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The Future of Railroads

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The Resilience of the Railroad Industry

Lindsay Millar, Jessica Settlecowski & Mike Gawel
MGT 674
March 23, 2013
The history and resilience of the railway industry is rather remarkable as it has helped shape the landscape and the formation of the United States. Railways allowed colonies to settle in the West and the country suddenly became connected from coast to coast. This encouraged the exchange of goods and stimulated the development of towns and communities along track lines. Soldiers were shipped directly to the forefront of battleground lines and supplied with a constant flow of ammunition. Most importantly, trains were the steam engine that fueled the industrial revolution. The railway industry’s history is rich with experience and wise with age, as it has survived many seemingly insurmountable obstacles, including: the Great Depression, civil war, the advent of automobiles and airplanes and federal regulation. Federal regulation took the largest toll on the industry as it restricted the ability of the industry to adapt to future demands and market requirements. The growth of rail was stunted by 100 years of federal regulation and since the Staggers Act of 1980 which led to deregulation, the industry has been struggling to recover. After the implementation of the Staggers Act the industry has undergone serious reconstruction which has increased the overall performance and reliability of rail. As service levels improve the demand for low rates and large capacity hauls has skyrocketed. One study suggests that by 2035 the demand to move tonnage by railroads will increase by 88 percent, requiring a $135 billion investment to meet this increased demand (Nealer, Matthews, & Hendrickson, 2012). The increase in demand is a result of growing environmental consciousness and extreme scrutiny on the trucking industry. Rail provides long term environmental sustainability and this factor affords rail the potential to transform the transportation sector. Throughout this essay we intend to provide an analysis of the North American railway industry through the discussion of the economic and environmental benefits of rail and its potential weaknesses, while highlighting the industry’s unrealized potential.
Railways have helped shaped the formation of the United States, as abandoned tracks still scar urban areas providing a constant reminder of the historical importance of this now perceived archaic form of transportation. The first common carrier and class one railway in the United States was the Baltimore and Ohio Railroad (B&O) in 1830. The B&O railway proved to be particularly advantageous during the American Civil War between 1861 and 1877, as it was used to deliver ammunition, guns and eager soldiers onto the battle grounds. However, during the civil war the B&O was deemed collateral damage as confederate forces destroyed it in an effort to cut off supply lines. Into the 19th century railways became the primary method of land transport, peaking in importance in the early 1900s (Rodrigue, 2008). Market share subsequently declined in the face of competition from cars and aviation, although rail was still able to retain a modest level of passenger and freight transport (Rodrigue, 2008). The Staggers Rail Act of 1980 was a major development in the US railroad industry and led to the vitality and subsequent resurgence of the industry (Winston, 2005). The Staggers Act ushered in a new era where federal regulatory control over the entire industry was released. Railroad companies were able to abandon unprofitable lines, form mergers and acquisitions and adjust rates, placing the entire industry on a secure financial footing. Railway operating efficiency began to flourish as a result of regulatory freedom and several major improvements were developed, including: the switch from steam to diesel engines and electric traction; containerization with a focus on long-haul and unit-train freight operations (Rodrigue, p. 233, 2008).
Since the deregulation of rail, the industry’s infrastructure has exponentially expanded to create the largest rail network in the world. The C.I.A’s publication of The World Factbook (2007), has reported that the U.S railway is composed of 139,679 miles of track, doubling the second highest ranked country Russia, which has 54,156 rail miles. The 139, 679 miles of United States railroad ships 30 percent of the countries grain, 70 percent of all automobiles and 65 percent of all coal (Freightrailworks 2013). Wheat, corn, beer, potatoes, wine and many other staple foods make it to tables countrywide courtesy of rail. In addition, a large portion of all paper and raw materials travel through rail, including: lumber, steel, fuel and cement (Association of American Railroads, 2012).
As the effects of global climate change become increasingly apparent the desperation to find alternative modes of transportation which do not irreparably scar the planet is vital. The accelerated consumption of fossil fuels is changing the face of our planet and directly contributing to climate change. The transportation sector claims 20 percent of fossil fuel usage and is responsible for 33 percent of total US carbon dioxide (CO2) emissions (Armstrong & Preston, 2011). As the awareness of environmental damage caused by the transportation sector raises, public pressures to increase corporate social responsibility grow. The long term sustainability of the transportation sector is the key to future viability, as affordable fossil fuels are becoming increasingly scarce. Armstrong and Preston (2011) argue that “oil production will peak within the coming decades and may already have reached a plateau; this is likely to cause comparative scarcity and increased prices, if demand is maintained at current levels, or as seems likely, continues to increase” (p. 1572). The future sustainability of rail is this sectors most advantageous strategic quality, as rail claims a low environmental burden compared to truck or air. The Environmental Protection Agency (EPA) claims that for every ton-mile a truck emits roughly three times more nitrogen oxide and particulates than a locomotive (CSX, 2012). The CSX class one railroad boasts that a train can move one ton of freight 500 miles with one gallon of diesel fuel (CSX, 2012). The American Association of State Highway and Transportation Officials estimates if 10 percent of intercity freight transported by truck were shifted to rail it would save 2.5 million tons of CO2 per year (Nealer, Matthews & Hendrickson, p. 589, 2012). Rail is not only a less costly solution for the shipment of freight, but the use of this transportation sectors aligns a company with green initiatives and reveals an organization that is making strides to improve corporate social responsibility.
Since 1980 the railway sector has improved fuel efficiency by 61 percent, while the trucking industry has witnessed a 75 percent reduction in cost efficiency (Ampuja, 2013). The fuel efficiencies of rail create economic savings which are directly transferred into the pockets of shippers, as shipping rates are a reflection of fuel efficiencies. In the last decade, the trucking industry has become slaughtered by rising costs in fuel, higher wages, labor shortages and congestion on roadways. All of these variables are cannibalizing the trucking industry’s profits and making it extremely expensive for shippers to move freight. Rail is comparatively 4.3 times more energy efficient (455 ton-miles per gallon), has 4.7 times the capacity (216 million tons per mainline per year) and 1.8 times less costly (2.7 cents per ton-mile) than trucking (Armstrong & Preston, p. 1575, 2011).
Rail productivity has largely increased due to the deregulation of rail transport in the early 1980s by the Staggers Act. Deregulation allowed firms greater freedom to adjust rates, to merge with other firms, and to abandon or sell unprofitable lines. These freedoms allowed firms to change the structure of the industry and to alter their operating characteristics. For example, partial deregulation permitted firms the unprecedented freedom to customize their rate structures. The negotiation of contract rates allows railroads the ability to tailor their services to shipper’s preferences and for both parties to share the resulting gains in productivity (Da1vis & Wilson, p. 5, 2003). Gains in productivity and efficiency were also realized by offering shippers incentives through rate reductions by enticing them to consolidate shipments over longer distances in labor-saving unit trains, which allowed railroads to exploit unrealized economies of traffic density and services (Davis & Wilson, p. 866, 2003). Additionally, shippers who required service to and from a given destination would receive a reduced rate because it eliminated an empty backhaul for the railroad (Davis & Wilson, 2003). As efficiency improved labor demands decreased and industry employment fell by 60 percent, reducing overall variable costs and improving profit margins (Davis & Wilson, 2003). Financial viability became quickly restored within the railway industry and the sector is now able to compete with other modes of transportation.
In North America, mergers and acquisitions within the railroad sector allowed the industry to become more efficient and better able to withstand an environment that is flooded with competition from other modes of freight shipment (i.e. air, truck, sea). Before deregulation, roughly 70 percent of total car miles consisted of interline services (i.e. involving two or more carriers) (Harris & Winston, 1983). Interline services generates congestion on the track which ultimately increases transit time and total cost of shipment. The problem with freight car supply and distribution is complex because it involves not only the vertical relationship of shippers to carriers (the rail service) but also, the horizontal relationship among railroad firms (freight car interchange) (Berglund, p. 4, 1977). The absorption of Conrail by Norfolk Southern and CSX in 1999 left the United States with four large (Class I) railroads: Norfolk Southern and CSX in the East, and Burlington Northern-Santa Fe and Union Pacific-Southern Pacific in the West (Winston, p.8, 2005). These vertical mergers reduced interline services thereby simplifying the supply chain which allowed rail companies to efficiently manage their own systems (Harris & Winston, 1983). The minimization of interline services permitted increased visibility of shipments and improved organization and optimization of carriers. For example, vertical mergers enable a rail firm to pre-block trains at their intermediate yard for their ultimate destination, reducing car miles, car hours and classification tie (Harris & Winston, p. 35, 1983). The consolidation of the physical network allowed companies to decrease the total number of carriers on a track which in turn, decreased transit time resulting in the reduction of overall shipment costs. Mark DePaul the Solutions Manager of Canadian National (CN), in a recent phone interview stated that, “the recent purchase of Elgin, Joliet & Eastern Railroad (which operates in the Chicago area) by the Canadian National railway has alleviated the congestion around the Chicago area, making deliveries much more efficient and reducing overall costs” (DePaul, 2013). In a surprising turn of events, railway companies have passed the cost savings onto shippers offering lower rates and significantly improved service times and reliability (Armstrong & Preston, 2011). Total shipment costs via rail have decreased by 65 percent between 1980 and 2008 (Armstrong & Preston, 2011). The cost savings resulting from the reduction in the number of carriers on the track are immense for rail companies and as variable costs plummeted their profit margins began to swell. With a modest 33 percent reduction in carriers per route, the predicted cost savings are between 9-18 percent of variable costs (Harris & Winston, p. 35, 1983). The resulting cost savings have been diverted into diversifying railway company’s portfolios through the investment of various assets. For example, The Canadian National Railway has purchased trucks and warehouses in an attempt to develop a robust business model. Instead of contracting a third party logistics provider (3PL), CN is able to use their own resources to reduce the overall cost while simultaneously allowing the company greater visibility of their supply chain.
Horizontal mergers provide additional unrealized benefits for the industry and shippers. Horizontal mergers involve the merger of parallel railroads serving the same markets, thereby reducing the number of routes in a market (Harris & Winston, 1983). Horizontal mergers enable railroads to consolidate train traffic and make better use of equipment. For instance, companies can avoid congestion on routes by rerouting traffic, reducing car-miles by choosing the shortest routes and dedicating routes to specialized services (Harris & Winston, p. 35, 1983). With shipment costs and total transit time decreasing consumer satisfaction is flourishing. Improved railroad service has enabled railroads to increase total market share. Since reaching a postwar low in the mid-1980s, carloads have grown from 19.5 million in 1985 to 27.9 million in 2002 (Winston, 2005). Overall deregulation of the railroad industry allowed the sector to improve efficiency which has resulted in an estimated $2-$3.3 billion in cost savings (Winston, 2005).
The resulting cost savings have been allocated to advancements in technology in order to better manage the supply chain. The advent of new technologies within the railway sector has created efficiency and optimization within the supply chain. Extensive development in computer information systems now permits precise tracking of shipments and routing of cargo (Winston, p. 9, 2005). In addition, video cameras that were once placed in rail yards to monitor freight cars have been replaced with electronic scanners that automatically record each car’s arrival (Winston, p. 9, 2005). The most notable development in the railway sector is containerization and double stacking measures which permits trains to carry the equivalent of 280 tractor trailer trucks (Winston, 2005). In an attempt to improve safety conditions the railway sector has employed Positive Train Control Technology (PTC) technology. The Congressional Research Service has designed PTC which aims at minimizing the potential accidents through errors made by train operators and dispatchers (Price, 2006). The train receives information about its location and its surroundings using GPS systems and subsequently transmits this information to the operator presenting the safest way to travel (Price, 2006). Equipment on board the train enforces safe maneuvers by preventing perceived unsafe movement of the train (Price, 2006). The technology has resulted in in the reduction of rail worker injuries and accidents resulting from separations and collisions (Price, 2006).
The unrealized market potentials of the railway sector are inhibiting the industry’s ability to dominant the market. The rail industry has additional opportunity to swallow up a larger portion of the market share through the movement of short hauls. There is a common misperception in the transport industry that trucks are more efficient than rail for low-density short hauls. This generalization does not take into account shipment size and the congestion of roadway traffic. The dissolution of this misguided perception provides an opportunity for rail to secure a previously untapped market. According to Erikson (2001), truck is superior for low-density moves, but rail is superior for short hauls where density (lot size and complementary volume) is sufficient (p.1). The urban movement of freight between short distances is a market that has yet to be exploited by freight. Urban areas can easily satisfy the movement of rail freight where the lot size only has to house a small amount of railcars. Erickson (2011) argues that there should be a niche market for lower-purchase-price, lower-capacity rail equipment such as the bygone 40-foot boxcar of 3,700-cubic-foot capacity. There is a large portion of the $300 billion worth of ground transportation now moving in truckload volumes to and from urban areas which can be supported by rail through minimum right-of-way maintenance and daily switching service. (p. 2).
Currently rail is accepting the perceived superiority of trucks for short hauls and is submissively backing away from this opportunistic market that would further secure the future viability of rail. The substitution of rail freight for trucks would create a remarkable transformation of the urban landscape, where private enterprises would be paying for the maintenance of congestion-free freight access and where roadways are less congested resulting in the reduction of traffic accidents (Armstrong & Preston, 2011). According to data from the U.S. Department of Transportation (2011), 140,215,987,089 fatal and non-fatal tractor-trailer accidents occur every year, which causes approximately 89,000 injuries and 5,000 fatalities throughout the country. Reducing the number of tractor-trailer vehicles on the road should be a primary goal of politicians and environmentalists as these vehicles are threatening the health and safety of US citizens in terms minimizing the potential risk of traffic accidents and reducing carbon dioxide emissions. Additionally, the overabundance of tractor-trailers is eroding the conditions and usability of roadways. A Federal Highway Administration study estimated that 60 percent of urban interstate paving is in "fair" condition and $43 billion is needed within a 10 year span just to maintain these poor conditions (Erikson, p. 7, 2011). Rail provides a viable alternative to trucks and is economically, environmentally and logistically a superior mode of transportation for a variety of parties (i.e. shippers, politicians, government officials, environmentalists, urban planners).
The growth in international trade has driven up the demand for national shipments coming from ocean ports to distribution centres located across the United States. The resulting growth in national shipments is creating a market which is best served by rail. The trucking industry is restricted by rising fuel costs, capacity of tractor-trailers and traffic congestion which is stunting the potential growth of this industry. Rail has the capacity, cost savings and decreased transit time to fulfill the needs of this growing market. Particularly in the area of cost, rail provides astronomical economic benefits to shippers in comparison to truck. For example, for containerized shipments it costs about $1,500 to move a 40 foot container from the West Coast to Chicago by rail, while the same shipment costs $3,000 by truck (Rodrigue, p. 235, 2008). National haul lengths have risen by 24 percent (775 km) for the trucking industry and 18.7 (1380 km) percent for rail between 1990 and 2003 (Rodrigue, p. 235, 2008). The trucking industry cannot feasibly accommodate anymore growth in haul length due to additional labor demands, energy and labor costs and empty backhauls these distances create (Rodrigue, p. 235, 2008). Over 25 percent of freight is carried over distances of more than 640 km which accounts for approximately 130 million loads per year (Rodrigue, 2008). Page Siplon, executive director of the Georgia Center of Innovation for Logistic stated that, “U.S. companies are expected to create more than 115,000 truck driver jobs per year by 2016, but the number of Americans getting trained to fill those jobs each year is barely 10 percent of the total demand” (Bynum, p. 4, 2012). While the trucking industry is looking rather dismal, this could in turn advocate more business toward the railroad sector. The opportunities for rail in the future to absorb the majority of shipments and steal market share from the trucking industry are immense.
The longer and more complex global and national supply chains demand efficiency and organization. Gateways which provide exchanges between maritime shipments and domestic shipments are overflowing as the demand for out-sourcing sores. The large volume of containerized traffic handled at gateways is creating capacity constraints which the trucking industry cannot efficiently manage. In an attempt to cope with incoming volumes of containerized shipments, distributors send in additional trucks which only further compounds the problem, as increased traffic congestion creates delays and disorganization. As the expansion of the Panama Canal is underway, trucks cannot be expected to efficiently serve the increased volume of shipments this construction expects to generate for the Eastern seaboard. The expansion of the canal, according to Mark DePaul means, “a greater business opportunity for rail by creating more activities in the supply chain by using the existing infrastructure of rail to service more customers” (DePaul, 2013). The Panama Canal expansion is not only predicted to bring in larger volumes of containerized shipments, but larger capacity shipments. As bottleneck traffic jams are delaying loading processes and creating disorganization, the only suitable remedy to handle the increased capacity and volume of containers is trains. The logistics of rail is logically superior, as it is possible to fit three 53 foot tractor trailers into an 86 rail box car (Erickson, 2011). With double stacking measures employed, one train can carry the equivalent of 280 tractor trailer trucks (Erickson, 2011). This only further proves that inland distribution is best served at ports by intermodal rail, as this transportation method is immune to capacity constraints and truck congestion. Intermodal rail simplifies the supply chain, has the potential to speed up transit time and allows for a greater capacity of goods to be shipped, thereby reducing overall costs to shippers. However, intermodal rail freight demands rigorous optimization in order to remain the superior transport choice. Rolling stock companies need to effectively manage their supply chain (including maintenance crews, drivers and trains) in an attempt to shatter the misperceptions regarding trains unreliability and timeliness.
A major opportunity for North American rail is available through the investment into high-speed technologies. For the past 30 years the European nations have heavily invested in high-speed rail (i.e. trains reaching speeds of 150 mph) and the result has given rise to an economically stable and profitable industry. High-speed railroads have become the backbone of European society, as they are responsible for transporting 397.8 billion passengers per kilometre, compared to the United States measly 17.2 billion passengers (Vassallo & Fagan, 2007). The difference in passenger rail is no doubt accredited to technologically advanced infrastructure of European rail which creates a logistically effortless movement of passengers and freight. The lack of maintenance on US railways remains a major cause for concern, as the current infrastructure was graded with a C- (Dovell, 2012). This grade signifies that $200 billion in investment is required by 2035 in order to satisfy projected future demands of rail (Dovell, 2012). Mark DePaul (2013) attested to the poor safety and track conditions present within the industry and stated that safety is key issue which requires attention. The venture towards updating the existing infrastructure of US rail, in addition to placing electrically-powered high speed cars on the track will not only drastically reduce the nation’s oil dependency, but it would also generate previously unimaginable profits. The increased transit time of rail is the industry’s primary obstacle to growth, as it prohibits the shipment of perishable goods. High-speed rail can easily accommodate the low transit time required for perishable goods which opens up the rail industry to a previously unattainable market. California’s Caltrain recognizes the potential benefits of this endeavour, as the company is looking to invest $750 million on a new rail corridor that could reach speeds of 200 mph between San Francisco and San Jose (Geoghegan, 2011). This system is expected to cut Caltrain's operating costs in half and reduce greenhouse gas emissions by more than 90 percent (Geoghegan, 2011).
Additional opportunities for advancement are available to the US through an analysis of Chinese rail. The Maglev is a Chinese railroad system within Shanghai that operates using electronic magnets that hover above the track. The magnetic levitation of railcars allows trains to reach staggering speeds of up to 268 mph (Geoghegan, 2011). This operating system creates an immense strategic advantage for the rail sector, as this type of technology is not dependent on fossil fuels. NBC news reported that the $4.4 billion dollar railway system will cut travel time from Shanghai to Hangzhou down to 30 minutes, a trip which previously could take up to two hours (Maglev, 2006). The Maglev highlights that the opportunities for United States rail to advance are never-ending and that the industry has immense unrealized potential. However, the current weaknesses of the United States rail industry are proving to be a major hindrance for growth. The barriers to entry are virtually insurmountable obstacles, as the capital expenditure that is required to properly maintain and operate rail is enormous. On average, 18 percent of total revenue is accredited to capital expenditures which are needed to fund rising property taxes, over compensated workers and constant maintenance on tracks (Rodrigue, 2008). Rodrigue (2008) argues that the rail sector is prone to risks and many potential investors are unwilling to commit capital for infrastructure projects since potential returns are uncertain and may benefit one mode more than the other (p. 7). Fortunately, savvy investors like Warren Buffet exist who are seeking opportune investments. Warren Buffet understands the unrealized potential of the railway industry and has recently purchased the Burlington Northern Santa Fe (BNSF) for $26 billion (Wile, 2013). Following the transaction, BNSF claims that the company will boost crude-oil shipments by 40 percent this year (an increase of 700,000 barrels per day) in an effort to combat the lost sales on coal haulage (Wile, 2013).
The recent drop in cold temperatures during the winter has negatively impacted the consumption of coal. With 43.3 percent of rail tonnage attributed to the shipment of coal totaling 24.7 percent of revenue, the industry has taken a major blow (Wile, 2013). According to the Association for American Railroads, the decline in coal shipments between 2008 to 2011 is over 80 million tons (Association of American Railroads, 2012). The railways industry’s dependence on coal to generate a significant portion of their revenues is economically risky and makes the industry extremely vulnerable. A higher level of coordination with other commodities within the supply chain will generate greater volume in shipments thereby securing stability, which will in turn reduce the need for capital costs and financial returns will improved. The reduction in risks and improved financial returns will lead to attraction of more investors and hopefully produce the resurgence and importance of rail. The potential for rail to improve overall environmental conditions and optimize the logistics of national supply chains is all too often overlooked. As public demands for social corporate responsibility grow so too will the market share of railroads. The foreseeable future holds a bright outlook for the rail sector, as it has the potential to become the dominant mode of transport for freight shipments. The railway industry’s comparatively low rates, capacity volumes and low environmental burden make it an increasingly attractive transport method. However, railroads still have a long “track” ahead of them to optimize service times and become fully responsive to shippers needs. Technological advancements will propel the industry’s success in the 21st century, as the current infrastructure is archaic and inefficient. The reform of the transportation and shipping industry is underway and while regulation may have caused railroads to start late out of the gate, the industry’s sustainability will propel it past its competition.

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