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The Governance of Innovation: The Case of Rolls-Royce plc
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Industrial and Corporate Change Advance Access published May 9, 2005
Industrial and Corporate Change, page 1 of 42

doi:10.1093/icc/dth061
Dynamic capabilities and sustained

innovation: strategic control and financial
commitment at Rolls-Royce plc
William Lazonick and Andrea Prencipe
Rolls-Royce plc is currently a powerful competitor in the turbofan engine industry,

notwithstanding its own troubled history and the relative lack of international
success of British companies in high-technology manufacturing over the past half-
century. This paper seeks to contribute to the development of a theory of innova-
tive enterprise by analyzing the roles of strategy and finance in sustaining the
innovation process at Rolls-Royce over four decades from the mid-1960s. Through
an analysis of ‘strategic control’ and ‘financial commitment’ as conditions of
innovative enterprise at different stages in Rolls-Royce’s evolution, we adduce
evidence that innovation depends in part on who strategic managers are and how
they gain control over financial resources.
1. Dynamic Capabilities and Social Conditions

In 1991, Richard Nelson argued that ‘it is organizational differences, especially differ-
ences in abilities to generate and gain from innovation, rather than differences in
command over particular technologies, that are the source of durable, not easily imi-
table, differences among firms. Particular technologies are much easier to understand,
and imitate, than broader firm dynamic capabilities’ (Nelson, 1991: 72). In a pioneer-
ing contribution to an emerging ‘dynamic capabilities’ literature, Teece et al. (1997:
516) defined ‘dynamic capabilities as the firm’s ability to integrate, build, and recon-
figure internal and external competences to address rapidly changing environments’.
They also argued that the firm’s strategy entails choosing among and committing to
long-term paths or trajectories of competence development (Teece et al., 1997: 524).
Whereas the firm’s asset positions determine its competitive advantage at any point in
time and its evolutionary path constrains the types of industrial activities in which a
firm can be competitive, its organizational processes transform the capabilities of the
firm over time.
While organizational processes are clearly the essence of dynamic capabilities that
can generate innovation and competitive advantage, both strategy and finance are of
critical importance for how firms ‘integrate, build, and reconfigure internal and external
© The Author 2005. Published by Oxford University Press on behalf of Associazione ICC. All rights reserved.
page 2 of 42 W. Lazonick and A. Prencipe
competences to address rapidly changing environments’. Who decides what kind of

competences to integrate, build, and reconfigure? How is the funding mobilized to
support these innovative strategies? The challenge presented by a focus on dynamic
capabilities is to construct a theory of innovative enterprise that can explore, and ulti-
mately explain, the links among strategy, finance and organization.
This paper seeks to contribute to the development of a theory of innovative enter-
prise by analyzing the roles of strategy and finance in sustaining the innovation pro-
cess at Rolls-Royce plc over four decades, beginning in the mid-1960s.1 At the
beginning of the twenty-first century, Rolls-Royce plc is a power in the turbofan
engine industry, notwithstanding its own troubled history and the relative lack of
international success, more generally, of British companies in high-technology manu-
facturing industries over the past half-century or so. Rolls-Royce’s Trent—or, using
the generic appellation, RB211—family of gas turbine aircraft engines enables the
company to compete in the high-thrust turbofan market as one of the ‘Big Three’,
along with US-based General Electric Transportation (which includes the former
General Electric Aircraft Engines) and Pratt & Whitney, a division of United Technol-
ogies Corporation.
Indeed, in the late 1990s and early 2000s, Rolls-Royce surpassed Pratt & Whitney
as the number two aircraft engine company. At the beginning of 2003, General Elec-
tric (GE) (along with CFM, its joint venture with the French company, SNECMA)
had 56% of the total aircraft engine market, Rolls-Royce 20% and Pratt & Whitney
12%. In the Boeing 777 market, the shares were GE 38%, Rolls-Royce 35% and Pratt
& Whitney 27%, while in the Airbus A330/340 market the shares were GE and CFM
48%, Rolls-Royce 30% and Pratt & Whitney 22%. Rolls-Royce had 51% and the GE-
Pratt Engine Alliance 49% of engine orders for the new Airbus A380 (‘Jet engine mar-
ket statistics,’ Airline Business, March 2003). In 2003, for the first time, Rolls-Royce
had more engine orders for wide-body jets than GE, and in 2004 outdid GE in this
market by two to one, with Pratt & Whitney very far behind (Michaels et al., 2005).
During 2004 Boeing selected both GE and Rolls-Royce, but not Pratt & Whitney, to
power its new 787 Dreamliner airliner (Rigby, 2004). At the end of 2004 CFM had
2276 engines on order; GE, 1478; Rolls-Royce, 1106; International Aero Engine (a con-
sortium of Pratt & Whitney, Rolls-Royce, Japan Aero Engines, and MTU Aero Engines),
942; Pratt & Whitney, 378; and the Engine Alliance, 268 (Michaels et al., 2005).
Rolls-Royce’s current position in the industry is based on its superior technological
capabilities, embodied in the three-shaft architecture of its turbofan engines (see
1
While, in previous research (Prencipe 1997, 2000; Paoli and Prencipe, 1999), Andrea Prencipe has
had access to Rolls-Royce company information concerning the organization of its technical compe-
tences, this paper relies almost entirely on data that are in the public domain. At an early stage of this
research, the Rolls-Royce’s board of directors turned down our request that Rolls-Royce participate
in the study. Notwithstanding this refusal, in the age of the internet one can go quite far in doing
company level research on strategy and finance by relying on publicly available information.
Strategic control and financial commitment at Rolls-Royce plc page 3 of 42
Figure 1 Rolls-Royce RB211. Source: Pugh (2001: between 150 and 151), by permission of
Rolls-Royce plc.
Prencipe, 1997).2 The modularity embedded in the three-shaft architecture (see Figure 1)
has enabled Rolls-Royce to develop and stretch its Trent family of engines with an
unmatchable range of power to meet different market niches and therefore deploy
2
The fan, mounted at the front of the turbofan engine, combines with the core engine, where com-
pression of air and combustion of fuel occur, to generate thrust, measured in pounds (lb), which pro-
pels forward the engine (and the aircraft to which it is attached). The proportion of thrust generated
by the fan depends on the amount of mass flow bypassing the core engine since it is this colder air
that, when mixed with hotter air emerging from the core, provides thrust. The higher the ‘bypass ra-
tio’ (the ratio of the mass flow entering the fan duct divided by that entering the core), the greater the
thrust of the engine. Turbofan architectures are either two-shaft or three-shaft. In a two-shaft design
the low-pressure compressor and the fan run on the same shaft driven by the low-pressure turbine.
The fan has to rotate relatively slowly in order to keep the fan blades’ tip speed within viable mechan-
ical limits. The slow rotation of the fan restricts the low-pressure turbine speed and therefore the
compression achievable by the low-pressure compressor. As a result, most of the compression duty is
left to the high-pressure compressor. The longer the compressor and therefore the greater the
number of stages, the more complex becomes its aerodynamic and mechanical design. In a three-
shaft design, the compression work is split across three compressors. Each compressor can be driven
by its own turbine at its optimum speed. In a three-shaft design, the mapping between functions and
physical structures tends to be more one-to-one than in a two-shaft engine. A three-shaft engine,
therefore, is more modular, shorter, and less complex than a two-shaft engine. For more information
on how turbofan engines work, see e.g. http://www.ueet.nasa.gov/StudentSite/engines.html and
http://www.aerospaceweb.org/question/propulsion/q0033.shtml.
similar technological solutions across engines, thus saving on development costs.

Moreover, three-shaft engines are simpler, shorter, lighter and more rigid than com-
peting engines based on two-shaft architectures. These characteristics enable the
three-shaft engine to sustain high levels of performance throughout its life, thus
resulting in low maintenance costs (Williams, 1995). In the mid-1990s, aviation
expert Bill Gunston (1997: 196) had already summed up the advantages of the RB211:
‘Although customers choose engines mainly for political/financial reasons, on tech-
nical grounds the Trent [with its three-shaft architecture] is hard to beat. It offers
more than adequate thrust, unsurpassed fuel economy, outstanding ease of mainten-
ance, and the lowest weight of all big fan engines.’ Pratt & Whitney and GE—two
companies that have far more ‘financial muscle’ than Rolls-Royce—have teamed up
in a ‘risk and revenue-sharing partnership’ (RRSP) to develop a new engine for the
Airbus A380. The technological capabilities and cost advantages of the RB211’s three-
shaft engine architecture, however, have enabled Rolls-Royce to enter, and succeed in,
the A380 competition on its own.
Over three decades ago, in February 1971, the initial attempt to develop the RB211
for the Lockheed L-1011 jumbo jet drove Rolls-Royce into bankruptcy. As a national-
ized company under both Labour and Tory governments, from 1971 to 1987, however,
Rolls-Royce sustained its investments in the RB211. In 1987 Rolls-Royce was privatized,
and since that time has been operating as a publicly listed corporation. What, we ask,
were the roles of strategy and finance in sustaining the innovation process at Rolls-Royce?
Given the uncertain, cumulative and collective characteristics of the innovation pro-
cess, innovative enterprise depends on three social conditions: strategic control, finan-
cial commitment and organizational integration (Lazonick and O’Sullivan, 2000; see also
O’Sullivan, 2000, 2004; Lazonick, 2004b, 2005). Strategic control is a set of relations
that gives decision-makers the power to allocate the firm’s resources. For innovation to
occur, those who occupy strategic decision-making positions must have both the abili-
ties and incentives to allocate resources to innovative investment strategies. Their abili-
ties to do so will depend on their knowledge of how the current innovative capabilities
of the organization over which they exercise allocative control can be enhanced by stra-
tegic investments in new, typically complementary, capabilities. Their incentives to do
so will depend on the alignment of their personal interests with the interests of the
business organization in attaining and sustaining its competitive advantage.
Financial commitment is a set of relations that ensures the allocation of funds to
sustain the cumulative innovation process until it generates financial returns. What is
often called ‘patient’ capital enables the capabilities that derive from collective learn-
ing to cumulate over time, notwithstanding the inherent uncertainty that the innova-
tion process entails. Strategic control over internal revenues is a critical form of
financial commitment, but such internal funding must often be supplemented by
external sources of finance such as stock issues, bond issues or bank debt. The ques-
tion, then, is how those who exercise strategic control gain access to external sources
of finance that will be committed to sustaining the innovation process.
Organizational integration is a set of relations that creates incentives for people to

apply their skills and efforts to organizational objectives. The need for organizational
integration derives from the developmental complexity of the innovation process—
that is, the need for organizational learning—combined with the imperative to secure
high levels of utilization of innovative investments if the high fixed costs of these
developmental investments are to be transformed into low unit costs. Modes of com-
pensation (in the forms of promotion, remuneration and benefits) are important
instruments for integrating individuals into the organization. To generate innovation,
however, a mode of compensation cannot simply manage the labor market by attract-
ing and retaining employees: it must be part of a reward system that manages the
learning processes that are the essence of innovation; the compensation system must
motivate employees as individuals to engage in collective learning.
A key issue that this study raises is the dynamic relation between strategic control
and financial commitment in the allocation of resources to sustained innovation at
Rolls-Royce.3 Specifically, did the company’s innovative strategy shape the types and
timing of external finance to which it sought access or did a need for external finance
shape the company’s strategic orientation? The evidence that we adduce in this study
shows that this relation between strategy and finance changed over time, but that sus-
tained innovation at Rolls-Royce required the dominance of strategy over finance.
At Rolls-Royce the strategic control that drove innovation was ‘engineer’ control.
Throughout its history, a creed of engineering excellence guided the company’s deci-
sions. The company’s systems for recruiting and training engineers transmitted this
creed from one generation to the next. Most of Rolls-Royce’s top managers were engi-
neers who had spent their entire careers at Rolls-Royce, and therefore understood the
technological, market and competitive challenges of developing a world-class turbo-
fan engine. The introduction of widebody passenger planes by Boeing, McDonnell-
Douglas and Lockheed in the last half of the 1960s created a momentous market
opportunity for an aircraft engine producer such as Rolls-Royce.
In responding to that opportunity, however, the company faced enormous chal-
lenges. With the Lockheed contract in hand, the engineering-dominated strategy was
dependent on external finance at a time when the RB211 remained an unproven tech-
nology. Moreover, Rolls-Royce competed with two engine producers that not only
were divisions of powerful US conglomerates but also had for decades benefited from
US government support.4 From the 1920s Pratt & Whitney had been among the bene-
ficiaries of government-funded aerospace research and government subsidies—for
example, the McNary-Watres Act of 1930 that subsidized airmail delivery—in becom-
ing the leading producer of civil aircraft engines. During World War II, as part of the
3
For lack of access to non-public firm-level data, this case study has little to say about organizational
integration.
4
The following draws on Schlaifer (1950), Constant (1980); Mowery and Rosenberg (1989: Ch. 7),
Doz and Hamel (1998) and Heppenheimer (1998).
Allied effort, the British handed the USA the Whittle jet engine, invented by a Royal
Air Force engineer, which the US government gave to GE to develop for military pur-
poses. At the time GE was not an aircraft engine manufacturer, but, as a company
built on power generation, had been engaged in gas turbine research for some four
decades. The Whittle engine became the foundation of the modern turbofan engine
and, in the late 1960s, GE, supported by military contracts, was the world’s leading
producer of engines for the military but was not a player in commercial markets.
Meanwhile, as the beneficiary of US military contracts, GE was compelled to share its
knowledge of turbofan engine technology with Pratt & Whitney, which, building on
its long-standing dominance of the propeller engine industry, emerged in the 1950s
and 1960s as the leading producer of turbofan engines for civil markets. As for GE, its
entry into the civil markets, which it ultimately dominated, would come, beginning in
1971, through its strategic alliance with SNECMA, a company wholly owned by the
French state, to produce engines for the new Airbus, an aircraft produced by a
European consortium that was highly subsidized by the governments of the nations in
which the member companies were based.
In retrospect, given the magnitude of the challenges that it faced at the time, it is
not surprising that Rolls-Royce went bankrupt in 1971. Given the committed finance
needed to remain a viable competitor in the high-thrust aircraft engine industry and
given the well-known deficiencies of the British financial sector in supporting British
industrial development (Best and Humphries, 1986; Prevezer, 1994; Lazonick and
O’Sullivan, 1997), bankruptcy was necessary if Rolls-Royce was ultimately to succeed.
It forced the British government to finance the further development of the RB211,
and in effect helped to level the playing field for Rolls-Royce in competition with GE
and Pratt & Whitney.
Successive British governments—first Tory, then Labour, then Tory again—that
supported Rolls-Royce financially over 16 years of nationalization reluctantly and skep-
tically left strategic control in the hands of the company’s executives. In the critical
period from 1972 to 1980, spanning all three governments, the executive chairman of
Rolls-Royce was Sir Kenneth Keith, a prominent City banker who was an ardent and
consistent supporter of the development of the RB211. During his tenure, a genera-
tion of engineers who had joined the company in their early twenties in the decade
and a half prior to the bankruptcy, and who would eventually lead the company out of
nationalization, came into their own.
Even then, the stagnation in the civil aviation industry in the early 1980s almost
resulted in Rolls-Royce’s withdrawal as an independent producer of high-thrust tur-
bofan engines as it agreed to take a junior position to GE in an RRSP in the big engine
market. The return of more favorable economic conditions in the mid-1980s, com-
bined with a recognition of the developmental advantages of the RB211’s three-shaft
architecture, enabled Rolls-Royce’s career engineers to reverse that decision and
return the company to profitability before it was privatized in May 1987. As a priva-
tized company in the late 1980s, Rolls-Royce was in sound financial condition, with
engineers in full control. Its share of the civil engine market soared, and by the early
1990s it was clearly one of the ‘Big Three’. The first half of the 1990s were dangerous
times, however, as an industry slowdown combined with the necessity of heavy R&D
expenditures to place the financial viability of Rolls-Royce in question once again. On
the basis of a now proven technology that nevertheless needed to be constantly
upgraded at great expense, Rolls-Royce stayed in the game, and even strengthened its
market position. During this period, the company adroitly managed external financial
markets to gain financial commitment without relinquishing strategic control. Since
the mid-1990s there has been some of the obligatory rhetoric of managing for ‘share-
holder value’ emanating from Rolls-Royce, but, as we shall see, the performance of the
company’s stock has been lackluster while its competitive position as one of the
world’s leading producers of turbofan engines has gone from strength to strength.
Section 2 of this paper describes how Rolls-Royce’s attempt to develop the three-
shaft engine for Lockheed at the end of the 1960s resulted in bankruptcy. In Section 3 we
detail how, as a nationalized company from February 1971 to May 1987, Rolls-Royce
continued to develop the three-shaft engine, first as an add-on to its military efforts
and then in the 1980s to compete in civil markets in preparation for privatization. In
Section 4 we document the exercise of strategic control and the sources of financial
commitment at Rolls-Royce as a privatized company from 1987 to the present. Sec-
tion 5 draws out the implications of this case study for the theory of innovative enter-
prise, considering in the process the influences of both the company’s ‘entrenched
management’ and financial markets on sustaining the innovation process.
2. The origins of the RB211 and the bankruptcy of

Rolls-Royce
2.1 The British national context

Already in the mid-1940s Rolls-Royce had proved to be the most successful and com-
petent British aircraft engine firm. Unlike vertically integrated competitors such as de
Havilland and Siddeley Armstrong Motors, Rolls-Royce was an independent engine
supplier that could seek orders from any of the airframers. Rationalization of the Brit-
ish industry occurred between the end of the 1950s and the beginning of the 1960s. A
series of combinations reduced the number of airframers to three—Hawker Siddeley
Group, British Aircraft Corporation and Westland Aircraft—and engine manufactur-
ers to two—Rolls-Royce and Bristol Siddeley Engines. Then, in 1966, when it
appeared that Bristol Siddeley would join with SNECMA to build the Pratt & Whitney
JT9D engine for the Airbus, Rolls-Royce acquired Bristol-Siddeley and thus became
the only British aircraft engine company that could contemplate competing on global
markets (Pugh, 2001: 94–102). Both Bristol Siddeley Engines and the British govern-
ment welcomed the takeover.
2.2 Engineer control

‘A basic engineering training is a good training for management and for top engineer-
ing decisions’ (quoted in Gray, 1971: 75). This statement, attributed to Sir Denning
Pearson, summarizes Rolls-Royce’s management philosophy. Several commentators
underlined the fact that Rolls-Royce was an engineering company run by engineers
who were devoted to engineering excellence. An industry expert recalled that, having
laid their hands on a Pratt & Whitney engine, Rolls-Royce engineers were appalled by
the crudity of the engineering solutions embedded in the engine. They were even
more appalled, however, by the fact that the competitor’s engine worked. The pursuit
of engineering excellence informed every allocative decision taken within Rolls-Royce,
sometimes with little regard for time and cost constraints.
Rolls-Royce was a paternalistic company that was run by and for its long-time
employees, especially its engineers. Getting a job in Rolls-Royce was made easier if the
applicant had a relative already working for the company. Employees tended to stay
with the company for their entire working lives. This attachment occurred not only at
the top management level, but also on the shop floor. As underlined by Gray (1971: 75):
Before Rolls-Royce merged with Bristol Siddeley in 1966 only one of their
eight directors had been with them for less than twenty-five years. Such
links with the past were to be found on every level: in 1964 over a third of
the workers in the Derby factory had been employed there since before
the Second World War.
Rolls-Royce did not adopt job rotation policies, so that engineers tended to stay
within the same department for years, sometimes decades, with the likelihood that
they would become experts in a specific component and/or subsystem of the aircraft
engine.
Inspired by the culture of engineering excellence, Rolls-Royce’s engineers main-
tained a solid grip on the resource allocation process during the early stage of the
development of the RB211. This grip was loosened, however, when Rolls-Royce went
bankrupt and emerged from that bankruptcy as a nationalized company.
2.3 The three-shaft engine architecture

With engineers in control, the development of Rolls-Royce’s civil business rested on
two important decisions: (i) to develop a large turbofan aircraft engine; and (ii) to
break into the US market. In 1965 an internal study indicated an expanding future
market for engines rated over 30,000 lb. At Rolls-Royce the first program for a larger
turbofan engine was based on the two-shaft Conway turbofan engine. The engine,
labeled RB178, was rated at 28,500 lb and had a relatively low bypass ratio. The com-
pany’s view was that the fuel consumption benefits of a high bypass ratio would be
more than offset by (i) the fuel consumption costs attributable to the larger size of the
fan; (ii) the greater weight of the engine; and (iii) the higher installed drag of the larger
nacelle that a high bypass ratio would entail (Cownie, 1989; Pugh, 2001: 105).5
This view changed, however, when, according to Rolls-Royce engineer Philip Ruffles
(1992: 3), ‘tests in the US demonstrated that the installed drag penalty of the nacelle
was less than half that assumed in European studies’. As a result, the bypass ratio of
the RB178 was increased up to 8, which in turn led Rolls-Royce’s engineers to choose
‘a three-shaft configuration as the best for both aerodynamic and mechanical reasons’
(Ruffles, 1992: 4). This design layout, labeled RB178-51, would provide much higher
thrust than the previous RB178. A demonstrator program was launched to test the
new technological solution, with the first engine test run taking place in July 1966
(Cownie, 1989). After tests revealed a number of mechanical defects related to the rev-
olutionary character of the three-shaft architecture, the demonstrator program was
cancelled. Instead Rolls-Royce started a smaller three-shaft engine program, the
Trent, which permitted the company to gain some experience on a lower-rated ver-
sion of a three-shaft engine. The Trent program, however, was cancelled in 1968.
Cownie (1989: 232) later stated that ‘many believed that some of the problems later
experienced in RB211 development could have been solved earlier if running had con-
tinued with the RB178 demonstrator’.
When Boeing launched the 747 in 1968, Rolls-Royce submitted a proposal for the
RB178-51 to power the widebody aircraft (Ruffles, 1992). Boeing selected the Pratt &
Whitney JT9D, however, mainly because of its larger size. After failing to sell the
RB178-51 to Boeing, Rolls-Royce became even more convinced that the future of its
aircraft engine business depended on the development of large turbofan engines.
Forecast studies showed that sales of Rolls-Royce’s existing engines would fall from
£58.9 million in 1969 to £3.5 million in 1975, and revenues from the aftermarket from
£36.5 to £31.9 million (Cownie, 1989; Pugh, 2001: 106). Towards the end of the 1960s,
Rolls-Royce had in place two three-shaft engine projects, the RB207 and the RB211.
The RB207 was the larger one, rated at over 50,000 lb and proposed for the twin-
engined European Airbus, US jumbo jets and the BAC Two-eleven projects. The
RB211 was smaller, rated at 30,000 lb, and proposed for three-engined airliners.
2.4 Development of the RB211

In June 1967 Rolls-Royce entered into negotiations with Lockheed to manufacture the
RB211 for its projected L-1011 three-engined widebody aircraft (Pugh, 2001: ch. 4).
Rolls-Royce’s marketing team (led by David Huddie) focused its campaign on techno-
logical superiority and lower prices. Technological superiority was supposed to derive
from not only the revolutionary three-shaft architecture but also the all-composite
(Hyfil) fan blade. These technological advances would result in an engine that was
5
A higher bypass ratio requires a larger fan, which in turn requires a larger nacelle, the metal housing
that surrounds the engine. A larger nacelle creates more added friction, or ‘installed drag’, as the
plane moves through the air.
‘lighter, cheaper to run, simpler in construction (with 40 per cent fewer component
parts) and easier to maintain than existing turbo-fan engines’ (Gray, 1971: 84). Also,
given the lower wages in Britain and the further devaluation of the British pound
against the US dollar, the RB211 engine was offered at £203,000, compared with
£250,000 for the General Electric engine and £280,000 for the Pratt & Whitney engine.
Pratt & Whitney pulled out of the race, while General Electric cut its price to
£240,000. After tough and intense negotiations, Rolls-Royce won the contract by cut-
ting its price to just under £200,000 (Reed, 1973). Lockheed announced the launch
order for the RB211 in March 1968. Lockheed ordered 150 ‘ship sets’ of RB211
engines (totaling 450 engines), with TWA and Eastern Air Lines as launch airline cus-
tomers. Air Holding of the UK ordered 50 Lockheed aircraft, which was politically
advantageous for Rolls-Royce because it offset the offshore purchase of British engines
and therefore helped the US balance of payments (Cownie, 1989).
The news of the Lockheed deal was very well received in Britain. Anthony
Wedgwood Benn, Minister of Technology in the Labour government, stated that the
contract was ‘a terrific boost to British technology and its export potential’ (quoted in
Gray, 1971: 86). The City also welcomed the deal, and Rolls-Royce’s share prices
moved up from £2.225 to £2.35, adding £30 million to Rolls-Royce’s market value
(Reed, 1973). As Gray (1971: 86) pointed out, however, the optimism was based on
the mistaken assumption that, with the aid of the company’s newly developed com-
puter centre, ‘Rolls-Royce’s success was due to the careful control of costs’. In fact,
Rolls-Royce’s success in securing the contract was based on price cutting, a strategy
that, as Gray (1971: 86) put it, ‘did not require a computer’.
The development of the RB211 was unique for Rolls-Royce. As Harker (1976:176)
summed it up: ‘This was a mammoth task; the engine itself was much bigger in overall
dimensions than anything the company had produced before; it was a different shape
and the diameter of the fan was eighty-six inches, which necessitated large machinery
to cut metal and required new techniques in welding’ (see also Cownie, 1989: 234;
Pugh, 2001: 110). When Rolls-Royce took up the RB211 challenge, it employed 84,000
people, of whom 73,000 were employed in jobs related to gas turbine engines, 43,000
being allocated specifically to the RB211 effort (Pugh, 2001: 111). The task of develop-
ing the RB211 became even more complex when the design specifications of the
engine were modified to accommodate changes in the design of the aircraft. By the
time the engine was ordered, aircraft performance requirements had increased, with
the thrust required from the RB211 rising to 40,600lb. In 1972 the thrust requirement
climbed even higher to 42,000 lb because of increased weight of both aircraft and
engine. This thrust was twice that of the largest engine that Rolls-Royce had previously
produced.
The government’s initial contribution was 70% of the launching costs of the
RB211, totaling around £47 million. It was an exceptional contribution since the gov-
ernment had set a limit to launch aid at ‘normally not more than 50%’ of the launch-
ing costs (Department of Trade and Industry, 1972: Annex A). Even then, the initial
launching costs had been seriously underestimated; the as yet unproven technologies
being introduced in the RB211 resulted in soaring development costs. First, the Hyfil
carbon fiber that made up the fan blades failed the so-called ‘bird strike test’. The fiber
was reinforced to strengthen the leading edge of the blades, but this solution caused
stresses at the root of the blade (Gray, 1971). As a result, the all-composite fan blade
was abandoned and the ‘old’ solid titanium blades with snubbers were reintroduced.
This change, however, added 300 lb to the weight of the engine, thus necessitating
expensive redesign work. The sheer size of the engine also required the construction of
new testing facilities. As a result, the progress of the program was delayed, and it
became highly likely that Rolls-Royce would incur the heavy late-delivery penalties
stipulated in the Lockheed contract.
2.5 Rolls-Royce’s bankruptcy

During the first half of the 1960s Rolls-Royce’s revenues had been stagnant in the
range of £100–120 million per annum, but during the second half of the decade they
soared, peaking at about £330 million in 1968 and then declining to about £300 mil-
lion in 1970. In line with this increase in revenues, production costs also increased
sharply in the second half of the 1960s, averaging £96 million per annum in 1961–
1965 and £269 million per annum in 1967–1970. In addition, R&D costs rose from an
annual average of £5.6 million in 1961–1968 to £10.6 million in 1969–1970. During
the 1960s Rolls-Royce recorded modest after-tax profits that averaged £4.8 million
annually over 1961–1969, ranging from £1.8 million in 1962 to £9.0 million in 1968
(Bowden, 2002: 37–38). To boost reported earnings, the company did not charge
R&D costs as a current expense during this period; if it had, after-tax profits would
have averaged £3.5 million annually over 1961–1969 (Pugh, 2001: 139)
Towards the end of 1969 Rolls-Royce financial situation started deteriorating, with
after-tax losses of £9.0 million recorded for 1970 (Bowden, 2002: 37–38). In May 1970
Rolls-Royce asked the Industrial Reorganization Corporation for a loan of £10 million
to cover these losses. More important than current losses, however, were frequent
upward revisions in the estimated launching costs of the RB211, which would not
generate revenue until 1972, rising from £89.2 million in September 1968 to £170.3
million in September 1970 and ultimately reaching £202.7 million in January 1971
(Pugh, 2001: 143; Bowden, 2002: 39). By the end of 1970, moreover, the estimated
production costs of an installed engine under the Lockheed contract had increased
from an original £153,655 to a revised £237,452, thus portending a loss of over
£34,000 on very engine sold (Pugh, 2001: 154).
In taking on the Lockheed contract, Rolls-Royce’s top managers, including its chief
executive (from 1957) and chairman (from 1969), Denning Pearson, were aware of the
potential financial dangers involved. In 1961, in a strategy memo written when he was
managing director of the Aero Engine Division as well as chief executive and deputy
chairman of the whole company, Pearson had stated (quoted in Pugh, 2001: 138–139):
Our best estimates show that neither in volume nor profit will the turn-
over of the years ahead be sufficient to carry present launching costs while
maintaining the ability to undertake profitable new projects as they
arise . . . No project is started without the most careful scrutiny of its com-
mercial prospects and possible profitability; but no matter how successful
any one project may be, the time which elapses between the commence-
ment of expenditure and the delivery of a sufficient quantity of engines
and spare parts to recover the launching costs may be as much as 15 years.
During the 1960s Rolls-Royce had relied primarily on bank loans as a source of exter-
nal finance, mainly in the form of bank overdrafts (Pugh, 2001: 141). When the crisis
at Rolls-Royce became apparent over the course of 1970, the company turned to the
British banking system for the necessary infusions of cash. As part of a £60 million res-
cue package negotiated in September 1970, the Bank of England agreed to lend £8
million to Rolls-Royce, while Midland Bank and Lloyds Bank also agreed to lend £5
million, each with the stipulations that they would have a representative on the Rolls-
Royce board and could further assess the company’s financial situation. In addition,
the government increased its launch aid by a further £42 million, bringing its own
total contribution to the RB211 program to £89 million (Department of Trade and
Industry, 1972: 7–8; Bowden, 2002: 39, 50).
The price of this rescue package was a change in the company’s top management
that directly challenged the control of the engineers. After taking on the Lockheed
contract, Rolls-Royce’s top executives knew that they might eventually have to go to
the City to finance the RB211. Bowden (2002: 44–51) has shown that from May 1968
the City merchant bank Lazards was in frequent communication with Rolls-Royce’s
senior executives and had a representative at meetings of the Rolls-Royce main board.
In the event, once the company turned to the Bank of England, Midland and Lloyds
for emergency funds, the strategic control of Rolls-Royce’s engineer-managers was no
longer secure. As it was, in July 1970, David Huddie, managing director of the Aero
Engine Division and architect of the Lockheed deal (for which he had been knighted
in 1968), had collapsed from exhaustion. In October of that year, at the age of 54, he
resigned his position on the grounds of ill-health (Pugh, 2001: 136–137). In November
Pearson, Rolls-Royce chairman and chief executive, who had joined the company as
an engineer in 1932 at the age of 24, resigned (see http://100.rolls-royce.com/people/
idex.jsp?id = 138). Lord Cole, just retired as head of Unilever, became non-executive
chairman, while the chief executive’s office was filled by a four-man committee
headed by Ian Morrow, a well-known accountant with a track record for turning
around sick companies (‘Rolls-Royce has $7.4 million loss from operations,’ Wall
Street Journal, November 12, 1970).
Notwithstanding changes in management, redundancies and augmented financial
aid from the British government and the banks, Rolls-Royce was not able to overcome
the problems with the RB211 development program. Rolls-Royce internal assessments
(reported to the Ministry of Aviation Supply) showed that due to a number of design
modifications and subsequent changes in the production process, development and
production targets could not be met. These delays meant a postponement of at least
6 months for engine deliveries (Department of Trade and Industry, 1972). The
Department of Trade and Industry later estimated that ‘a further £110 million cash flow
would [have been] required, as compared with the £60 million estimated in September
1970’ (Department of Trade and Industry, 1972: 11). The Conservative government
of Edward Heath, elected in June 1970, had previously, while in opposition, ‘adopted
a policy of “disengagement” from industry with references to the need to end public
support for “lame ducks” ’ (Hayward, 1989: 138). Now the Tories had to decide
whether to continue to provide financial support to Rolls-Royce or allow it to go
bankrupt. On February 4, 1971 Rolls-Royce went into receivership.
What had gone wrong? The problems were technical, financial, managerial and
contractual. The use of Hyfil carbon fiber for fan blades turned out to be a failure. The
technological viability of the RB211’s revolutionary three-shaft architecture had yet to
be demonstrated. As mentioned above, the RB178 demonstrator program had been
cancelled, leaving the design team dependent on parametric studies of the Spey and
smaller turbo-fan engines. It did not help matters that, in 1967, Adrian Lombard, dir-
ector of engineering of the Aero Engine division, a 25-year Rolls-Royce veteran who
was described as one of the finest ‘trouble shooting’ engineers in the industry
(Hayward, 1989: 137), collapsed at his desk and died at the age of 52 (see http://
100.rolls-royce.com/people/view.jsp?id = 130).
At the time that the RB211 program was launched, Rolls-Royce was involved in the
development of the larger RB207 engine for the European Airbus as well as in a
number of military programs (Harker, 1976). Although the two civil engines shared a
common architecture and several design features, ‘development of two large engines,
and especially the RB211 to Lockheed’s stringent contract terms, was straining [Rolls-
Royce’s] resources’ (Hayward, 1989: 136). In addition, the acquisition of Bristol Sid-
deley Engines absorbed financial resources; Rolls-Royce’s purchase of Bristol cost
£63.6 million, £26.6 million of which was paid in cash to Hawker Siddeley Aircraft
(Hayward, 1989: 123). The valuation included about £20 million in goodwill and
shares in British Aircraft Corporation and Westland, which Rolls-Royce later sought
unsuccessfully to sell. The Bristol acquisition placed considerable demands upon
managerial resources for rationalizing the engine divisions. In fact, Rolls-Royce would
have to provide additional capital to support the Bristol side of the business at a time
when its own liquidity was under pressure from its fateful contract with Lockheed.
Hayward (1989, 123) stated ‘With hindsight, it is evident that the determination to
prevent P&W [Pratt & Whitney] obtaining a European foothold led Rolls into a precip-
itated and ill-judged act. Although the merger [with Bristol Siddeley] was not the main
cause of Rolls’ later problems, it would be a significant contributory factor.’
As for the Lockheed contract, the main problem was that Rolls-Royce had agreed
to a relatively low fixed price with, as Hayward (1989: 136) put it, ‘strict and onerous
penalties for delay, giving Rolls very little leeway in the event of serious technical or
financial problems’. Harker (1976: 186) emphasized that ‘Six hundred engines were
contracted, but the price did not make sufficient allowance for the unexpected inflation
that ensued in the economy or the unanticipated development costs that arose’.
3. The era of nationalization
3.1 Emergence from bankruptcy

On the same day that the Rolls-Royce receiver was appointed, Frederick Corfield, the
Ministry of Aviation Supply stated (quoted in Department of Trade and Industry,
1972: 14):
To ensure continuity of those activities of Rolls-Royce which are import-
ant to our national defence, to our collaborative programs with other
countries and to many air forces and civil airlines all over the world, the
Government has decided to acquire such assets of the aero-engine and
marine and industrial gas turbine engine divisions of the company as they
may be essential for these purposes.
A new company, Rolls-Royce (1971) Limited, was therefore formed that
took control of the assets of Rolls-Royce acquired by the government
(Department of Trade and Industry, 1972).6
At that point the development of the RB211 was almost cancelled. But Lord
Carrington, the Minister of Defence, commissioned a technical and cost study that
involved veteran Rolls-Royce engineers Fred Morley, Stanley Hooker and Arthur
Rubbra, and that gave an optimistic assessment of the RB211 (Pugh, 2001: 230).7 The
study argued that the RB211’s development problems could be overcome with a six-
month delay and a cash flow injection of a further £120 million (Department of Trade
and Industry, 1972). According to Gunston (1997: 195), the nationalized company
took ‘the RB211 on board, funded on a cheeseparing daily basis’. The British govern-
ment entered talks with Lockheed to renegotiate the RB211 contract—a deal that
Lockheed also desperately needed. Already in financial difficulty because of cost over-
runs in its military contracts with the US government, a failure by Lockheed to launch
the L-1011 would have pushed it into bankruptcy as well. After a lengthy negotiation
involving the British and the US governments, Rolls-Royce (1971) Limited and Lock-
heed signed a new contract for the completion of the RB211 program. Under this new
agreement, Lockheed agreed to buy RB211 engines at increased prices. Meanwhile,
6
Subsequently, in 1973, the company’s luxury car division became a separate company.
7
For biographical sketches of Hooker, Morley and Rubbra, see http://100.rolls-royce.com/people/
idex.jsp?id = 138.
the US Congress had authorized a rescue package for Lockheed (see http://www.glo-
balsecurity.org/military/systems/aircraft/l-1011-history.htm), and the British govern-
ment stood ready to finance the further development of the RB211.
According to the 1971 Memorandum of Understanding that outlined the relation-
ship between the British government and Rolls-Royce, the government, as the sole
shareholder, maintained ultimate control over strategic planning and financial alloca-
tions related to the launch of new engine development programs (Hayward, 1989). In
particular, ‘any investment decisions over £25 million (US$41 million) had to be
referred back to the government for approval’ (Verchère, 1992: 33). The government
was not involved in the company’s day-to-day management, although the Rolls-Royce
board agreed to keep it informed about its operations (Hayward, 1989).
A number of the government appointees to the new board of Rolls-Royce (1971) Lim-
ited were clearly supporters of the RB211 program. They included Sir William Cook, a
former scientific advisor to the Ministry of Defence, and Sir St John Elstub, Chairman of
Imperial Metal Industries, both of whom had already advised the Heath government on
the viability of the RB211 (Pugh, 2001: 234–235). Yet, as summed up by Hayward (1989:
140), the bankruptcy and bailout entailed a dramatic challenge to engineer control:
. . . it was soon evident that Rolls required a long period of convalescence
and a sharp taste of internal reform. Pearson, Huddie and the Rolls board
took the full brunt of the post mortem. There had been fatal flaws in
Rolls’ management structure and the dominance of engineers at the top of
the company was singled out for particular criticism. As one Rolls man
would later put it, ‘the first thing we had to learn was that the company
was not just a playground for engineers to amuse themselves’.
Rolls-Royce had to be rebuilt, and Sir Kenneth Keith’s appointment as chairman in
September 1972 marked the start of the process that under his command would run
for over seven years (Hooker, 1984).
3.2 Engineer control and bureaucratic interference

With government and board support for the RB211 program, engineers regained com-
plete control over the evolution of the program itself. In the aftermath of the bankruptcy, a
number of Rolls-Royce’s most illustrious engineers had come out of retirement. Among
them was Sir Stanley Hooker, who, among other things, had led the development of the
engine for the Concorde while working at Bristol Aero Engines (Pugh, 2001: 90–92).
Hooker became both Technical Director and a member of the Rolls-Royce board of direc-
tors with the charge of getting the RB211 program back on track. Cyril Lovesey and Arthur
Rubbra, both well over 70 years old, worked with Hooker as what he called ‘a kind of Chief
of Staff committee’ (Pugh, 2001: 235, quoting from Hooker, 1984).
When the Labour government took office in 1974, however, the spector of bureau-
cratic interference reappeared. Rolls-Royce was put under the control of the National
Enterprise Board (NEB), whose role was to oversee the company’s operations. Indeed,
Rolls-Royce was the main holding of NEB, which in turn came to symbolize Labour’s
foray into industrial policy. Rolls-Royce management disliked this intrusion; Keith
believed that the National Enterprise Board added a redundant bureaucratic layer
between Rolls-Royce and the government (Hayward, 1989: 159; see also ‘Rolls-Royce:
middle-man or meddler?, The Economist, December 27, 1975: 42; ‘National Enterprise
Board: Rolls-Royce of a problem,’ The Economist, February 11, 1978: 112). Tony
Benn, as Minister of Trade and Industry after Labour returned to power in February
1974, had his first meeting with the Rolls-Royce chairman in March of that year. Keith
told Benn that when he had accepted the Rolls-Royce position in 1972 he had told
Prime Minister Heath that he would ‘take it on so long as I am not buggered about by
junior Ministers and civil servants and officials’. Benn responded that ‘while I am in
charge I will not accept chairmen of nationalized industries indicating to me that they
won’t be mucked about by junior Ministers and civil servants: Rolls-Royce is a nation-
alized company and must be accountable for what it does’ (Pugh, 2001: 255–257).
From 1971 to 1979, Rolls-Royce reportedly received £425 m in state aid (‘The real
problem is money,’ The Economist, November 17, 1979: 108). During 1979, over a period
that included the election of the Thatcher government in May, there was open hostility
between Keith and the NEB chairman, Sir Leslie Murphy. In late 1979 Murphy told Sir
Keith Joseph, Thatcher’s Minister of Industry, that the Rolls-Royce chairman should be
sacked in the light of the company’s poor financial performance (‘NEB and Rolls-Royce:
Who needs a lame-duck hospital?’ The Economist, November 17, 1979: 108). In the event,
Sir Keith took control of Rolls-Royce away from the NEB (resulting in the resignation of
the entire NEB board), and placed the company in the hands of the Department of
Industry (see ‘Industrial policy: Mrs Thatcher’s awkward inheritance,’ The Economist,
May 5, 1979: 120; ‘Rolls under Whitehall’s wing,’ The Economist, November 24, 1979:
83), while Sir Kenneth retired as Rolls-Royce chairman in early 1980.
3.3 Worsening financial conditions and the GE deal

From 1979 the company’s financial situation worsened, despite Rolls-Royce’s 1000th
RB211 going into production in 1980. With uncovered foreign exchange as the value
of the pound appreciated under the first Thatcher government as well as a prolonged
strike, Rolls-Royce recorded losses of £58 million in 1979 (Pugh, 2001: 299). A severe
recession in the civil aerospace industry in the early 1980s meant persistent losses for
Rolls-Royce.8 In 1983 Rolls-Royce lost £193 million, and in 1983 and 1984 delivered
only 126 new RB211s, even though the ‘worst-case’ scenario in the company’s 1982
8
According to a 1984 report in the Wall Street Journal, Rolls-Royce lost the equivalent of $253 million
in 1983 and ‘Rolls-Royce last posted a profit—currently equivalent to $9 million—in 1978. Its best
year since then was 1981, when it posted income before extraordinary items of $18 million, but a net
loss of $4 million after an extraordinary charge of $22 million due to restructuring costs. It had a net
loss of $176 million in 1982’ (Ingrassia, 1984).
plan had been 350 engines (Pugh, 2001: 297, 304). Between 1980 and 1984 Rolls-
Royce cut its labour force from 62,000 to 41,000, mainly through voluntary severance
and with no industrial disputes (Pugh, 2001: 300, 321, 325). From 1979 through 1988
successive governments would provide Rolls-Royce with £437 million in launch aid,
of which £118 million was repaid from sales levies (Hayward, 1989).
Nevertheless, these adverse financial conditions almost led Rolls-Royce to exit as
an independent competitor from the high-thrust engine market. In 1984, in the after-
math of a string of unprofitable years stretching back to 1979, Rolls-Royce entered
into two RRSPs with GE, whereby GE took a 15% stake in the development of the
medium-sized RB535E4 engine to power the Boeing 757 while Rolls took a 15% stake
in the development of a GE engine designed to exceed 60,000 lb (Pugh, 2001: 311–
319). As reported in an article entitled ‘Rolls faces up to reality’ that appeared in the
Financial Times the day after the agreement was announced:
By swapping a share in one of its new engines for a stake in one of General
Electric’s, Rolls has finally moved away from the course which it has fol-
lowed in the civil engine market for the past 20 years—a course which has
taken this proud engineering company into bankruptcy, and which more
recently has left it with an increasingly weak position in the market for
high thrust commercial engines. (Lambert and Makinson, 1984: 16)
The article cites Ralph Robins, who was at the time Director—Civil Engines, as saying
(in the words of the journalists) ‘that to develop the RB-211 series up to the
[60,000lb+] size range would have effectively required the designers to start with a
clean sheet of paper. On this basis the project could have cost $1-1/2bn or more’.
As a journalist was to write from the vantage point of 1990 on the eve of the first
test of the Trent engine, the 1984 RRSP deal had been made because the company’s
new chairman, Sir William Duncan, ‘believed that any attempt by Rolls to go it alone
in developing high-thrust engines would threaten a repetition of the 1971 RB211 cri-
sis. His answer was for Rolls to stay in the game by opting for minority partnership
with one of it American rivals’ (Lorenz, 1990).9 Or as another journalist, also looking
back at the Duncan agreement from the vantage point of 1990, remarked, ‘implicit in
the deal was the understanding that Rolls would stay out of the big engine end of the
market—shutting it out of the highest growth area and limiting it to a subordinate
role’ (Crooks, 1990: 10).
3.4 Reversal of strategy: the ‘stretch’ capability of the RB211

By 1986, however, some two years after agreeing to the high-thrust RRSP with GE,
Rolls-Royce was marketing its own high-thrust engine, the RB211-524D4D in direct
9
Duncan was an engineer who, at the age of 59, had spent 41 years at Imperial Chemical Industries,
rising to deputy chairman before being passed over to head the company (‘Long wait,’ Financial
Times, September 28, 1982).
competition with not only Pratt and Whitney’s PW-4000 but also GE’s CF6-80C2, in
which Rolls-Royce still had a 15% stake. In August 1986, much to the displeasure of
GE, the RB211-524 secured a £600 million order from British Airways for its new
long-range jumbo jets. GE claimed that its pact with Rolls-Royce precluded its ‘part-
ner’ from bidding for the BA order. Rolls-Royce disagreed (Donne and Cassell, 1986).
Subsequently the GE–Rolls high-thrust RRSP fell apart, with the collaboration being
terminated in November 1986 (Crooks, 1990; Pugh, 2001: 314–319).
Why the reversal of strategy? The improvement in the market for turbofan engines
from 1985 clearly had much to do with it; in 1986 Rolls-Royce had pretax profits of
£120 million and outstanding orders worth £3.1 billion (Pugh, 2001: 323). Rolls-
Royce’s engineers also found, over the course of 1984 and 1985, that, because of the
modularity embedded in the three-shaft architecture, they could upgrade the RB211
for the big-engine market without increasing the fan diameter, with dramatic savings
in development costs compared with Robins’ earlier estimate (Pugh, 2001: 314).
Whether or not a change in the top management of Rolls-Royce was a factor in the
reversal of strategy is difficult to say. In late October 1984, some 8 months after the
high-thrust RRSP, Duncan, the Rolls-Royce architect of the RRSP, announced that, as
of December 1, Ralph Robins would become managing director of the company, the
number two position. A week after the announcement, Duncan died suddenly at the
age of 61. Sir Francis Tombs, who replaced Duncan as chairman, had been appointed
to the Rolls-Royce board as a non-executive director in 1982 and hence had been
involved with the company when the pact with GE had been made. From the perspec-
tive of 1990, Tombs was able to argue that the agreement with GE ‘was leading us
nowhere. The decision to pull out was a watershed’ (quoted in Lorenz, 1990).
As a result of the reversal of the decision to take a subordinate role to GE in the
development of the high-thrust engine, Rolls-Royce increased its market share of the
world civil engine market from 5% at the time of its 1987 privatization to 20% in
1990. The basis of the company’s success was, as Crooks (1990) put it, ‘Rolls’ massive
advantage in having the RB211 engine’. As Lorenz (1990) summarized these advan-
tages that, by 1990, had resulted in the Trent engine:
. . . the RB211 engine core, whose development costs put the company
into receivership, has become the key to its survival and success. Its revo-
lutionary design, using three shafts rather than Pratt and GE’s two, has
proved so flexible that in successive upgradings since 1971 the engine
power has been doubled without incurring the huge expense of significant
design changes. The three-shaft engine is shorter than two-shaft engines,
more rigid and therefore more durable. It wears less in service, preserving
its outstanding fuel economy over its full life. Along the way Rolls
developed a new, wide fan blade, the ‘wide-chord’ fan, which needs fewer
blades to produce the same, or more, power, is quieter and more fuel-
efficient than conventional fans. Only with the Trent did the original
RB211 fan diameter have to be increased, but no other fundamental

change has been made. As a result, the Trent development is likely to cost
about £400 million (with about 25% being funded by Rolls’ partners in
the project, including BMW and two Japanese companies). By contrast,
industry estimates suggest the GE90 project will cost more than £1 billion.
4. Corporate control and financial markets
4.1 Privatization, restructuring and reorganization

From 1979 the Thatcher administration had wanted to privatize Rolls-Royce as part of
the Tory policy ‘to reduce government intervention in industry and to spread “popular
capitalism” through wider share ownership’ (Hayward, 1989: 160). As one minister
put it, ‘the business of aerospace must pay its way. Defence considerations apart, there
is no reason why aerospace should not be subject to the financial disciplines and
opportunities of the marketplace.’ Or, in the words of Norman Tebbit, the Minister of
Industry who succeeded Keith Joseph, ‘the aerospace industry is for making profits, it
is not a form of occupational therapy’ (both quoted in Hayward, 1989: 160).
With losses piling up in the early 1980s, Rolls-Royce was not yet ready to throw
away the protection of government ownership. But in late 1984 a recovery in the civil
aerospace markets began, and in 1985 and 1986 Rolls-Royce posted substantial prof-
its. In May 1987 Rolls-Royce was privatized, with the flotation raising £1.36 billion for
the government—a nice return on its investment in Rolls-Royce—from the sale of its
shares to the public. In addition, at the request of Sir Francis Tombs, Rolls-Royce
newly appointed chairman, the government authorized an additional share issue that
injected £283 million into the company. Notwithstanding the privatization, the British
government retained in perpetuity a ‘golden share’ of Rolls-Royce that gave it the
power to veto any takeover attempt. In an effort to limit the possibility of such a situ-
ation arising, the privatization limited foreign ownership of Rolls-Royce to 15% of its
outstanding shares on a first-come, first-served basis (Hayward, 1989). This limitation
on foreign ownership was challenged by the European Commission, and was subse-
quently increased to 29.5% in 1989 and then to 49.5% in 1998.10
Once privatized, Rolls-Royce searched for productivity gains through significant
organizational restructuring that entailed focusing on core businesses, outsourcing,
downsizing and cost-cutting schemes. This restructuring was pursued with the aim of
making the servicing of customers, especially civil airlines, central to the strategy of
the company. Restructuring also involved an increasing involvement of suppliers and
10
‘Investor limit up at Rolls-Royce,’ New York Times, July 20, 1989: D5; “BAe, Rolls-Royce foreign
ownership limit raised to 49.5 pct from 29.5, AFX News, March 12, 1998. Since the late 1990s most
‘golden shares’ have been ruled illegal by the European courts, but, as a defence contractor, Rolls-
Royce remains protected by the British government’s ‘golden share’.
universities as partners in development and research programs. Organizational

restructuring was pursued also via several internal programs informed by lean manu-
facturing, total quality control and business process re-engineering principles. The
aims of these programs were to improve the efficiency of business processes through-
out the company and to modify the management structure to improve accountability.
At the beginning of the 1990s, Rolls-Royce embarked on an internal quality-enhancing
program, labeled Project 2000. The program was clearly inspired by the Japanese qual-
ity movement and aimed at identifying and eliminating the firm’s business processes
that did not add value (Verchère, 1992).
The supplier base was also rationalized through the reduction of the number of
first-tier suppliers and the introduction of a supplier ranking system. Also, in
1998 Rolls-Royce reorganized itself into two types of business units: (i) customer-
facing business units with responsibility for identifying and meeting customer
needs; and (ii) operating business units with responsibility for delivering sub-systems
on time, to cost and to specification. It was expected that this flatter structure
would enhance the accountability of the business units (Rolls-Royce Annual
Report, 1998).
This intense and profound restructuring resulted in job-cutting, with the average
number of Rolls-Royce’s employees steadily declining throughout 1990s. In 10 years
there was a net reduction of about 20,000 employees, accounting for about one-third
of the workforce in 1990. Nevertheless, in Britain at least, long-term employment
appears to have remained the norm. Rolls-Royce has recognized the importance of a
committed and trained labour force. The 2000 Annual Report stated:
Rolls-Royce is fortunate to have extremely talented and dedicated

employees. In the UK the average length of service is approaching
20 years. This is important in an industry where development and pro-
duction programs may have lives of more than 50 years and in which the
customer relationship with an individual product may be 25 years or
more. (Rolls-Royce Annual Report, 2000: 16)
Over the 1990s the absolute amount of spending on R&D increased constantly,
with net R&D as a percent of sales in the 6–7% range. Much of this spending (as we
shall see) was aimed at the further development of the RB211. From the late 1990s the
strategic emphasis shifted to the generation of technologies that could be exploited
across the company’s different lines of business. Technologies originally developed for
aerospace applications are being exploited for energy applications and more recently
in the marine business (in particular, computational fluid dynamics tools are being
applied to marine propulsion design). New technologies are being researched to
reduce the adverse environmental impacts (in terms of noise and emissions) of the
company’s products. New technologies are also being used to support the more recent
move towards the provision of customer support and service.
4.2 Corporate strategy and the sources of committed finance

As a nationalized company, Rolls-Royce prepared a corporate strategic plan for gov-
ernment approval every year, and relied on corporate revenues, short- and long-term
borrowing, and government support in the form of defence contracts and launch aid
to maintain its organization and fund expansion. With the privatization of the com-
pany in May 1987, Rolls-Royce still had access to these sources of funds, although
launch aid would only be forthcoming if other sources were unavailable. The main
difference was that, as a publicly traded company, the management of Rolls-Royce
was now accountable to the corporation’s public shareholders, the vast majority of
whom had a purely financial interest in the company.
According to Verchère (1992), after privatization senior managers felt more under
public scrutiny by the investment community and private shareholders. As a Rolls-
Royce senior manager stated: ‘We’re becoming much more of a financial and
accountability culture than before’ (quoted in Verchère, 1992: 34). From the begin-
ning of the 1990s Rolls-Royce engaged in ‘a three-tier planning discipline comprising
a ten-year review of market trends backed by five-year financial and strategic plans’
(Verchère, 1992: 34). The third tier was a two-year operating plan and budget that is,
in turn, informed by quarterly and four-week financial budgets that, according to
Verchère (1992: 34), have had ‘the net effect of tightening financial controls at all lev-
els, including the shop floor’.
Yet throughout the 1990s Rolls-Royce underperformed the FTSE 100, with the
gap in stock prices increasingly perceptibly in the late 1990s (see Figure 2). How did
September 1987=100
300
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200
150
100
50
0
Sep-87
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Sep-03
R o lls -R o yc e FTSE100
Figure 2 Stock Price Indices, Rolls-Royce plc and FTSE 100, September 1987–March 2005
(adjusted close on the first trading day of each month). Source: Yahoo! Finance UK.
Rolls-Royce’s exposure to the stock market actually affect strategic decision-making

and the allocation of resources at the company?
To answer this question, one has to determine what roles the stock market has
actually played at Rolls-Royce since 1987. The stock market can exert its influence on
corporate behavior through four different functions that it can perform (see Lazonick
and O’Sullivan, 2004). First, it can structure the relation between owners and manag-
ers in exercising strategic control over corporate allocation decisions. Second, it can
provide the corporation with cash that can be used to restructure the corporate bal-
ance sheet, fund operations (including R&D), invest in plant and equipment, or
acquire existing physical and intangible assets. Third, it can provide the corporation
with its own combination currency that can be used instead of or in addition to cash in
mergers and acquisitions. Fourth, it can provide the corporation with its own compensa-
tion currency that it can use, instead of or in addition to cash, to reward employees and
other stakeholders (for an application of this framework, see Carpenter et al., 2003).
At times, these different functions can be in conflict with one another. For
example, the use of stock as a source of cash can depress its stock price, thus under-
mining its function as a combination or compensation currency. The use of stock as a
source of cash may also, under certain circumstances, lead to a change in stock ownership
that poses a challenge to the strategic control of incumbent management. Or the use
of stock as a combination or compensation currency may result in a dilution of share-
holdings that depresses the company’s stock price and prompts the company to
repurchase its own stock on the market, thus making it a supplier of cash to the stock
market rather than vice versa. The critical question is then whether these functions of
the stock market support or undermine the social conditions of innovative enterprise
(see Carpenter et al., 2003).
As we shall see in the following account of the relation between Rolls-Royce’s cor-
porate strategy and financial markets, the stock market has played all four roles at
Rolls-Royce during the past 18 years, starting with the company’s privatization. Not-
withstanding the relatively poor performance of Rolls-Royce’s stock price in the
1990s, thus far Rolls-Royce’s top management has adroitly made use of the stock mar-
ket to sustain the innovation process. Indeed, a conclusion that one might draw from
the following account is that had Rolls-Royce’s management been more concerned
with maintaining the company’s stock price than with sustaining the innovation pro-
cess in the 1990s, the company would probably not occupy the strong position that it
now does in the aircraft engine industry.
4.3 Ownership and control

The privatization of the company in 1987 transferred ownership of Rolls-Royce’s
shares from the British government to institutional investors and households. Table 1
shows the size distribution of holdings of ordinary shares on December 31, 1988,
December 31, 1991 and December 31, 2003. It is worth noting that on December 31,
Table 1 Size distribution of ordinary shareholdings: Rolls-Royce plc
Size of holdinga December 31, 1988 December 31, 1991 December 31, 2003
Number of % of total % of total Number % of total % of total Number of % of total % of total

holders holdings shares of holders holdings shares holders holdings shares
1–150 612,545 72.32 11.43 345,974 58.21 5.26 118,573 37.18 0.90
151–500 200,769 33.78 4.63 154,244 48.37 2.45
151–1000 210,226 24.82 8.28
501–10,000 45,521 7.66 8.66 43,914 13.77 4.75
1001–10,000 22,491 2.66 6.88
10,001–100,000 1099 0.13 5.00 1348 0.23 4.71 1494 0.47 2.27
100,001–1,000,000 474 0.06 20.34 574 0.10 21.34 497 0.16 10.07
1,000,001 and over 115 0.01 48.07 149 0.02 55.96 169 0.05 79.56
TOTAL 846,950 100.00 100.00 594,335 100.0 100.0 318,891 100.00 100.00
Sources: Rolls-Royce Annual Report (1988: 34; 1991: 13; 2003: 84).
a
The 1988–1990 annual reports provide data on shareholding for those with 151–1000 shares and 1001–10,000 while the 1991–2003 annual reports
Strategic control and financial commitment at Rolls-Royce plc
provide data on shareholding for those with 151–500 shares and 501–10,000 shares.
page 23 of 42
1968, on the eve of the difficulties that had plunged Rolls-Royce into bankruptcy,
Rolls-Royce had 59,712 shareholders, of which 50,742 were individuals (who held
46% of the number of shares outstanding), while 218 were insurance companies, 948
banks and 134 pension funds (Bowden, 2002: 41–42). Twenty years later, as a repriva-
tized company, Rolls-Royce had a vastly increased number of small shareholders, but
a smaller number of large institutional shareholders held a much larger proportion of
the shares outstanding.
As can be seen from Table 1, from 1988 to 2003 the number of small shareholders
declined, while the concentration of shareholdings among the largest shareholders—
all institutional investors—increased dramatically. Whereas at the end of 1988 the 115
holders of more than one million shares had 48% of Rolls-Royce’s shares, at the end
of 2003 the 169 largest shareholders had 80% of the shares. As of February 11, 2004,
the largest shareholder, with holdings of 10.19% of the outstanding ordinary shares,
was Franklin Resources, Inc., a major US-based institutional investor that manages
the Franklin-Templeton investment funds. The second largest shareholder was BMW
AG, with holdings of 9.51%. The German automobile company had acquired these
shares as a result of Rolls-Royce’s purchase of BMW’s stake in a joint aircraft engine
venture.
Notwithstanding this growing concentration of shareholding at Rolls-Royce, the
company’s management was dominated by insiders who, protected from takeover by
the British government’s ‘golden share’, remained firmly in control of corporate allo-
cation decisions. The key executive over this period was Sir Ralph Robins. Upon grad-
uating from Imperial College in 1955, Robins, age 23, had joined the company as an
apprentice engineer. He became managing director in 1984, chief executive in 1991
and chairman in 1992. A 1999 profile of Robins in The Financial Times noted that ‘Sir
Ralph . . . has been in charge throughout the glory years’. The article went on to say
that, while the City remains unimpressed with Rolls-Royce’s stock market perform-
ance, ‘no one in the City has a bad word to say about the slim, pinstriped, impeccably
courteous Sir Ralph’. The profile went on to quote one unnamed City analyst who
remarked: ‘He’s everybody’s favourite uncle. But his priority is to maintain Rolls as an
independent British company. Shareholder value is secondary to him’ (Skapinker,
1999: 19). More recently, as a newspaper reporter put it in March 2002 in comment-
ing on Robins announcement of his retirement: ‘Sir Ralph Robins, chairman of Rolls-
Royce, is no great fan of the City and it of him by the look of the 7 per cent surge in the
Rolls-Royce share price that greeted news of his retirement’ (‘Outlook: Prickly Sir
Ralph derives his place in history,’ The Independent, March 8, 2002).
Like Robins, most of the other top executives at Rolls-Royce from privatization to
the present built their careers with the company. In October 2001 the person who
Michael Howse replaced as Director—Engineering and Technology was Philip
Ruffles, an engineer who had joined the company in 1961 at the age of 23. In addition,
Ruffles’s predecessor as Director—Engineering and Technology was Stewart Miller,
an engineer who had joined Rolls-Royce in 1954 at the age of 21 and had been
appointed to the Board in 1984 before retiring after 41 years of service in 1996. Count-
ing Robins and Ruffles, of the nine executive directors who were with the company in
2001, six had joined the company in 1969 or before at an average age of 22.5 years and
had on average 37 years of service with the company. Five of these six were engineers.
Of the other three, John Rose and Paul Heiden, who joined Rolls-Royce in their 30s,
both had finance backgrounds, while James Guyette joined the company subsequent
to the Allison acquisition. These executives, who effectively controlled Rolls-Royce’s
resource allocation decisions, were long-term career managers, and most of them had
spent their entire careers with Rolls-Royce. The importance of the company’s finan-
cial strategy for sustaining the innovation process over the dangerous decade of the
1990s may explain why Rose, a non-engineer, became managing director of the Aero-
space Group in 1994 and chief executive of Rolls-Royce in 1996, a position that he
continues to occupy.
4.4 The relation between internal and external finance

Figure 3 shows the relation between Rolls-Royce’s internal sources of funds and its
most important uses of funds, not including acquisitions, since it was privatized.
‘Adjusted Internal Sources’ adds the costs of net R&D to Funds from Operations on
the Cash Flow Statement to show the amount of internal sources of funds available to
cover not only capital expenditures and cash dividends but also net R&D. Especially in
1000
900
800 A djus te d Inte rnal

So urc e s
700
C P X+ C D S+ N R D
600
£m NRD
500
400 C PX
300
CDS
200
100
0
1987
1989
1991
1993
1995
1997
1999
2001
2003
Adjusted Internal Sources=Funds from Operations + Cost of net R&D

NRD=cost of net R&D
CPX=capital expenditures
CDS=cash dividends
Figure 3 Rolls-Royce: sources of internal funds and major uses of funds other than acquisi-
tions, 1987–2003. Sources: Rolls-Royce Annual Reports.
the aircraft engine industry, notwithstanding accounting practice, R&D is not a cur-
rent expense but rather a capital investment that will only generate returns in the
future and hence must be financed. As Figure 3 shows, in most years, net R&D expen-
ditures were greater than capital expenditures. Over the period 1987–2003, net R&D
expenditures totaled £4014 million, capital expenditures (not including acquisitions)
£2895 million, cash dividends £1011 million, and funds from operations £4223 mil-
lion. As can also be seen in Figure 3, cash flow, while never negative, was weak in the
years 1991–1994, with funds from operations not even covering reduced dividend
payments in 1993 and 1994. Yet is was in these years that, by sustaining the innovation
process, Rolls-Royce was able to consolidate the capabilities that enabled it to surpass
Pratt & Whitney as the number two high-thrust aircraft engine producer.
It was in the first half of the 1990s that external finance became critical to Rolls-
Royce, as Figure 4 shows. Rolls-Royce had made substantial profits from 1987
through 1990, as indicated in Figure 3, but then a slowdown hit both the military and
civil segments of the aerospace industry. After suffering an operating loss of £172 mil-
lion in 1992, Rolls-Royce found itself facing the high costs of both sustaining the
development of the high-thrust widebody Trent and rationalizing its existing activities.
NEI Financial Allison Vickers

Privatization acquisition restructuring acquisition acquisition
700
600
500
400
£m
300 AOA
DOA
200
PSI
100 ChangeLTD
0
1987
1989
1991
1993
1995
1997
1999
2001
2003
-100
-200
-300
AOA=acquisition of assets
DOA=disposal of assets
PSI=public stock issues
ChangeLTD=Change in long-term debt
Figure 4 Rolls-Royce: external financing and acquisitions, 1987–2003. Sources: Rolls-Royce

Annual Reports.
The first Trent 700 engines for the Airbus 330 were to be delivered in the winter of 1994,
and the higher-thrust Trent 800 that was being developed for the Boeing 777 would be
tested in September 1993 (‘Rolls-Royce plc interim results 1993,’ PR Newswire
European, September 2, 1993). The rationalization program, which was announced in
March 1993, entailed the closing of six of twelve of the company’s main manufacturing
sites and layoffs of 2900 people, a 6% reduction of the workforce (Tieman, 1993).
The company had taken on debt from the late 1980s (see Figure 3), and with cash
flow low in 1993 and 1994 was reluctant to take on more. In September 1993 it was
reported that the company thought that the rationalization program alone would
absorb £130 million over the next two years. Rather than take on more debt, the Rolls-
Royce board decided that a rights issue of ordinary shares would be a much safer fin-
ancial course to follow (‘Royce-Royce 1—right issue offsets rationalisation costs,’
Extel Examiner, September 2, 1993). In September 1993 Rolls-Royce announced a
rights issue that would raise £307 million net of expenses (see Figure 4). One new
share would be offered to the company’s existing shareholders for each four shares
that they currently held. A Rolls-Royce press release explained why the company was
going to shareholders for more equity capital:
In July this year the financial resources of the Group were strengthened by
a successful $300 million bond issue. However the Board of Rolls-Royce
does not wish to place undue reliance on bank and other forms of debt
financing. The Board believes it appropriate to finance the Group’s long
term activities predominantly through equity capital rather than debt.
This approach was adopted in the Group’s capital structure at the time of
privatization in 1987 when the Group came to the stock market with no
net debt. The requirement for a rights issue should be seen in the context
of turnover which has risen from £1973 million in 1988, when sharehold-
ers’ funds were £949 million, to £3562 million in 1992 on a similar equity
base (‘Official correction: Rolls-Royce—rights issue,’ Extel Examiner,
September 2, 1993).
Rolls-Royce had seen its share of new orders of civil aircraft engines rise from 22% in
1992 to 28% in the first half of 1993—placing it just ahead of Pratt & Whitney, and
even with General Electric—but market conditions, intense competition, and the
imperative to sustain R&D raised concerns among shareholders about when they
would see a resurgence of Rolls-Royce’s share price to its post-privatization levels
(Tieman, 1993; ‘Extel financial exclusive: Rolls-Royce to fund “R&D at highest level
ever”—chairman,’ Extel Examiner, September 2, 1993). The Times editorial on the
rights-issue announcement observed that ‘Rolls-Royce asks a great deal from its
shareholders’. In The Times’s full report on the condition of Rolls-Royce, reporter
Ross Tieman (1993) observed that ‘the last time Rolls-Royce needed more cash to
develop a new aero-engine, it went bust. This time it is asking shareholders to contrib-
ute.’ But Tieman continued:
The need for money is fundamentally different to that which existed 22

years ago, when Edward Heath’s government was obliged to bail the com-
pany out of its cost over-runs on the development of the RB211 airliner
engine. Today, the problem is one of success. But ironically, the RB211 is
still at the root of Rolls’s financial embarrassment.
Ideally, the prices that Rolls-Royce could secure from the airlines in the new engine
market would reflect the improvements in reliability that would save on future servic-
ing and replacement costs. But the generally depressed market conditions since 1989
had led airlines to ground older planes with ‘spares-hungry’ engines while creating
intense competition among the Big Three for new orders, including engines for the
Boeing 777, in a multisourcing world (Tieman, 1993). It was under these economic
conditions that, in 1993, Rolls-Royce went to its shareholders for cash.
On the announcement of the rights issue, the price of Rolls-Royce shares fell by
almost 7% to 152½p. The rights issue was offered at 130p, a 20.5% discount from the
market price on the announcement date. Those British shareholders who did not
want to take up the issue had a window of opportunity to sell the rights to those who
did. At the same time, foreign holdings had reached the maximum of 29.5%, thus
restricting foreign sales (Rudd, 1993: 17).11 In the event, the deep discount on the
rights issue meant that 87.2% of the 211.6 million new ordinary shares offered were
taken up by existing shareholders, with the broker underwriting the rest of the issue
and offloading the shares at 145p, mainly to two large institutional investors (Kibazo
et al., 1993: 50). In the process, the proportion of shares that were foreign-owned
dropped to 25% (Pain, 1993: 22).
Just 18 months later Rolls-Royce once again went to the stock market for cash, but
this time to make a US-based acquisition rather than to restructure the company’s
balance sheet. In January 1995 Rolls-Royce paid $525 million, equivalent to £328 mil-
lion, to acquire Allison Engine Company, a US military engine supplier that had been
founded in 1915 and that from 1929 to 1993 had been a subsidiary of General Motors.
Rolls-Royce had made a previous bid for Allison in 1993, but GM had sold the com-
pany to a management buyout team for $370 million (‘Rolls-Royce buys Allison
Engine,’ European Information Service, January 5, 1995; ‘Clayton, Dubilier & Rice
completes sale of Allison Engine Company to Rolls-Royce,’ PR Newswire, March 24,
1995). When Rolls-Royce had announced its plan to buy Allison Engine on November
21, 1994, the news was, according to Investors Chronicle, ‘welcomed by the City’, with
Rolls-Royce’s share price moving up 2p to 185p (‘Popular shares: R-R ahead of
Allison OK,’ Investors Chronicle, February 10, 1995: 54). Financial analysts apparently
believed that the Allison acquisition would be done in Rolls-Royce shares, whose price
had risen substantially over the past year and which were listed on the New York Stock
11
Some foreign investors had already been forced to sell their holdings to comply with the limit.
Meanwhile Rolls-Royce lodged a request with the government to raise the limit to 49.5%.
Exchange in the form of US-dollar-denominated American Depository Receipts.12

Allison’s current owners were not, however, interested in accepting Rolls-Royce’s
shares in payment, even denominated in US dollars. To finance the acquisition, there-
fore, in March 1995 Rolls-Royce did a rights issue of £331 million (net of expenses),
offering one ordinary share at 154 p for every 5.4 ordinary shares held on March 16,
1995.
The March 1995 rights issue differed significantly from that of September 1993.
Instead of offering new shares directly to existing shareholders, Rolls-Royce, through
its sole underwriter N. M. Rothschild & Sons, offered the 227.3 million shares to City
institutional investors at 154p, which was a discount of just over 5% on the opening
price of 164p—and hence less than one-quarter of the discount that the 1993 rights
issue had imposed on the company’s shares (Rodgers, 1995: 17). The combined result
of the two stock issues, however, was to raise £638 million, about equal to the total
amount that Rolls-Royce spent on net R&D over the three-year period 1994–1996.
After these years the company’s cash flow moved up sharply (see Figure 3), and the
danger of another bankruptcy disappeared.
4.5 Alternative acquisition currencies

In late October 1988 Rolls-Royce secretly purchased a 4.7% stake in Northern Engi-
neering Industries (NEI), a power station equipment and heavy engineering group
based in Newcastle (Garnet, 1988: 33). Rolls-Royce then entered into talks with NEI
concerning a friendly bid for the company that would total £360 million and be paid
mainly in cash, to be covered by Rolls-Royce’s cash balances and the proceeds from a
Eurobond issue.
Subsequent merger talks between the two companies appeared to have come to an
end in late December (Gribben, 1988: 19). When the merger was agreed in April 1989,
however, no cash was involved. Between the aborted discussions in December and the
merger agreement in April, Rolls-Royce’s share price had risen from 128p to 185p, an
increase of 45%, outperforming the rising FTSE 100 by 29% (‘View from City Road:
NEI an “add-on” for Rolls-Royce,’ The Independent, April 11, 1989: 25). Instead of
cash, seven new Rolls-Royce shares were exchanged for every 10 NEI shares, thus val-
uing NEI at £306 million (‘Rolls-Royce and NEI to merge,’ PR Newswire European,
April 10, 1989. See also Garnet, 1989). In using its shares for the merger, Rolls-Royce
was able to maintain control over its cash reserves.
The NEI purchase price represented a 23% premium over the price of NEI shares
on the date before the disclosure of Rolls-Royce’s 4.7% holding in NEI. The new
shares issued by Rolls-Royce entailed a 16.7% increase in its issued ordinary share
capital, thus placing a substantial burden on the NEI acquisition to generate sufficient
12
ADRs track a foreign-based company’s share-price movements on its home stock market, but obvi-
ate the need for US holders of these securities to assume the exchange-rate risk of holding the actual
shares.
earnings to maintain existing earnings per share. In 1988 NEI had reported pre-tax
profits of £38.5 million, equivalent to 22.9% of Rolls-Royce’s level of pre-tax profits in
that year (‘Rolls-Royce and NEI to merge’). Thus, the NEI acquisition promised to
pay its own way. More importantly, the NEI acquisition launched Rolls-Royce on a
diversification strategy that, as already described, became focused in the last half of the
1990s around the application of gas turbine technology to energy and marine uses, as
well as aerospace.
Alongside Rolls-Royce, Vickers was the other major British engineering company
to survive the pressures of competition and consolidation over the course of the
twentieth century. Indeed the relation between Rolls-Royce and Vickers went back to
1919 when the first non-stop transatlantic flight was made in a Vickers Vimy aircraft
powered by Rolls-Royce Eagle engines (Lister, 1999). In September 1999, Rolls-Royce
announced its proposal to acquire Vickers for £576 million in cash—a premium of
53% over Vickers’ market capitalization at the time—in order to gain access to its
capabilities in marine power systems (‘Rolls-Royce plc: Proposed recommended offer
for Vickers plc from company for £576 m,’ Global News Wire, September 20, 1999). As
Sir Ralph Robins told reporters in the manner made famous by GE’s Jack Welch: ‘Our
strategy is to get to No. 1 or 2 in the various markets in which we operate. We
are there in aerospace, this will put us there in marine’ (Cowell, 1999). Vickers share-
holders were also given the option of receiving, in lieu of cash, loan notes issued by
Rolls-Royce, redeemable at the holder’s option in whole or in part at six-month inter-
vals directly from Rolls-Royce, but not listed or traded on a stock exchange (‘Vickers
plc—Recommended cash offer—Part 1,’ Regulatory News Service, September 20,
1999). With revenues strong in 2000, the company was able to reduce substantially the
debt taken on to acquire Vickers (see Figure 4).
In 1999 Rolls-Royce made three other acquisitions. To build capabilities in the
energy sector, it acquired the rotating compression business of Cooper Cameron,
named Cooper Rolls, for £132 million in cash. It acquired National Airmotive, a ser-
vice and repair facility in Oakland, California, for £47 million in cash. Finally, on
December 31, 1999 Rolls-Royce purchased the 50.5% shareholding that BMW AG
held in BMW Rolls-Royce GmbH for 33.3 million shares and the waiver of a £180 mil-
lion loan that BMW owed to Rolls-Royce, for a total acquisition value of £289 million.
The business was renamed Rolls-Royce Deutschland GmbH (Rolls-Royce Annual
Report, 1999: 38). It was as a result of this deal that BMW acquired a 10% stake in
Rolls-Royce and became its second largest shareholder.
4.6 Stock-based compensation

After its privatization, Rolls-Royce had two stock-based compensation plans. One was
the Employee Sharesave Scheme, which enabled an employee to buy limited amounts
of Rolls-Royce shares at a discount (generally 15%) on the condition that, for those in
the UK, the employee enter into a contract with Inland Revenue to hold the shares for
5–7 years. The Sharesave Scheme was broad-based; for example, during 1995, 1800
employees entered the Scheme for the first time, bringing the number of participants
at the end of the year to 13,000, or about 30% of the company’s workforce (Rolls-
Royce Annual Report, 1995: 21).
The other stock-based compensation plan was the Executive Share Option Scheme,
which covered 46 directors and senior executives a year after it was inaugurated in
1987 and 92 directors and senior executives when it was terminated in 1997 (Rolls-
Royce Annual Report, 1988: 27; 1997: 44). Under the executive plan, the vesting period
was 3 years, with expiration after 10 years. Options could be granted annually, but in
1993 and 1994 there were no options granted. In 1995, in line with the Greenbury
Committee’s Report on Directors’ Remuneration, the right to exercise stock options
became conditional on the attainment of the performance criterion that earnings per
share (EPS) growth exceed the rate of growth of the UK retail price index (RPI) by 2%
per annum over a three-year rolling period. In the event, this target would be missed
in 1998 and 2000–2003, thus limiting executives’ gains from stock options even when
the market price of Rolls-Royce’s shares exceeded the exercise price of the options
(Rolls-Royce Annual Report, 1995: 21).
In 1997 a Long Term Incentive Plan (LTIP) replaced the Executive Share Option
Scheme. The Rolls-Royce Remuneration Committee believed that ‘the introduction of
the LTIP will greatly strengthen the identity of interest between senior executives and
shareholders by creating a new and powerful incentive towards improved perform-
ance in the longer term’ (Rolls-Royce Annual Report, 1997: 23). Rather than options,
LTIP awarded shares to 60 executives in 1997, including all the executive directors, up
to a maximum of 60% of an executive’s salary. Executives could potentially realize the
market value of the shares after 3 years if, as in the previous option plan, the growth in
Rolls-Royce’s EPS exceeded RPI by 2% over the three-year period. In addition, how-
ever, even if that performance criterion were met, the proportion of the award that
executives would realize depended on Rolls-Royce’s total shareholder return (TSR)
relative to ‘a group of 19 comparator companies comprising other leading engineer-
ing and industrial companies’. If Rolls-Royce ranked first, second or third in TSR, the
executives would receive 100% of the LTIP award, with the percentage declining to
40% if Rolls-Royce placed ninth, and 0% if tenth or below (Rolls-Royce Annual
Report, 1997: 23).
Awards under the LTIP were made in 1997, 1998 and 1999, and when the last
three-year performance period had ended on December 31, 2001, no gains under the
scheme had been realized (Rolls-Royce Annual Report, 2001: 30). By that time, the
company had shifted back to a stock option plan, first to 69 US-based executives in
1999, and then to a total of 363 directors and executives in 2000 (Rolls-Royce Annual
Report, 2000: 54). Under the new stock option plan, EPS growth had to exceed RPI
growth by 3% over a three-year period for options to be exercised. In 2001, with
Rolls-Royce’s EPS languishing and its stock price falling, and in view of that fact that
‘As a major employer in the US, the Company also had a need to provide rewards for
strong performance which were more in line with US practice’, the company decided
to increase sharply the number of options that it was awarding to ‘key members of the
executive team’ (Rolls-Royce Annual Report, 2001: 31). Eight executive directors, who
had averaged 157,000 option awards in 2000, were granted an average of 802,000 in
2001, falling back sharply to 296,000 in 2002. Ralph Robins, as chairman, received
165,000 option awards in 2000, 861,000 in 2001 and, given his pending retirement,
none in 2002. John Rose, as chief executive, received 283,000 option awards in 2000,
1,281,000 in 2001, 638,000 in 2002 and 802,000 in 2003.
Top Rolls-Royce executives may eventually reap US-style returns from stock
options, but thus far they have not done so. Of Robins’s total nominal compensation
of £5,979,154 from 1987 until he retired in January 2003, £480,363 (or 7.44% of the
total) came from the exercise of stock options. Rose’s total compensation as chief
executive from 1996 through 2003 was £5,706,000, of which the exercise of stock
options (all in 1996 and 1997) contributed £175,420 (2.98%).13 In fact, given Rolls-
Royce’s stock-price performance, most options awarded in the early years expired
without being exercised. When he retired in 2003, Robins had over one million unex-
ercised options, while on December 31, 2003 Rose had over 3.1 million options out-
standing, with exercise prices ranging from 77p (798,702 options granted in March
2003) to 216p (1,273,149 options granted in March 2001).
Even without sizeable gains from the exercise of stock options relative to the rest of
the Rolls-Royce workforce, the company’s executive directors received increasingly
generous pay over the period 1987–2002, as Table 2 shows. In 1987 the pay of the
highest paid Rolls-Royce executive was 9.0 times that of the average pay of all Rolls-
Royce employees, while the average pay of all executive directors was 6.1 times that of
all employees. By 2002 these figures had risen to 28.9 and 18.2. Between 1992 and
2002, the average nominal pay of Rolls-Royce employees had almost doubled, from
£19,345 to £38,367, while that of the company’s executive directors was 3.7 times
higher (£187,643 to £697,375), and that of the highest paid executive was almost four
times higher.
While it can be misleading to compare the relative pay of top managers to employ-
ees across companies and industries in which the composition of the labor force may
differ significantly, it would appear that, notwithstanding the generally rising ratios
displayed in Table 2, Rolls-Royce as a company has had a comparatively egalitarian
distribution of income. The Guardian’s 2004 pay survey for the FTSE 100 companies
found that the ratio of chief executive pay to the average for all workers ranged from
447:1 at BSkyB to 4:1 at Carlton, with an average ratio of 72:1. The claim was made
that a generation ago this ratio had been 25:1, about what Rolls-Royce’s has been in
the 2000s (Seager, 2004).
13
Rose’s total compensation of £1.1 million in 2003 placed him in 158th place among the highest paid
British executives. See http://www.guardian.co.uk/executivepay/0,1204,543498,00.html (The Mil-
lionaires, Part 1 and 2).
Table 2 The relative pay of Rolls-Royce executives and Rolls-Royce employees, 1987–2003
Year Pay of highest-paid executive to Average pay of executive directors

average pay of all employees to average pay of all employees
1987 9.0 6.1

1988 11.2 6.9
1989 12.5 6.6
1990 14.8 9.5
1991 14.3 7.7
1992 14.4 9.7
1993 14.5 10.6
1994 16.6 11.0
1995 13.3 9.3
1996 14.4 10.7
1997 19.2 12.7
1998 18.5 13.0
1999 18.9 14.9
2000 20.1 13.2
2001 25.0 16.5
2002 28.9 18.2
2003 24.1 16.0
Sources: Rolls-Royce Annual Reports (1987–2003).
Compared with the US corporate economy, the CEO:worker ratio in Britain looks
modest, even today. According to Executive Paywatch, a website maintained by the
AFL-CIO, the average ratio of CEO:worker pay of major US corporations was 42:1 in
1980, 85:1 in 1990 and 531:1 in 2000, ‘moderating’ to 301:1 in 2003 (see http://
www.aflcio.org/corporateamerica/paywatch/retirementsecurity/). Of more direct rel-
evance for this study is a comparison of the pay of John Rose, as chief executive of
Rolls-Royce, with that of David L. Calhoun, the president and CEO of GE Transporta-
tion (the division of GE that includes what was formerly GE Aircraft Engines), and of
Louis R. Chênevert, the president of Pratt & Whitney, a division of United Technolo-
gies Corporation. Calhoun has not been among the top five highest paid executives at
GE as a whole, so data on his pay are not reported in the company’s annual Proxy
Statements. But data for Chênevert are available from 2000 through 2004, covering
the period that he has been the head of Pratt & Whitney, and we can compare the pay
of Rose and Chênevert for 2000–2003. Over the four years, Rose received $5,937,061,
or an annual average of $1,484,265, while Chênevert received $9,300,0697, or an
annual average of $2,325,174.
Gains from exercising of stock options contributed nothing to Rose’s remunera-
tion, whereas, at $3,740,280, they represented over 40% of Chênevert’s compensation
over the four years. Without stock option gains, Rose’s pay was about the same as
Chênevert’s in 2000, but increased to 1.85 times that of Chênevert’s in 2003, buoyed
up in part by the weakening dollar (at the 2000 exchange rate, Rose’s pay would have
been 1.71 times that of Chênevert’s non-option pay). Once the gains from exercising
stock options are added in, however, Rose’s total compensation is only 50% of Chên-
evert’s in 2000, rising to only 65% in 2003. ‘Shareholder value’ had supercharged
Chênevert’s pay package. Whether stock-based incentives have supercharged Pratt &
Whitney is more in doubt. By the early 2000s, after decades of sustaining innovation,
Rolls-Royce had left Pratt & Whitney turbines behind.
5. Implications for a theory of innovative enterprise

It is in the nature of innovative enterprise that each case is unique, and the case of
Rolls-Royce is no exception. It is only once one has analyzed a case like Rolls-Royce as
an evolving historical process that one can consider, to paraphrase Nelson (1991),
why this particular firm differed and how its particular history mattered. Precisely
because of the inherent uniqueness of each particular case, an accumulation of case
studies—successes as well as failures—is essential for the construction of a relevant
and rigorous theory of innovative enterprise.14 A theory of innovative enterprise can
claim relevance by distilling the essence of the conditions of innovative enterprise
from existing case studies. A theory, thus developed, can claim rigor by providing a
conceptual framework that generates testable hypotheses for further case studies that
enable one to elaborate, modify and possibly reject propositions that constitute the
substance of the existing theory.
The case of Rolls-Royce that we have analyzed provides substance to the concepts
of ‘strategic control’ and ‘financial commitment’, and thereby enables us to refine
hypotheses of why and how strategy and finance influence the innovation process.
The ‘strategic control’ hypothesis contends that a necessary condition of innovative
enterprise is that those who control the allocation of corporate resources have the
abilities and incentives to confront the technological, market and competitive uncer-
tainties inherent in the innovation process. During the history of the RB211, most of
the people who occupied positions of strategic control were engineers who were
devoted to developing and selling aircraft engines. Working for the only remaining
world-class aircraft engine company in Britain in the last half of the 1960s, they were
presented with the opportunity of a lifetime of producing a high-thrust turbofan
engine for the widebody jetliners being introduced. Despite the technological, market
and competitive uncertainties of this challenge—uncertainties of a magnitude that
14
On the use of case studies in building theory, see Eisenhardt (1989), Leonard-Barton (1990) and
Doz (1996). On the integration of theory and history, see Lazonick (2002). For other studies that
makes use of the ‘social conditions of innovative enterprise’ framework, see Carpenter et al. (2003)
and Lazonick (2004a).
made it clear that they were ‘betting the company’ on the outcome—they grabbed the
opportunity, landing the Lockheed contract.
As salaried managers, Rolls-Royce’s senior engineers occupied positions of stra-
tegic control. They had unique capabilities acquired from experience and powerful
incentives bound up with their careers to allocate resources to the development of the
RB211. Rolls-Royce’s bankruptcy in 1971 could have been the end of the RB211 story.
Indeed, even before Rolls-Royce went into receivership, the effort at innovation had
put an end to the careers of some of the company’s top engineer-managers, and the
subsequent governmental inquiry (Department of Trade and Industry, 1972) laid the
blame for the bankruptcy squarely on Denning Pearson and David Huddie.15 But the
strategic importance of jet engine capability to the British nation kept the company in
operation, and provided the possibility for a younger generation of engineers to con-
tinue the work of those who had preceded them. Given the willingness of successive
British governments to support the company, members of this younger generation,
most notably Ralph Robins, themselves eventually rose to positions of strategic con-
trol within the firm. In the critical interim, the opportunity for these engineers to
develop the RB211 was protected by a series of government-appointed chairmen, with
Kenneth Keith (1972–1980), a banker, and Francis Tombs (1985–1992), an engineer,
playing the most important roles.
The reassertion of the influence of the career engineers over corporate strategy was
not fully secured until the last half of the 1980s, spanning the transition from a
nationalized to a privatized company. By the late 1980s the RB211, an unproven tech-
nology in the late 1960s, had become highly competitive in the civil high-thrust turbo-
fan aircraft engine market. In 1990 Robins was named chief executive and in 1992
chairman, the first Rolls-Royce career manager to rise to that position since Denning
Pearson in the pre-bankruptcy era. Over the course of the 1990s, Rolls-Royce’s grow-
ing share of this market solidified the control of these career managers, although per-
haps significantly, given the financial challenges that Rolls-Royce continued to face in
the first half of the 1990s, it was someone with a financial background, John Rose,
who, in 1996, was named the company’s chief executive, with Robins continuing as
executive chairman until he retired at the beginning of 2003.
According to some theories of corporate behavior, the case of Rolls-Royce plc
should have ended in failure. With the British government’s ‘golden share’ insulating
Rolls-Royce’s managers from the market for corporate control, agency theorists
would predict that ‘entrenched management’ of the type that has existed at Rolls-
Royce is bound to result in a misallocation of resources (see Jensen, 2000: ch. 1).
Entrenched managers, the argument goes, build empires that serve their own self-
interests at the expense of maximizing shareholder value, and as a result waste the
‘free cash flow’ that could have been better allocated to alternative uses.
15
See e.g. ‘Rolls-Royce: Harsh judgment: 2 men get the blame in classic collapse,’ New York Times,
August 26, 1973 (a review of the 1972 DTI report when it was published in 1973).
Agency theory highlights the very real problem of self-serving managerial control
that one finds in many companies in different times and places. The Rolls-Royce case
suggests, however, that entrenched management might be a necessary condition of
innovative enterprise. Did Rolls-Royce’s entrenched managers create or waste value?
To address such a question, one must analyze whether Rolls-Royce indeed gener-
ated higher quality, lower cost products at prevailing factor prices than would other-
wise have been available. The evidence presented in this paper is that it did. The
company developed a leading technology and, against powerful competitors, became
the number two aircraft engine producer in the world. According to the data we have
collected, from the outset of the RB211 program in the late 1960s to the re-emergence
of Rolls-Rolls as a publicly listed company in 1987, the British government provided
Rolls-Royce with a net of £833 million in launch aid, and got back £1.36 billion in the
1987 privatization. As a privatized company, Rolls-Royce has been consistently profit-
able, and over time has become increasingly so. The company has, moreover,
employed tens of thousands of people annually at rising wages and captured increas-
ing market shares. Rolls-Royce increased its earnings per share from an average of
7.97p in 1991–1996 to 16.12p in 1997–2004. Shareholders have had an average divi-
dend yield of 3.75% from 1988 to 2004, and for 1999–2004 the Rolls-Royce dividend
averaged 4.35% compared with 2.74% over this period for the FTSE 100. Rolls-
Royce’s shareholders have not seen persistent stock-price gains, but over the past
eighteen months Rolls-Royce’s stock price has been rising faster than the FTSE 100
and has reached new highs (see Figure 2).16 In the Rolls-Royce case, the agency theory
hypothesis that entrenched management will waste corporate resources finds no support.
The ‘financial commitment’ hypothesis contends that a necessary condition of
innovative enterprise is that those who exercise strategic control can mobilize the
types of financial resources that will remain committed to sustaining the innovation
process. What were the sources of such ‘patient capital’ at Rolls-Royce, and what are
the implications for a theory of innovative enterprise? When in 1970 Rolls-Royce
turned to the City for bank loans, the response, led by the Bank of England, was to
ante up £18 million, a stop-gap loan given the sums that were needed to complete the
development of the RB211. Rolls-Royce made no attempt to go to security markets.
Given that Rolls-Royce’s stock price had been moving sharply downward since late
1968 and then collapsed in late 1969, the times were not propitious for a stock issue.
Even though a number of insurance companies increased their holdings of Rolls-
Royce shares in 1969 and 1970, a number of others, including Rolls-Royce’s largest
shareholder, Prudential Insurance (which in 1968 held more shares than the next
seven largest institutional investors combined), reduced their holdings to zero in 1969
and 1970 (Bowden, 2002: 41).
16
While the analysis of Rolls-Royce’s relative stock-price performance is beyond the scope of this
paper, one factor that may have constrained the company’s stock-price increases over the past decade
is the fact that, unlike many major UK corporations, Rolls-Royce has not done stock repurchases.
With the bankruptcy of Rolls-Royce in 1971, the British government stepped into
fund the company to ensure that the nation retained a critical military capability.
Even then, as we have seen, British government finance displayed its limits for a com-
pany that sought to compete in civil markets when, rather than risk bankruptcy again
in the lean years of the early 1980s, Rolls-Royce accepted a minority-position RRSP
with GE that implied its withdrawal as an independent producer of high-thrust civil
engines. The situation was saved by the return of prosperity to the civil aerospace
industry in the mid-1980s combined with the discovery by Rolls-Royce’s engineers of
the development-cost advantages of the RB211’s three-shaft architecture. The govern-
ment then returned the company to the business sector on a sound financial footing,
with no debt and the proceeds of a special public share issue that netted £289 million,
even as the sale of the company returned £1.36 billion to the state treasury.
From the late 1980s, the key to sustaining the innovation process at Rolls-Royce
was the management of financial commitment. Retentions, and hence cash flow,
became critical to sustaining the innovation process in the highly competitive civil air-
craft engine markets in which a failure to make large investments in R&D meant
certain loss of advantage and in which the prices of new engines were sharply discounted
for the sake of a stream of parts and servicing revenues in the ‘aftermarkets’ of the
future. As we have recounted, and here the details are of the essence, Rolls-Royce’s
strategic managers made use of its stock as a source of cash to restructure the com-
pany’s balance sheet in 1993 and to do the Allison acquisition in 1995, at a time when
more debt could have placed the company’s future in jeopardy. Then, in the late
1990s, with its stock price down but its cash flow up, Rolls-Royce used debt and cash
as it sought to extend its success in the aircraft engine markets to other lines of busi-
ness that could benefit from its advances in turbofan technology.
The facts of the Rolls-Royce case suggest that the analysis of the sources of financial
commitment that support innovative enterprise must take into account (i) the stage
of development of a firm’s innovation process; (ii) the financial condition of the firm
when it seeks external funds; and (iii) the strategies of corporate executives in access-
ing these funds. In the literature on finance and innovation, the distinction has been
raised between relational (or bank-based) finance that venture capital and banks can
supply and transactional (or market-based) finance that stock and bond markets can
supply (Zysman, 1983; Dosi, 1990; Hall and Soskice, 2001). Bank-based finance is
associated with financial commitment; market-based finance with financial mobility.
What is the significance of this distinction in the case of Rolls-Royce?
At an early stage in the innovation process, before it is generating substantial reve-
nues from the sale of products, an innovating firm needs relational finance. In 1970
Rolls-Royce looked to the City banks for financial commitment, but, given the financial
challenge at hand, the finance that they supplied was too meager and the commitment
too impatient, and within a few months Rolls-Royce was bankrupt. If Rolls-Royce had
had access to a bank-based financial system, say in Germany or Japan, perhaps the
outcome would have been different. As a British company, however, Rolls-Royce
sought external finance in the advanced nation that is generally considered to possess
the most market-based financial institutions, and hence least likely to support the
uncertain investments in innovation that Rolls-Royce needed to finance.
Yet in the 1990s, Rolls-Royce was able to secure large amounts of external finance
from the British stock and bond markets, and, as we have shown, the British financial
system served it well. The key difference was the state of development of the firm, not
a change in the British financial system. In contrast to the late 1960s and early 1970s,
the RB211 was from the late 1980s a proven technology that was generating positive
cash-flow. In financing the further development of the RB211 and in transferring the
technology to related lines of business, Rolls-Royce’s executives were also, as we have
seen, strategic in terms of both the timing of external fund-raising and the types of
sources (stock issues versus bond issues) they sought. It was Rolls-Royce’s internal
financial condition that made it possible for its executives to ‘manage’ British financial
markets to help sustain the innovation process.
In managing financial markets to sustain the innovation process, Rolls-Royce was
not unique. Finance requires control over purchasing power; yet purchasing power is,
by its very nature, easily mobile from one use, and hence one firm, to another. In
order to mobilize financial resources to sustain a particular innovation process over
time, those who exercise strategic control must immobilize the movement of these
resources to alternative uses at every point in time. Put differently, the organization
must dominate the market. It is for this reason that internal funds—purchasing power
controlled by the firm’s strategic decision-makers—are the foundation of corporate
finance (Myers and Majluf, 1984; Corbett and Jenkinson, 1997). If internal funds can
cover investment requirements, strategic decision-makers do not have to seek external
finance, the allocation of which, in its ‘external’ state, they do not control. Moreover,
if internal funds need to be leveraged with external funds, control over internal funds
enhances the bargaining power of a firm’s strategic decision-makers in dealing with
those who control the allocation of external funds. The challenge that faces those who
exercise strategic control of the innovative enterprise is to convince these ‘outsiders’ to
turn mobile money into finance that is committed to their particular firm, and that
the ‘insiders’ can henceforth control.
The case of Rolls-Royce plc supports the hypotheses that strategic control and fin-
ancial commitment are necessary conditions of innovative enterprise. However, they
are by no means sufficient conditions. Innovation depends on organizational learn-
ing, and organizational learning depends on organizational integration: a set of rela-
tions that creates incentives for people who participate in hierarchical and functional
divisions of labor to apply their skills and efforts to the innovation process. A com-
plete analysis of the determinants of innovative enterprise at Rolls-Royce would
require an analysis of how, at the various stages of the company’s development, the
requisite organizational learning was achieved. What was ‘requisite’, however,
depended on not only how well Rolls-Royce itself transformed technologies and
accessed markets, but also the relative success of its competitors—in this case Pratt &
Whitney and GE Transportation—in generating higher quality, lower cost engines.

The concepts of strategic control and financial commitment introduce power and
money into the analysis of innovative enterprise. A full understanding of why firms
differ and how it matters requires an analysis of organization and competition as well.
Acknowledgements
We would like to thank Joe Lampel, Mary O’Sullivan and two anonymous referees for
this journal for comments on earlier drafts of this paper. This research was funded by
the Targeted Socio-Economic Research (TSER) Program of the European Commission
(DGXII) under the Fourth Framework Program, European Commission (Contract
No.: SOE1-CT98-1114; Project No.: 053) and by INSEAD Association for Research.
Address for correspondence

William Lazonick, University of Massachusetts Lowell, Lowell, MA 01854, USA.
Email: william.lazonick@insead.edu.
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The Governance of Innovation: The Case of Rolls-Royce plc

Chapter · September 2004

William Lazonick Andrea Prencipe

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Industrial and Corporate Change, page 1 of 42

Dynamic capabilities and sustained

Rolls-Royce plc is currently a powerful competitor in the turbofan engine industry,

1. Dynamic Capabilities and Social Conditions

competences to address rapidly changing environments’. Who decides what kind of

similar technological solutions across engines, thus saving on development costs.

Organizational integration is a set of relations that creates incentives for people to

2. The origins of the RB211 and the bankruptcy of

2.1 The British national context

2.2 Engineer control

2.3 The three-shaft engine architecture

2.4 Development of the RB211

2.5 Rolls-Royce’s bankruptcy

3. The era of nationalization

3.1 Emergence from bankruptcy

3.2 Engineer control and bureaucratic interference

3.3 Worsening financial conditions and the GE deal

3.4 Reversal of strategy: the ‘stretch’ capability of the RB211

RB211 fan diameter have to be increased, but no other fundamental

4. Corporate control and financial markets

4.1 Privatization, restructuring and reorganization

universities as partners in development and research programs. Organizational

Rolls-Royce is fortunate to have extremely talented and dedicated

4.2 Corporate strategy and the sources of committed finance

Rolls-Royce’s exposure to the stock market actually affect strategic decision-making

4.3 Ownership and control

Number of % of total % of total Number % of total % of total Number of % of total % of total

4.4 The relation between internal and external finance

800 A djus te d Inte rnal

Adjusted Internal Sources=Funds from Operations + Cost of net R&D

NEI Financial Allison Vickers

Figure 4 Rolls-Royce: external financing and acquisitions, 1987–2003. Sources: Rolls-Royce

The need for money is fundamentally different to that which existed 22

Exchange in the form of US-dollar-denominated American Depository Receipts.12

4.5 Alternative acquisition currencies

4.6 Stock-based compensation

Year Pay of highest-paid executive to Average pay of executive directors

1987 9.0 6.1

Sources: Rolls-Royce Annual Reports (1987–2003).

5. Implications for a theory of innovative enterprise

Whitney and GE Transportation—in generating higher quality, lower cost engines.

Address for correspondence

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