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June 2012



Class Is Article
Union Pacific focuses on growth as it marks its 150th anniversary



Class Is

by Jeff Stagl, managing editor

Peter Drucker, the late writer and business consultant who's considered the father of modern management, once wrote: "The value of service is not what you put into it. It is what the customer gets out of it." That, in essence, is Union Pacific Railroad's mantra.

The value that dependable and desirable service can create for customers, from helping them best manage their inventories to controlling their transportation costs, is paramount to growth, senior executives believe. The value generated for UP — such as acquiring new customers and increasing revenue — is vital, too.

During interviews conducted in late April at UP's headquarters, senior team members stressed the importance of fostering a fluid, opportunistic and profitable railroad to generate optimal value for shippers, investors and employees.

This year marks the company's 150th anniversary and affords time to reflect on and celebrate many accomplishments, such as forming the nation's first transcontinental railroad with the Central Pacific and eventually becoming North America's largest Class I. UP created a website and scheduled many celebrations in the field this year to mark the occasion with employees.

But assessing the next forward steps along the value-generating course is much more vital than pondering the railroad's rich past, senior execs say.

The focus remains, as always, to push harder in order to boost financial and operational performance — for the remainder of 2012 and post-150, says Acting President and Chief Executive Officer Jack Koraleski.

The push reaped results in the first quarter: Revenue ($5.1 billion), operating income ($1.5 billion) and earnings ($1.79 per share) reached record levels. In addition, the customer satisfaction rating (94 percent) climbed to an all-time high, the operating ratio (70.5) fell to an all-time low, and volume (2.2 million units) inched up 1 percent despite weak domestic coal and export grain demand.

"Whole industries have come and gone. We're still here," says Koraleski. "The good thing about reaching this point is that we're at top performance. We're more efficient than we were. [But] we're always looking to the future."

Fixating on the road ahead has been a bit more challenging since early March, when Chairman Jim Young took a leave of absence from his president and CEO duties to seek treatment for pancreatic cancer. Koraleski assumed the top post while Eric Butler succeeded him as executive vice president of marketing and sales.

A UP executive since 1972, Koraleski had expected to retire this summer, but he now plans to remain acting CEO as long as necessary.

Despite the turn of events, the revamped senior team aims to maintain and build on UP's momentum.

"We need to think about who we want to be: the safest railroad with great reliable and damage-free service that keeps rates down and provides great returns," says Koraleski. "Our competition is watching us to see if we take our eyes off the ball, and we can't let them pass us up."

Koraleski credits Young — who has led the railroad since late 2005 — with getting UP well past the misplaced cars and network congestion of the late 1990s and early 2000s, and transforming the Class I into a more reliable, customer-first railroad.

"We're trying to have a customer-centric view. If we really understand that, good things will happen," says Koraleski, citing as an example UP's efforts to establish infrastructure and foster relationships with supply chain constituents to take advantage of intermodal opportunities stemming from the Panama Canal expansion.

It's also generally understood that UP will continue to charge forward on its post-150 path as long as sufficient infrastructure-bolstering capital is committed, emerging traffic opportunities — both along and well off the network — are tapped, more technology is developed and employed, and customers and employees are increasingly engaged.

"We need to focus on creating value for customers and drive that through the entire organization, ensuring that everyone has that focus," says Koraleski. "We have one customer that actually pays us more than the competition. It comes down to service. They tell us there's an almost total willingness of everyone at UP to [offer] help."

One main objective to stay on target: avoid complacency. Although the 94 percent customer satisfaction rating in Q1 was stellar, "what about that other 6 percent?" Koraleski asks.

"It's important how we work effectively with customers," he says. "There's a lot more we can do."

To-Do List

The "dos" include working more collaboratively with shippers who still complain about long transit times, tight car availability and high rates, and winning over more shippers who are unfamiliar with UP and freight-rail transit. Although satisfying all customers all of the time might be an unrealistic goal, lingering operational issues need to be better addressed, senior execs say.

One longtime grain shipper credits UP with making gradual strides since the service performance meltdown that followed the Southern Pacific Railroad/UP merger in 1996, and another service drop-off that followed crew reductions from 2004 to 2008. Operational improvements were evident last year when UP experienced minimal train delays despite heavy Missouri River flooding and track damage in the nation's midsection, said the shipper — who asked to remain anonymous — in an email to Progressive Railroading.

"We have enjoyed more follow-up from marketing personnel, as well. Issues are being addressed more promptly, quarterly reviews are done by phone, and even a personal visit has been scheduled," the shipper said. "This is a welcome change from recent years past and does convey an effort to develop a relationship."

Although more shippers are expressing satisfaction with UP's service these days, the overall customer experience can be heightened to the point that the railroad can "astound and delight" rather than just satisfy them, says EVP Butler. Elements of service aren't really "broken," so efforts are focused more on making it easier for customers to conduct business with the railroad, he says.

To that end, UP offers an "onboarding" group that helps customers — especially new ones who aren't familiar with rail — through every step of the shipment process. In addition, the group provides customized shipment monitoring services for 90 days.

"It's a concierge-like service," says Butler.

UP also offers an online Unit Train Customer Interface (UTCI) tool designed to help shippers determine which of their cars are on a train and the size of a unit train. Developed three years ago, UTCI will be rolled out in grain markets, says Butler.

For shale play flows, UP offers an online Customer Pipeline Inventory (CPI) tool that helps shippers determine how much traffic is coming to their location.

CPI is among a "ShipmentVision" suite of online tools designed to help customers manage and track their shipments. The suite offers a single Web-based system for all shipment, product, inventory and carrier information.

In addition, UP late last year released mobile versions of its secured equipment trace and equipment release applications to enable customers to access shipment information from their smartphone or mobile Web browser. The Class I plans to continue releasing mobile apps to offer more fast and easy-to-use tools.

The various tools are all about speed, agility and responsiveness, says Butler.

Meanwhile, newly developed equipment is all about flexibility. In the automotive sector, UP soon will offer shippers a new rail car designed to accommodate either small or large vehicle movements.

The railroad has developed a 90-foot-long, multi-level AutoFlex™ car that can be transformed from two to three decks based on a customer's vehicle needs. The Class I holds 15 patents related to the car's design and build, and expects to begin producing several hundred AutoFlexs later this year.

"Customers can customize it. I'm real excited about our equipment advances," says Butler, adding that UP also is developing a "tank car of the future."

More Business By Extension

He is equally enthusiastic about UP's prospects to capture more traffic beyond its physical track structure. Characterized as "network extensions" — such as moves that require a transload well off the railroad's lines — the segment currently generates only 5 percent to 8 percent of core manifest traffic, says Butler.

"It's a large market opportunity," he says, adding that UP is only involved in 15 percent of the traffic associated with network extensions. "It's a higher-cost option than direct rail, but cheaper than truck."

Key is demonstrating to customers that they don't need to be located along track to be served by the Class I, says Koraleski.

"We like to say, 'Let us show you,'" he says.

Productivity a 'Forever Goal'

Marketing and sales personnel also would like additional chances to prove to customers that UP is more productive than in years' past, such as by handling a higher volume of traffic with fewer assets and less network variability.

"Our business planning processes are better and more robust, our infrastructure is better with a record-low number of slow orders and we have better safety processes," says EVP of Operations Lance Fritz. "In the past, we perhaps focused more on process improvements but didn't get that engagement from the workforce. The team understands the endgame, that's key. Productivity is a forever goal for us."

So is leveraging more technology. For example, current rail inspection technology primarily employs ultrasonic methods. UP is working with the Transportation Technology Center Inc. to develop a laser-imaging system designed to more comprehensively inspect rail, says Fritz.

"We can get a full image inside the rail," he says.

In addition, UP is trying to adopt more thermal-imaging devices to better inspect wheels and bearings.

"Hot-box detectors are static and can only read bearings," says Fritz. "With thermal imaging, we can get a full picture of the wheel and bearings, and make better decisions with the data points."

Finding more ways to adopt technology and boost productivity will help increase fluidity and reduce costs, he says.

"We have a target-rich environment for improvement," says Fritz.

Pushing the Innovation Curve

Senior VP and Chief Information Officer Lynden Tennison couldn't agree more.

"We always ask ourselves, 'What will allow us to be better, faster and more efficient?' We continue to push the [technological] envelope a bit," he says. "It's important that we aren't afraid to look at owning technology or vertically integrating technology. It helps push the innovation curve and is a vehicle to drive technology."

Past efforts to drive technological change have led to the establishment of 34,000 miles of fiber optics and 700 microwave sites, making UP one of the world's largest private telecommunication companies and a large "software systems shop," according to Tennison.

The railroad also employs 46,000 mobile devices, 20,000 personal computers, 7,700 locomotive radios, 7,700 end/front of train devices, 5,800 routers and switchers, 5,000 locomotive data radios and 4,400 defect detectors to maintain and drive information technology.

Technology employed systemwide enables devices to "talk" to each other and provides real-time data, which helps UP meet its safety, service and efficiency goals, says Tennison.

Now, the railroad is in the midst of replacing its antiquated transportation control system to accommodate today's business processes, phasing in an integrated graphical interface to make all transactions web-enabled, and pursuing more simulators that feature virtual reality or video game functionality to mimic actual field exercises.

R&D Is Key

UP is working with more than a dozen colleges on various research and development projects, says Tennison. Among them, the Class I is analyzing several rechargeable energy methods, such as using wheelsets as alternators, seeking ways to install more sensors on more assets and determining ways to "be more mobile," he says.

"Workers can be in the field and obtain notifications on their smartphones instead of sitting at their desks," says Tennison.

Longer term, he envisions the integration of robotics in various areas to further boost safety and efficiency, perhaps as a way to perform difficult inspections without a worker.

"You have to be willing to take a risk, and some things won't pan out," says Tennison. "The challenge is prioritizing it. We create a rank order as we go after things. It keeps the juices flowing, and then we aren't chasing blind holes."

Diversity to Avoid Adversity

Blind chases aren't going to help UP's cause. What will help business generation-wise is a balanced portfolio. Measured by revenue, UP has a more balanced commodity portfolio than BNSF Railway Co., according to an equity research report issued by Robert W. Baird & Co. Inc. on April 20.

"While BNSF's portfolio is concentrated in coal, intermodal and ag, and therefore is largely consumer-centric, UP maintains a more diversified mix," Baird analysts said in the report. "Those three commodity types represent 60 percent of UP's revenue base versus 77 percent for BNSF. The remaining 40 percent of UP's revenue is generated from industrial-driven sources, which provides UP with a more balanced portfolio and greater exposure to an improving manufacturing/industrial base."

Increasing crude oil production in the Bakken Formation, a 200,000- square-mile shale covering parts of Montana, North Dakota and Saskatchewan, is expected to help boost UP's energy, chemicals and industrial traffic fortunes via movements of frac sand, drilling pipe and other materials.

"There are 6,000 wells in the Bakken now and there is the potential for 22,000 wells. If we would get [business from] one-third of that, I'd be a happy guy," says Acting CEO Koraleski. "It all spells opportunity."

Growing international imports, broad port access and share gains from trucks spell opportunities to increase intermodal volume, as well.

"UP believes the addressable domestic market is two to three times the current size, providing a source for sustainable growth over the intermediate term," Baird analysts said in their report.

Given UP's innovation efforts, large capital investments and cost-reduction measures, Baird analysts believe the Class I is positioned to obtain a mid-60s operating ratio (OR) in the next several years. The railroad is anticipating a sub-70 OR for the second quarter.

"UP is executing well, and legacy pricing tailwinds support efforts to achieve its stated 65 to 67 long-term OR targets," they said in the report.

Up, And To The Right

Ultimately, the ongoing charge is to continue performing optimally and advancing the growth strategy, senior execs say.

EVP Fritz believes that adhering to the following six critical operating department initiatives will help in that regard:

  • reducing variability via root-cause problem solving and continuous-improvement tools;
  • ensuring resource readiness to optimally align mainlines, terminals, human resources and rolling stock;
  • leveraging technology to support and advance operational strategies;
  • implementing a comprehensive capital management strategy to optimize returns on investments that increase network throughput and harden infrastructure;
  • standardizing work to ensure tasks are performed in a consistent manner and are regularly improved by employees; and
  • fostering a culture that engages employees to help drive continuous improvements in safety, service and efficiency.

Years from now, perhaps when UP is marking another major milestone, Fritz hopes the network is slow order-free, the workforce is more fully engaged and every initiative is posting progress.

"I hope the chart for each one of the six critical initiatives is up and to the right," he says.

UP's workers, who have had a big hand in bolstering operational performance and changing shippers' perceptions about the Class I's service by helping to improve work processes, have taken ownership of continuous-improvement efforts and are a large cog in executing the growth strategy, says Koraleski.

"Our people are a big difference now. They think about our company in a favorable light," he says. "There's a large amount of buy-in and people take pride."

Although everyone likes to meet objectives, there are certain risks associated with "chasing" a goal, such as the obsession in attaining it or stagnation that might come afterward, says Koraleski.

Nonetheless, senior execs don't expect to stop setting and trying to meet goals. UP's 150-year history is filled with many unique achievements because of a relentless pursuit of objectives, such as becoming the first railroad to employ articulated steam locomotives and test gas turbine-electric locomotives.

"We have accomplished so many things," says Koraleski. "But I think the single most important lesson we've learned is to create good value for customers. It's not just about fixing a wheel and trying to get back on schedule."



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