IF THE BUSINESS MODEL ISN'T BROKEN, REPLACE IT

IF THE BUSINESS MODEL ISN'T BROKEN, REPLACE IT

A lot of serious students of the U.S. railroad industry like to say that the business model is broken.

I have a different variation on the theme. The model isn't broken, but the universe in which railroads operate has changed so much that the railroads need to develop a new one. The old one worked just fine for the environment that existed as recently as 50 years ago.This is more than a difference without a distinction. All of the major railroads are working as hard as they can to fix something that may not be broken. The goals they are achieving aren't acceptable to the outside world. Railroad managements continue to do the same old, same old, only better. And that won't solve what's wrong with U.S. railroads.

Neither customers nor Wall Street have appreciated what they have done the last several years, and have penalized them accordingly. A Morgan Stanley Dean Witter survey of shippers last spring showed that businesses expect to ship more frequently and in smaller volumes. This is not good for railroads, which have a business model that says repeatedly shipping large volumes of goods is what they do best.

Hundreds of industrial parks and warehouses have been built all over the country in recent years with no direct rail access. And, it isn't just light industry: the head of logistics of an automobile manufacturer has said rail access was not crucial to future plant siting decisions.

This is not good for railroads.

That is why I say ''fixing'' the business model is not going to solve the railroads' problems. They need to be developing a new business model, one that is suited to the 21st century business environment.

If I knew what that model should be I wouldn't be writing a column; I'd be making a fortune advising railroads. There are people out there, however, who have some ideas on how to build a new railroad business model. Unfortunately, nobody seems to be listening to them.

The current generation of railroad leaders isn't known for its creativity. Perhaps that's the reason they are so focused on doing what railroads always have done, but better.

Some critics, this writer included, have questioned where the boards of directors are. While it's true that more than a few directors don't bring anything of value to the table, blaming the boards isn't the solution either. It's unreasonable to expect direction from an uninformed, uninvolved group. The proper role of a board of directors is to approve the strategy developed by the management and once the business course is set, to hold management's feet to the fire.

This the boards do not appear to be doing. In other industries that have seen nearly half of their market capitalization erode in less than a year, boards have forced chief executives out. No railroad CEO, however, has suffered that fate.

Railroad boards of directors have the usual mix of investment bankers, women, African-Americans and academics. They also have something that is lacking in many other industries - representatives of major customers. That raises the issue of whether directors are representing the owners - their fiduciary responsibility - or their own interests.

At Norfolk Southern Corp., a newly named director was one of the signers of a letter to Senate Commerce Committee Chairman John McCain, R-Ariz., and ranking member Fritz Hollings, D-S.C., in which a large number of chemical and forest product industry CEOs called for greater efforts to increase rail competition. It's hard to see how that benefits NS shareholders.

What the boards don't have are representatives of the so-called new economy, the dot.com types known for thinking outside the proverbial box. The review of management strategy - perhaps even the development of that strategy - might be affected if the boards contained a different mix of members than the traditional. We've seen what they can do.

Outside-the-box thinking is more than just a buzzword. For example, railroads today are part of a capital-intensive industry. Operating strategy generally has been shaped by a desire to reduce expenses in an effort to improve the ratio of operating expenses to revenue and thereby increase net revenue and return on capital. Executives seem to be content with revenue growth that at best keeps up with industrial growth in the economy.

This spills over into merger strategy, in which carriers try to improve return on capital by acquiring competitors and eliminating redundant facilities, or acquire connecting railroads in an effort to increase length of haul and grow revenue in that way.

Must railroads be so capital intensive? Do they need to be as vertically integrated as they are, owning everything from the ground under the tracks to the cars that roll over them? Can they find a way to market to less than gigantic customers without losing brand identity, franchise and ''ownership'' of the customer?

There are no easy answers. But that's no excuse for not even asking the questions.