December 6, 2018
RailTrends 2018 was jam-packed, exciting and filled with new trends, plans, technology. We who now live in these exciting times for the freight railway industry must, however, pause to consider the often cyclical nature of change; of what’s new can be old or reconstructed. Consider the attached photograph of a coffee mug extolling “Precision Transportation” from the Norfolk & Western Railway, and this article from the HBR in 1960 (!):
“The railroads did not stop growing because the need for passenger and freight transportation declined. That grew. The railroads are in trouble today not because that need was filled by others (cars, trucks, airplanes, and even telephones) but because it was not filled by the railroads themselves. They let others take customers away from them because they assumed themselves to be in the railroad business rather than in the transportation business. The reason they defined their industry incorrectly was that they were railroad oriented instead of transportation oriented; they were product oriented instead of customer oriented….” Theodore Levitt’s HBR Article Marketing Myopia 1960
But also consider this from last week’s conference:
“I have never been so excited to be in the railroad industry and to be at (my) railroad” – paraphrasing three rail leaders at RT18
“PSR is foundational” – Eric Jakubowski, CCO of the Anacostia & Pacific short line holding company and ex-PSR strategy vet at CN (echoing many related comments)
Five top takeaways from RailTrends 2018 (aside from the need for capacity – at the conference)
I believe in the commitment of the newcomers to PSR – particularly Union Pacific, whose CEO Lance Fritz gave a detailed speech and stated they were accelerating their change process (Norfolk Southern clearly kept some dry powder for their critical February 7 Investor Day)
PHR (post-PSR) – CN, CP & CSX, so far -is the future, and the future looks bright
Kansas City Southern may have jumped to the top of the leaderboard in terms of Technology (& Innovation) – and promised that their railway will be fully automated in 6-10 years!
Short Lines may be entering a New Golden Age, in terms of organic growth fueled by technology, better Class One cooperation and merchandise focus – and through the creation of new shortlines (a la CSX)
Risks and challenges surely do remain – huge investments in technology by and into competing modes, tighter service requirements, the need for greater network cooperation, etc. But the means and increasingly the mindset to change exists as well….
PSR (& PHR) and Technology were the twin-stories of this year’s conference: RailTrends 2018, like the 13 predecessors, obviously flows with the times and so reflects not just the future but the topical activities of the present within the industry. As such, these two themes, Precision Scheduled Railroading (PSR), now sweeping the industry (see slides, attached, or, specifically on the “PSR Spectrum”, at the bottom) and Technology, dominated the discussion in various forms). The room was (too) full – sold out, in fact; apologies, again. Every Class One was represented – by top leadership, save one (BNSF, sorely missed and in the audience – and a big player at “MARS” in January), as were the vast majority of short line holding companies. The audience was also high powered as per (and even more than) usual – rails, shippers, investors, suppliers, consultants and thought leaders, labor, foreign entities, etc. The discussion was active– of execution, of competition, of failure to innovate – were also in evidence, as were the related challenges of imposing change on such an “ancient” industry. Rather then break down RT18 chronologically, lets look at it thematically (and as such I am eliminating from this discussion the excellent presentations, for example, by Amtrak, by FRA Administrator Ron Batory - covered in my write-up on the RTA meeting - and by Dick Kloster and new RSI chief Mike O’Malley on railcars, covered elsewhere):
PSR 2.0 (existing practitioners)
PSR Next-Gen (newcomers, and the level of PSR adoption – and commitment)
How a rail world increasingly PSR-impacted will look, and the implications for shippers, short lines, consolidation, etc)
Risks & Challenges: The rails are having another terrific year from a financial perspective, but as we have covered almost ad nauseum, service was still subpar, leading to missed opportunities and a suboptimal situation with shippers and their representatives. Will rails right the ship in time to handle the still strong demand and capture (or recapture) market share? Can they fend off the rising tide of investment into technologies that will narrow the gap in two of their three competitive advantages versus the highway (labor and fuel efficiency)? Will they continue to develop their network to take advantage of their third, and most enduring competitive advantage, their control over their own network? Let’s look at four presentations that touched on these themes of challenge – Oliver Wyman on technology, the short lines panel, and representing the government impact, our annual “DC (& Ottawa) Panel” and the STB.
Rod (“Dr. Doom”) Case, head of the rail practice at industry thought leaders Oliver Wyman, made his usual annual presentation – but I should begin with his conclusion. Since he began his fact-filled crusade to get rails to regain their tech mojo, he has noticed a real change in leadership attitude, a new level of acceptance - and a renewed view of carload, manifest business s as an opportunity. But he still called on rails to improve efficiency (not just cost; not just OR takeout) and resiliency. Part of that is a changed leadership thought pro-cess – he noted that most railroads value train delay hours at ~$200 (thinking locally and operationally); one puts a $1500 price tag on that delay (capacity; missed revenue opportunity). He encouraged the industry to try new services or technologies even if many will flame out or fail (yes; he did bring in a European – sigh - example: Mercitalia FAST, a passenger-scheduled shared asset experiment: “they may fail but at least they tried”). But he did live up to the nickname – without change, and with the changes coming, someday in trucking (if not fully AV soon, certainly platooning), rails can still grow but they will lose between 16 and 22% market share to faster growing trucks to 2045….ouch. So, he, and we, might say, time is of the essence. Rod’s presentation was scary, as usual but also, as usual thoughtful, detailed, and with a game plan to change the score before the clock runs out….
The short-line panel (and Peter Gilbertson of A&P, representing the short line association, ASLRRA on the DC Panel) noted the gaps, narrowing but still extant, between rail rhetoric and real cooperation in what is a network business. Two issues stand out to me – the belief that data capture, looking even brighter post-PTC installation, is seen by too many as proprietary. Data must be shared to grow overall market share and customer appreciation (see the inbound empty example below). The other is that while PSR is concerned with the first mile and pre-blocking (and thereby pushing work and costs onto shippers or shortline/switching partners, it is the last mile that remains, as one said, “the black hole of PSR”. And, in a warning in many ways to the Street, the short line panel, as bright a bunch as we have put under our bright lights, decried the OR-driven but futile attempt to precisely match capacity with demand while therefore sacrificing….resiliency (with all that implies for shipper share, regulator interest etc).
The presentation by Ann Begeman, the Chairman of the Surface Transportation Board, was most interesting. Historically at RT, and elsewhere, government officials are often beyond circumspect with their words, knowing their various constituencies (and the trade and business press) are there to interpret their speeches….Chairman Begamen did not follow the historic pattern, providing a true breath of fresh air to the event – but also some warnings to rails and to their investors that, although a GOP appointee and a vocal supporter of a deregulated rail industry, a more active STB looks to be in the offing. Noting that we cannot see a repeat of the CSX experience of 2017, she has already demanded regular info and data from Norfolk Southern and Union Pacific (the two railroads implementing some form of PSR at present – see below and “Spectrum” at bottom) and, in effect, chided them for using demurrage etc to change customer behavior, a regular PSR tool. Unlike some in the financial community, she applauded UP’s “measured approach”, and discounted my question of whether a fast, painful but then concluded (“so-called “rip off the bandaid”) approach yielded gains for the shipper (“CSX gains in the metrics were against….2017!”). Two other statements made investors sit up – concern over reduced railway capex 2016-2018 (I share that concern, as my “Grand Bargain” comments have noted, but I do worry when the government does) and noting she thought the new Congress (not the STB) was interested in preventing future CEO/activist “raids” like Hunter at CSX. Now that made several investors take notice – as if the shareholders (aka owners) are not entitled to choose their managements!). Commissioner Begeman is one of two (soon to be only one?) STB Commissioners, well short of the full complement of five, so we have seen delays in big rulings but an increase in weekly pro-activeness….
To the extent that the major strategic advantage for rails likes in their self funded network, any cooperation in the next congress with Trump on his top (2017) priority, infrastructure, noted by the DC panel as one of the few areas of possible agreement across party lines, but on which action I think is in fact IN-probable - and which would involve a lot of rail moves of steel and cement - would only serve to help mitigate the deterioration of the highway system….
Speaking of politics we all noted that on day 2 of RT18, the three North American nations signed NAFTA 2.0. there is obviously a lot of work to be done to try to get back to a fully investable environment and to promote free trade….to that end I applaud the rail industry (especially KSU and UNP) for their public efforts in this regard.
Consolidation dreams are always a risk – but UP’s Fritz adamant argument for the NO (or…Remain!) position – that the need for “enhanced competition” means that the risks of the approval process trumps any benefits that might accrue. Given the mighty UP’s position in the industry – which cuts both ways; see STB, below – that ought to put the ki-bosh on this idea for a while.
This isn’t the best spot for this, but countering those in government (we’ll exempt Chairman Begeman for the time being) and others from undo interfering in private enterprise has been the Association of American Railroads, and the valedictory speech by outgoing CEO – and 2018 Progressive Railroading & RailTrends Innovator of the year – Ed (the “railroad guy in DC”) Hamberger was terrific, and the presence of his successor Ian Jeffries (as well as new railway Association of Canada CEO Marc Brazeau), was reassuring concerning continuity of passion and purpose for those who “walk on that wall” for the railroad industry. Do seek out “Progressive Railroading” magazine’s excellent profile of Ed in the current issue.
One necessary response to the challenge comes, of course, from innovation & technology. Rod outlined the story today and, as the Ghost of Railroad’s Future, what might be given different strategies that could be employed today (3/4 of future logistics expenditures will be on data)….But it was Kansas City Southern in the form of newly minted Chief Innovation Officer and ex-CMO Brian Hancock who offered a roadmap to a brighter future, for KSU and for the industry. A quick note – I might have implied in my note on this news for Brian that this was….not a positive career step. Or it was inferred. In any event, his boss, CEO Pat Ottensmeyer, was (very) quick to tell me that this position, led by Brian, was the future. Brian talked about the railroads being a “knowing” culture – the downside if a 150-yar old strong culture is the concept that already “know” what to do; the must move to becoming a “learning” culture (as an industry – Brian joined with the SL Panel in declaring that “data must be democratized”. KSU will focus on using innovation and IT on infrastructure (to help solve issues like the lack of space at Monterrey); on the use of technology itself – they are rail pioneers in blockchain which early on has been adapted to international transactions and will look to bring some form of PTC (next-gen) to Mexico to help serve as the “backbone of the digital railroad” (the phrase comes from RT17 and the NS’ John Scheib). They will also focus their innovation strategy on Process and Operational excellence and Cost Savings & Efficiency (not unrelated IMHO). Three pronouncements stand out:
In “6-10 years” all rail operations will be autonomous at KSU. Whoa!
KSU will reinstate earnings guidance
KSU thinks that some 65% of PSR principles apply to its railway – noting hat their high interline percentage both makes PSAR inevitable but also impacts its full application; furthermore their Mexican concession impacts this as well. They will (and in fact have already started) applying PSR, in effect, to try to eliminate variability (and thus waste) and are using blended service, optimized train length (given their network constraints), trip plan compliance, rationalized fleet and total cost rationalization “techniques”.
It’s everywhere! Everyone mentioned technology, of course – as Rod noted, the mindset has totally changed in just a few short years. These include the visibility projects going on at the short lines, CN’s boxcar based track inspection (thus used in revenue service rather than capacity-sucking special cars – 8 on order for 2019) and automated train inspection portals (at speed – up to 60mph - and without the manpower and time of an optical inspection); CP discussed bots and predictive analysis;
PSR 2.0, or The Old Guard Looks to the Future – the PHR, the Post-Hunter Railroad). We heard from the CFOs at both the first and second PSR CN and CP, respectively (CNI CEO JJ Ruest took sick, unfortunately but Ghislain Houle filled in most admirably, the best Pinch Hitter from Montreal since Rusty “Le Grande Orange” Staub). Interestingly these three presenters (Foote, Houle and CP CFO Nadeem Velani), as well as key shortline presenter Eric Jakubowski (CCO of the Anacostia & Pacific) are all graduates of the PSR revolution under Harrison at the Canadian National. This level of industry leadership from one source, the CN mothership, explains somewhat the burning desire of the investment community to have the others hire someone with similar experience (what I have called the “hunt for a Canadian”, though in truth Foote and Jakubowski – as well as Creel & Hunter himself, are actually American). CN & CP share a nationality of origin, of course, as well as being the most tenured in the PSR/PHR space. They also differ from the newest member of the club in relating a PSR to PHR timeline, from an inward focus on operations and culture change to a “pivot to growth” as articulated by both CFOs (the quote is from Nadeem; CN refers to “feeding the beast”). When I asked CSX about where they were on the PSR timeline Foote quite adamantly stated the question didn’t apply to his railroad, that they were looking to growth. I suspect that this is semantics – CSX had an accelerated PSR revolution so has reached the PHR (sadly, quite literally) stage very quickly compared with the experience of the pioneer, CN. This echoes conversations at RT17 – between CSX and CP at the time. Given CSX parallel track restructuring – they aren’t yet done with intermodal and they did in fact start growing business again in H2/17, in retrospect I suspect that Michael Rutherford was correct last year. But CP’s timeline chart is easy to follow intellectually, So for what its worth I place them on PSR/PHR timeline - and in any event they are all now on the same path….So, reverting to chronological order, both of presentation and of PSR experience:
CN expects to become boring next year. After a year of demand overwhelming growth (a lesson apparently learned, again about resiliency and the folly of precision, in demand planning, anyway), CN hopes go back to being “boring and predictable” in 2019. Their efforts and expense to restore operational order appear to be paying off (though Mr. Houle wanted to be clear – this isn’t a “turnaround”, one wasn’t necessary). Their long term goals are a mid-50s OR (essentially their run rate) with growth (export coal & grain, intermodal, etc) driving a 10% plus EPS CAGR. This level of service isn’t cheap – they are spending some 25% of revenues on Capex 2018-19 – and will return to their “historical range of 18-20%” (bless!) – but comes with a great payout (15-16% ROIC). This is the epitome of PHR.
CP “rebuilt their engine” (PSR) before the inflection/growth pivot. Velani reiterated themes we heard at their October Investor Conference in Calgary – growth would be “thoughtful, disciplined and sustainable” (perhaps, just perhaps, in response to CN’s rocky year but important nonetheless). Another differentiator with their PSR and Canadian “big brother” is the amount of banked land (under the category “room to grow”) versus CN’s capacity struggles in 2018 and in Toronto specifically – that and the Canadian grain jump-ball business now that both are investing into new rolling stock etc will be fascinating to watch play out. On Ag, the first round might be going to CP, as the regulators are allowing an almost 6% increase in grain rates this crop year, more than double allowed (yes, allowed) to CN. Going back to CP specifically, PSR was not about slashing costs (the “biggest myth”) but about culture; now that the revolution is over (the engine rebuilt), a culture of “constructive (but respectful) tension” would persist. The revenue planners now report to the CFO, Velani, to maintain disciplined growth (though there are some who criticize the rail industry, of not CP directly, of being too beholden to the CFO and to investors).
CSX’s CEO Foote gave us a barn burning victory speech – CSX is growing again, and doing so with less: with 9 fewer yards, some 22 thousand fewer cars and 1100 locos; velocity and dwell are both approaching 20% improvement levels (though against the revolutionary year of 2017 as the STB pointed out – but still….) and they reached the industry leadership position in safety as determined by the personal injury ratio. No apologies necessary….
New to the game – PSR and the rest: So….we have covered the growing PSR presence, the two major rails who announced Q3/18 conversions to the faith (UP then NS), those who have to adapt to the much bigger interline partners such as KSU and the shortlines. So the question is to what degree is this really being done? While CP’s Velani declared himself (as his CEO had done before) “no fan of a “measured approach”, KSU’s Hancock gave the first and best argument for taking elements but not necessarily all of PSR (as it has been applied to date) and the STB gave ample warning on why total disruption would have political consequences. And UNP CEO Lance Fritz then gave to me the closer’s argument – they are in it, to win it (it’s no “lite” approach). Norfolk Southern’s CMO Alan Shaw gave a similar strategic policy defense and NSC will have another, fuller go at it in their Investor Conferences on February 7.
The short lines are ready for the changes that are happening and are coming. We saw the retail future of the industry in the five panelists representing GWR, Watco, RJ Corman, A&P and Pan Am. In many ways the SLs already practice PSR; in others they have to adapt to their much bigger partners operating plans. SLs serve as the first-mile, “pre-blockers” for much of the merchandise business – and as the “shock absorbers” for the overall network (GWR). The last mile is still the “last frontier” (A&P) but they can help reinstate the boutique, customized businesses (Watco) that are being compressed into the mainstream by the C1s (see UP below). They do see the changes in focus at the C1 – they have defined the rules better (Watco); the move faster (Pan Am executed a new service deal from “soup to nuts” with CSX in only 30 days). They see some opportunities in new line segments (Watco’s Decatur Line, ne CSX, is showing to be a big winner from the gate) and in switching opportunities (RJC). They do admit to some angst in watching these transformations (RJC) and they worry about the OR focus at the C1s, which manifests itself in trying to balance expensive, long-lasting capacity with greatly imperfect demand planning, leaving out resiliency and surge capacity. There is no “perfect equilibrium” – balance is hard to achieve and impossible to maintain. I worry about that, too….
First – can we even really define what is PSR?
Second – NS and UP’s approaches are similar (incorporating some of it into their own new plans; taking a measured approach; led by existing rather than outside revolutionary management) but different, too. They may serve as the Great Britain role in revolutionary era – conservative by nature, changing enough to preserve the best of their culture and institutions. Before I am asked, I am not comparing any of the original PSR rails to France, or Russia for that matter). But if their approach is “measured”, remember that they follow the CSX experience – great for shareholders, somewhat chaotic – at first – for other stakeholders. Like a hockey player reacting to a cheap shot and then getting sent to the box for the reaction, UP (and NS) know that everyone in DC (etc) is shining a spotlight on them (and I am certainly not comparing CSX to a hockey “goon”!)….I would be hypocritical if I said that every rail should follow the Hunter formula exactly – after all, I wondered why by the 2nd, 3rd or even 4th time all stakeholders had to feel put out. Maybe there is a better way? Or maybe that dilutes the sense of urgency. CP’s Velani, echoing his boss Keith Creel, declared he was “no fan” of the “measured approach”. We’ll see how that plays out. No railroad has done this without Hunter; all 3 have had him as an outsidechange agent. Is that imperative? In addition we will all see how elements of PSR (and not the whole “playbook”) can be incorporated, as Brian Hancock so articulated for KSU. At the PHR stage, is there a first-mover advantage?
Union Pacific is committed – Lance Fritz was more than convincing about that. Sure, there was the chaotic, off-screen start after the May 1 Analyst Day (which never incorporated “PSR” in what then were the Long term Plans). “Old UP” (that is, spring 2018) had a plan that got unwieldy, running as Lance said, a lot of train-based “boutique” businesses and lanes (coal, rock, intermodal) designed to maximize efforts for those commodities and shippers – but often at the expense of the network by adding complexity and unshared capacity. So – back to the drawing board, and the focus on car trip plan compliance focus (something UP had introduced years before, in fact). They plan to constantly review their Plans as much as 2-3X/year; they are bringing in PSR vets to help guard against unintended consequences (the killer of the boutique business). Are they committed? Sure, they still have hump yards – they are building one still (Brazos, 2020) – but even Hunter didn’t hate hump yards if they have the volume to justify themselves. UP does (though I would suspect that some smaller yards or terminals etc might go at some point). Well, the first segment, their Mid-American Corridor, is no small step. It is, in fact, bigger than all of CSX, or CP plus CN. Is it working? Is sure seems so – metrics are already improving, the STB says “so far so good” (and shippers at RT18 were supportive, if, as ever, wary), they have taken 750 (older) locos out over the last three months. And most importantly, the success so far at the MAC has encouraged them to accelerate the second region to be transformed (LA to Chicago), beginning last month rather than the original schedule of January.
Norfolk Southern’s CMO Alan Shaw also knows that in some ways, what’s old is new again, though now powered by a new sense of urgency and technology. NS’ annual talked about the need for “customer focus” – in 1988 (see also retired NS Chairman’s coffee mug photo, attached – “Precision transportation” on the Norfolk & Western Railway. NS continues to see great demand, and to benefit from earlier development of their intermodal “Corridor” system (including a new one for me, the ex-CRR “Premier Corridor, Chicago-NJ). Their Strategic Plan was delivering, financially – but not on service reliability and consistency, which is so critical and was costing them on the merchandise side. They needed to “re-imagine the NS network”. This wasn’t news to us – and not to them either, as they began a process of “clean sheeting” (re-thinking old problems new ways, akin to “white boarding”) back at the beginning of the year. Unlike UP’s regional approach, they are starting with yards and local services (Shaw: “working backwards from the customers”). Can that work? Is one way better? Are all “tenets” of PSR applicable to NS (noting, among other things, how much of their value is tied to the intermodal system)? Can the creators of the old Flexible & Balanced Plan be the re-imagineers? We have the late holiday present of a (critical!) Analyst Day in Atlanta to look forward to….
Game time! For the rails now, from an operating plan foundation to a technology development/rollout to a creating a true customer centric North American network, it’s Game On. Or, as the good Doctor implied, it’s Game Over. Place your bets! I now where my chips will be placed….
Anthony B. Hatch