Commentary: Will railroads grow organically or just recover?

The railroads’ executives will use their processes for managing financial results during the second half of 2020’s “recovery” pace (assuming such an event occurs).

But at some point a railroad analyst is going to ask “where is the beef for the promised longer term competitive customer growth positioning?”

Executives often respond that they now see “organic” growth since the precision scheduled railroading (PSR) promise of being the lowest cost provider is now in hand.

Yet, two obstacles remain:

•  First, low productivity costs do not mean lowest price for customers moving goods.
• Second, it is not clear what organic traffic actually means.

As for price, shippers buy on complex. internalized formulas that involve their total logistics and physical distribution costs. That includes their forward inventory adjustments because their goods shipped by rail are not always precisely delivered to their destination on time. 

So far, there is little evidence of PSR price bargains to drive a modal shift from truck to rail. This price pattern might change.  That could induce rail market growth.

As for organic growth, let’s straighten out the terminology. Organic growth is different from growth by acquisition, which involves the purchase of existing companies to expand the reach of your business.

Organic growth is slower. It is also a rather deliberate process that is customer-driven, yet adaptable to what a railroad has decided to stick with.

If innovative new rail cargo and service patterns are required, railroads might not be willing to either invest in or switch operationally toward those patterns. PSR  has shown market exit tendencies.  

Therefore, rail carrier profitability margin targets might not sync with organic targets. There is an uncertainty here.

Organic growth once was coal and iron ore moved by rail. That is no longer the case. Organic growth today? E-commerce qualifies. Rail-centric? Not so far.

Organic businesses typically harvest a blend of existing – and some new – customers to push the growth.

PSR tactics would need to be incorporated into customer organic needs. Which rail company has demonstrated an excellent record at doing that?

To a customer, “organic” might not easily fit with a converging conveyor-belt PSR train dispatching service.

Organic growth models – the ones that customers like – require an element of relationship transactions between the “transport carrier” and the inventory managers and the floor space/e-commerce dispatchers.  

That intense human connectivity is not yet typical as the PSR railroading business model output. It’s being taught at some university railroad programs (an example is the Michigan State University program).  But Michigan State graduates are not yet today’s senior railroad leaders. Adoption could take time.

Social media is often used to both communicate and then evaluate customer feedback “organically.” To do that, most existing major railroad media platforms will need upgrading.

So, where are the opportunities for organic rail freight growth?

Here are a few.

1) Expand width dimensions.

Build upon the vertical and train linear length and axle load improvements already invested in and completed – the fundamental engineered and physically implemented innovations that gave customers stack-trains and heavy-axle long freight trains with lowered unit costs per ton-mile.

Add to that service suite the benefits of two to four feet of cargo-carrying capacity across at least the strategic core network. That could mark the final delivery of core dimensional freight high and wide organic capacity.

Costs for a 20% to 30% network coverage on a wider platform? Arguably about $7 to $10 billion – recoverable as a strategic asset balance sheet item.

• This amount is less than the roll-out capital expenditure of positive train control (PTC) dispatching at ~$12 billion.
• Perhaps twice the cost of double-locking the Panama Canal.
• About the same as the recent transfer of dollars from two of the six PSR railroads to shareholders in order to buy back shares?

Why not everywhere?

•   Same economic logic for not offering 315,000 pound routes everywhere.
•  Wider-load modern industrial products like air exchangers and new generators don’t go everywhere. 

Figuring it all out strategically?

It is easy when organic is part of a railroad’s strategic planning. The railroad would integrate with the national electrical machinery and emergency response heavy manufacturing sector and also with the U.S. Department of Transportation and federal energy planners to set up a superior high/wide hub-and-spoke distribution network. Then finance it together.

Here’s the missed opportunity. None of them are customer/supplier/financier integrated yet in a plan that they all will pay into.  

That could be fixed. Who will lead that? What senior railroader is so engaged?  Because this represents organic growth additive to the still active rail network.

2) Another organic growth opportunity is the often hidden intermittent storage functions of freight railroads.

Cargo often moves in a “fits and starts” pattern. In other words, freight movement does not happen continuously, but stops and then starts again many times. Cargo gets loaded – then stops enroute. Some cargo is redirected to new destinations. Some cargo is loaded – but moves only a short distance and is then held. As in “parked.” Reasons for this include:

• Congestion enroute
• No firm order or destination yet

Other loaded rail cars move forward to regional yards for “Storage in Transit.”

Here is a railroad company earnings opportunity. Execute a logical pre-positioning of high value freight for subsequent quick replacement of “shelf stock” or alternatively just in time (JIT) manufacturing input.

The overall size of this storage and logistics “black box” market is big.

Rod Case of global management consulting firm Oliver Wyman is among a few touting this logistics black hole. Oliver Wyman proposes that if the railroads added logistics and inventory storage to the rail revenue mix it would provide multiple market opportunities. 

Railroad revenues are in the ~$85 to $90 billion/year range. Logistics holding/processing/storage might add about ~$30 billion per year of new business billings. That’s calculated as a  possible share of a $500 billion total all modes size of supply chain inventory management or storage costs. 

The railroads’ hypothetically could pivot towards growth by going after some part of the $30 billion in estimated supply chain storage and handling costs that their customers deal with.  (See suggested black target within the Supply Chain and Storage market chart area).

Hitting half of that target could boost rail company revenues by as much as 15% or more a year.  

Activity-based car management systems fed by the PTC/GPS “smart” systems would generate a greater return on investment. The railroads are not using the full potential of the GPS business capabilities of the railroad PTC investment. That would be organic growth.

3) A third opportunity is turning railcars in the existing North American railcar fleet more “reliably.” Those added railcar loads per year might add between 15% to 30% in carload movement revenues without any capital expenditure spending to add new railcars.

These are really big numbers – if executed. If the railroads have the newer functionality IT tools. If they aggressively strike out for these unconventional services built upon the existing track network, which they just “streamlined.”

It’s much more than just car demurrage fees that I have written about.

• It’s partly smarter railcar scheduling.
• It’s partly freight car on-board integration of customer loads. 
• It’s really customer support work.

FreightWaves investigative data scientists similarly point out the opportunities for such high growth and the significance of strategic warehousing and inventory in motion/storage processing opportunities.

That entire process used to be railway direct service and often railway-managed. When? Until about the late 1960s. Then, that “product” was sold off. What was it? “Railway Express” services.

Conclusion

There are opportunities for the railroads to achieve organic growth and not just execute an economic recovery “crawl-back.”

But it’s not a conventional approach. It will not occur just because railroads are more profitable.

It would involve new skills and investment into new hardware, software and communication links. These are things not visible as details in the Class 1 investor presentations. Not yet.

The inventory and storage processing opportunities are not state secrets. The railroads have been briefed on these markets over the past three decades. The buy-in hasn’t yet solidified. We hear the right words in speeches and read them in annual reports. But no execution details or timelines are yet apparent from the Class 1 railroads.

As always, if there is evidence we have missed here, let’s please see it. Will you share it even if it is contrary to my arguments?

 Notes and acknowledgements

•  En route is often written as one word – enroute. It depends on your dictionary and your transport mode subject.
• Check further with Oliver Wyman’s distinguished rail group for a better definition of the possibilities. Or the senior officers at your Class 1 railroad.