 Lockheed 23,977 Boeing 22,681 16 17 Martin 18 Lockheed 26,562 EADS 23,336 McDonnell 13,447 19 Martin Douglas 20 BAE For18,236 Peer BAE Review19,661 British 11,635 21 Systems Systems Aerospace 22 23 Northrop 18,126 Raytheon 15,443 Aerospatiale 9,948 24 Grumman (F) 25 Raytheon 17,449 United 12,358 United 8,852 26 Technologies Technologies 27 United 13,216 General 10,779 DASA (G) 8,636 28 29 Technologies Electric 30 General 11,141 Honeywell 9,988 Hughes 8,314 31 Electric Electronics 32 Honeywell 8,855 Northrop 7,782 Northrop 8,071 33 International Grumman Grumman 34 35 Thales (F) 8,035 Bombardier 7,112 Raytheon 7,769 36 Bombardier 7,194 Rolls-Royce 6,890 General 6,302 37 ( C ) Electric 38 General 6,970 TRW 6,237 Thomson- 6,264 39 Dynamics CSF (F) 40 41 Rolls-Royce 6,179 Thales 5,977 Allied Signal 5,714 42 Snecma (F) 6,130 Snecma 5,204 GEC (UK) 5,653 43 Finmeccanica 5,041 Mitsubishi 4,841 Rolls-Royce 4,616 44 (Italy) Heavy 45 46 Industries (J) 47 Average size: 48 UK v USA 63% 77% 61% 49 Average size: 50 Europe v 61% 67% 70% 51 52 USA 53 Average size: 54 EU v UK 97% 87% 113% 55 56 Notes: i) Sales figures are in current prices and are for aerospace sales only. Most 57 58 companies have other sales, but total sales figures are not reported here. 59 ii) C = Canada; E = Europe; F = France; G = Germany. 60 iii) Average size of firm is based on firms in the top 15.

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1 2 3 Sources: Flight (1997; 2002; 2003) 4 5 6 (iv) Development time-scales 7 8 The time taken to develop an aircraft from start to delivery is a further indicator of 9 competitiveness. Traditionally, the US aerospace industry developed both civil and 10 military aircraft faster than the UK and European industries. For example, between 11 12 1945 and 1969, the average UK development times for military aircraft were 8 years 4 13 months compared with 6 years 3 months for the USA; and for civil aircraft, the 14 average development times were 4 years and 4 months and 3 years and 7 months, 15 respectively (Elstub, 1969). 16 17 18 Since 1980, the position has changed. On large jet airliners, Airbus is now 19 competitive with Boeing on development times (where Airbus involves a UK 20 component on the wings, engines and other equipment). Table 6 shows development 21 times for a similar groupFor of Airb Peerus and Boeing Review civil aircraft, with similarity defined 22 by their characteristics. Airbus aircraft were developed some 4-7% faster, with 23 Airbus being faster from start to first flight, but slightly slower from first flight to 24 25 Certificate of Airworthiness. Interestingly, this evidence confirms that European 26 collaboration in civil aircraft has created a competitive industrial organisation. 27 Regression analysis of various measures of development time against aircraft 28 characteristics, a time-trend and a country of manufacture dummy variable gave a 29 significant and negative coefficient for the time-trend only. As expected, the country 30 31 of manufacture dummy was not significant. 32 33 Table 6. Average Development Times for Civil Aircraft 34 35 Development Times Aircraft Characteristics 36 37 Aircraft (months) 38 Start to First Total Speed Weight Passengers Range 39 first flight Time (mph) (lbs) (miles) 40 flight to CoA 41 Airbus 42 43 (n=7) 43.4 13 56.4 595 325,179 252 4653 44 Airbus 45 (n=6) 43.8 11 54.8 602 318,748 250 4716 46 Boeing 47 (n=7) 48.9 9.9 58.7 606 388,078 240 4516 48 49 50 Notes: 51 i. Airbus n=7 sample: A300;A310; A320; A319; A321; A340; A330. The sample 52 n=6 excluded the A300 with a first flight in 1972. All other Airbus airliners had a 53 first flight date of 1982-95. 54 55 ii. Boeing n=7 sample: B737 Next Generation; B747-400; B757; B767; BMD11; 56 B717-200, all with first flight dates of 1981-98. 57 iii. Weight is maximum take-off weight; months are rounded to nearest month; CoA 58 is award of Certificate of Airworthiness. 59 60 Source: Janes (2001)

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1 2 3 The traditional competitive advantage of the US industry in development times for 4 5 military combat aircraft is shown in the following regression equation. This allows for 6 combat aircraft characteristics: 7 8 TCS = 143.71 – 0.12S + 2.32W* + 0.02R + 54.40CM + 0.39T 9 (1.97) (1.99) (2.69) (1.26) (2.36) (0.26) 10 _ 11 2 12 R = 0.70 13 14 where TCS = total time from contract start to service (months); S = speed; W 15 = weight; R = range; CM = a dummy variable for USA = 0 and rest of world = 16 1; and T = a time-trend based on date of first flight. The equation was based 17 18 on a sample of 11 US, European, Russian and Japanese modern combat 19 aircraft (see also notes to Table 7). 20 21 For Peer Review 22 The equation shows a significant and predicted positive impact of weight on 23 development times; but surprisingly, other aircraft characteristics, namely, speed and 24 25 range were not significant. The country of manufacture dummy is almost 26 significant, showing a substantial US advantage in development times (some 4.5 27 years). 28 29 On current generations of combat aircraft, development times are similar between 30 31 Europe and the USA, confirming that the US no longer has a competitive advantage 32 in this aspect of industry performance. On three current generation European combat 33 aircraft (Gripen; Rafale; Typhoon) average development times were 181 months 34 compared with an average of 209 months for two US combat aircraft (F-22 and JSF, 35 neither of which have yet entered service). Since the end of the Cold War, 36 37 development times have been ‘stretched’ reflecting defence budget problems and less 38 urgency due to a reduced threat. Using pairwise comparisons, the European 39 collaborative Typhoon has been developed in a considerably shorter time, namely, 40 214 months, than the US F-22 aircraft which is due in service in late 2005 (231 41 months). Admittedly, the US F-22 is a more complex, high-performance aircraft 42 which is more advanced than any of the current European combat aircraft. Overall, 43 44 the evidence shows that the traditional US competitive advantage on development 45 times for civil and military combat aircraft no longer applies. 46 47 v) Labour hoarding 48 49 50 The speed at which firms vary their labour force in response to changes in output is 51 another indicator of their competitiveness. A slow response suggests labour hoarding 52 and labour retention policies. Once again, the US ‘model’ is of an aerospace industry 53 which adjusts its labour force quickly to variations in output. The statistical evidence 54 suggests that since 1980, the UK aerospace industry’s employment has become more 55 responsive to variations in output (cf Table 7: equations (2) and (3)). Also, the UK 56 57 industry’s employment responsiveness to changes in output is considerably higher 58 than for the French aerospace industry and similar to that for the EU industry (Table 59 7: equations (1), (4) and (6)). Moreover, whilst the UK industry’s employment 60 responsiveness remains below that for the US aerospace industry, there was evidence of it approaching US levels.

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1 2 3 4 5 Table 7. Employment Equations 6 7 Dependent Coefficients of: _ 8 variable Constant Log t Log ,1 ,11 8 R2 d 9 Q Lt-1 10 11 1) LogLt 3.59* 0.38** -0.04** 0.42** 0.38 0.65 0.58 0.980 2.1 12 (UK) (2.35) (5.02) (4.74) (3.45) 13 2) LogLt 0.87 0.35** -0.02** 0.69* 0.35 1.14 0.31 0.968 1.3 14 (UK) (1.97) (5.64) (6.62) (15.12) 15 3) LogLt -2.65 0.65** -0.02* 0.69** 0.65 2.1 0.31 0.961 1.7 16 (UK) (1.21) (4.26) (2.75) (5.35) 17 4) LogLt 3.90** 0.41** -0.02** 0.39** 0.41 0.67 0.61 0.988 2.1 18 (EU) (4.55) (5.28) (3.34) (4.00) 19 5) LogLt 2.80** 0.42** -0.003 0.46** 0.42 0.77 0.54 0.985 2.4 20 (USA) (3.88) (5.19) (1.14) (8.17) 21 For Peer Review 22 6) LogLt 4.21** 0.16* -0.01* 0.51** 0.16 0.33 0.49 0.96 2.0 23 (FR) (3.91) (2.35) (2.34) (5.26) 24 Notes: 25 i) All equations are log linear: logLt = log a + bt + c logQ + d log Lt-1 where ,1= c; 26 ,11= c/ 8; d = 1 - 8 where 8 = lagged adjustment of actual to desired employment. 27 28 29 ii) Lt = employment; t = an exponential time trend representing technology and the 30 capital stock; Q = value of turnover in constant 1999 prices (US $ millions); Lt-1 = 31 lagged dependent variable. 32 33 34 iii) Equations (1) and (3) included a dummy variable for end of Cold War (not 35 significant); equation (4) included a dummy for end of Cold War in 1991 36 (significant); equation (5) included slope shift dummies for mergers and dummies for 37 end of Cold War (none were significant); equation (6) also included a dummy for end 38 of the Cold War (not significant). 39 40 41 iv) Equations (1), (3), (5) and (6) based on 1980–2000; equation (2) based on 1948- 42 2000; equation (4) based on 1980-1999. Equations (1), (4) and (6) use consolidated 43 turnover; equations (2) and (3) use unconsolidated turnover. 44 _ 45 v) t-ratios in brackets; R2 is adjusted for degrees of freedom; d = Durbin Watson 46 47 statistic; * significant at 5% level; ** significant at 1% level. 48 49 Exports 50 51 Exports and market shares are often used as major indicators of competitiveness. In 52 2000, civil and military exports accounted for 60% of the UK aerospace industry’s 53 54 turnover. Civil aerospace sales accounted for almost 55% of the UK industry’s 55 turnover in 2000; and some two-thirds of this civil business was exported with civil 56 aerospace exports accounting for 36% of total UK industry sales (SBAC, 2000). On 57 civil aircraft, the UK industry designs and manufactures the wings for Airbus; and UK 58 firms are also suppliers of engines and equipment to Airbus, Boeing and to the 59 60 regional aircraft manufacturers. These exports reflect the fact that the UK is a world leader in wings, aero-engines and equipment some of which are represented on Airbus civil aircraft.

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1 2 3 4 5 Airbus was a new entrant to the large jet airliner industry with its first deliveries in 6 1974 to a market which had been dominated by US firms (Boeing; Lockheed; 7 McDonnell Douglas in the early 1970s). Since then Airbus has increased its share of 8 the world market for large civil aircraft, achieving a 38% share in 2000 with the 9 market changing from a US-dominated oligopoly to a European-US duopoly. Table 10 8 shows the trends in Airbus penetration of the world market. Two points can be made 11 12 about entry time and costs. First, it took Airbus 21 years to achieve a market share of 13 over 30%. Second, Airbus entry involved substantial costs for European taxpayers, 14 especially in France and Germany and particularly for the Airbus A300 and A310. 15 By December 2003, Airbus had delivered 780 A300/310 aircraft compared with 2109 16 units of the A320 family which is similar to Boeing scale of output for its successful 17 18 airliners. 19 20 Table 8. Airbus and Boeing Sales, 1974 - 2000 21 For Peer Review 22 Gross 1974 1980 1985 1990 1995 2000 23 24 deliveries 25 (units) 26 Airbus 5 38 42 95 124 311 27 Boeing 28 (incldg 284 363 282 527 261 504 29 30 McDonnell 31 Douglas) 32 Airbus 33 share 1.7 9.5 13.0 15.3 32.2 38.2 34 (%) 35 36 37 Source: DTI (2002). 38 39 The military-civil sales ratio has changed substantially since 1980 when military sales 40 accounted for about 65% of the UK aerospace industry’s sales and civil sales the 41 remaining 35%. In 2000, military sales accounted for 46% of the UK aerospace 42 43 industry’s sales, shared equally between domestic and export customers (SBAC, 44 2001). In comparison, the military-civil ratios of sales for the EU and the US 45 aerospace industries were 30/70 and 40/60, respectively. 46 47 Military aerospace exports dominated UK defence equipment exports over the period 48 49 1980 to 2000, especially in the 1990s with sales to the Middle East. However, 50 defence exports are determined by both economic and political factors which makes it 51 difficult to assess competitiveness. Even standard competitiveness measures such as 52 equipment prices are misleading, since they can reflect different national subsidies to 53 producers, differences in national preferential purchasing, various financial support 54 arrangements (eg state export credits), offsets, a willingness by the supplying nation 55 56 to waive R&D levies and the provision of gifts-in-kind (eg equipment and training 57 free of charge). Equipment prices can also be for the basic equipment or might 58 include various amounts of spares, training and support services. Political factors are 59 also important, especially the supplying nations views on the political and military 60 importance of the buying country (eg. allies and friends; ethical criteria; willingness of rival nations to supply).

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1 2 3 4 5 Table 9 shows examples of the unit prices of various military aircraft. Amongst 6 trainers, the UK Hawk appears to be competitive on price. This is confirmed by its 7 status as a world leader for subsonic combat aircraft with 27% share of the world 8 market compared with a 26% share for the USA over the period 1986 to 1997 (based 9 on volume data: DoS, 2000). For both trainers and combat aircraft, some of the price 10 data are for aircraft in the early stages of development whilst others are for aircraft in- 11 12 service (eg.in-service aircraft at 2000 included Hawk, Gripen, F-15, F-16, Harrier 13 and SU-27). Amongst combat aircraft, the F-16, Gripen and SU-27 are relatively 14 cheap, whilst the US F-15E and F-22 are costly aircraft, but technically advanced. 15 The collaborative Eurofighter Typhoon (with the UK as a partner) is cheaper than the 16 US F-15 and F-22 but more expensive than Rafale. If the Lockheed Martin JSF is 17 18 successful and its estimated costs are achieved (major assumptions), it will be a 19 competitive aircraft and a major threat to Typhoon and Rafale. 20 21 TableFor 9. Military Peer Aircraft ReviewUnit Prices 22 23 24 Aircraft Unit Price 25 (US$ millions) 26 Trainers 27 Hawk (UK) 18-21 28 MAKO (EADS) 22-25 29 30 KTX-2 (S. Korea) 18-20 31 Combat Aircraft 32 Eurofighter Typhoon 68 33 Rafale (France) 58 34 35 Gripen (Sweden) 35 36 F-15E (USA) 75 37 F-16 (USA) 24-25 38 F-18 E/F (USA) 50 39 F-22 (USA) 183 40 41 Joint Strike Fighter (JSF:USA) 31-38 (different versions) 42 Harrier AV8B (UK-US) 36 43 Mitsubishi F-2 (Japan) 115 44 SU-27 (Russia) 35 45 46 47 Sources: Various aviation and defence magazines (eg Defense News; Aviation 48 Week; Janes Defence Weekly; Flight; Flug Revue; Air Forces Monthly). All data are 49 for 1999, 2000 or 2001. 50 51 Statistical analysis of the determinants of UK aerospace exports was constrained by 52 53 the available data. Some limited, exploratory equations were estimated and examples 54 are shown in Table 10. The time-trend variable gave the expected significant and 55 positive coefficient for civil exports; but a surprising negative coefficient for total 56 exports. The end of the Cold War resulted in a negative impact on total and military 57 exports. Passenger miles gave an expected positive impact on total exports, but a 58 59 surprising negative coefficient for civil exports. There was no evidence of a 60 ‘crowding-out’ effect from UK military equipment spending. Military equipment

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1 2 3 imports were positively associated with total UK military exports, which might reflect 4 5 the general level of demand in world military markets. 6 7 Table 10. UK Aerospace Exports. 8 9 Dependent Constant Coefficients of: _ 10 Variable t Cold PASM DSP MIMP R2 d 11 War 12 13 Dummy 14 1) TEXP -6.95 -0.64** -1.66* 0.02** 0.0002 0.20 0.93 2.1 15 (1.89) (3.36) (2.72) (5.45) (0.55) (0.11) 16 2) TMX 4518.4 67.09 -1661.6* -0.23 2.53* 0.79 1.7 17 (1.78) (0.66) (2.48) (1.21) (2.14) 18 3) TCX 8417.7* 711.55** -207.5 -16.33** -0.12 0.85 1.9 19 (2.28) (3.54) (0.32) (4.69) (0.73) 20 Notes: 21 For Peer Review 22 i) TEXP = total UK aerospace exports; TMX = total UK military aerospace exports; 23 TCX = total UK civil aerospace exports. All value data in £ billions, 1999 prices. 24 Equations (1) and (2) are based on 1980-1998; equation (3) based on 1980-2000. All 25 equations are linear. 26 27 ii) t = time-trend; dummy variable (1,0) for the end of the Cold War was based on 28 29 either 1991 or 1992; PASM = world passenger miles (billions); DSP = UK military 30 equipment spending; MIMP = UK military equipment imports lagged one year. 31 32 iii) Other details as in Table 7. 33 34 35 A relatively new feature of the UK aerospace industry is its global dimension with 36 both inward and outward foreign direct investment. The UK industry has 37 considerable aerospace manufacturing assets overseas. In 2000, these subsidiaries 38 recorded sales of £5.55 billion and employed 47,000 personnel outside the UK. Some 39 60% of these overseas sales and employment were located in the USA ( UK firms 40 with US subsidiaries included BAE, Rolls-Royce and Smiths), so allowing UK firms 41 42 to achieve entry into the US market, especially its defence market. Similarly, some 43 overseas companies have located in the UK or acquired UK aerospace companies (eg. 44 Bombardier/Shorts; Finmeccanica/ Agusta-Westland; TRW; Thales). As a result, the 45 UK aerospace industry now comprises both UK and foreign-owned companies 46 located in the UK. 47 48 49 Profitability 50 51 In competitive markets, profitability can be regarded as the final indicator of industry 52 performance and competitiveness. Over the period 1985 to 2000, the UK aerospace 53 54 industry achieved the highest median profit rate on sales, exceeding both the EU and 55 the USA. The UK industry’s annual profitability exceeded that of the EU in twelve of 56 the sixteen years and exceeded that of the USA in ten of the sixteen years. The data 57 are shown in Table 11. It is, however, recognised that national aerospace markets are 58 imperfect: the EU and US markets are characterised by national monopolies and 59 oligopolies, respectively, and both have national preferential purchasing policies (eg 60 Buy America Act). In principle, the UK market is different with its competitive procurement policy for military equipment, so that its profitability record is a more

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1 2 3 accurate reflection of international competitiveness. Moreover, the UK industry’s 4 5 profitability record was achieved despite the US industry’s advantage with its larger 6 scale output and larger firms. 7 8 9 Table 11. Industry Profitability 10 11 12 Profit as percentage of sales (%) 13 Aerospace Industry 14 Year 15 UK EU USA 16 17 18 1985 5.5 5.2 3.1 19 1986 5.0 4.2 2.8 20 1987 For Peer 4.4 Review 3.5 4.1 21 1988 3.4 3.8 4.3 22 23 1989 4.2 3.2 3.3 24 1990 2.8 2.4 3.4 25 1991 2.2 2.4 1.8 26 1992 -1.2 -0.6 -1.4 27 1993 2.2 0.7 3.6 28 29 1994 0.5 0.0 4.7 30 1995 5.4 0.0 3.8 31 1996 4.8 2.2 5.6 32 1997 6.2 3.9 5.2 33 34 1998 6.9 6.7 5.0 35 1999 6.4 6.8 6.5 36 2000 6.4 4.9 4.7 37 Median 4.6 3.4 4.0 38 39 40 Sources: AECMA; SBAC; USAIA 41 42 Profitability data are also available at the company level and these are shown in Table 43 12, based on the year 2000. There are two features of this Table. First, the 44 profitability of the two UK major aerospace firms, BAE and Rolls-Royce, generally 45 46 exceeded that of their major and much larger US rivals, namely, Boeing and 47 Lockheed Martin. Second, the profitability of some of the UK equipment suppliers 48 exceeded that of the much larger UK and US companies (BAE; RR; Boeing; 49 Lockheed Martin). 50 51 52 53 54 55 56 57 58 59 60

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1 2 3 4 5 Table 11. Company Profitability, 2000 6 7 Company Profit on sales Profit on capital 8 (%) (%) 9 BAE 7.8 5.6 10 11 Rolls-Royce 8.0 12.9 12 GKN 8.0 24.8 13 TRW 18.9 11.6 14 Cobham 17.1 25.2 15 16 Smiths 18.5 24.6 17 Hunting 2.1 13.5 18 Bombardier (Shorts) 13.7 Na 19 Meggitt 24.6 14.5 20 Ultra Electronics 13.9 35.3 21 For Peer Review 22 Martin Baker 14.4 Na 23 UK Sample Average 9.6 Na 24 UK Aerospace Industry 8.8 12.6 25 Average 26 27 Boeing 6.6 14.2 28 Lockheed Martin 4.8 6.0 29 30 Note: Sample average is for all the UK companies shown in the Table; UK Industry 31 average is based on UK companies in top 100 aerospace companies (Flight 2001b) 32 33 34 Sources: SBAC (2000); Flight (2001 b) 35 36 Conclusion 37 38 The UK aerospace industry is the largest in the EU. The USA is the UK industry’s 39 40 major rival and provides the ‘benchmark’ for assessing its performance. On this basis 41 and using the indicators reviewed in this paper, the UK industry improved its 42 competitiveness over the period 1980 to 2000. There were improvements in labour 43 productivity, output levels, development times, employment responsiveness and 44 export performance. The results are summarised in Table 12. 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

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1 2 3 4 5 6 Table 12. Competitiveness Indicators, 1980-2000 7 8 Indicator UK industry performance relative to 9 USA 10 11 1. Labour productivity Improving 12 2. Output (a) Civil Airbus achieving US scales of output 13 (b) Military UK/JSF = US scales of output 14 Eurofighter = higher output 15 3. Development times US no longer has competitive advantage 16 17 4. Labour hoarding UK employment responsiveness has 18 improved and is approaching US 19 levels. 20 5. Exports For Peer Reviewa. Military aerospace exports dominated 21 UK defence exports; 22 23 b. World leader for subsonic combat 24 aircraft; 25 c. Airbus: rising share of world market 26 6. Industry profitability Higher than USA 27 28 29 Statistical indicators confirm past and current performance and competitiveness, but 30 do not guarantee future successful competitiveness. The main problems facing the 31 UK aerospace industry arise from the lack of new R&D programmes to provide the 32 next generation of projects. Some of this new R&D will require government funding 33 (IGT, 2003). Technical change is also a challenge to the future UK aerospace firm. 34 The possible emergence of unmanned combat air vehicles (UCAVs) could 35 36 revolutionise air warfare and lead to the end of manned combat aircraft and an 37 increased emphasis on electronics and electronic warfare. For civil aircraft, the UKs 38 future looks to be through an involvement in collaborative Airbus programmes. 39 However, the 2005 WTO dispute between the EU and USA raises doubts about the 40 future of UK (and European) Government repayable launch investment for civil 41 42 aircraft programmes (TIC, 2005). Also, the future absence of any UK-designed 43 military and civil aircraft will mean the increasing importance of its equipment 44 suppliers. 45 46 Benchmarking against the US aerospace industry and continued competition with its 47 US rivals will provide a major competitive stimulus for the UK aerospace industry. 48 49 Evidence suggests that “…the more a given manufacturing industry is exposed to the 50 world’s best practice high productivity industry, the higher its relative productivity 51 (the closer it is to the leader). Competition with the productivity leader encourages 52 higher productivity” (Bailey and Solow, 2001). On this basis, part of an industry’s 53 productivity disadvantage reflects organisational slack and/or reluctance to change 54 55 and innovate. Failure by the UK aerospace industry to adjust to change will mean 56 more exits and the loss of its world leader companies. 57 58 59 60

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1 2 3 REFERENCES 4 5 6 AECMA (2000; 2002). The European Aerospace Industry: Facts and Figures, 7 AECMA, Brussels. 8 9 Bailey, M.N. and Solow, R.M. (2001). International productivity comparisons built 10 from the firm level, Journal of Economic Perspectives, 15, 3, Summer, pp.151-172. 11 12 13 Bishop P (2003, Collaboration and firm size: some evidence from the UK defence 14 industry, Applied Economics, vol. 35, December, pp. 1965-1969. 15 16 Bonte W (2003). Does federally-financed business R & D matter for US productivity 17 18 growth, Applied Economics, vol. 35, no. 15, October, pp. 1619-1625. 19 20 Braddon D and K Hartley (2002), UK Aerospace Competitiveness, Department of 21 Trade and Industry;For July. Peer Review 22 23 24 Chung S (2001). The learning curve and the yield factor: the case of Korea’s 25 semiconductor industry, Applied Economics, vol. 33, no. 4, March, pp. 473-483. 26 27 DTI (2004). The Value Added Scoreboard, 2004, DTI, London. 28 29 DoS (2000). World Military Expenditures and Arms Transfers, 1998, US 30 31 Department of State, US Government Printing Office, Washington DC. 32 33 Elstub St.J (1969). Productivity of the National Aircraft Effort, HMSO, London 34 35 Flight (1997; 2002; 2003). Aerospace Top 100, August, Flight International, 36 37 Surrey. 38 39 Frantzen D (1998). R & D efforts, international technology spillovers and the 40 evolution of productivity in industrial countries, Applied Economics, vol. 30, 41 November, pp. 1459-1469. 42 43 44 Gopinath M, Pick D and Y. Li (2004). An empirical analysis of productivity growth 45 and industrial concentration in US manufacturing, Applied Economics, vol. 36, no. 1, 46 January, pp. 1-7. 47 48 Graham D J (2001). Productivity growth in British manufacturing: spatial variation in 49 50 the role of scale economies, technology growth and industrial structure, Applied 51 Economics, vol. 33, May, pp. 811-821. 52 53 Janes (2001). Jane’s All the World’s Aircraft, Jane’s Information Group, Coulsdon, 54 Surrey. 55 56 57 Khambampati U.S. (2000). Industry competitiveness: leadership identity and market 58 shares, Applied Economics Letters, vol. 7, no. 9, September, pp. 569-573. 59 60 ICT (2001). Competitive Assessment of US Large Civil Aerostructures Industry, US International Trade Commission, Washington DC, June.

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1 2 3 4 5 IGT (2003). An Independent Report on the Future of the UK Aerospace 6 Industry, Aerospace Innovation and Growth Team, DTI, London, June. 7 8 Manzur M, Wong W-K, and Chee I-C (1999). Measuring international 9 competitiveness: experience from East Asia, Applied Economics, vol. 31, no. 11, 10 November pp. 1383-1391. 11 12 13 NAO (2001). Maximising the Benefits of Defence Equipment Co-operation, 14 National Audit Office, The Stationery Office, London. 15 16 Porter, M.E. (1990). The Competitive Advantage of Nations, Macmillan, London. 17 18 19 SBAC (2000; 2002). UK Aerospace Facts and Figures, SBAC, London 20 21 TIC (2005). The UKFor Aerospace Peer Industry ,Review Trade and Industry Committee, House of 22 Commons, HC 151-I, Stationery Office, London. 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

22 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK