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SPEECH

David P. Hess, Pratt & Whitney President, CBIA Economic Summit and Outlook 2011

Friday, January 7, 2012

A Vision for Job Growth and Prosperity in Connecticut: Transforming Our State into a 21st Century Competitive Advantage for Business

Transcript

Good morning, and Happy New Year to everyone. Thank you, Joe [Savage, executive vice president of Commercial Banking at Webster Financial Corp. and Webster Bank], for that kind introduction.

And my thanks to John Rathgeber and Joe Brennan from the CBIA, and “Oz” Griebel from the MetroHartford Alliance for their efforts in putting this conference together, and for continuing to be such strong advocates for business in the state.

Today I want to take some time to talk about something that we all hope not to be an oxymoron...doing business in the state of Connecticut... I promise that I won’t just stand up here and whine, but rather attempt to suggest some things we can do to help foster prosperity and grow jobs in our state.

First, let me say that Connecticut has generally been good to Pratt & Whitney for 85 years now – since we first set up shop on Capitol Avenue in 1925, and then moved to roomier quarters across the river in East Hartford. It has been, and remains, a good place to do the right kind of work in our offices, labs and factories here. We’ve been successful here because generations of Pratt people have faced tough challenges and transformed our company to meet those challenges.

  • • While we were wildly successful with our iconic WASP radial engine up through World War II... at the end of the war Pratt had never built a jet engine. A massive effort by our people – along with the investment of millions of dollars – meant that, by the early 1950s, we were a world leader in jet engine technology.
  • • During the same period, we built a space propulsion business virtually from scratch.
  • • Some of you may remember the so-called Great Engine War of the 1980s between Pratt & Whitney and GE... for advanced fighter engines for the F-16. Following that challenge, our people worked with incredible dedication and we invested wisely to win the F-22 and F-35 fighter engine contracts... indisputably these are the most advanced military jet engines in production in the world today.
  • • Over the years, we’ve transformed Pratt & Whitney from a Connecticut-based company that just made and sold engines and spare parts... to a truly global business with a worldwide R&D, manufacturing and aftermarket service network driven by the demands of an international airline industry.
  • • Very recently, there were those who said that Pratt was out of the large commercial engine business when we were not on the Boeing 787 and the Airbus A350, both launched in the first half of the last decade. Well, to quote a famous former resident of the city of Hartford... “the reports of our death are greatly exaggerated.”
  • • That turned out to be a short-sighted perspective... we were focused on the long term. Our engineers were working on a whole new engine concept, and we spent about $1 billion in R&D to make it a reality. And by the way...that’s just for starters...
  • • The fruit of this big investment is the PurePower family of Geared Turbofan engines. They are game changers that provide double-digit improvements in fuel consumption, emissions and noise, and that offer our customers significantly lower maintenance and operating costs. So far, PurePower engines from Pratt & Whitney have won places on new aircraft being developed in Japan, Canada and Russia...
  • • And more recently... in December 2010 we were selected to provide a new version of the Geared Turbofan for the Airbus A320 family, a big step toward reenergizing our presence in the most lucrative single-aisle commercial aircraft segment.

Connecticut Must Compete

I mention these things as examples of how a healthy company grows and re-invents or transforms itself in the face of new challenges. I am sure that many of the companies represented here today have had similar experiences. But Connecticut must recognize that it too needs to compete for jobs, not just against other states in the U.S., but internationally as well... It needs to transform itself – just as all of us have had to recognize a changing world and transform ourselves with a focus on competitiveness, innovation and next-generation technology.

Certainly, most of you understand this. There has been a huge shift in the global economy with profound implications for our state. Some of you may remember that former UTC Chairman George David spoke to the CBIA back in 1997 about these trends. Companies around the world were using process re-engineering to get leaner and more efficient by an order of magnitude.

This was vital because, as in many of your businesses, we find it is difficult if not impossible to get real price increases to improve earnings. This is certainly the case for the airline and aerospace industry...

Notwithstanding what some of you may have paid for airline tickets to visit your friends or family over the holiday, an airplane ticket is a bargain when considering what you had to pay for a round-trip ticket in 1960 to fly from New York to London. In today’s dollars, it was about $5,400. Today you could buy nine tickets for what you paid for that one ticket 50 years ago.

Since the airlines were deregulated in 1978, ticket prices have fallen by about 45% in real terms, and yields for U.S. airlines have fallen steadily right alongside. That pricing pressure flows right down from the end consumer to the airline, and ultimately to the airplane and engine manufacturers.

And Mr. David and our current CEO, Louis Chênevert, regularly speak about globalization narrowing the gap between traditional economic powers and the rest of the world. Both Mr. David back in 1997 and Mr. Chênevert today recognize that to succeed in Connecticut, businesses must concentrate on high-value, high-knowledge work with a major technology component. And we must recognize that low-value, low-knowledge work would leave high-cost places and probably never come back.

In the past 13 years those trends have only accelerated, particularly because people in what we used to call the “developing world” have been getting more educated and more highly skilled at a faster rate than anticipated.

Economic growth and wealth creation are accelerating in places like China, India and Brazil. In 2009, gross domestic product in North America, Europe and Japan were all down anywhere from 3 to 5%. However, even in the face of the largest global economic crisis in many years, GDP grew 7% in India and 9% in China. When the final figures are in for this year we think GDP will be up in North America a bit under 3%... as compared with 10% in China and 8% in India.

These countries are increasingly important customers. Even with Pratt & Whitney’s large U.S. military business, well over half our sales are international. For all of UTC, that figure is 60%. And we have found highly skilled people in countries like India, China, Poland, and Singapore that give us high-quality, low-cost material sources to keep us competitive and give us access to local markets.

These global economic changes – including emerging market customer demand – have led us to transform Pratt & Whitney from basically a Connecticut/U.S.-based supplier to a global company with a continued strong Connecticut presence, but with operations all over the world. Pratt & Whitney sales have grown from $7.4 billion back in ’97 to almost $13 billion this year.

In the same time, our earnings went from just over $800 million then to over $2 billion today. That’s an average annual growth rate of about 4 and a quarter % (4.24%) for revenue and close to 8% (7.7%) for earnings over these past 13 years... in part driven by rapid growth in these emerging markets.

And both our manufacturing footprint and workforce have shifted, mirroring this growth and globalization. In 1990, 69% of Pratt’s workforce was Connecticut-based – seven out of 10 employees lived and worked right here! Today it’s 30% – and it’s that way in response to the competitive global market.

Similarly, today about 15% of the manufacturing cost for our Connecticut-based Military Engines and Large Commercial Engines businesses is outside of the U.S. – versus hardly anything back in 1990.

Aerospace Transformation

Pratt & Whitney is certainly not the only aerospace company that’s had to reassess and transform how and where it operates. Boeing has not only moved its corporate headquarters from Seattle to Chicago, it is choosing to assemble some of its new 787s in South Carolina. These will be the first Boeing commercial airplanes built outside Washington State.

Airbus now assembles some A320s in China, and if Airbus wins the Air Force tanker competition it will assemble those aircraft in Alabama, not in Europe. And both Boeing and Airbus are looking over their shoulder at emerging airliner competitors in China, Russia, Japan, Canada and Brazil.

...Another example: Our major competitor, General Electric, has its headquarters in Connecticut and operates a huge complex in Ohio that looks remarkably like our East Hartford plant. However, it’s moving to build its new, large commercial engines in North Carolina.

But what has this most recent Pratt & Whitney transformation meant for Connecticut? First of all, it means that global success and shift in workforce and manufacturing cost has enabled us to generate the margins and earnings growth that allow us to make major investments right here at home! It may be counter intuitive but the two are inextricably linked!

We have spent about a billion dollars in the past 20 years to develop our Geared Turbofan technology that solidifies our position as a global aerospace leader... much of it being R&D and engineering investment money spent in Connecticut! In the past seven years, we have put about $150 million in capital into our Connecticut facilities.

At the same time, our global footprint is changing year-by-year as we position ourselves competitively. We now maintain facilities totaling roughly 12.5 million square feet, with about 45% of that in Connecticut.

This same split is seen in Pratt & Whitney’s employment base. About 46% of our employees work outside the United States, and as we respond to customer needs that share is sure to grow to more than half. Of the remaining 54%, about 30% are in Connecticut and the remainder are elsewhere in the U.S.

But while the Connecticut-based workforce as a percentage of our total Pratt & Whitney workforce has shrunk... the absolute total number of Connecticut employees has held relatively steady at around 12,000 for about the past 15 years or so – until the recent economic crisis when we have had to adjust that down to about 10,500 … however, we are actually increasing again as we recruit and build our engineering organization to support the important new programs we’ve won. And it’s worth mentioning that UTC’s workforce in Connecticut continues to be stable at about 26,000 employees.

But the important thing to note is that the hard decisions that we have made over the years to lean out the enterprise... invest in technology... expand our footprint into emerging markets and focus our work in Connecticut on high-value, high knowledge-work, has enabled Pratt & Whitney to grow the overall business and maintain a stable workforce in Connecticut!

Yes... the profile of our people in Connecticut has changed... and unfortunately... that’s what usually gets the headlines... as we’ve shifted our focus to the high-value, high-skill jobs that are right for Connecticut. This is the type of work that makes sense here.

In 1995, only 48% of our total Connecticut-based workforce was salary – less than half. Today that is 67%, or two of every three employees. Fifteen years ago, 20% of our Connecticut employees were engineers... one in five. Today it’s one in every three.

These are highly skilled employees: engineers, technicians, attorneys, financial managers and the whole support structure necessary for a global company, with pay averaging about $95,000 a year. Our highly skilled hourly employees in this state don’t just turn bolts – they concentrate on the most complex, high technology manufacturing we do … things like applying low-observable coatings to engine parts that help make an F-22 almost invisible to radar … or manufacturing engine turbine blades that have to stay on-wing for more than 10 years under extreme pressure and temperatures that exceed 3,000 degrees F. Our union machinists average about $90,000 a year.

And with the Joint Strike Fighter engine going into production and the Geared Turbofan family of engines coming on line, the outlook for highly-skilled, knowledge- based jobs in our Connecticut operations can be excellent... in the right business environment.

The presence of these jobs and our company in Connecticut is also very beneficial for the state as a whole. Our work creates jobs throughout the supply chain, where we order goods and services from close to 600 suppliers throughout Connecticut, supporting thousands of jobs.

And, as I’m sure everyone here is aware, we are an important element in the tax base. The precise figure can be arrived at in various ways, but it’s safe to say that UTC pays tens of millions of dollars in corporate taxes in Connecticut. This includes income, sales, payroll and property taxes. It does not include the many millions in income and sales taxes paid by UTC’s more than 26,000 employees residing in Connecticut.

The difficult decision we made to close our engine overhaul operation in Cheshire, and the small parts repair operation in East Hartford are the result of the changes in the competitive global landscape that I’ve talked about. This highlights what I’ve been saying about the changing 21st Century business environment, and the need for transformation. It underscores the need to focus on doing the right work in Connecticut. Actions surrounding that tough decision certainly generated a lot of heat, headlines and legal fees – but they also shed some light on the challenges we face.

Growth in Asia/China

Now in the case of our Cheshire engine overhaul center... the business volume was declining because a number customers were taking their overhaul work back inside their own shops. We had to move some of the remaining work to Asia because that is where the customers are, and where the growth is.

Twenty years ago, China represented just 1% of world air travel as compared to the U.S. at the time with 41%. Today it’s 7.7% and the U.S. has dropped to 25%. By 2020, projections call for China to nearly triple its air traffic and represent almost 12% of world air travel, versus the U.S. at only 21%.

Also, our costs here in Connecticut were not competitive. Aerospace is a global business, and there are other operations in much lower-cost areas in the U.S. and around the world run by our competitors that can easily do the work... so it means that we take action or lose the business all together.

Customers demanding competitive prices were voting with their business. We had our facility in Cheshire and we have a similar, but lower-cost, facility in Georgia. Both had excess capacity, so we consolidated the rest of the remaining work there so we could compete successfully.

These were not easy decisions. Our employees in Cheshire and the parts repair operation in East Hartford are good people doing good work. But it was no longer viable in the current 21st century business environment to do that kind of very labor intensive work in Connecticut.

However, because we were growing our overall business and had flexibility, we were able to lessen the hurt. We could offer people a generous early retirement and others a chance to transfer to new manufacturing work that requires a high skill level.

Again, Connecticut is a good place to do the right kind of work. But there are issues that it needs to address to keep it that way. Just as those of us in the business sector must always be sensitive to our competition … so must our state.

First, we understand that Connecticut will never be a low-cost place to do business. Our location in the Northeast, housing costs, the general cost of living, the lack of cheap energy all work against that. However, if the state makes itself attractive enough as a competitive advantage to business, there are things we can do to offset some of those factors. The urgency of the state’s financial crisis ought to be more than enough incentive to start transforming our state.

Step 1: Attitude

An attitude change is the first step. Even our state government’s own studies have said repeatedly that Connecticut is perceived as unfriendly to business. We have to move from a sometimes adversarial relationship to a more supportive one. The first instinct of some in state government has been to file lawsuits against companies making tough but necessary decisions to ensure their global competitiveness.

Not only does this discourage existing Connecticut-based companies from expanding operations in-state, but it gives pause to any non-Connecticut company from establishing a business here.

It is those very companies, however, whose growth will generate the wealth to solve some of the problems our new governor and the General Assembly face. There are innumerable studies about the competitiveness of Connecticut, and I won’t go into a long recitation, but here are just a few points to consider:

  • • We are dead last in job creation with zero job growth for several years.
  • • CNBC’s study of the best states for business ranks us 47th in business costs and 23rd in business-friendliness.
  • • Moody’s says we have the 6th highest state cost of doing business.
  • • Forbes ranks us 35th in competitiveness.

As I mentioned earlier, a number of major aerospace companies have moved significant manufacturing operations to other states who have offered them competitive advantages. As we have seen during the past couple of decades, automotive manufacturers have done much the same, too.

Both sectors have proven that manufacturing in the right locations can prove highly successful in the U.S. I recommend that the leaders of our state consider benchmarking states like Virginia and South Carolina that have a consistent track record of attracting business to see what they can apply here.

Certainly one of the issues posing challenges here is taxes. As a business leader who has had to make very tough calls to deal with difficult fiscal realities – both at Pratt & Whitney and, before that, at Hamilton Sundstrand – I am sympathetic to the challenges the leaders of our state face. Given a $3 billion-plus deficit right now, and even bigger ones later, it seems inevitable that we will face some combination of tax hikes and spending cuts.

I don’t envy our new governor or the men and women of the legislature the decisions they face. But I do have some suggestions about how they might approach them to help create a climate that generates job growth – and the prosperity that will help us out of our current fiscal crisis.

What Connecticut Needs

Connecticut’s tax structure has to be stable and predictable. Debating major tax changes every year creates uncertainty – and that kills investment. As an illustration... in Pratt & Whitney’s case we make long-term decisions because of the life cycle of our products. Work on the engines for F-35 JSF began in the 1980s, and that engine went into production just last year. The same is true of the Geared Turbofan. The investments are measured in billions over a number of years, and the earning power of new engines is not realized for decades.

We have to have some predictability on the tax burden we face when we make the decisions where to locate R&D and manufacturing work. The stability and predictability of taxes is as important as the actual tax rates.

Unfortunately, that has not always been the case here in Connecticut. In the early 1990s, for example, we decided to move our entire Military Engine business from Florida to Connecticut to be more efficient. We brought 1,200 high-paying mostly engineering jobs to the state. Part of what influenced that was the R&D tax credit.

But within a few years the state changed the rules, and the credit could only be applied to 70% of our tax liability. That was a 30% hit on multi-million dollar, long-term R&D programs that we were committed to.

Another example is the sales tax exemption on many manufacturing activities. Every so often people propose eliminating the exemption. It hasn’t happened yet, but the discussion creates uncertainty that can be a true disincentive to investing here. I can tell you if the exemption were eliminated it would make our Connecticut operations untenable.

There are also those who say the corporate income tax should be increased. But business pays a lot of taxes already. Connecticut ranks 18th in corporate tax burden among the 50 states. Its taxes on personal income and unemployment insurance also are higher than in many states. Stack up those factors with a very high property tax on real estate and business assets, and you’ve guaranteed a poor climate in CT for business investment and growth.

The Tax Foundation’s State Business Tax Climate Index ranks CT 47th – fourth worst – among the 50 states. About half the total sales tax revenue the state gets comes from businesses. Between 30 and 40% of property taxes are paid by companies. And the income taxes, sales taxes and fees we all pay... comes from the paychecks that companies generate.

By the way, UTC is still the state’s largest private employer, with our payroll here at about $2 billion.

So I would ask the new governor and the legislature to look at tax policy this way. Tax us on our success, not on our ability to achieve success. Set up a stable tax structure that encourages growth and you will be able to gain taxes from the fruits of that growth. Support businesses that employ people in Connecticut and make products that are exported from the state but return wealth here. Our economic future will come from areas such as high-precision manufacturing, aerospace, biotech, and financial services.

I must say one of the things that attracts Pratt & Whitney to places like Singapore, China, Turkey and Poland is the long-term commitment of those governments to economic growth. They stick by the promises they make, and as a result we now have about 8,000 employees in overhaul and repair and manufacturing operations in those four counties.

Much the same could be said of the state of Georgia too, right here in the U.S., where we began operations in the 1980s. Georgia, by the way, ranks near the middle of the pack as far as corporate tax burden. But its cost of doing business is far below that of Connecticut in terms of real estate, energy costs and average employee wages.

Another area that bears looking at is regulation. The legislature’s Program Review Committee report on competitiveness stressed that we need a streamlined, inter-agency approach to regulation. We need predictability in regulation, too. When Pratt & Whitney makes a decision on a new piece of equipment or a new process, we need to know that a multimillion-dollar investment won’t be regulated out within a few years.

Perhaps major regulatory changes could be phased in so businesses have time to plan the investments needed to comply. It is very important that Connecticut enhance its place as a “green” state. But we must know the costs and benefits of regulations.

And regulatory processes should be easier and faster. According to the Center for Digital Government, we rank 37th in electronic services for businesses. The legislature’s own study on competitiveness points out that technology is available to create a single web site where a business or an individual can go and get all the necessary plans, approvals, inspections and certificates for a project...

Trying to comply is not always easy or clear in Connecticut... a few years back we were doing the right thing... remediating some environmental issues in East Hartford. Our plans had to be reviewed by the Army Corps of Engineers, the Coast Guard, the federal EPA, the state DEP and the Town of East Hartford.

It’s encouraging to hear that, last summer, the DEP began working to adopt “lean” process techniques to speed up and better coordinate review and decision-making in 25 permit programs that it administers. Streamlining regulatory processes and getting agencies to coordinate and avoid duplication should be a top priority for the new administration. And ... who knows... we might save some money that could make our entire state more competitive!

With all due respect to Jeff Butler... and my colleagues at the utilities... they have their own set of challenges and are also trying to do the right thing, and they don’t need me piling on but... we have the second highest electricity costs in the nation here in Connecticut. In fact, electricity costs are so high that they made a business case for us to start generating much of our own power and get off of the grid in Middletown. We probably are not going to discover oil or natural gas under Avon Mountain, but perhaps there are things we can do.

  • • In the debate about deregulation or re-regulation, we believe that a deregulated, competitive wholesale market for electricity is in Connecticut’s best interest over the long run.
  • • About 30% of Connecticut’s electricity comes from natural gas. We need to develop more natural gas infrastructure to make sure this resource is available to Connecticut. Large discoveries of shale gas – and the ability to deliver that gas to New England – can help control costs.
  • • Even with the importance of natural gas, we can diversify. A mix of oil, gas, nuclear, clean coal and renewables like solar, wind and hydropower give us options and assure a robust system that can meet future demand.
  • • We need to improve our electricity transmission system and delivery infrastructure. Access to lower-cost generation capacity outside Connecticut can control costs and improve the reliability of our power grid.
  • • We should not use electric bills as a back-door tax collection device. In years past, the conservation fund surcharge on electric bills has been diverted from conservation into the General Fund. The Competitive Transition Assessment was enacted to cover the cost of moving to competitive electric markets. Then instead it was extended to pay for bonds used to reduce the state deficit.

We are blessed in Connecticut with great public and private colleges and universities. And we have a highly educated and trained workforce. But our workforce is aging, and a lot of young people are leaving the state for college and never coming back. We must find ways of making education and training more affordable and accessible.

We are proud of the UTC Employee Scholar program, which was begun by UTC almost 15 years ago. So far at Pratt & Whitney we have invested $322.6 million in our people through Employee Scholar, and employees have earned 10,766 degrees. For all of UTC, the program has spent more than $934 million on tuition, fees, books and other study materials and stock awards upon graduation, and our employees have earned 30,584 degrees at accredited colleges and universities. So we are “walking the walk,” and we continue to believe that enhancing higher education is one of the surest ways of spurring economic development and keeping us competitive.

Health-care costs are a national issue, but we can find ways to control them. Right now we have the fifth-highest health insurance premiums in the country according to the Kaiser Foundation. And employee contributions to premiums are the fourth highest.

I think we can all agree that there is a lot to like about Connecticut. We have a highly educated and skilled workforce. Our proximity to New York, Boston and Washington is a plus, despite the traffic. We have a great quality of life in this beautiful state and easy access to the mountains and the ocean. And as the Constitution State, we also have a great sense of history that enables tourism. And as I’ve said, we have some of the best colleges and universities in the world. All of you are here today because you want to find ways to grow your business in the State of Connecticut.

Connecticut has some tough issues, but I sense a new attitude about tackling them, including the promise of enlightened leadership from Governor Malloy, who has already reached out to the business community in a big way.

We need to work in partnership with the governor and the state to make sure Connecticut becomes the competitive state it can be. We need to be in dialogue with our representatives in Congress about what we need to make Connecticut business more competitive.

Conclusion

...with basketball season under way, I’m reminded that we know a little bit about competition here in Connecticut... as any UConn Huskies fan can tell you. Jim Calhoun and Geno Auriemma have demonstrated year after year that if you create the conditions for success, and cultivate great talent, there’s no telling what you can achieve.

If we have a real collaboration between government, business and education... there is more than enough brainpower in this state to set big goals and achieve big results. But Connecticut cannot win by sticking with business as usual. As Governor Malloy proclaimed recently, “Connecticut must be open for business.”

The state budget crisis tells us business as usual has failed. We all have seen plan after plan, year after year. Now we must act to transform ourselves to be competitive in a 21st century global economy.

We want to be the best-educated, smartest people doing the best work in the world, creating prosperity and security for the future. Business goes where it can be successful. That’s why Frederick Rentschler left a company in New Jersey and came here in 1925 to found Pratt & Whitney. Globalization means that companies have many options.

For Connecticut to compete and win, the state must transform itself and find ways to become a competitive advantage for businesses. I am confident that our state can partner with business to be successful in this global race, but a race must be run to be won.

Every day we stand still, we fall behind. There is no reason why Connecticut can’t continue our longstanding heritage of being a world leader based on skilled work, productivity and technology innovation. If we can commit to these things there can be no doubt that together we can win in terms of prosperity for business, and prosperity for the State of Connecticut.

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