How to revive growth

Posted by Fred Frailey
on Tuesday, July 26, 2016

Railroad revenue declines are not just in coal and crude oil, but across the board. Take Union Pacific’s second quarter versus 2015: Chemicals, down 5 percent; automotive, down 13 percent; industrial products, down 14 percent; intermodal, down 16 percent; coal, down 27 percent. The whole industry is contracting while the economy is growing.

            I spoke the other day with Tom Hoback, the recently retired founder and chief executive of Indiana Rail Road. Before starting INRD in the late 1980s, Tom worked in marketing and learned how to sell railroad service at Western Pacific and Illinois Central. His nose for finding new shippers on the Indiana Rail Road was exceptional. The purpose of our conversation: How to revive the carload business.

            Let’s start by asking, what’s wrong with the industry’s approach to soliciting carload traffic? There’s a lot of opportunity. The problem starts at the top. If your focus is on preserving quarterly earnings, you won’t do anything that adds to expenses, unless you see an immediate benefit to the bottom line. Trust me, there are chief executives who are ducking under, determined to ride out the storm. I talked to the chief financial officer of a Class I railroad, who asked if his railroad improved service and tried to increase market share, would profits follow? He felt that if his railroad took the lead, Wall Street would hand him his head because he would be increasing costs without a short-term return. To recap, I think the railroads have gotten used to this pricing environment, where they can get away with large above-inflation rate increases every year. They don’t worry too much about diversion. They know they’ll lose a little, but they more than make up for it with higher revenue per unit.

            Are marketing departments organized to pursue more carload business? No. The big railroads view marketing as overhead, and therefore a detriment to a low operating ratio. So staffs are cut to the bone. When I began, many railroads actively looked for new opportunities. Headquarters interacted with field sales people to identify and develop new business. Today, I know of no railroad that has a professional staff doing so. Instead, railroad marketing relies on a centralized staff that answers emails or telephone calls for rate quotes. It relies on leads that come from outside. “I just got a call from someone who wants to ship 20,000 carloads of crude oil from North Dakota to Texas.” That’s railroad marketing today. All this tells me that the Class I’s are only interested in more carload traffic that arrives with high revenue per car, the shipper furnishes equipment, and there are no service commitments.

            One gets the impression railroads think there’s much more business to be had. . . If you drive around central Indiana or Illinois, in some of these county-seat towns, you’ll see truckloads of plastics, you’ll see containers, domestic and international. Then ask yourself: What does this company do? What does it make? Where do products go? Where do raw materials come from? You’ll see scads of opportunities. But this is very labor-intensive. Let’s be fair. Railroads are not going send a zillion people into the field to do these things. But what’s to prevent their sending some bright young marketing people into a specific piece of the railroad to see what’s going on out there? States like Indiana and Illinois have extensive data on major industries, what they produce, and from where. These are shortcuts that can be very effective.

            Going back to that CFO you spoke to, won’t the added expense spook investors? What I told him was, go to the analysts and tell them, look, we’re going to increase our carload business by 2 percent in 2017 and 3 percent in 2018. There means an investment in manpower. But here’s how it will affect out top and bottom lines for years to come. What’s wrong with laying out the growth story? Nothing. People will understand. And then the railroad should put some people to work in market research. Pick an area—Decatur, Ill., for example, or any manufacturing center you don’t know much about. Spend some time there and in the surrounding region. If it’s Decatur and you’re Canadian National or Norfolk Southern, you’ve already got operations there. Pretty soon you’ll be billing two cars a day or five cars from new customers. Doesn’t sound like much, but over a year’s time this represents $2 million or $3 million, and your incremental costs will be low. This is what the regional and short line railroads do so well.

            Are railroads pricing their services too high? I think so. I talked to a friend who was a cost analyst for several railroads, large and small. He says railroads claim they need X dollars to move a car A to B because their costs are so high. The costs are pretty much anything you want them to be. God bless the CEO who says, “Our chemical business is off. Let’s find replacement traffic and be flexible on pricing.” That’s not today’s mindset. Everyone is intent on maximum revenue per car. So you get rate quotes that are embarrassing to give to prospective customers.

            So put yourself in the place of a Class I CEO. You want more carload business. What do you do? You start with the chief commercial officer, who needs to know his rewards are going to be based on his degree of success in finding new business. Then set realistic targets over a two- or three-year period. Commit to the cost of more market research at headquarters supporting more people out in the field, and let Wall Street know. Start in just a couple of cities or regions of the railroad, where opportunities seem greatest. Follow through on leads. Be realistic on pricing. Make sure the operating people are on board and supportive. Voila! There’s more to it, of course, but that’s the idea. Another thing you might consider is hiring a couple of smart truck brokers. They are unbelievably good at what they do, and use highly sophisticated tools that show them where the loads are.

            What about the absence of infrastructure—businesses that don’t have sidings or took them out? That’s actually a plus, the reason being it’s easier if you go through a reload facility. There are so many plastics users around the Midwest, my god, it boggles the mind. A railroad can set up a network of plastics reloads and perhaps use them for other commodities. A lot of Indiana Rail Road’s growth came from customers that don’t have spurs.

            Last question: Do you hold out hope that railroads will really try to find that new carload business that you say is out there? No, I do not, and yes, it is sad—depressing, actually, for an industry that has the abilities railroads do. I mean, look at the efficiencies they have baked into their systems, the huge investments they’ve made in infrastructure. The fact that this infrastructure is so underutilized, and that they do so little to try to fill it up, is what’s depressing. So I keep waiting for one of the Class I roads to break out of the mold and say, well, things have really changed, so we have to do business differently. Then from that conclude that they need to find more business that’s not captive, that doesn’t fall into their laps. If any railroad is close to doing that, it’s BNSF Railway, but you haven’t said a word to me that makes me believe it’s happening.

           My concluding thoughts: Tom Hoback is a national treasure. Driving across Illinois with him one hot summer afternoon, I said, “Tom, pretend for a moment that Michael Ward retired and the CSX board wanted you to run the railroad. How would you shake up that shop?” Hoback thought for a moment and replied: “I’d gather up my chief marketing officer, chief operating officer, and chief financial officer and tell them, ‘We’re going to visit in coming months our top 100 customers, and ask them what we need to do to get more of their transportation business. You’ve all got to be on these visits, because nothing will get done unless each of you buys in to whatever it is the customers says in response.’ And I would tie some of their compensation to how successful we are in gaining new business.” Pretty good response, don’t you think?—Fred W. Frailey

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