NEW YORK — If current Class I railroad volume growth efforts don’t bear fruit, railroads will either have to turn to transcontinental mergers or try to shrink themselves to prosperity.
That’s the conclusion Oliver Wyman consultant Adriene Bailey has reached after examining trends of declining traffic and anemic revenue growth as railroads continue to lose market share to trucks.
Eventually, a lack of growth will put pressure on railroad CEOs to boost earnings, she says. “CEOs worth their salt will not accept being relegated to running glorified utilities,” Bailey says. So they’ll either push their teams to get creative and figure out how to increase revenue and profits — or they’ll be replaced as investors demand change.
“What are our options if rail fails to grow? Oliver Wyman sees two remaining choices,” Bailey told the RailTrends conference earlier this month. “The first would be that the four largest Class I railroads merge into two transcontinental systems like Canada. The second would be for the Class Is to shrink to greatness and share a lot more infrastructure.”
Current Surface Transportation Board regulations frown on major mergers. But Bailey says that creating two U.S. transcontinental systems would eliminate redundant costs, significantly expand the single-line service that shippers prefer, and open up so-called watershed markets that aren’t served well today because origins and destinations within a couple hundred miles of the Mississippi River are short hauls that are not attractive to the eastern or western railroads.
“Mergers may reduce some competitive options for shippers, but railroads will have a vested interest in keeping the volume from going back to trucks,” Bailey says.
Absent mergers, the big railroads could reduce costs by sharing main lines, yards, and terminals where it’s feasible, Bailey says. These arrangements are nothing new, she says, pointing to examples like the BNSF Railway and Union Pacific Joint Line along Colorado’s Front Range and the Directional Running Zone that Canadian National and Canadian Pacific Kansas City use in the Fraser and Thompson river canyons of British Columbia.
“These sharing arrangements exist today for a variety of reasons, but if growth remains elusive, the pressure to shrink to prosperity will intensify,” Bailey says.
“But the larger question is, do the railroads really want to shrink to greatness, further reduce their future options, their competitiveness against trucks, and their role in the North American economy,” she asked.
The answer seems to be no, given that all of the Class I railroads say they are now focused on volume growth.
“The railroads seem to be embracing what we see as the top three areas of opportunity: intermodal, rail-centric industrial development, and short line growth,” Bailey says. “I’m more than pleased to hear the Class I CEOs actively talking about volume growth. But I do not yet see evidence that the industry is delivering on the top two things that are required to tip the scales permanently in the favor of rail: A serious and demonstrated commitment to transit reliability and making it much easier to transact.
“More concerning is I’m not yet sensing that investors and perhaps even boards have bought into that strategy — and we should not underestimate the influence of the investment community on where public companies focus their efforts,” she says.
It’s no surprise, Bailey says, that railroads are not growing when the strategy has been to raise rates without making improvements to service.
Continued cost-cutting and price-taking won’t deliver the profit growth needed for the industry, according to Oliver Wyman’s analysis. What will maximize shareholder value, Bailey says, is adopting volume growth strategies while becoming more customer friendly.
“Is there a reason the industry isn’t figuring this out? Some might ask if there really isn’t any growth to be had. Isn’t this a fool’s errand? It’s a good question and I’ll say it once more. What I’ve heard loudly and consistently from shippers: ‘We want to put more freight on rail. We just can’t stand the difficulties and the frustrations it involves.’”
The stakes for the industry are high.
“Failure to achieve industry growth aspirations will have very unpleasant consequences if the industry fails. And this indeed would be an epic failure giving up on nearly two centuries of painstaking value creation,” Bailey says. “Railroads would be forced to shrink, lose jobs, tear up infrastructure. And I believe for myself and for many of you here in this room, that is not a story we want to see told to future generations.”
RailTrends is sponsored by independent analyst Anthony B. Hatch and trade publication Progressive Railroading.
Railroads have been in shrink mode ever since Staggers. How can you grow a business when physical plant has been shrinking? How can 3 mile, 15,000 ton slugs going 40 mph ever provide carload service and compete with trucks?
50 years ago refrigerator cars from California would be delivered on the 4th morning to the Hunts Point market in NYC. Today, almost ZERO produce ships by rail. Locally there is virtually no carload traffic.
Lastly note the çproductivty”