Shrink or grow? The answer . . .

The TV audience for NFL games was down noticeably this season. Nobody really professes to know why, but the television networks are worried, the National Football League less so. The NFL’s attitude is let’s wait and see what happens—in other words, do nothing. I’m telling you this because it’s an apt analogy for what’s happening in the railroad business these days. Business has been down pretty much across the board, including intermodal, the past year. But the big railroads do nothing except cut costs (smart) and raise rates on the traffic that remains (maybe not so smart). Of course, there are exceptions; I’m told Norfolk Southern and Canadian National are beating the bushes for new carload business.

You’d think that top executives of all the railroads would be aware of the perilous position their companies are in, which is this: In a high-fixed-cost business like railroading, as the traffic base shrinks, the more each remaining carload must bear of those fixed costs. Therefore, at a certain point your costs per car handled suffocate you. But one of three things appear to be happening. The industry either is in denial, like the NFL, or has forgotten how to sell services at the retail carload level, or is afraid to incur Wall Street’s wrath by increasing costs to finance a long-term sales strategy. Any way you cut it, this isn’t a winning game. And the idea that rising intermodal revenue will by itself make up for lost coal income wears thin as, month after month, intermodal lags year-earlier volumes.

It’s not enough for me to be a scold. What would I do? I’d start by asking whether there really is a freight transportation recession. There is no recession for truckers like J.B. Hunt Transport. Its volume has been increasing all year in each of its four major divisions. So there’s business to be had if you look for it, but where? And therein lies the problem. Roughly eighty percent of the $1 trillion-plus U.S. surface freight market is over distances of less than 500 miles—in other words, precisely the short-haul market where big railroads feel they are not competitive.

Still, if you don’t want to slowly go out of business, or become irrelevant in the transportation field, doesn’t it make sense to go where the money is? Competing for traffic in the sub-500 mile sector isn’t easy, but plenty of railroads do it. Ask any regional railroad, for instance. Florida East Coast Railway runs a profitable intermodal service over the 350 miles between Jacksonville and Miami, grossing (in 2013) just $429 per trailer or container. It does this by keeping terminal costs low and making it easy for customers to do business with it. FEC will pick up your trailer as far away as Atlanta or Savannah, Ga., if needs be, and its online app (FECR Connect) gives you a door-to-door price and lets you reserve space on its trains without picking up a phone. You can even negotiate a lower price with the app! Norfolk Southern offers a similar convenience.

Or look at what the European freight railroads do. More than 200 companies operate under various forms of open access, and essentially all of their traffic is short haul.

I once proposed (see “A Different Way to Run a Railroad,” Oct., 2013) that regional railroads operate local train services over Class I railroads. Better yet, they should also market these operations in partnership with the larger railroads. Actually, a Class I railroad did approach a regional connection with just such a proposition. But the Class I railroad decided its profit margin would shrink unacceptably under such an arrangement.

And this gets us to the crux of things. Almost anything that will expand the shrinking traffic base of railroads is going to cost money. To illustrate the dilemma, you can’t serve under-200 mile or under-500 mile city pairs well running 200-car trains once a day at most. You can’t sell service if you keep your marketing department on life support to suppress costs. But if you budget for better marketing to capture more carload business—and thereby increase costs—you endanger the net worth of middle and upper managements. Their compensation is partly or largely tied to stock and stock-option grants. When costs go up before the revenue arrives that these costs generate, up goes the operating ratio and down goes net income. Forget that over the long term, you’ll have a lower OR and higher earnings. In the interim, Wall Street will interpret the numbers as meaning you’re in trouble and smack the stock price with a hard paddle. There goes morale at headquarters.

I know I’m appearing to be a dreadful cynic. But I’m told time and again this is how life is on today’s big railroads. Those of you who listen to quarterly conference calls railroad managements conduct with securities analysts: When was the last time an analyst asked what plans the chief executive had for going after business his railroad doesn’t already have? Actually, most questions are mundane and hue closely to whether the railroad will meet Street expectations for the next two quarters.

Actually, I’m an optimist. Sometime, somehow, a railroad CEO will grow so frustrated with today’s state of affairs that, maybe out of sheer desperation, he will burst out of the mold and devise a better business model, one that emphasizes long-term results over short-term window-dressing and business growth over stagnation. Nothing stirs the imagination better than hard times, and that’s where this industry finds itself today.—Fred. W. Frailey

This blog is adapted from my column in the forthcoming January issue of Trains Magazine