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Introduction To Precision Railroading, Part 1: The Industry's Savior Or Villain, Take Your Choice

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Introduction To Precision Railroading, Part 1: The Industry's Savior Or Villain, Take Your Choice

This article by FreightWaves advisor and intermodal consultant Brian Bowers is the first of three reviewing the controversial subject of precision railroading, an operational system and a management philosophy that in the railroad business today is leading to one question: which side are you on?

Few topics in the rail industry elicit the emotional reaction of precision railroading.

Advocates declare it to be a universal solution to transform performance while opponents believe that it is a shortsighted financial strategy. Finding the truth may be as challenging as understanding the creator of precision railroading, Hunter Harrison. 

After achieving significant breakthroughs applying the strategy to the Canadian National and Canadian Pacific Railway Limited (NYSE: CP), Harrison encountered a spectrum of problems when he applied the same plan at an American Class 1 railroad, CSX Corporation (NASDAQ: CSX).  Financial results have been good, but service provided to customers and employee morale have been reported to have suffered and are still being addressed.

Financial performance during Harrison's tenure at Canadian National and Canadian Pacific was impressive.   Harrison achieved the equivalent of a "four minute mile" breakthrough to establish a new standard for rail operating results.   The operating ratio at both railroads dropped twenty points from the eighties to low sixties and high fifties. Shareholders benefited through the creation of billions of dollars in incremental market cap.  

So what's precision railroading all about? I've identified five key principles to it.

  • Improving customer service by prioritizing delivery of customer shipments on fixed point to point schedules while minimizing in-transit work events.  This allows customers to better plan for shipment arrivals and departures.
  • Strict cost control across the organization
  • Monitor the use of each asset to optimize utilization of railcars and locomotive power.  Improved asset productivity creates incremental capacity and allows the diversion of capital to other areas of the railroad.
  • Operating safely is a priority.
  • Value, develop and empower employees at all levels.

Those new standards now reverberate across the rail landscape.  Each quarter rail performance is measured against those expectations for operating ratio improvement. Is it reasonable and prudent to expect that level of improvement at all North American railroads?   

Companies that have not adopted precision railroading might argue that these standards are not any different from their own. For example, what railroad would say that operating safely is not a priority?

But first, the point to point schedules are significantly different from a hub and spoke system that a non-precision railroad might use. It's probably the key difference between the two. And critics of the system might argue that customer service suffers from precision railroading; it isn't enhanced by it, though some shippers would argue that service has improved.

As other railroads join the precision railroading push, it is reasonable to ask whether the two company/transcontinental Canadian railroad environment is very different than the eastern United States.  The long length of haul and lack of congestion on Canadian rails is very different than the compact operating environments of Norfolk Southern Corp. (NYSE: NSC) and CSX. Did the much shorter length of haul or network congestion cause precision railroading implementation to derail at CSX?   Did the success achieved in Canada result in changes to the pace and level of sensitivity to employees and customers?   

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Will pressure from shareholder activists motivate leadership at the Norfolk Southern, BNSF or Kansas City Southern (NYSE: KSU) to take similar action?  Many believe that was the catalyst behind the Union Pacific announcement last month that it was initiating a precision railroading plan this fall.

Earlier this month Matt Rose, the Executive Chairman at BNSF, announced his retirement effective in April, 2019.  Under his leadership the BNSF has set the standard for growth and performance.  What impact will the leadership change have on the long-term strategy at BNSF?  These are all critical questions that will set the future direction for the railroad industry.

Capital investment is a fundamental requirement to fuel growth and keeping a railroad viable.  It typically equals 15 to 25 percent of total revenue. That level of investment makes it an easy target and annual battleground with investors.  Individuals not familiar with the industry often question whether that level of investment is necessary.  

Network maintenance, the largest consumer of capital, is not sexy. The option of deferring investment in that area can look attractive. Maintenance of way, however, is critical to the long-term viability of a railroad and failure to maintain the required baseline can adversely impact safety and network capacity. Anyone who has lived through a railroad capital planning cycle understands the reality of prioritizing strategic projects whose cost inevitably exceeds available funds.  Rail assets and infrastructure are expensive and often require extended time periods to plan, implement and earn a return on investment.  This reality appears to conflict with the common perception of precision railroad's emphasis on operating ratio and short term results.   

Most industry leaders agree that performance can and needs to improve. Pat Ottensmeyer, the CEO at the Kansas City Southern, recently commented that, "It's hard to spend money in this environment…when it might not have a clear short-term payoff.  But in the long-term it could be useful and important." 

This is an important perspective that should be considered when assessing precision railroading.  If rail or any mode disengages from the technological transformation that is occurring in global transportation, the long-term impact could be costly.  Is the answer to modify the strategy to include selective strategic investment or do other options exist?  Railroads have never resided on the leading edge of technology or change so getting this right is a critical challenge for industry leadership.

Through a three-part series of articles we hope to better understand the value, impact and definition of precision railroading.  We will look at how it is best applied and what modifications or alternatives are available to improve industry capacity, service and financial performance.  Great organizations are driven by great strategies that create sustained value for all stakeholders – shareholders, employees, customers and service vendors.  Input from all parties would be beneficial as we explore this intriguing strategy and the industry it serves.   Let me know you thoughts at bbowers@freightwaves.com.

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