Rolls-Royce’s New Profit Mantra Hampers Airbus Sales Campaigns

The focus on profit over market share at Rolls-Royce Holdings Plc has won new Chief Executive Officer Tufan Erginbilgic plaudits from investors, who have lifted the manufacturer to the best-performing major UK stock this year.

(Bloomberg) — The focus on profit over market share at Rolls-Royce Holdings Plc has won new Chief Executive Officer Tufan Erginbilgic plaudits from investors, who have lifted the manufacturer to the best-performing major UK stock this year. 

But the newfound financial discipline has also created some negative side effects, with aircraft partner Airbus SE noticing that it’s making some sales campaigns harder to get across the line.

Just in recent weeks, Airbus was confident of securing a top-up order from British Airways for a handful of its A350 twin-aisle jets powered by Rolls-Royce engines. BA already operates 15 units of the model, with another three on order. 

But then BA parent IAG SA decided in July to convert options on six of Boeing Co’s competing 787 Dreamliner into firm orders, with an option for another six of the same model at a later point. The group is also considering switching to General Electric Co. powerplants on the new planes from the Rolls-Royce Trent 1000 that sits under the wings of its existing Dreamliners, according to people familiar with the deliberations. 

Airbus, for its part, concluded that it lost in large part because Rolls-Royce was unwilling to compromise on pricing for the A350 engines, said the people, who asked not to be identified discussing private negotiations.

And by ordering Boeing’s widebody, which comes with two types of engines, BA has the option of selecting the GEnx turbofan — and negotiating larger maintenance savings with the US engine maker, said one of the people.

Airbus, Rolls-Royce and IAG declined to comment on commercial discussions. Rolls-Royce said it’s “improving our business deals to deliver better financial outcomes,” while Airbus called collaboration with Rolls-Royce on the A350 a “winning airframe-engine combination.”

Engine contracts are among the most significant parts of all aircraft purchases as they represent the single most expensive component on an airliner. While Airbus has established a commanding lead in the single-aisle market, the European company is pushing to chip away at Boeing’s dominant position in wide-bodies, where Airbus sells the A330neo and the A350 jets, both exclusively powered by Rolls-Royce. 

“Most of Rolls Royce’s problems stem from the fact that it has been driven by a desire for market share for most of its modern existence,” said Nick Cunningham, an analyst at Agency Partners. “That approach hasn’t made any money.” 

As the only engine supplier to Airbus’s wide-body aircraft, Rolls-Royce plays a pivotal part in bringing home competitive campaigns. Traditionally, engine makers have been willing to sell their products at a loss at the outset and then make money over the lifetime of an engine with lucrative service packages. 

But with provisions of £1.4 billion ($1.8 billion) on what Erginbilgic calls onerous contracts, the CEO is on a mission to rewrite those deals and ensure Rolls-Royce doesn’t fall into the same trap on new orders. 

Delta Air Lines has been in discussions with Airbus for several months on a large wide-body order, Bloomberg News reported in May. The airline is still negotiating the deal and is yet to commit, some of the people said, who attributed the delay partially to a lack of common ground between Airbus and Rolls-Royce on the commercial aspects of their offer. 

Delta declined to comment on commercial discussions with suppliers.

To be sure, the two European manufacturers are still winning business together. Qantas Airways Ltd. announced late on Wednesday that it would buy 12 Boeing 787s and 12 Airbus A350s to replace the bulk of its aging fleet of Airbus A330s, along with options to buy more of the two aircraft types in coming years. Qantas has a history of evenly spreading its order book between the two rival manufacturers.

Erginbilgic, who likened the biggest UK manufacturer to a burning oil platform shortly after taking over at the start of this year, has called for what he describes as a “change of mindset” that puts the focus on profitability. 

At the Paris Air Show in June, he signaled that Rolls-Royce might miss out on some sales opportunities as it focuses on building a stronger company, while emphasizing that Airbus “is well aligned with us and we would like to grow together.”

Last month, Rolls-Royce gave investors accustomed to lackluster earnings a pleasant surprise when it raised its profit targets, giving the shares a 21% jolt on a single day.

Among measures put in place by the CEO is new pricing framework that ensures all new and renewing contracts have a satisfactory level of profitability. In addition, all new and renewing contracts get reviewed by an investment committee. 

“We are primarily focusing on the quality of earnings and cash, not market share,” Erginibilgic said on a call this month, adding that Rolls-Royce would “rebalance” unfavorable contracts. “A strong Rolls-Royce will be a much better partner to our customers and deliver superior service.”

Rolls-Royce currently only makes engines for widebody commercial aircraft, along with engines for some business jets, after it withdrew from a venture for narrowbody models like the Airbus A320 series in 2011. The first Rolls-Royce powered Airbus model was the A330 created in the early 1990s, and the two companies have worked together ever since.

For now, Airbus doesn’t have much of a choice on wide-body aircraft. The A380 super-jumbo that came with two options is no longer in production, and Rolls-Royce extended its exclusive status in 2021 on the smaller A350-900 model until 2030. 

A growing rift between the two manufacturers could prompt Airbus to weigh options with other engine makers, one of the people said. But opening up the the larger, slower-selling A350-1000 for a rival engine such as those made by GE, would be a massively expensive exercise, said Cunningham.

“In the near term, Airbus and Rolls will have to live with each and find a common path,” he said

–With assistance from Kate Duffy and Mary Schlangenstein.

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