Precision Scheduled Railroading

 In Railroads

Railroads Begin Managing Quality, Velocity & Yield

Something big is going on in railroading.
With the stunning improvement in financial performance at CSX, the rail trade press is full of articles about something called Precision Scheduled Railroading (PSR). What is it? Does it work? What does it mean for trucking and the North American logistics world in general?

The History

Please meet Hunter Harrison.
First, a word about its history. PSR is not a new thing. Many railroaders have practiced parts of it going back as far as E.H. Harriman, the executive of the Union Pacific, mentioned in that classic western Butch Cassidy and the Sundance Kid. However, the ideas, and execution, were first practiced on a large scale, and noticed, at the Illinois Central Railroad (IC) [1] in the early Nineties.

1 The Illinois Central ran from Chicago to New Orleans, with a major branch to Omaha. Its prime passenger train was the City of New Orleans, subject of the classic blue grass song.

Railroading: Scheduled with Precision

It was at the IC that a classic hard-driving railroad operating executive by the name of Hunter Harrison first got control of an entire firm. At the time the IC was considered a lost cause, a property soon to be acquired by one of the larger railroads at a fire-sale price. In a major surprise, Harrison turned the property into the most profitable railroad in North America. In 1998, the IC and Mr. Harrison were acquired by the Canadian National Railway, another inefficient property. Harrison shortly turned that much larger railroad around, making IT the most profitable railroad in North America. After retirement in 2010, Harrison waited a year and a half before taking over the Canadian Pacific Railroad (CP) and turning it around quickly. Finally, in early 2017, Harrison joined a hostile takeover of CSX and got his long-awaited chance to run one of the big four U.S. roads.

CSX was widely regarded as the weakest of the four. Mr. Harrison died in December of 2017 before his reforms bore fruit. Mr. Harrison’s critics gleefully pointed to the substantial changeover problems at CSX, stating that his simple methods would not work on a large network railroad like CSX. However, under the leadership of his protégé, Jim Foote, CSX is now the most profitable of the U.S. railroads. Norfolk Southern and Union Pacific are now implementing PSR. Privately held BNSF is the lone holdout, although its owner Warren Buffet is no dummy. The whole industry will soon be operating PSR. Thus ends the saga of easily the most important railroader since the aforementioned E.H. Harriman.

How’s It Work?

What’s Harrison’s secret sauce?
Secret No. 1 – start from a low base.
To fully understand this revolution, one must consider the starting point of Hunter Harrison’s reforms. Unlike their counterparts in other modes of freight transport, railroad executives wake up each morning secure in their possession of considerable market power. [2] They share such power with other owners of basic infrastructure, like electric and gas utilities and your cable TV/Internet provider.

[2] Railroad executive will vehemently deny such power. That may be true over the very long term but is untrue in the short run. If a rail siding is served by a single railroad, as is the case about 60% of the time, only that railroad has the right to enter therein. Since most bulk commodities rail costs are well below truck costs, the most likely nearest competitor, railroads have the power to charge well above their marginal costs. That is how economists define market power wherever the railroads’ lawyers say before the regulators.

As such, few face reduced pressure to control costs or rigorously manage the yield of their various lines of business. Of course, they also have significant pricing power, usually subject to oversight by a public regulatory body. The economic result, as we all understand, is a business that makes reasonable money despite very ordinary operating and commercial discipline. Such performance makes for a target rich environment that can make a reformer look very good indeed.

Secret No. 2 – Manage the cost of quality.
From his earliest days as a trainmaster on the Frisco Railway [3] (now part of BNSF), Hunter Harrison was driven to do things right the first time and had the energy to drive his subordinates to do that, too. Such discipline, required in highly competitive businesses, was rare in the very messy world of railroading, where management had learned to live with problems and still make that decent money.

[3] Frisco was short for the St. Louis – San Francisco Railway, a mid-continent railroad that never reached San Francisco, but did serve St. Louis, Birmingham, Pensacola, Kansas City, Oklahoma City, and Dallas. It is best known today for giving its name, Frisco, to the Dallas suburb that is the home of the Dallas Cowboys. The Frisco had major facilities there many years ago.

Harrison intuited that such problems caused major spikes in costs, something generations of rail financial managers had failed to grasp. His approach was simple. Make a clear plan. Insist that his people follow it. Reward those that do and dump those that don’t. Simple! Many people hated him for it. The stockholders loved it. This secret is the Precision in PSR. 

Secret No. 3 – Asset velocity counts!
Again, because of their sheltered position, railroads paid scant regard for the intensity with which they used their assets. Slow and steady seemed to maximize the use of their expensive labor. It didn’t hurt that so many of their customers provided their own cars. Harrison, without the benefit of an expensive MBA, realized that moving assets faster – and using labor more intensively – saved money.

There are two fundamental, revolutionary aspects to his approach. First, he realized that running trains on schedules allowed him to manage flows across the often-congested networks at the same time it positioned locomotives and crews properly for the next operations. Conventional railroading holds trains in terminals until they are completely full. Imagine sitting in your local airport while your airline waits to fill the last two seats, and your connection time in O’Hare is steadily dwindling.  This is the Scheduled in PSR.

Second, Hunter realized that the automated “hump” yards that traditionally fed incoming traffic to the proper outgoing train were velocity killers. Harrison’s railroad took the Southwestern Airlines approach. Avoid the hubs whenever you can. When he arrived at CSX, that property had twelve hump yards, each holding its cars for an average of about a day per visit. CSX now has six hump yards. Next month, I fly to Durango, Colorado. Until recently I would have had to visit two airline “hump yards” en route: Philly and Dallas. Now I only have to visit one, Dallas – great! My asset velocity improves by at least 25%. Like American Airlines, Harrison realized that a little extra cost coming out of my home terminal (a smaller aircraft) was more than offset by the circuity and time spend serving their traditional hub airports.

Secret No. 4 – Manage yield.
If you run a traditional railroad, each car appears to have the same value. Just give me the hundred cars I need for this train start. I don’t care which. Harrison manages according to the classic principles of opportunity cost. This is a critical concept in a system that has many points of limited capacity. Railroads are just like freeways. Too many autos cause traffic to stop. Too many trains cause the railroad to stop. Hunter didn’t want the bottom-feeding loads if they lowered his precious velocity.

When the CN took over the Wisconsin Central Railroad in 2001, it had an intermodal business hauling trailers and containers from Green Bay, WI to Chicago for interchange to other railroads. Because of tough truck competition on that short haul, the rates were low. Harrison took one look at the operation and jacked up the rates very significantly until that traffic earned as much as the other traffic moving on the congested, single-track mainline to Chicago. The main customer, Schneider National, protested that it could truck the boxes to Chicago for less money. Hunter said, “Go ahead. I want my mainline clear for the high-rated traffic coming down from Canada.” The Green Bay intermodal yard is a now dirt lot waiting for urban renewal. 

Does It Matter?

The press and stockholder love PSR.
The spectacular financial results of PSR and its lovely demonstration of efficient network management have rightfully gained widespread press coverage for the concept. It appears that PSR is the final icing on the “railroad renaissance” that has taken an industry on the verge of failure in the 1970s to the pinnacle of transport profitability. In the first quarter of 2019, CSX reported an operating ratio (OR) of 59.5%. That is a far cry from the 98% OR it reported when I started there in 1986. [4] CSX stock is up more than 30% since Harrison took over. It expects its OR to reach the mid-fifties later this year.

[4] Operating ratio is operating cost over total revenue. A ratio of 59.5% means that CSX earned more than forty cents on every dollar of revenue – to apply to long-term capital projects, dividends, stock buyouts, and executive salaries.

Does anybody else like PSR?
Clearly, many rail employees do not. PSR has cost the CSX workforce 2,000 jobs, and still counting. I am writing this piece to analyze whether customers like the concept and whether such gains in efficiency will shift traffic back towards rail. Let’s look at the economics to see if the truckers should be worried.

Velocity is good for customers.
PSR railroads have consistently improved the speed of their trains and reduced the dwell times of cars in yards. This is good for customers, faster door-to-door transit times, and reduced variability. However, PSR also emphasizes maximum train length. Yes, the trains leave on time, but they are significantly longer. That means the schedules must be adjusted to allow for more cars to be collected for each train. Reduced frequency of departure means longer door-to-door transit times. The result has been modest improvements in service performance but still close to historical norms. A thousand-mile haul was nine days plus or minus two. Now it might be eight days plus or minus one. That is a strong statistical improvement but in no way competes with a truck that does it in 2 days plus or minus 2 hours.

Yield management is bad for railroad customers.
Because railroad customers are used to poor yield management, as Schneider National was with Wisconsin Central, they do not like this aspect of PSR at all. PSR railroads systematically withdraw from marginally profitable routes and business lines, reserving their heavily-used prime networks for the profitable stuff – as they should. If anything, PSR has accelerated the reductions in rail capacity, locomotives, and miles of track, which has been the rule since the early Eighties. Yes, total rail ton-miles continue to rise slowly, but the efficiency gains from PSR have been largely used to reduce assets rather than gain new business. We have the efficiency of the competitive modes, none of which have monopolies, to thank for that. The traffic that is shed by PSR moves more cheaply on other modes than on fully priced railroading. The latest round of changes focuses on accessorial services like demurrage and private car storage. With the more accurate financial analysis of PSR, railroads are raising prices to reflect their full costs.

PSR pricing is bad for railroad customers.
Although in the long run the efficiencies gained through PSR may result in lower prices, in the short run – where many bulk shippers have few options aside from rail – the successful PSR implementers have decided, quite rationally, to pocket the savings as increased margin, hence the historically low operating ratios. Moreover, two factors have worked to raise average pricing. One of the forces is simply mix. As the PSR players shed the lower margin traffic, the average price of their mix increases. In addition, the new-found financial discipline makes them more likely to increase prices on their remaining business, as we see currently with accessorial services.

PSR has mixed reviews for peak-season service.
To the good, the marketing discipline of PSR railroads means less traffic to clog the system at peak times or when bad weather hits. To the bad, the financial discipline means that PSR railroads are not going to fund high levels of surge capacity, if any at all. As a result, PSR railroads will continue to clog up when traffic surges or problems arise. Providing peak capacity is difficult for any mode. It is very difficult for railroads. So, stressed performance may show some improvement over the poor historical performance, but will fall well short of shipper expectations. [5]

[5] Shippers, at least publicly, continue to expect reliable rail performance despite overwhelming historical data demonstrating the opposite. That they continue to purchase this service suggests that they value low price much more than reliable service. It is no different than airline travelers complaining about crowded seats after consistently choosing the lowest-fare ticket.

For most of us, it doesn’t matter.
My point is going through this litany is to show that, at least in the current environment, PSR is unlikely to result in either price reductions or enough service improvements to shift traffic towards rail or induce current rail shippers to adjust their supply chain design. Hunter Harrison’s innovations are indeed revolutionary and follow well-respected principles of managerial economics. When practiced by suppliers possessing significant market power, such changes have resulted in increased rail profitability rather than some radical change in customer benefit. It follows that shippers and rail competitors can safely file away press coverage of this revolution, as it means little to their operations or prospects. PSR is a story for rail stockholders.

But things could change.
There is however, one scenario where PSR could become a major shipper issue. The Surface Transportation Board (STB) still has the power to regulate rail rates in cases where shippers prove “unreasonableness”. When rail operating ratios were north of 80%, it was easy for the railroads to shows that higher pricing was necessary to justify continued investment in this highly capital-intense business. Remember, the railroads have to pay to fill their own potholes and replace their own bridges. At levels below 65%, which are now common, high prices are much more difficult to defend, although the rail lawyers defending those rates at the STB remain successful, given the deregulatory bias of recent administrations. Should the Democrats win the Presidency in 2020, a new set of STB appointments could produce a different set of biases: biases that would make 55% operating ratio’s much more difficult to defend.

Here’s the point. The remarkable improvement in rail financial performance, fueled significantly by the very smart principles of PSR, is also, in part, made possible by the railroad’s market power. In trucking, when productivity improves, the benefits very quickly result in lower prices for shippers. That’s why truckers do not usually lobby for larger, heavier vehicles. That is for shippers to do. In contrast with PSR, we have a major improvement in rail cost performance, accompanied by continued rises in pricing. In the absence of major improvements in service, such a result is only possible where suppliers have significant pricing power. Since the STF exists in part to control such power, it is likely that it will increase its scrutiny of rail pricing. If Congress and other political units are looking closely at pharmaceutical pricing, formally a sacred cow of deregulation, the same thing could easily happen to rail pricing.

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