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November 18, 2017
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No time to lose

Comment
Rail freight shippers need to start thinking now about how they will handle the impact of a coming capacity crunch and rising rates.

This time last year, the economic outlook was bleak and getting bleaker. Presently, things are better and seem to be fairly steadily (albeit not rapidly) improving. What does this mean for buyers of transportation services now and over the longer term?

The cost of buying transportation capacity and shipping product in every mode will continue to increase, albeit with periodic "adjustments" along the way. In part this will be due to rising costs (notably labor and fuel), a reduction of excess capacity, and, simply, carriers' ability to bump up rates from the low points they reached during the past 18 to 24 months.

Article Figures
[Figure 1] Annual productivity index for the U.S. rail industry
[Figure 1] Annual productivity index for the U.S. rail industry Enlarge this image

Within this general trend, railroads and their customers are facing a unique set of challenges related to capacity constraints. By gaining some historical perspective on these issues, shippers will not only better understand what's going on but also develop strategies to deal with market realities. Frankly, this is not nearly as simple as saying "Just regulate rail rates so they can't take advantage of us"—even though some seem to think it is.

From Staggers to the recession
Part of the challenge for buyers is dealing with the legacy of the Staggers Act in 1980, which deregulated certain commercial aspects of the railroad industry. Since the passage of that law, rail rates generally have fallen significantly—even as the carrier landscape consolidated to the "Big 6" we have in North America today. This also happened to rates in other modes that were deregulated. That means for 30 years, with few exceptions, capable supply chain managers at well-run organizations were able to cut their transportation costs in virtually all modes. From the railroads' perspective, that was okay because during that same period, productivity—driven by smaller crews, bigger locomotives and cars, longer trains, and more automation—reached its highest point in history. And, for the first time since the end of the World War II era, railroads' earnings approached and in some cases actually met their cost of capital. This improvement attracted a more robust infusion of capital and led to an unprecedented level of investment in infrastructure as well as in new locomotive technology and larger-capacity rolling stock.

This was all very good news until the productivity curves began flatlining in 2000 and then declining in 2006. (See Figure 1.) At the same time, the Class 1 railroads' networks began experiencing congestion, and service suffered.

In an effort to regain margin, railroads raised some rates (in general, only "slightly," according to the U.S. Government Accountability Office) beginning in about 2001.1 But the result was that shippers ended up paying more money for service that wasn't as good as what they'd received in the past. Meanwhile, railroads were faced with having to make much-needed and very large-scale investments, mostly in infrastructure improvement and capacity expansion.

But the long-term issues of capacity expansion and infrastructure improvement were shunted aside by the 2008-2009 recession. Because of the drop in economic activity, freight volumes declined, which led to more fluid networks and improvements in service quality. As a result, it became easier to forget the looming capacity problem. But this is only a temporary reprieve. As freight volumes return and continue to grow, the rail network will again become strained unless two things happen: the railroads expand capacity, and they continue to improve their operating efficiency.

A map prepared for the Association of American Railroads shows what the rail network would look like in 2035 if capacity has not been added, and it's not a pretty picture. Major portions of the network—particularly in the middle of the country—are predicted to have reached or exceeded capacity. If you combine that picture with what the highway infrastructure is predicted to look like at that point, the whole view becomes even more distressing for those who are tasked with moving product (or people).

The bottom line is that building and maintaining an effective national transportation network with sufficient capacity will require immense infusions of capital from both the public and private sectors. Best estimates put the rail capital shortfall (what's needed versus what the carriers expect to generate from earnings) at about US $39 billion. That figure, however, does not reflect the predicted $12–15 billion required to meet the federally mandated Positive Train Control initiative that's designed to prevent collisions.

Start now
As a shipper, why should you care about the future of railroad infrastructure? Because more money is needed, and it basically will have to come, in some ratio, from two places: increasing revenue (rates) and decreasing costs (making operations more efficient). The only other sources are investment capital, which is only attracted by strong growth and returns, and public funding, which comes from a well that already serves many other constituents.

The railroads are adept at minimizing cost and maximizing efficiency. But their ability to wring out sizeable additional productivity gains is diminishing because they have already made most of the easy-toachieve improvements. This does not mean that new ways to boost productivity won't be uncovered. New technology (such as electronic braking, flexible blocks, enterprise asset management for linear and rolling assets, and integrated information technology platforms) may open a new frontier in productivity, but timing will be a factor.

The sum of all this is that rates across all modes will rise, as will the total cost of shipping cargo (rates plus fuel and accessorial charges). The question is, how much and when? There will be some fluctuation, but the overall trend will inexorably be upward.

This may sound like it's too far in the future to be of practical use now. But I would argue that the best long-term strategies incorporate tactics for dealing with these broader, more complex issues, and achieving that takes time, strategic thinking, and discipline. Successfully serving customers while confronting some very challenging conditions in the future will require vision and planning that begins today.

You can take steps in the short run to begin this process by focusing proper and rigorous scrutiny on your existing and anticipated supply chain network, and then developing plans to execute an integrated, multimodal strategy that strives to account for the changes you foresee.

History can be instructive if we pay attention. In the 1960s a vice president of the then-bankrupt New Haven Railroad boldly stated, "We have vast problems and only 'half-vast' solutions." This approach will not suffice in the future. And procrastinating is not a good option.

Endnote:
1. "United States Government Accountability Office Report GAO-07-94," October 2006.

Brooks Bentz is a partner with Accenture in its Supply Chain Management Operations Practice.

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