One Size Doesn’t Fit All

One Size Doesn’t Fit All

Back in the bad old days before U.S. railroads were relieved of the most onerous of government regulations, shippers had little to choose from when selecting a carrier. Today, each major railroad has different strengths — and weaknesses — and, like baseball managers, each plays to those strengths and away from the weaknesses.

Rates before deregulation were pretty much identical between any origin-destination pair, and service generally was poor, if not downright bad.
It wasn’t that railroads wanted to provide poor service. They had no real choice. Even the most profitable railroads did not earn enough to justify or support reinvestment in their fixed plant. Without investment, track deteriorated, slow orders increased, aging equipment failed, and the railroad industry fell into a vicious cycle of bad begetting more bad.

There rarely is a single cause of good or bad; invariably, a series of events or incidents combine. That certainly was true in rail transportation.

Railroads set rates collectively, and for those who don’t remember the time before passage of the Staggers Rail Act of 1980, they attempted to protect all participants. I was employed by the Association of American Railroads then, and can remember when a group of dark-suited men carrying bulging cases would show up and take over a conference room. That meant the industry was about to file another rate case at the Interstate Commerce Commission.

There may have been five railroads competing for business between Chicago and Kansas City, for example, and each got a vote on what the rate increase should be. But if a sixth railroad that did not have a direct route between the two cities could cobble together a route by way of St. Louis, it also got a say in what the increase should be.

The people who negotiated rates didn’t seem to see the folly of such a system. That was the way rail rates were determined and they always had been determined that way, was their attitude.

Once a rate increase was filed, affected customers and unaffected customers who were concerned about competitive fall-out routinely filed protests. The ICC, which saw its role as primarily protecting shippers, frequently suspended the proposal for investigation. Usually, the increase eventually was approved, but the railroads, which operated for months without the needed revenue, never got a retroactive payment.

When Consolidated Rail was activated and took over six bankrupt rail systems in the Northeast and Midwest, 25 percent of industry track miles were operating in bankruptcy proceedings. Only in the South and West were railroads remotely successful, and they suffered low earnings and even lower stock prices and values of their securities.

Fast forward to 2009. There are many fewer railroads today, and they endure the sharp traffic decline that marks the current recession. But none is in danger of failing, and all are taking the long view of their business. Capital spending programs continue, although those at the margins are being postponed. Service quality not only is being maintained, but, according to most indexes, is improving.

How did such a change come about? Railroads were deregulated. Congress didn’t intend it to work the way it did. Railroads were expected to raise rates under the assumption that incremental revenue would underpin new investment in rail plant. But Congress also deregulated trucking in 1980 and railroads never had the luxury of raising rates.

Railroads used their new freedom to cut costs wherever possible and to become more efficient. Over time, excess capacity was wrung from the system.

The Staggers Rail Act forced railroads to end collective rate-making, leading each to consider its unique selling point and to focus on using its strengths to draw business and increase earnings.

Securities analysts increasingly see railroading as a business made up of railroads with distinct operating models, not simply “the industry,” as previously viewed.

Rick Paterson, rail analyst with UBS, the Swiss-based investment bank, recently wrote in a note to clients: “Differences in commodity exposures are most often perceived as the primary differentiator between railroads, but we believe relative changes in productivity are more important . . . Dismal volume growth in 2009 is going to have to be offset by a combination of three things in order to maintain earnings: improvements in productivity, core price growth above cost inflation, and benefits from lower fuel prices net of unwinding fuel surcharges.”

CN and Norfolk Southern recently announced the MidAmerica Corridor agreement to share some track. Shaving 60 or 100 miles off various routes can produce real savings, especially where a railroad’s traffic volume might not support an investment in upgrading the line.

Under regulation, need for productivity improvement was so great that projects such as the NS/CN arrangement didn’t get a second look. The thinking then was, “Why struggle to make improvements when a competitor will match the price and we won’t get the benefit of our efforts?”

Today, improvements lead to revenue and earnings growth.

Lawrence H. Kaufman, former intermodal editor of The Journal of Commerce, is a Denver-based consultant whose clients include the Association of American Railroads. Contact him at Lkaufman81509@aol.com.