1. Management of Transportation Chapter 4 The Railroad Industry © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 1

2. Introduction Rail: dominant mode from 1850s to WW II ◦ Superior in both price and service quality to road transport for most of this period ◦ Superior in service quality to water transport Development facilitated by standardization of track gauge and rolling stock Pivotal role in U.S. economic development ◦ Great expansion in track mileage, post-1870s ◦ Financed by private capital ◦ Too much track mileage relative to demand © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 2

3. Introduction Domination begins to wane after 1920 ◦ 1929: rail carried 75% of freight ton-miles ◦ Today: carries about 43% of freight ton-miles ◦ Some reasons for relative decline  Large-scale government construction programs for roads and inland waterways  Private financed construction for oil pipelines  Government also helped develop air transport that provided superior service for passengers and mail  Economy and shipper service-related needs change ◦ Note: total rail ton-miles continue to grow © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 3

4. Introduction Railroads remain vital part of U.S. economy ◦ Industry revenues about.4% of GDP ◦ Industry revenues about 12.7% of total expenditures for freight transport service in U.S. ◦ Railroads employ about 187,000 people ◦ Railroads invested over $117B in new plant and equipment in 2007 © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 4

5. Industry Overview Number of Carriers Industry structure ◦ Concentrated: Small number (565) dominated by a few large (Class I) carriers  7 Class I railroads  Rest are regional or local (short line) carriers Total rail system mileage ◦ Reached peak in 1916 (254,251 miles of road) ◦ Today: about 94,440 miles of road ◦ Reasons for decline © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 5

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8. Industry Overview Competition Intensity changed during 2 nd half of 20 th century Intramodal (between railroads) competition ◦ Current industry structure is a differentiated oligopoly  Small number of large carriers  Few places served by multiple railroads ◦ Number of carriers is small in part due to  Large financial barriers to entry  Financial attractiveness of mergers and consolidations © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 8

9. Industry Overview Competition Intermodal (between modes) competition ◦ Very intense for non-bulk traffic  Some modes offer service advantages over railroads  Other modes offer price advantages over railroads ◦ Staggers Rail Act  Helped railroads to become more price competitive  Helped railroads to develop more customized responses to customers’ level of service needs © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 9

10. Industry Overview Competition Mergers  Large number over time, trend accelerated in 1980s following Staggers Act  Motivation  Early mergers made to expand capacity, create EOS  Side-by-side mergers done to strengthen financial position and reduce duplication  End-to-end mergers done to improve competitive position, first vs. other RRs, then vs. other modes, and service levels via fewer interchanges between railroads  Consequence - small number of carriers own majority of track and carry majority of rail freight © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 10

11. Industry Overview Competition Abandonment of rail lines ◦ Context: early over expansion followed by increased competition between modes ◦ Most abandonments involve duplicate track or track serving small markets with little rail freight ◦ Some track taken over by smaller railroads ◦ Alternative uses for land  Rails-to-Trails Conservancy  Rail-banking program © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 11

12. Operating and Service Characteristics General Service Characteristics Characteristics of principal commodities ◦ Railroads carry wide variety of products  But, 83% of total 2007 rail carloadings concentrated in low-value-to-weight (bulk) products Principal commodities hauled ◦ Bulk products: coal, farm products, chemicals, food and kindred products, nonmetallic minerals ◦ Non-bulk: Transportation equipment, intermodal mixed freight Traffic shifts: Growth of intermodal traffic © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 12

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14. Operating and Service Characteristics Constraints and Strengths Constraints on railroads ◦ Fixed rights-of-way impedes door-to-door service ◦ Other service level limitations Strengths of railroads ◦ Large carrying capacity (few size or weight constraints) enable low average cost operations ◦ Capable of handling almost any type of cargo ◦ Railroads assume liability for loss and damage  Railroads tend to have higher damage claims © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 14

15. Operating and Service Characteristics Constraints and Strengths Strengths of railroads ◦ Recent emphasis on equipment, technology innovations, and quality programs  Improved suspension, end-of-car cushioning devices, and in-car force instrumentation packages  Quality certification program (M-1003) ◦ Intermodal services  Double-stack services – greatly improve productivity  Terminal improvements, equipment redesign, and right- of-way improvements designed to reduce in-transit delays ◦ Microprocessors for communications and signaling © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 15

16. Operating and Service Characteristics Equipment Carload: basic unit of measure ◦ Carloadings declining due to increasing average car size, improving carload productivity ◦ Ave. carload in 2007: 99.5 tons and growing ◦ Standard gross vehicle weight: 263K lbs  May rise to 286K, bridge and track constraints ◦ RRs own and maintain 42% of rolling stock  Non-railroad companies own 58%, growing trend © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 16

17. Composition of rail car fleet has changed over time to meet changing shipper requirements ◦ Historically, standard box car was most numerous car in fleet – used for hauling general mfg. goods ◦ Today, fleet contains many specialized rail car types  Cars custom designed to accommodate different types of bulk products or shipper need  More than 85% of car fleet designed for transport of bulk products and raw materials © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 17 Operating and Service Characteristics Equipment

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19. Operating and Service Characteristics Service Innovations Piggyback service: intermodal service directed to non-bulk, manufactured products ◦ Includes both container-on-flatcar (COFC) and trailer-on-flatcar (TOFC) services  Definitions, basic differences between COFC and TOFC ◦ Accounts for second highest number of carloadings ◦ Competes directly with truckload (TL) service  However, some TL carriers are also major customers of piggyback service © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 19

20. Operating and Service Characteristics Service Innovations ◦ Competitive advantage piggyback service  Combines cost-efficiency of RR long haul with flexibility of truck pick-up and delivery ◦ Principal disadvantage of piggyback service  Transit time and on-time delivery performance ◦ To counter service disadvantage  RRs create dedicated intermodal trains  Trains run on regularly scheduled departures and priority operating schedules © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 20

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22. Operating and Service Characteristics Service Innovations Public benefits of piggyback vs. TL services ◦ Reduced fuel consumption ◦ Reduced road congestion and road damage ◦ Lower emissions COFC: component of international trade ◦ Land-bridge operations  Substitutes rail for portion of ocean voyage ◦ Double-stack container trains  Greatly improves rail equipment and train productivity © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 22

23. Operating and Service Characteristics Service Innovations Unit trains: specialized, one commodity trains ◦ Direct origin to destination movement  Run on priority service schedules  No stops in-transit ◦ Used frequently for coal and grain shipments ◦ Shippers often own rail cars ◦ Disadvantage: empty backhauls Computer and communication systems ◦ Management control and shipment monitoring ◦ Car tracing, ordering and billing simplified © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 23

24. Cost Structure Fixed Costs Railroads have high % of indirect fixed costs in short run ◦ Short run: means that capacity remains constant ◦ Estimated 30% of costs do not vary with volume due to high % of long-lived (durable) assets  RRs own and maintain networks (rights-of-way) and terminals (freight yards)  Geographically fixed, impedes responsiveness to changes in demand  Equipment: locomotives and rolling stock  $ billions in annual capital expenditures © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 24

25. Cost Structure Semi-Variable and Variable Costs Semi-variable costs: over 40% of total costs ◦ Includes maintenance of rights-of-way, structures and equipment ◦ Often deferred during financially difficult periods Variable costs ◦ Labor: Largest component of variable costs  26.4% of each revenue dollar  Unionized work force, 14 craft unions  Work rules: productivity challenges and issues ◦ Fuel: 2 nd largest component of variable costs  Locomotives: increasingly productive and fuel efficient © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 25

26. Cost Structure Economies of Scale (EOS) Means falling average costs ($/ton) as scale or capacity increase, assuming capacity utilized Economies of density or utilization ◦ Falling average costs as volume carried increases, assuming capacity remains constant ◦ Large among RRs due to high fixed costs ◦ Following example indicates impact of higher utilization on average costs and profits © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 26

27. Cost Structure, cont’d Economy of Density Example Case I Fixed C. $3.5M Var. C. $2.5M Total C. $6.0M Revenue $7.0M Profit $1.0M Cost/Ton $0.03 Case II +20% Traffic Fixed C. $3.5M Var. C. $3.0M Total C. $6.5M Revenue $8.4M Profit $1.9M Cost/Ton $0.027 © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 27

28. Financial Plight Pre-WWII period ◦ Dominant mode, periods of financial difficulties ◦ Highly regulated economically Post-WWII to 1975 ◦ Other modes emerge, helped by public investment ◦ Economic regulation hampered RR ability to compete, market share declines ◦ RR industry suffers through several periods of severe financial distress, inability to earn adequate returns on investment © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 28

29. Financial Plight Legislative Reform Reduces economic regulation ◦ Regional Rail Reorganization Act of 1973 (3R Act)  Creates process to reorganize bankrupt railroads in northeast U.S. ◦ Railroad Revitalization and Regulatory Reform Act of 1976 (4R Act)  Provides capital and operating assistance for Conrail  Reduces economic regulation of railroads, providing greater pricing and service flexibility © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 29

30. Financial Plight Legislative Reform ◦ Staggers Rail Act of 1980  Further relaxes regulatory framework for railroads  Authorizes contract rate-making  Enables railroads to tailor services to shipper-specific needs  Evens playing field with truck and water carriers  Results in great improvement in RR financial condition ◦ ICC Termination Act of 1995  Eliminates Interstate Commerce Commission  Transfers remaining regulatory authority to Surface Transportation Board in U.S. DOT © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 30

31. Financial Plight Improved Service to Customers Many signs of improved service ◦ Increase in intermodal traffic  Up 484% from 1980-2007 ◦ Decrease in train accidents  Down 70% from 1980-2007 ◦ More and improved tailored services and equipment for shippers ◦ Greatly improved financial condition © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 31

32. Current Issues Alcohol and drug abuse ◦ Effect of and on work environment Rail: more energy-efficient than truck ◦ Lower environmental impact Technology ◦ Train, yard control systems, “smart” equipment Future role of smaller railroads Customer service Drayage for intermodal service © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 32