New-breed Class I leaders and their navigation challenges (February 2006)

— by Jeff Stagl, managing editor

Business change has a way of compounding itself and, before you know it, deep and far-reaching issues trigger deep and far-reaching adjustments within the marketplace and the organizations dotting the marketplace. Only historical hindsight will verify whether or not the Class Is are in the midst of a "new-era dawning," or merely an adjustment period — a state of flux.

But one thing's certain: The large roads are in a special place in their evolution. How well they successfully navigate or flounder about in this surging sea change depends on their ability to adapt and adjust to evolving times, leadership and business paradigms.

The Class Is have been in the midst of tackling a variety of challenges for some time now, such as changes in traffic volumes, capacity needs, shipper demands, short line relationships, fuel costs and competition from other transportation modes.

But the biggest challenge might be the changing face of management. In less than five years, all large roads most likely will be run by new chief executive officers.

Five Class Is already have new leaders. BNSF Railway Co. Chairman, President and CEO Matthew Rose; CSX Corp. Chairman and CEO Michael Ward; and Canadian National Railway Co. President and CEO E. Hunter Harrison assumed their top posts within the past four years. And since November, Norfolk Southern Corp. President Wick Moorman succeeded David Goode as CEO and chairman, and Union Pacific Railroad President James Young became CEO to succeed Dick Davidson, who remains chairman.

These men — who've served their respective railroad a long time and, in many cases, have been groomed for the top job — are leading their railroads at a time unlike any other in Class I history. Large roads, for example, are moving unprecedented numbers of carloads, charging higher rates, and earning record revenue and income.

"The opportunities outweigh the negatives in the industry today," says A. R. "Pete" Carpenter, who served as CSX Transportation's president and CEO from 1992 to 1999, and vice chairman until he retired in 2001.

It'll be up to the new chief executives to not only seize opportunities, but overcome some lingering challenges: capacity constraints, lower train speeds, higher terminal dwell times, soaring fuel costs and not earning the cost of capital.

The new CEOs will predictably do everything in their power to make sure they learn from the experiences of their predecessors. The service meltdowns brought about by mergers and the subsequent Wall Street-driven downsizing will have an impact on future decision-making.

"In the '80s and '90s, the railroads tried to get out of their own way," says Credit Suisse analyst Jason Seidl. "They had mergers and then service difficulties after the mergers."

The new top execs will need to find ways to play a larger role in the global supply chain, forge more track-sharing and haulage agreements with other Class Is, strengthen business relationships with short lines and shippers, and implement "scheduled" operations down to each carload. They'll also have to determine how to continue to raise rates while keeping shareholders and shippers happy, yet avoid the temptation to chase every carload to increase traffic, according to analysts and industry observers.

"The new leaders will need to get away from the "just-get-the-business" mentality and keep focusing on yield and profitability," says UBS Investment Research analyst Rick Paterson. "Whoever can manage price increases and improve service at the same time will be doing well."

In order to raise rates, the new CEOs will have to incorporate price hikes into a larger chunk of long-term contracts. To improve service performance, they'll need to be more proactive about working with customers to solve transportation problems, shippers say.

The new leaders should be open to interacting with customers to improve the "inner workings" of both railroads and shippers, says John Ficker, president of the National Industrial Transportation League, which promotes the interests of about 600 shippers.

"I'm hoping the somewhat strained relationship between shippers and railroads will end, but the relationship between a buyer and seller is always somewhat strained," he says. "Each mode has to look at its role in the entire transportation industry and not concentrate on its own mode as has happened in the past."

Lessons Learned

The new leaders are aware of the sometimes-contentious relationship railroads and shippers have had in the past and should try harder to meet customers' transit time needs, says Credit Suisse's Seidl.

"The path to improving relationships lies in improving service levels," he says. "The supply and demand pendulum is swinging heavily in railroads favor."

However, shippers are concerned the Class Is might return to the days of cutting costs at the expense of declining service metrics. According to their customers, the new CEOs should concentrate on adding track and rolling stock instead of shrinking networks and getting rid of rail cars.

"I would also hope that they make an even bigger push for their respective railroads to be more like partners with customers," says Curt Warfel, manager of logistics and distribution for Akzo Nobel Co.'s Eka Chemicals Inc.

The Class Is need to be partners with short lines, too, says American Short Line and Regional Railroad Association President Richard Timmons. The number of small roads has increased form 190 in the late 1980s to more than 500 today, and the railroads help generate 17 percent to 25 percent of a Class I's business, he says.

"The old leaders came into the industry in the '60s and '70s when the industry was in steep decline, and their outlook was shaped by dealing with slow orders and shortages, and making cuts," says Timmons. "The new leaders have already shown that they're willing to sit down and listen to us because they have a different outlook and come at problems differently."

Build On The Past

Lately, the CEOs have tried to take a different approach to overcome what's arguably their biggest obstacle: capacity constraints. Large roads have reached track-sharing and haulage agreements with other Class Is — such as the one forged last month between BNSF and Canadian National — to expand network capacity without constructing track. But the large roads still will need to build more track to double the U.S. rail network in the next six years to keep up with traffic demands, says Gil Carmichael, senior chairman of the University of Denver's Intermodal Transportation Institute, and former Federal Railroad Administrator and Amtrak Reform Council chairman.

"There's no way on God's green earth that we could double the highway system in six years," he says. "The rail industry needs double track and longer sidings and GPS and grade separations."

The CEOs should listen to customers and railroad senior managers to best determine where to expand capacity, says former CSXT CEO Carpenter.

"To provide service in intermodal instead of automotive means some capacity is in the wrong place," he says. "The new generation will need to be clever to make sure they have capacity in tight lanes, such as double tracking only where necessary and extending sidings."

Intermodal capacity has become tight as Asian imports continue to increase. Class Is are dealing with congested terminals and container shortages. So, the large roads will need to find ways to expand their role in global supply chains and ensure they have the intermodal capacity to handle the business, says Association of American Railroads President and CEO Edward Hamberger.

"Thirty years ago, do you think the top executives talked about global dynamics and logistics chains?" he asks. "Now, the railroads look at their role in the whole economy and how they can benefit their customers' business models."

Tough Act To Follow

As the new CEOs find ways to address capacity and other issues, their successes will be measured against the accomplishments of their predecessors — men who guided the Class Is through the mergers, service performance meltdowns, economic woes and stock price tumbles to reach what today is described as the "rail renaissance."

"The men coming on board already have played roles in what's happening in the industry with the pricing paradigm, intermodal sector and [operation] scheduling, and they'll need to accelerate those trends," says independent rail industry analyst and Progressive Railroading columnist Tony Hatch. "But much of what's happened is a matter of the efforts of the people they're succeeding."

To leave their own marks on their respective railroad, the new CEOs will rely on different educational backgrounds and job experiences than their predecessors — many of whom were lawyers. The new leaders, mostly MBAs, have experience in operations, finance, engineering, human resources and marketing.

"When I entered the business, a large focus was on legal matters and attorneys were involved in every business situation," says Carpenter. "The new leaders will still need to involve the law department in their decisions, but they can be more of a business leader today."

After Goode retires, there won't be a Class I CEO who's also a lawyer — an industry first, says the AAR's Hamberger. Today's CEO no longer needs to master the legal complexities of mergers or rely on a law degree to grasp federal regulations in the post-Staggers era.

Change All Around

As the new CEOs rely on their experience to develop a strategy, new challenges will emerge.

"You look at any industry, and there's always a difference in challenges and approaches after leadership changes," says Credit Suisse's Seidl.

To tackle old and new challenges, the new leaders will need to avoid a business-as-usual approach if they want to remain on the traffic- and revenue-growth track, according to industry observers.

In the past, Class I leaders sometimes relied too heavily on tried-and-true strategies to speed up trains or reduce terminal dwell time — such as limiting train starts — to the dismay of shippers and shareholders. The new CEOs will need to prove they can bring new ideas to the table, such as co-production and track-sharing partnerships with fellow Class Is.

Carpenter believes the new top execs are showing signs they're good communicators — both in and outside of their respective railroad — and are more apt to think outside the box than their predecessors.

"The new leaders won't rely on anecdotes to solve problems — they're more of a fact-based group," he says. "I see them as an externally focused group as opposed to the internally focused group of the past."