BNSF and NS Do It Right
I’m often very critical of the Class 1 railroads in my writing so I want to take a moment to give the devil his due and call out a great piece of news from a couple weeks back. From the Trains article,
“BNSF Railway, Norfolk Southern, and the Northwest Seaport Alliance have teamed up to offer faster international intermodal service to inland points from the ports in Seattle and Tacoma.
“The new service, they announced yesterday, will cut three days from existing transit times for traffic from the Pacific Northwest destined to and through Chicago.
“Port terminals will build trains in less than two days of on-dock dwell, with enough density to allow the trains to serve Chicago and destinations on Norfolk Southern in Ohio and Pennsylvania.
“BNSF and NS will deliver all interchange traffic to one Chicago location, NS-Ashland, and make a single crew swap.
“‘This service product collaboration was an outcome of listening to our joint customers, who emphasized the desire to use more rail, but would need to also reduce inventory carrying and total landed transportation costs out of their networks in 2025,’ Jon Gabriel, BNSF’s group vice president of consumer products, said in a statement. ‘We are proud to deliver a solution that accomplishes these goals.’”
This is a great move by all those involved. Taking 3 days out of the service by better synchronizing operations between the port, BNSF, and NS is a big win for rail shippers. Reduced transit and dwell means reduced inventory in transit and lower working capital requirements for those shippers.
Establishing cooperative partnerships is exactly the strategic growth that all railroads, Class 1, 2, and 3, should be sprinting towards. In a network business, no man is an island. By improving originating traffic flows and synchronizing to those flows, NS is able to market a more attractive service to its customers. BNSF and SEA-TAC win in the same way when they align with the needs of terminating carriers. More of this please!
It’s All About Costs
UP CEO Jim Vena spoke at the ASLRRA conference last week. From the Trains.com report quoting Vena,
“When it comes to short lines, the baseline has to be that you do a better job than a Class I. The short line has to be much more efficient, costwise, than a Class I. But short lines can have a better relationship with a customer because they work in a community at the local level, and grow the business that way.”
Although I didn’t attend Vena’s presentation, I did talk with several folks about it afterwards who did. The reaction, particularly from shortlines, seemed to be a mixture of bemusement and disbelief. Why was Vena berating shortlines about keeping costs down and being more efficient than UP? Since when is a shortline able to deliver a lower operating basis than a Class 1 with massive scale economies?
I’ll give you a hint: Labor arbitrage between union and non-union labor. More on that later.
If you had just crawled out of a hole in the ground and heard Vena speak, you might assume that shortline cost structure was pricing business out of the market. I have never once come across anyone from a shortline or a Class 1 who’s said, “Gee, these shortline guys are really holding us back because they can’t keep their costs down.”
Instead, I repeatedly hear the following:
“We took a business opportunity to the Class 1 and they turned it down because it didn’t fit their ‘cost profile’.” (i.e., margin was too low)
“One of our customers wanted to bring additional volume on rail, but the Class 1 wouldn’t adjust their service because there wasn’t enough volume to capture their interest.”
“The only times our service suffers is because the Class 1’s can’t provide us good enough visibility for a smooth interchange.”
Not once has cost structure been identified an issue in growing volumes or keeping existing business and, in fact, I’ve never once heard a complaint about the shortline’s ability to attract and service the business. It’s always been the Class 1, usually from disinterest, who has been the source of issues for shortline traffic.
When you have a hammer, everything looks like a nail.
Vena’s comments also provide another lens to view UP’s recent shortline partnerships in Eugene and Kansas City. How much of these deals were driven by improved local service vs. simply playing the cost arbitrage between UP’s union labor and a shortline’s (usually) non-union labor? UP gets to shed cumbersome labor agreements while looking like a shortline advocate.
I think former STB Chairman Robert Primus was right on the money when he wrote an opinion with the STB’s approval of the Eugene deal. From the Railway Age article,
“In a separate expression to the STB decision, Robert Primus said that while he voted to approve the CORP-UP transaction, he ‘did so with conflicting sentiments.’ On the one hand, he pointed out, ‘I see this as a big win for The Central Oregon and Pacific Railway (CORP) and the more than twenty shippers in the Eugene and Springfield areas served by Union Pacific,’ as CORP ‘has developed a solid reputation for its customer-centric service and commitment to safety’ and ‘has provided consistent and reliable service to customers along its service lines’ since being acquired by G&W. Primus said that he expects such service to continue when the lease transaction is consummated. ‘As I have publicly stated, our nation’s short lines truly are the growth engines of our freight rail network,’ Primus noted. ‘Their white glove service has enabled many short lines to experience double digit growth, even as growth among Class I’s has been relatively flat.’
“However, ‘while there are clear winners within this transaction, there is also a clear loser, and I am especially concerned about the negative consequences confronting affected members of the various rail labor unions who, in all likelihood, will either lose their union jobs or see a decreased workload as a result of this transaction,’ Primus said. ‘Profit over people, time and again, has proven to be a disastrous formula for the network. I find myself wondering if this is this truly an effort on behalf of UP to provide its customers with better service or yet another cost cutting measure seeking to lower its operating ratio to further satisfy the appetite of short-term investors.’”
While I was hopeful that UP’s shortline deals were a recognition in the benefits that could come to the rail industry from a wholesale vs. retail model, I have to say that I’m with the former Chairman on this one.
As Flexible As My 7-Year Old
UP wasn’t the only Class 1 at the ASLRRA. At a panel with 3 senior Class 1 executives, the question was asked about how flexible they would be on pricing in working with shortlines to add new business. The general consensus from the Class 1’s was, “Oh definitely, we can be flexible on price.” The unsaid part was, “…up to a point.”
Maybe I’m just cynical about the shortline-Class 1 relationship. I could definitely have some bias given that the more that I speak and write about the subject, the more folks confirm what I’m putting out there.
Why don’t Class 1’s share with their shortline partners, at least in broad strokes, what the hurdle rates are to bring on new business? Maybe some do, but from conversations with shortlines I had, the opposite is the rule: Class 1’s press the shortlines to open the kimono while they give nothing in return. How is that constructive towards business development? It’s not, but “protecting the franchise” was never about constructive business development. It was only about short-sighted margin protection in a cynical world where the pie only shrinks and never grows.
Cost again came up with this Class 1 panel. One of the executives even went so far as to say they don’t really know what their unit costs are to even price the business! I’ve heard about some of the funky cost accounting done at the railroads in the past and how that’s killed growth before. If so, that seems entirely self-inflicted and surely an area that a cost-conscious, profitability-focused PSR railroad would be all over??
What’s most frustrating to me is just how self-defeating all this one-sided behavior is. Sure, you don’t want to share confidential information with a shortline that could find its way into the hands of your regional competitor. I get that. But if you only focus on what you lose rather than what you could gain (i.e., extreme risk aversion), you’re never going to grow anything.
All of this raised the question in my mind, is it possible to push your leverage too far?
Too Much Winning?
The Trump administration has received a lot of criticism from the way it’s rolled out its tariffs. Trump supporters have crowed about the 36-dimension chess that President Trump is playing while his detractors have called these moves nothing more than erratic ramblings of a madman who has the global economy lurching from one crisis to the next.
There are volumes to write about the whole episode, but that’s not the point of this article. Rather, one thing continues to stick out to me is something I highlighted in my last article,
From the article,
“If the US becomes harder to deal with, other countries are going to seek alternatives. BRICS as a replacement for the USD as a reserve currency was one such, unsuccessful, reaction. Forcing other countries to go their own way may lead the US to be cut out of future trade, security, and political alliances that are ultimately detrimental to the long-term interests of the US.”
There may be “So Much Winning!” in the short-term, but economic theory suggests that if the pain is too great, if too much is extracted from the US’ trade partners in these bilateral deals, that they will seek alternative arrangements that ultimately reduce their dependence on the United States.
(Sidenote: I don’t disagree with the need to rebalance trade. In fact, it’s been my contention for months that there needs to be a Bretton Woods 2.0 that resets the global trade dynamic. I just don’t believe we’re going to get there without either a global war or the collapse of either the US, China, or some other colossal tragedy to get people to the table with the right mindset).
The parallels to the Trump Administration’s new aggressive trade policy with the superior economic leverage that the Class 1’s enjoy over their customers and shortline partners is uncanny. Both alphas have significant leverage. Both appear to be using them to extract a lot of concessions from their partners/customers.
While I don’t think the US is in danger of losing it’s global hegemony, even from China, I do think that the rail industry has seen the long-term substitution scenario play out over the course of the past two decades. More and more freight has fled from the rails to trucks with no sign of stopping. Customers who have a choice have left. Those who remain are stuck with little recourse available to them.
Extracting more and more from your customers through rate increases and reduced service windows may help you hit your numbers for the quarter, but it sure isn’t doing a lot for the long-term organic growth that the Class 1’s just have not figured out.
Sometimes it may be helpful to leave a little more on the table to not starve your counterpart.