economic’impact’analysis’of’pratt’&’whitney’s’...

Economic Impact Analysis of Pratt & Whitney’s Expansion of the Engine Services Facility in Columbus, GA

Christopher Taylor and Mark Williams

ABSTRACT

In 2011, Pratt & Whitney announced the planned expansion of their engine services center in Columbus, GA. The company would spend $19.3 million to upgrade the facility in order to be able to offer services to the F117 engine line, and predicted that the investment would result in the creation of 180 jobs. This paper explores the potential impact of the investment on the economy of the state of Georgia, employing the principles of economic impact analysis to chart the path of the invested funds as they ripple throughout the economy.

Table of Contents

INTRODUCTION 1

OVERVIEW OF PRATT & WHITNEY’S BUSINESS 1 UNITED TECHNOLOGIES CORPORATION 1 PRATT & WHITNEY’S BUSINESS MODEL 1 THE MRO INDUSTRY 2 FINANCIAL STATEMENTS 3

THE EXPANSION DECISION 5 STRATEGIC REASONING 5 GEOGRAPHICAL FACTORS 6

THE ANALYSIS 7 OVERVIEW OF ECONOMIC IMPACT ANALYSIS 7 MODEL INPUTS 7 MODEL SCENARIOS 8 ANALYSIS 9 CONCLUSIONS AND NEXT STEPS 10

SOURCES 11

Introduction

In 2011, Pratt & Whitney announced plans to expand its Columbus, GA engine services center. Before the expansion, the facility provided engine services for the V2500-‐A5 and PW2000 engine families used on commercial jets. The investment would allow the facility to service F117 engines used by the United States Air Force on the C-‐17 Globemaster aircraft. Pratt & Whitney planned to spend $19.3 million to complete a building refit, purchase additional tooling and equipment, and upgrade the facility’s test cell. Due to the nature of the business, the servicing a particular engine family demands that a facility be equipped with specialized tooling made especially for that product. The upgrades that Pratt & Whitney planned for the Columbus facility were designed specifically for the F117 engine. Being able to service this engine would add a revenue stream from a military rather than commercial customer, hedging against volatility in the commercial industry.

Pratt & Whitney estimated that this project would add 180 jobs to the local

economy. However, the true value added to the economy would likely be much larger. Economic impact analysis predicts the extent of this total effect. However, in order to fully understand these predictions it is important to first gain an understanding of Pratt & Whitney’s business model and the industry they operate in, as well as to more fully understand their decision to make this investment.

Overview of Pratt & Whitney’s Business

United Technologies Corporation Pratt & Whitney is a subsidiary of the holding company United Technologies

Corporation, which also owns five other companies, two of which are also in the aerospace industry. UTC earned $58 billion in revenue in 2011 and an operating profit of $8 billion. While financial statements for UTC are publicly available, Pratt & Whitney does not release its financial statements. However, a reasonable estimate can be constructed using UTC’s statements as a starting point.

Pratt & Whitney’s Business Model Pratt & Whitney earns revenue through two main operations. The first is the design,

development, manufacturing, and sale of aircraft engines for commercial and military applications. Its commercial engines power passenger jets for personal flight as well as engines used for cargo jets in the private sector. Thus, these engines attract a diverse customer base, including companies like Delta Air Lines that offer personal flights as well as companies like UPS that ship airfreight around the world. Revenue is also generated through the company’s fleet management service, a

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maintenance, repair, and overhaul (MRO) operation. This side of the business provides engine upkeep services to customers operating Pratt & Whitney engines, including scheduled repairs, like those for predictable wear and tear, as well as unscheduled maintenance, like those needed to meet new safety regulations or fix damaged engines. By selling engines in addition to repairing them, Pratt & Whitney realizes several benefits. Chief among these are the economies of scope gained from spreading the fixed cost of research and development of tooling, equipment, and technical documents across the manufacturing and maintenance services. Many competing firms either offer MRO services or sell engines, and thus incur similar costs but can only allocate them to one business function. In addition, Pratt & Whitney’s MRO service benefits from vertical integration. Firms that offer MRO services only have to buy parts, the major production input, from other firms. Pratt & Whitney’s MRO service, however, benefits from the more favorable alternative of getting parts from the manufacturing side of the company.

The MRO Industry As the Columbus facility performs MRO services, it is important to understand the

characteristics of the MRO industry. The industry is diverse and fragmented, comprised of many firms worldwide. About half of all MRO’s are in North America, but there are significant presences in Western Europe, Latin America, and other regions. The firms vary in size, from those with annual revenues of less than $50 million to over $1 billion, making Pratt & Whitney one of the larger MRO providers. MRO firms differ in the engines that they can repair and the services they offer. Some firms specialize in certain engines, while others, like Pratt & Whitney, offer services for a range of engine families. There are other firms that provide MRO services in addition to other functions. Delta Air Lines is both a carrier and an MRO provider. Essentially, the market is populated by firms as diverse in size as they are in function.

In the U.S., all firms that provide MRO services to commercial engines are bound by strict safety regulations. The FAA maintains rigorous standards dictating specifications for most parts and has the authority to certify that a firm can repair them. If a firm cannot maintain this certification, they will lose customers because the carriers are penalized for working with them.

Due to the engineering precision of each part, complex and expensive tooling is required to work on aircraft engines. Not only are the tools highly specialized in terms of the type of work they can perform, but many are specific to one engine family. This creates very high barriers to entry, as large capital outlays are required from entrants in order to purchase the necessary equipment. The combination of the barriers to entry, strict regulations, differentiated services, and diverse companies define the MRO market.

Financial Statements Understanding the generalities of Pratt & Whitney’s business and the MRO industry

is a framework for understanding the results of an economic impact analysis, but specific financial data for the firm is necessary to perform it. As was previously mentioned, Pratt & Whitney does not publicly release financial statements. To create a model for the Columbus facility expansion, statements were generated using estimation techniques.

The income statement and annual report released by UTC serve as a starting point for constructing an income statement for Pratt & Whitney. UTC’s income statement can be simplified to give a consolidated view of the company, as shown in Figure 1. In order to construct a similar consolidated statement for Pratt & Whitney, some values can be taken from the annual report and others must be estimated.

Figure 1 Consolidated UTC Income Statement (thousands of dollars)

Pratt & Whitney’s net sales and COGS are released, as is a combined value for SGA and other expenses. To estimate SGA and other expenses, applying the ratio of SGA to other expenses for UTC provides a reasonable estimate. To estimate the tax and interest expenses, applying the percent of revenue they represent for UTC to Pratt & Whitney’s net sales is acceptable. These calculations result in the income statement for in Figure 2.

Figure 2 Estimated Pratt & Whitney Income Statement (thousands of dollars)

UTCNet$Sales 58,190,000$$$$$$$Cost$of$Goods$Sold 42,153,000$$$$Gross(Profit 16,037,000$((($$$SGA 5,880,000$$$$$$$$$Other$Expenses 2,058,000$$$$$$EBIT 8,099,000$((((($$$Interest 494,000$$$$$$$$$$EBT 7,605,000$$$$$$$$$Tax 2,231,000$$$$$$Profit(After(Tax 5,374,000$(((((

P&WNet$Sales 13,430,000$$$$$$$Cost$of$Goods$Sold 9,805,000$$$$$$Gross(Profit 3,625,000$((((($$$SGA 1,204,444$$$$$$$$$Other$Expenses 421,556$$$$$$$$$$EBIT 1,999,000$((((($$$Interest 114,013$$$$$$$$$$EBT 1,884,987$$$$$$$$$Tax 552,979$$$$$$$$$$Profit(After(Tax 1,332,008$(((((

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Creating a balance sheet for Pratt & Whitney is a more involved process. Because the balance sheet for UTC represents companies in several industries, it is more useful to base Pratt & Whitney’s balance sheet on one from a competing MRO firm. For this model, the balance sheet for Vector Aerospace was used.

Figure 3 Consolidated Vector Aerospace Balance Sheet (thousands of dollars)

The annual report for UTC lists the total assets for Pratt & Whitney. Given that total assets equals total liabilities and equity, these two figures are known. Next, to estimate the balance for each type of asset owned by Pratt & Whitney, each type of asset on Vector Aerospace’s balance sheet should be converted to a percent of total assets value. Applying these percentages to the total assets value for Pratt & Whitney estimates the balance of each asset owned by Pratt & Whitney.

Estimating the total liabilities and net worth for Pratt & Whitney is done in a similar way. For each type of liability and net worth item on Vector Aerospace’s balance sheet, the percent of total liabilities and net worth is calculated. These percentages are then applied to Pratt & Whitney’s total liabilities and net worth in order to estimate each balance.

This estimation technique, creating a balance sheet for one company based on the ratios presented in another company’s balance sheet, is founded on the assumption that the two firms will have similar ratios. This may not be the case if the companies are in different points on the growth curve, operate in different markets, or offer different types

Assets %&Tot&Asst.Cash%and%Equivalents 40,299$%%%%%%%%% 9%Accounts%Receivable 101,436$%%%%%%% 23%Inventory 74,416$%%%%%%%%% 17%Other%Current%Assets 69,646$%%%%%%%%% 16%Total%Current%Assets 285,797$%%%%%%% 66%

P&E 128,788$%%%%%%% 30%All%Other%Assets 17,764$%%%%%%%%% 4%Total&Assets 432,349$&&&&&&& 100%

Liabilities&and&Equity %&Tot&L&EAccounts%Payable 87,927$%%%%%%%%% 20%Short%Term%Debt 25,162$%%%%%%%%% 6%Other%Current%Liabilities 35,774$%%%%%%%%% 8%Total%Current%Liabilities 148,863$%%%%%%% 34%

Long%Term%Debt 18,251$%%%%%%%%% 4%Other%Liabilities 21,001$%%%%%%%%% 5%

Total%Liabilities 188,115$%%%%%%% 44%Total%Equity%and%Net%Worth 244,234$%%%%%%% 56%Total&Liabilities&and&Equity 432,349$&&&&&&& 100%

of products. However, based on similarities between Pratt & Whitney and Vector Aerospace, such as operating in the same industry and having similar gross and operating profit margins, the balance sheet constructed for Pratt & Whitney is a good estimate.

Figure 4 Estimated Balance Sheet for Pratt & Whitney (thousands of dollars)

The Expansion Decision

Now that a complete picture of Pratt & Whitney’s business and industry has been established, it is appropriate to evaluate the reasons behind the decision to invest in an expansion of the Columbus facility. In reality, there were most likely many steps in the decision making process that led to the investment, but for the most part the rationale can be broken down into two categories -‐ the strategic reasons to make the investment and the reasons for picking the Columbus site.

Strategic Reasoning Strategically, the investment will bring many benefits to Pratt & Whitney. Before

the expansion, the Columbus facility focused on two commercial engine families, so demand for their services was highly exposed to volatility in the commercial airline market. This risk is exemplified by the fact that as fuel prices have risen in recent years,

AssetsCash%and%Equivalents 997,807$%%%%%%%Accounts%Receivable 2,511,564$%%%Inventory 1,842,547$%%%Other%Current%Assets 1,724,441$%%%Total%Current%Assests 7,076,359$%%%

Plant%And%Equipment 3,188,802$%%%All%other%assets 439,838$%%%%%%%Total)Assets 10,705,000$)

Liabilities)and)EquityAccounts%Payable 2,177,080$%%%Short%Term%Debt 623,013$%%%%%%%Other%Current%Liabilities 885,767$%%%%%%%Total%Current%Liabilities 3,685,861$%%%

Long%Term%Debt 451,896$%%%%%%%Other%Liabilities 519,987$%%%%%%%

Total%Liabilities 4,657,744$%%%Total%Equity%&%NW 6,047,256$%%%Total)Liabilities)and)Equity 10,705,000$)

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airlines have repaired engines more often than replacing them. While this trend has benefited the MRO businesses, others trends could harm them. The expansion allows the facility to serve military customers that are removed from this volatility, allowing Pratt & Whitney to hedge against volatility risks.

In addition, the investment creates the opportunity to service the new F117 engine at the Columbus location. Because Pratt & Whitney produces the engine, the company is aware of the quantity of engines sold and can forecast demand for repair services based on historical performance of their other engine families. The investment in the capacity to service the F117 is indicative of the amount of forecasted demand for the services and the fact that the company believes that the services will be profitable.

Geographical Factors Aside from the strategic benefits, characteristics of the Georgia economy impacted

the decision. Once the expansion is completed, highly skilled and specialized labor will be required to offer the new services. Georgia’s Quick Start program has proven successful for the other Columbus operations, and Pratt & Whitney believes that that success can be replicated for the new services. In addition, the availability of skilled aerospace engineers from Georgia Tech provides human capital for the site’s engineering needs.

The State of Georgia also boasts an infrastructure conducive to Pratt & Whitney’s

operation. The Hartsfield-‐Jackson International Airport, among the largest in the world, is in close proximity to the operation, allowing customers easy access. The Port of Savannah provides reliable and cost effective shipping of aircraft parts, the main production input for the MRO. The highly developed highway system allows for easy transport of the parts from the port and airport to the facility.

The proximity to the Warner Robbins Air Force Base is also an important factor for

the decision to offer F117 engine services. The base serves as a logistics hub for the United States Air Force, so military aircraft pass through it before deployment. The proximity of the base to the Columbus facility means that military aircraft would not travel far to be serviced.

While these factors most likely had a sizable impact on the decision to expand the

Columbus facility, they are not the only reasons that Pratt & Whitney made the investment. They are, however, representative of the types of factors considered in such a decision.

The Analysis

Overview of Economic Impact Analysis Economic impact is the effect on economic activity from a specific change in the

economy and can be measured in many different ways, including changes in output, income, or jobs. These changes describe the impact of a certain policy change or new investment on the regional economy.

By compiling financial data about how different industries spend money and

interact with other industries, it is possible to estimate how an investment in one industry can affect upstream and downstream industries, leading to an economic impact that is substantially larger than the investment, a principle referred to as the multiplier effect. The total economic impact is comprised of direct effects, indirect effects, and induced effects. The direct effect comes from the changes in spending as a result of the new investment, such as paying contractors to build a new facility. The indirect effect comes from the changes in the economy due to the direct effect, such as when those contractors buy supplies from local vendors, who then expand their businesses. Finally, the induced effect measures the changes in wages and employment from industries that are both directly and indirectly affected by the new investment. Two different models can be used to estimate economic impacts. The first is the Input/Output model, which works by determining a multiplier as previously stated. The second is a dynamic model, which accounts for dynamic changes over longer time periods by using a complex computer model of the economy. The following model was built using the Input/Output model built by MIG Inc. called IMPLAN to estimate the full economic impact of Pratt & Whitney’s investment in Columbus, Georgia.

Model Inputs The IMPLAN model requires several types of input data. The first, choosing the

sector in which the change occurs, determines which set of multipliers to use. For the Pratt & Whitney Model, the initial sector chosen was “Aircraft Engine and Engine Parts Manufacturing.” Although it is not a perfect match for the operation, it is the closest in IMPLAN’s sector list.

The second type of input data is the amount of sales resulting from the expansion,

estimated by using ratios from the balance sheet. First, the ratio of Pratt & Whitney’s net sales to plant and equipment assets was calculated. The resulting value, 4.21, represents the dollars of net sales earned on average by each dollar of plant and equipment assets. Next, since the expansion consisted of purchasing plant and equipment assets, the investment amount was multiplied by this ratio. This technique estimated that the $19.3 million investment would result in an increase in annual net sales of $81,284,120.

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Figure 5 Estimation of Sales Generated from the Expansion

Model Scenarios In order to obtain the best estimate of economic impact, four different scenarios are

considered. The first scenario assumes that this new investment is in the “Aircraft Engine and Engine Parts Manufacturing” sector, and that the local purchase percentage is 100%, meaning that there is no leakage. The results of this scenario are summarized below.

Figure 6 Baseline Scenario Results

Since the investment is into service operations and not manufacturing, the “Aircraft Engine and Engine Parts Manufacturing” sector is not fully. Thus, the second scenario was run using the best match to a sector search for “Aircraft Maintenance and Repair Services,” and holding the local purchase percent constant at 100%.

Figure 7 Modified Sector Scenario Results The third and fourth scenarios are similar to the first and second respectively in that

they use the same industry to estimate the impact. However, since it is unlikely that 100% of P&W new investment will stay in the local economy, the local purchase percentage is lowered to 75% and the model is rerun for each sector.

IMPLAN'INPUT'CALCULATION

Net$Sales$(in$thousands) 13,430,000$$$$$$$$Plant$&$Equipment$(in$thousands) 3,188,802$$$$$$$$$$Net$Sales$/$Plant$and$Equipment 4.21

P&E$Columbus$Investment 19,300,000$$$$$$$$Resulting'Sales'Increase 81,284,120$'''''''

Impact Type Jobs Income Total Value Added OutputDirect Effect 147 11,464,369$ 18,751,772$ 81,284,120$ Indirect Effect 62 4,391,502$ 6,861,008$ 23,021,243$ Induced Effect 107 4,402,113$ 8,008,876$ 13,186,327$ Total Effect 315 20,257,984$ 33,621,656$ 117,491,690$

Impact Type Jobs Income Total Value Added OutputDirect Effect 912 49,364,748$ 52,052,769$ 81,284,120$ Indirect Effect 173 8,702,615$ 12,641,280$ 21,302,058$ Induced Effect 392 16,169,548$ 29,436,222$ 48,443,799$ Total Effect 1,477 74,236,912$ 94,130,270$ 151,029,976$

Figure 8 Baseline Scenario with Reduced LPP Results

Figure 9 Modified Sector with Reduced LPP Scenario Results

Analysis The minor changes in the model inputs for the four scenarios resulted in a wide

range of predicted effects. The third scenario resulted in the smallest total effect of all four scenarios, predicting that the investment would add 236 total jobs, generate income of just over $15 million, create $25 million of value to the economy, and increase output by $88 million. The second scenario resulted in the largest total effect of all four scenarios. It predicted that the investment would add 1,477 jobs, generate income of just over $74 million, create $94 million of economic value, and increase output by $151 million.

Due to the wide range of predicted values, it is difficult to choose which scenario should is most reliable. If Pratt & Whitney’s claim that the investment would result in 180 direct jobs is to be trusted, then the first scenario generated makes the most sense. It predicted that the investment would create 147 direct jobs, the closest number to 180 out of all four scenarios’ predictions.

It is more likely that the impact will be within the predicted. Each scenario was

created to account for details of the investment not previously accounted for, but they all rely on incomplete information. Thus, calculating the median total effect of all four scenarios may be a more accurate prediction of the investment’s impact.

Figure 10 Median Results Summary


Impact Type Jobs Income Total Value Added OutputDirect Effect 684 37,023,561$ 39,039,576$ 60,963,090$ Indirect Effect 130 6,526,962$ 9,480,960$ 15,976,543$ Induced Effect 294 12,127,161$ 22,077,166$ 36,332,849$ Total Effect 1,108 55,677,684$ 70,597,703$ 113,272,482$

MEDIAN


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Conclusions and Next Steps While this calculated median prediction offers some insight into the total effect of

Pratt & Whitney’s expansion of the Columbus facility, it could be improved upon. If Pratt & Whitney released information about the actual sales gained from the expansion and the percent of the investment being spent locally, the model input data could be improved. In addition, if IMPLAN added a sector that more accurately reflected the facility’s operations, the multipliers used in the model calculations would better reflect how the money ripples through the economy. However, with the limited information that is actually available, the median predicted effect is a reasonable estimate of the economic impact of the expansion. Word Count: 2,984

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