ON a December day in 1963, a 19-year old man walked through the gates of a St Louis - San Francisco Railway (Frisco) freight yard in Memphis, Tennesee, and clocked in for the first shift of what would turn out to be a remarkable career. Hunter Harrison was an astute and diligent worker with a tendency to ask questions, and from his early days oiling axleboxes on freight wagons his drive to keep trains moving smoothly soon caught the eye of his superiors.
Harrison rapidly rose through the ranks at the Frisco and Burlington Northern, which absorbed the railway in 1980, and joined Illinois Central (IC) in 1989, where he became CEO in 1993. Just three years later, the railway’s operating ratio (operating expenses as a percentage of revenue, a widely-used metric for measuring the financial performance of US railways) had fallen from 98% to 65%, compared with an industry average of 83%. Return on invested capital was 12%, far ahead of the 8% industry average.
Harrison’s railroading ethos centred on eliminating inefficiency and keeping locomotives and wagons on-the-move. Precision Scheduled Railroading (PSR), as this business strategy was marketed, consolidated networks, abandoned less-efficient services and lines, and shifted traffic wherever possible from hub-and-spoke operations centred on freight yards to point-to-point train movements.
By running directly from origin to destination, PSR cuts out shunting, avoids intermediate yarding, enables the operation of longer trains, increases average wagon velocity and reduces terminal dwell times. Trains on PSR railways run to a strict schedule - if the customer’s wagons aren’t loaded, the train won’t wait.
“Few things bothered [Harrison] more than underutilised assets,” Howard Green writes in Railroader, his outstanding biography of the four-time railway CEO. “If an asset isn’t used, Harrison wrote, “it’s a liability” because of the costs associated with owning it. Railroads only make money when cars are moving.”
IC’s stock had risen considerably by the time the company agreed a $US 2.4bn cash-and-shares takeover by Canadian National (CN) in 1998. Harrison became CN vice-president and chief operating officer and immediately set to work rolling out PSR.
Before Harrison’s arrival at CN, the railway quoted delivery times in days. “That drove Harrison nuts,” Green writes. “He wanted to quote in hours, not days. If a train was scheduled to leave at 8am, Harrison wanted it to leave at 8am, whether there were 60 or 100 cars. If you measured in hours everything got more precise. Things began to change at CN in the latter part of 1999 when precision railroading kicked in. Faster trains and better service resulted in better market share - and yield followed.”
To achieve sweeping change quickly, Harrison understood the need for the workforce to buy into his vision for how an efficient railway should operate. ‘Hunter Camps’ - three-day sessions for managers led by the man himself - meant the PSR ethos permeated quickly through the organisation and ensured Harrison’s operational philosophy would crystallise in the thinking of the next generation of managers. More than 1800 employees from all levels of management passed through Hunter Camps at CN before Harrison retired as president and CEO of CN in 2009.
CN’s operating ratio fell from 89% in 1998 to 61% in 2006, far below any of its peers. As a result of this productivity improvement, the firm’s average share price soared from $US 4.93 in May 1998 to $US 27.18 in December 2009.
Following his retirement, Harrison retreated from the corporate limelight to his estate in Connecticut, where he indulged in his passion for rearing horses for show jumping. However, his zest for railroading and his stellar reputation in the financial community as the rail freight industry’s turnaround man meant he would soon be back in action taking PSR to a third railway.
In autumn 2011, hedge fund Pershing Square Capital Management, led by activist shareholder Mr Bill Ackman, began buying up shares in Canadian Pacific Railway (CP) and launched a proxy battle with the firm’s board with the aim of ousting president and CEO Mr Fred Green and installing Harrison in his place. Pershing Square prevailed and Harrison was appointed in June 2011. Soon after the company began reducing its headcount, furloughing locomotives, closing yards and moving its downtown Calgary headquarters to former railway land on the outskirts of the city. By the fourth quarter of 2014, CP’s operating ratio was down to 59.8%, ahead of even CN.
By 2017, average train length had increased by 21% compared with 2012, while average train speeds were up 26% and terminal dwell times were down 12%. Train accident frequency had fallen by 41% and CP was the safest Class 1 for the 12th consecutive year in 2017.
After his departure from CP, Harrison was appointed CEO of another Class 1 railway, CSX, in March 2017. Applying PSR at CSX would not be easy given the size and complexity of the network, but Harrison relished the challenge and the markets were confident in his ability to work wonders - stocks began to rally when it became clear Harrison would take over, climbing 23% in just one day to add $US 8bn to the firm’s value.
CSX quickly converted seven of its 12 hump yards (dubbed “major cost centres” by Harrison) to conventional flat yards, increased train lengths by 12.5% and cut the average number of wagons on the network from around 150,000 in the first quarter of 2017 to less than 120,000 at the end of 2018. In the first quarter of 2017 - the final quarter before Harrison was appointed CEO - the operating ratio fell to 69.2%, at that time a record low. By the second quarter of 2019 it had fallen to 57.4%, a figure unthinkable a decade ago and testament to Harrison’s talent as an astute railroader.
Under CSX’s PSR strategy the fleet was reduced by 900 locomotives and 26,000 wagons by the end of the second quarter of 2017 and Harrison aimed to cut the railway’s 31,000-strong workforce by nearly a third.
Following a period of ill health, Harrison died in December 2017, just eight months after taking the reins at CSX.
Harrison’s legacy is written in the financial results of the railways he led, and the fact that variants of PSR are now being adopted by the other Class 1s. Harrison protégés now lead the industry. CSX president and CEO, Mr James Foote, and his counterpart at CP, Mr Keith Creel, both worked under Harrison at CN. Mr Jim Vena, a 40-year veteran of CN and its chief operating officer until his retirement in 2016, is now spearheading Union Pacific’s PSR programme as the railway’s COO. Harrison’s focus on nurturing talent within the railways he led will cement the PSR doctrine in Class 1 boardrooms long after his death.
With its cost base lowered and restructuring largely complete, CSX’s PSR model is now focussing on asset management and wagon movements to achieve more balanced network flow. “Crew balance is part of this,” independent railway economist, Mr Jim Blaze, wrote in IRJ’s US sister magazine Railway Age in July. “CSX is looking to avoid disruptions from ‘surprise’ extra movements. And beyond its internal track network, CSX is working to balance freight car interchange flows to and from its railroad partners.”
The stellar improvement in Class 1 operating ratios has excited the financial community over the last decade, but some commentators are weary of judging the success of PSR by its impact on operating ratio. “A broader range of metrics is essential to assessing trade-offs, such as between operating and capital expenses; productivity, skilled labour and technology; static margins and growth; and impacts on safety,” Mr Frank Wilner, Capitol Hill editor for Railway Age, wrote in February. “In fact, an obsession with lowering the operating ratio can feed a perverse result. While deferring maintenance and shedding locomotives, employees and track-miles reduces operating expenses and improves operating ratio, such actions can discourage new business, irritate existing customers and labour partners, adversely impact safety, and attract unwelcome meddling by lawmakers and regulators.”
Wilner notes that CN reinstated double track on parts of its network “to remedy capacity problems resulting from Harrison’s obsession with beating down the operating ratio.”
This also raises the question of resilience and the Class 1s’ ability to quickly recover from disruptive events such as severe weather.
According to Mr Rick Paterson, managing director, equity division for Loop Capital Markets, there is no conclusive evidence that PSR railways recover faster from “meltdown level” disruption. “If we look at the seven North American Class 1s since 2014, CP and CN have each blown up once while UP, BNSF, CSX, NS and KCS have all blown up twice,” Paterson explains. “I’m defining blow up as a crew- or power-induced capacity crunch that erodes operating metrics by more than 10% off long-term averages for at least two quarters. The other evidence of resiliency is that CSX comfortably navigated hurricane season last year while NS took a bigger hit despite having less infrastructure and operations in harm’s way.”
“With regard to recoverability, the jury is out. Some customers worry that PSR railroads have more risk because crew and power resources are finely tuned with very little in the way of backup, latent, capacity. With little margin for error if things go wrong there are no resources to ride to the rescue.”
In the wake of the Polar Vortex which struck parts of Canada and the United States in early 2014, PSR railways recovered no faster than their peers. “CP took five quarters to recover - the same as UP and CSX and one quarter slower than BNSF,” Paterson says.
CN went into an operational meltdown in the fourth quarter of 2017 due to a 10% year-on-year surge in volumes. Average train speeds were still 10% below their post-recession average into the second quarter of this year, with another harsh winter hindering the recovery. “CN still isn’t running ‘like CN’ a year-and-a-half later,” Paterson says. “Its full recovery has actually taken longer.”
“Logically, we would expect PSR railroads to be more resilient because they’re a more simplified operation. There are fewer trains, fewer crews, and fewer locomotives per unit of freight compared with non-PSR railroads. Less trains on the network equals less risk of congestion and therefore the nasty feedback loop of congestion reducing network speeds, which in turn makes congestion even worse, impacting speeds and so on.”
CN is investing heavily in capacity, with measures including hundreds of new locomotives, thousands of new wagons, passing loop extensions and freight yard expansion (IRJ July 2018 p22). Under its 2018 capital plan, CN invested $C 3.4bn last year and the railway is spending a further $C 3.9bn across the network this year.
Converts and sceptics
Given the impact of PSR on the financial performance of the Class 1s, it should perhaps come as little surprise that variants of PSR are now being implemented by non-Harrison railways. Norfolk Southern began developing its Top21 PSR concept last year as part of its Reimagine Possible three-year strategic plan, using computer modelling and simulation tools to analyse data and train flows to “achieve optimum network fluidity and velocity.”
The stated aims of Top21 mirror those of previous PSR programmes: fewer, heavier trains; a balanced network and asset flows; more direct routing between origin and destination pairs; reduced reclassification; full integration of local and system operations; and lower costs.
Following extensive consultation with employees and customers, NS launched the first phase of Top21 in July, focusing initially on wagonload and automotive operations. NS said in July that the launch of Top21 had been successful with “a seamless changeover with minimal impact to customer service and network operations.”
NS plans to cut around 3000 posts from its workforce of 26,000 and store 500 of its 4100 locomotives.
In September 2018 Union Pacific (UP) revealed its new Unified Plan 2020, which aims to cut the railway’s operating ratio to 60% by 2020, and ultimately to 55%, by adopting PSR principles. Key features of the plan include:
- shifting the focus of operations from moving trains to moving wagons
- shifting the focus of operations from moving trains to moving wagons
- minimising wagon dwell time, wagon classification and locomotive power requirements
- utilising general-purpose trains by blending existing train services, and
- balancing train movements to improve rail asset and crew utilisation.
Implementation began in October 2018, initially focussing on the Wisconsin - Texas corridor, and UP expected to complete the rollout across the rest of the network by “mid-2019.”
Average train length increased by 10% between January and June, while wagon terminal dwell time fell by 14% in the second quarter of 2019, compared with the corresponding period in 2019. Wagon velocity is up 4% year-on-year, locomotive productivity has climbed 19%, and workforce productivity is up 4%. UP had 2150 of its 8300-strong locomotive fleet in storage on June 30 and its workforce was down 8% year-on-year. Second quarter operating ratio was a record 59.6%.
However, not all of the Class 1s are buying into the PSR philosophy. As a subsidiary of Berkshire Hathaway (the holding company of billionaire entrepreneur, Mr Warren Buffett) BNSF Railway is unique among the Class 1s in answering to only one shareholder. Mr Matt Rose, executive chairman of BNSF until his retirement in April, has publicly criticised PSR.
“A PSR method that seeks about $US 125m in cost savings from every thousand employees cut isn’t thinking long-term, as it often ignores service disruptions to customers,” Rose told Railway Age editor-in-chief, William Vantuono, at the Rail Equipment Finance 2019 conference in La Quinta, California, in March. “Cutting capex to a lower percentage of revenues, for example, less than 15%, to achieve PSR goals isn’t the correct measurement.”
Rose says the corporate focus for BNSF is on continued volume growth. “BNSF needs to grow units, not just revenue yield,” he says. “Disengaging from our customers to change internal cost savings is not a good long-term business strategy. De-marketing tactics can result in unanticipated but logical bad public policy outcomes. There’s nothing wrong with being a low-cost supplier, but ignoring your customers until you hit a wall on costs can have undesirable longer-term consequences.”
The impact of PSR on wagon utilisation also remains unclear. According to analysis by FTR Transportation Intelligence, wagon utilisation figures have remained flat since the implementation of PSR. “The historical long-run average for utilisation is around 82% and we are in the mid-to-upper 70% range through our forecast period extending through to the end of 2020,” says FTR vice-president, rail and intermodal services, Mr Todd Tranausky.
“The loss of freight has outweighed any sort of efficiency benefits shippers might have received from PSR. There is simply less freight out there that needs cars to move it compared with 2018. Part of that is a response to the weaker truck market, part of that is a slowing economy, but certainly part of that is also PSR and the changes carriers have made to their networks.”
Technological advances may help to change this. CSX is introducing better-integrated IT tools to accelerate customer wagonload routing. A mobile reporting tool enables CSX field crews to remotely direct wagon dispatching from origin to destination, avoiding delays at intermediate yards.
While PSR has generated handsome returns for shareholders, some critics question the long-term impact of continually driving down operating ratio. “After the initial PSR results are in, what happens to the investment capital ‘saved’? It’s buying back shares - in some cases by adding debt - and paying out continuing high dividends,” explains Blaze. “Maybe $US 60bn or so has been collectively declared ‘not needed for modern PSR railroading.’ That worries me strategically.”
Conversely, Blaze notes that the PSR Class 1s are in a much stronger position in terms of capital. “There is no longer a capital shortage,” he says. “There’s no longer a lousy return on invested capital. Return on investment is now in the incredible 14-18% range. I never thought I’d live to see that happen.”
In an industry under immense pressure from road competition, the North American freight railways have become well-accustomed to pursuing operational efficiency wherever gains can be made. “Cutting costs is part of the railroad cultural DNA in the United States, that’s actually not anything new,” Blaze says. “However, slashing capex expenses and cutting assets like locomotives out of the balance sheet is pretty aggressive with the PSR model. It’s a lot more aggressive than what I witnessed in my 40-year career. You never wanted to be short of horsepower and tractive effort on trains.
“PSR appears to have definite advantages to some parties. However, the focused cost cutting is done with a slash-and-burn zest rarely seen before by previous cost-cutters.”
Some rail freight customers have found the transition to PSR to be a difficult one. In August 2017 the Rail Customer Coalition wrote to the US Surface Transportation Board (STB) urging it to act on what it saw as a serious deterioration in service quality at CSX: “There are chronic service failures occurring across the CSX network which are impacting the entire North American rail network,” the coalition said. “Major service changes have been imposed with little advance notice, and CSX’s response to customer complaints has been woefully inadequate. Rail customers have had to take extraordinary steps at great cost to meet the needs of their customers because CSX has repeatedly failed to pick up and deliver cars. This has put rail dependent business operations throughout the US at risk of shutting down and caused severe bottlenecks in the delivery of key goods and services.”
Harrison said the RCC’s claims were “unfounded and exaggerated,” while admitting that a small minority of CSX staff were resisting the programme of “transformational changes” being implemented at the time, resulting in service disruptions.
Nonetheless, for many rail freight customers, PSR has meant recalibrating their operations to receive and dispatch wagons outside normal business hours, or handle more wagons on a given day. Some shippers have reported receiving “bunches” of wagons, exceeding their capacity for timely loading or unloading, while the time allowed for wagon handling has decreased.
Customers incur demurrage charges when they exceed specified wagon handling times or leave wagons on railway property for too long. All Class 1s have increased demurrage fees over the last two years and shippers claim they are feeling the pain.
At a Surface Transportation Board (STB) hearing on demurrage and access charges in Washington DC in May, railway customers vented their frustrations at demurrage penalties. “Shipper after shipper made the same point: PSR is neither precision nor scheduled,” says Mr Steven Ditmeyer, principal of Transportation Technology and Economics, who attended the hearing. “They said that the service they received from their carriers had deteriorated since PSR had been implemented, and that demurrage, switching, and/or storage charges and their own internal costs had increased. Only BNSF and Kansas City Southern escaped criticism from the shipping community during the time I was there.”
The STB says it is closely monitoring the implementation of PSR programmes at UP and NS.
Creel said in CP’s fourth quarter earnings call in January that customers are now enjoying better service as a result of PSR. “Talk to our customers that may have resisted the change at the onset,” he says. “They are happy customers today because we’ve created precious capacity, allowing those customers that have partnered with us to win in the marketplace.”
“If you look to the rhetoric and concern about investment in infrastructure, we’ve never invested more money. Look at our safety record: It’s never been better. So if you want proof that PSR works, if it’s executed properly, there’s a case study out there.”
Blaze says the emphasis in the initial phase of PSR transformations has been on reorienting the railway towards more efficient operating methods, which can be a difficult process for customers, but this does not mean the Class 1s have lost focus on the shipper. “As the PSR timeline passes, the PSR railroads turn back towards more customer service and IT-based process re-engineering,” Blaze says. “The CN strategic plan execution changes over the past half-decade bear that ‘focus shift’back to the customer out.”
With the rollout of Positive Train Control (PTC) now 90%-complete, Ditmeyer argues that the Class 1s should be looking to harness the capabilities of technologies they have already invested billions in to deliver greater precision in their operations. “If railroads utilise the continuous, real-time, accurate information on train speeds and locations that they receive from GPS receivers that are part of their newly-installed PTC systems, and integrate it with train consist information, work order reporting systems, locomotive health reporting systems, and yard management systems, they can really run a scheduled railroad with precision,” Ditmeyer says. “This provides much better service to their customers that, in turn, provides opportunity for traffic growth and higher profits.”
With all but one of the Class 1s adopting PSR, the story of Harrison’s legacy is still playing out. The balance sheets of the North American freight railways tell a remarkable tale of success in driving efficiency and financial strength for an industry seemingly in terminal decline when Harrison joined the Frisco in 1964. Of course, the railways achieved great gains in the wake of the 1980 Staggers Act, which deregulated the industry and enabled companies to make efficiencies and invest in their systems. Some commentators have argued that PSR is an evolution of what the Class 1 managers were already doing, and in that sense is more of an evolution than a revolution. The question now is whether the Class 1s can sustain record-low operating ratios while maintaining their assets and service quality at the level demanded by their customers.