Business Breakdowns
· Matt Reustle, Ramesh Narayanaswamy
[00:00:00] S0: You referenced some of the market shares that they have in this jet engine business. Can you just bring us back in time in terms of the origins of that industry, and that'll lead us on to how GE has captured the share and foothold that they have. But maybe go back in time. I have some sense of when jet engines came around. It was probably correlated to when airplanes came around, but maybe you can lay that out for us. [00:00:00] S1: The jet engine business is nearly 100 years old, so it's a fairly long time. It was first invented in the 1930s here in the UK. Actually, the first jet engine built in the US, however, was a GE engine, which incidentally was a copy of the British engine developed by Frank Whittle. Historically, you would find that as technologies develop, they become cheaper to manufacture and to scale. But what we have observed in jet engines is that that has not necessarily been the case. Even inflation-adjusted, jet engines still cost at least several billion dollars to make. And if you look at the most recent Pratt & Whitney geared turbofan engine, it reportedly costs perhaps something like $10 billion. Now, it's a good question to ask why that is the case. I would suggest that because jet engines are constantly pushing at the leading edge of materials, technology, and engineering, and you're tackling new problems at the frontier, that keeps costs high and entry barriers high as well.
· Ramesh Narayanaswamy, Matt Reustle
[00:00:00] S1: The jet engine business is nearly 100 years old, so it's a fairly long time. It was first invented in the 1930s here in the UK. Actually, the first jet engine built in the US, however, was a GE engine, which incidentally was a copy of the British engine developed by Frank Whittle. Historically, you would find that as technologies develop, they become cheaper to manufacture and to scale. But what we have observed in jet engines is that that has not necessarily been the case. Even inflation-adjusted, jet engines still cost at least several billion dollars to make. And if you look at the most recent Pratt & Whitney geared turbofan engine, it reportedly costs perhaps something like $10 billion. Now, it's a good question to ask why that is the case. I would suggest that because jet engines are constantly pushing at the leading edge of materials, technology, and engineering, and you're tackling new problems at the frontier, that keeps costs high and entry barriers high as well. [00:00:00] S0: It's the type of product that I don't mind if it's a little bit more expensive as well, given what it actually does and how I might be a user of it. Let's discuss GE's evolution in that space in terms of leading to this place where you always hear about the duopoly atop, in terms of the OEMs with Boeing and Airbus, not so much about the rest of the value chain. Who else is in the jet engine market? I think you've referenced Pratt & Whitney a few times, but how has that evolved over time?
· Ramesh Narayanaswamy
[00:00:00] S1: So first, to maybe set the scene, it's worthwhile putting the industry in context and why it's so hard to make a jet engine. In simplest terms, the barrier to entry into the industry is the requirement to have both extraordinary technical performance at extraordinarily low cost. So making a jet engine at scale is one of humanity's toughest technical challenges, right up there with some semiconductor fabrication, manufacturing biologics, or even things like reusable rockets. So this is a very, very hard technical challenge to overcome. Just to give you a flavor of what engines have to deal with in commercial aerospace, which we take for granted every time you take a flight, within the hot section of the engine, inside the high-pressure turbine, the temperatures can exceed the melting point of alloys, which, when you stop to think about it, is quite mind-boggling. Similarly, engines have to withstand and be tested extensively in a variety of harsh conditions, including extreme cold, extreme heat, dusty conditions, including things like bird strikes, which they have to be resilient against, which happens more commonly than you think. Even at the manufacturing level, atomic-scale defects can be catastrophic. For example, the most recent issue that Pratt & Whitney had with the geared turbofan: they found a microscopic contaminant in the manufacturing process, which led to a worldwide recall of the entire fleet. So even extremely small issues can cause significant after-effects and significant catastrophic losses for the engine makers. Now, once you have solved these technical problems, you now need to convince Airbus and Boeing that you can manufacture and supply this at scale, and then convince the airlines that this will be reliable to operate for decades on end, all at a cost of ownership that is competitive, based on sort of worldwide global aftermarket support. And, oh, by the way, you also need to sell at a loss to Airbus and Boeing before you can see the first profit from spare parts in five or ten years’ time from the airlines. This is an extraordinarily difficult industry with very significant technical barriers, in addition to regulatory barriers, where, rightly, regulators require extensive certification and safety testing of aircraft and every single part that goes into an aircraft, including the engines.
· Matt Reustle
[00:00:00] S0: It's a marvel in terms of what they've been able to do. Who's on the other side of the spectrum beyond Boeing and Airbus? What goes into those partnerships and those relationships that creates the ecosystem that now exists, where you do have certain parts of the value chain entirely relying on each other?
· Ramesh Narayanaswamy
[00:00:00] S1: When you look at jet engine makers, the primes, you only have three or four companies who can do this at scale. GE is one of them, along with Safran. Rolls-Royce is one of them, and Pratt & Whitney–MTU. Given the history of the industry, you can see that Rolls-Royce, for example, collapsed in the '70s and had to be nationalized trying to develop the RB211 engine, which was, ironically, a successful engine and the basis of their current Trent architecture. But they almost went bankrupt doing it. And similarly, if you think about state-owned companies, including China's COMAC, which is steeped in manufacturing muscle in China, it chose a GE or CFM engine to power their last aircraft. And while it's sort of developing its own engine, it just shows you the barriers to entry that even extremely scaled players and serious new entrants face when tackling this industry. Given these challenges in developing engines, it is not a surprise to see that most of the companies in the space enter into risk- and revenue-sharing agreements or joint ventures simply to mitigate the risk and to share the risk and revenue both when they are trying to develop new engines. For GE, the most prominent of that is in their narrow-body segment, where they have a joint venture with Safran. It's a 50/50 joint venture with Safran called CFM International, which we spoke about before. Through the CFM International program, you have a very strong presence that GE has in the Boeing platforms, which is sole, and the Airbus platforms, not to mention COMAC, which is also sole-source with GE.
· Matt Reustle, Ramesh Narayanaswamy
[00:00:00] S0: For that joint venture, I just have to ask: what is Safran doing and what is GE doing? [00:00:00] S1: Historically, CFM International has been a 50/50 joint venture. GE historically has done more on the hot side of the engine, and Safran has done more on the cold side of the engine. But, effectively, everything is split 50/50 in the partnership. And it's a very longstanding partnership, almost 50 years old at this point. It is one of the best models of joint ventures and risk- and revenue-sharing agreements in the industry. [00:00:00] S0: Interesting. Yeah, to have that longstanding of a joint venture and to be taking something as complex as this and splitting it amongst two businesses. So I can only imagine.