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Mettle testing: CPR's 2002 financial results confirm market strategy

By Tony Hatch

Canadian Pacific Railway's timing seemingly couldn't have been worse. Since becoming an independent entity a year and a half ago after the CP holding company was split, CPR has endured a broad slowdown of the North American economy, disruptions to Canadian coal exports and the worst drought on the Canadian prairies for years. But CPR actually has proved its mettle during these tough times, through hard transformational work and — in the vernacular of the North — rigorous process redesign.

In preparation for the spin-off, Chairman and Chief Executive Officer Rob Ritchie began an asset renewal program that included a significant infrastructure upgrade, an information management system renewal program (often taking "best-of-breed" examples from the industry, such as Norfolk Southern Railway's Thoroughbred Yard Enterprise System software) and a locomotive fleet upgrade from one of the oldest to one of the youngest. In addition, CP has (perhaps?) the largest AC locomotive percentage — almost 40 percent — and uses them in all types of service (often solo) given the weather and terrain issues inherent to Canadian railroading.

CPR also designed and instituted an integrated operating plan linking marketing to operations — both reporting to the plan's architect, Chief Operating Officer Ed Dodge. On the surface, it's similar to what several other Class Is are doing, but the plan is particular to CPR. Understanding the plan is critical to evaluating CPR's future. Described by Dodge as a "practical use of operations research and data," the plan is an intense, engineering-based methodical process in which data is king.

The key to forecasting CPR's future is understanding how the plan ties into CPR's promised goal of 4 percent annual revenue growth. On one hand, a disciplined effort to increase efficiency and productivity has succeeded in lowering CPR's cost structure — a positive in its own right, but also a competitive advantage as CPR takes its game to the highways. On the other, the same process that understandably has a home in efficient rail operations also can be applied to marketing. Of that 4 percent growth goal, half is "organic" (which can swing with the economic climate, among other factors); a quarter will come from price and "initiatives" each.

The plan has mandated a thorough review of CPR's business by corridor, customer, "same store" results, competitive info, etc. (data, data, data). An independent "Yield Team" has been created to, in the words of Senior Vice President Sales & Marketing Fred Green, "bring some tension" to the process (there's that word again) between sales and yield (growth for its own sake versus margin, as an analyst would see it). The goal is informed decision-making; the benefit to the sales force is a new, no-ceiling incentive-based compensation plan.

Specifically, CPR's plan attacks the three major revenue segments. In Bulk (mostly export grain and coal), CPR's goal is to be the best by being the most efficient and low-cost carrier. Canadian National Railway Co. provides a strong benchmark there. In Carload, CPR hopes to change the "gathering system" and offer truck-like service at rail prices. Key products and services here are Connetix(tm) (a transload operation in steel and lumber) and the alliances that extend CPR's reach, most notably with Union Pacific Railroad but also with the other majors. Forty percent of CPR's business is interline (about 60 percent in the merchandise/carload sector), and it's growing. Intermodal and Auto is divided into three parts: domestic (East-West); and retail service (as opposed to the predominant model south of the U.S.-Canadian border) where a co-location strategy in terminals is showing some encouraging signs and where close cooperation with trucking also pays dividends (just as it does in the lower 48).

Yield management is critical here, of course. International is tied to the ports of Vancouver and Montreal, and the cities of Chicago and Toronto. CPR won some diversions to Vancouver during last September's International Longshore and Warehouse Union lockout that it will fight to keep. Automotive isn't as big a piece for CPR as it is for the other majors, but the railway's close ties with fast-growing Honda and Toyota will help compensate for General Motors Corp.'s shutdown of the Camaro/Firebird names.

So how is it working? Well, for starters, CPR (with MultiModal Applied Systems Inc.) is one of six finalists in Institute for Operations Research and the Management Sciences' (INFORMS®) 2003 Franz Edelman Award for Achievement in Operations Research and the Management Sciences for its model-driven operation plan development program.

That is all very well and good, but in the real world? On Jan. 27, CPR reported a 7 percent increase in earnings per share for 2002 over 2001 — this despite a $149 million hit to revenues from the bulk area (caused by the drought and the drop in exported grain, and coal).

The integrated operating plan and CPR showed exceptional flexibility in asset and resource deployment away from the bulks and toward the merchandise carload and intermodal segments (which grew 6 percent year-over year in revenues, 11 percent in the fourth quarter). In a scorecard of its "2 + 1 + 1 = 4" growth goals, CPR fell a little short, mostly due to a shortfall in the "organic" segment, as "initiatives" and especially "yield" (+2 percent) held their own. CPR confronted the harshest conditions possible for a railroad: a weak economy and (particularly) a hit to the traditionally highest-margin segments of the business. And CPR did it with a three-point improvement in its operating ratio to a stellar 76.6, a number bested only by their Canadian neighbor.

CN has held that crown for a while, but if bulks come back and the IOP achieves its results, there will be a new North American titleholder.

Tony Hatch has been a senior transportation analyst on Wall Street for 16 years, starting at Salomon Brothers, proceeding to Argus, PaineWebber, and most recently at NatWest Markets (USA) prior to becoming an independent analyst/consultant at the latter's closing of operations.

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More News from 2/4/2003