Railroads: Asleep at the Switch

Lousy service is driving away freight customers

Tensions are running high on the nation's tracks. Just ask BP Amoco (BP ), the world's third-largest chemical producer. Last year, the London-based conglomerate shipped 25 million tons of chemicals by rail. Now, BP is making hefty investments in trucking fleets. It's not the most cost-effective or the safest way to ship chemicals, but it is a sure thing. "It's hard to guarantee consistent, on-time deliveries to our customers," says Caroline S. Thompson, director of customer logistics at BP's Naperville (Ill.) facility. "It's becoming nearly impossible to rely on freight rail."

She's hardly the only disgruntled shipper these days. Consolidation in the rail industry has left many a chemical, coal, and agricultural shipper more than grouchy. They may be paying less than they did before deregulation, but railcars arriving days late are no good, no matter how cheap. In exasperation, the shippers have taken to the roads, the courts, and even the halls of Congress to improve the situation.

Take DuPont, the nation's largest chemical company. It filed a lawsuit against Norfolk Southern (NSC ) following the carrier's 1999 acquisition of Conrail, which resulted in a herd of late and lost deliveries. A year before, Dow Chemical (DOW ) sued Union Pacific (UNP ), after its clumsy 1997 acquisition of Southern Pacific resulted in service outages that cost Dow more than $25 million in lost revenue. Since then, both carriers have integrated operations and improved traffic-flow plans.

OFF TRACK. The problems began with an effort to save the rail industry. Prior to 1980, railroads were drowning in debt, and one in five was headed to bankruptcy court. Plus, an increasing number of derailments and other safety problems plagued the industry. Congress was left with two options: Nationalize the rail system and pass the heavy tax burden on to citizens, or deregulate it entirely. Not surprisingly, in 1980, Congress passed the Staggers Rail Act, which freed the industry from 100 years of regulatory restraints. A string of freight-rail mergers ensued. Rail operators maintain the consolidation led to cost reductions, new economies of scale, and increased efficiency across the industry. "These mergers were a solution to problems, not the cause," notes John Bromley, director of public affairs at Union Pacific.

The shippers aren't so sanguine. Most agree that deregulation was necessary. But they argue that the problem starts with the Surface Transportation Board, the agency in charge of overseeing the industry. By shippers' reckoning, the STB protected the rail systems at the cost of the shippers. Sure, shippers are paying less--the STB figures that, on average, inflation-adjusted rail rates fell 45% since 1984. And overall safety has improved. But two decades after deregulation, the number of so-called Class I rail companies (those with revenues in excess of $250 million and which generally operate across state lines) has dwindled from 42 to 9, with four carriers dominating 95% of all freight rail traffic, two in the East and two in the West.

ANTIQUE. Critics contend this duopoly means late cars and lost goods. "For most shippers, it's not about rates, it's about service. Mergers have permanently lowered the bar," says Ed Rastatter, director of the National Industrial Transportation League, a Washington (D.C.) lobbying group that represents shippers.

Part of the problem could rest with the mountain of customer-service staff layoffs that came in the wake of rail mergers, or the snail's pace of long-promised innovations. Some systems still use 1950s-style routing technology and measure on-time car performance in days instead of hours. Shippers also want rail carriers to provide improved real-time satellite-tracking services for their cars.

But most of all, shippers want to see more competition. In many cases, this means laying more track to hook up a shipper to a second railroad. Problem is, that's easier said than done. A mile of track costs $1 million--prohibitively expensive for a $36 billion industry that can't earn its cost of capital. "Deregulation may have brought the railroads back from the dead, but they're a far cry from full recovery," says Jim Valentine, a freight analyst with Morgan Stanley.

Shippers have been left with few options. A number of chemical companies have resorted to increasing inventory levels to circumvent rail service problems--not the most favorable option, especially in times of economic downturn, notes the American Chemistry Council. Others, such as BP, have simply swallowed the higher cost of switching to trucks. Writ large, this trend means that while rail tonnage has grown by 32% since deregulation, truck loads have multiplied by 150%. Today, trucks move twice as much material as trains.

For some shippers, though, trucks are not an option. Because of federal transportation safety laws, chemical manufacturers can ship certain toxic materials only by rail--even when service gets lousy. And some goods are simply too expensive, and massive, to move by truck--a coal-fired power plant can burn tens of thousands of carloads of the black stuff in a year.

What's more, the consolidation has left some shippers connected to just one rail system and facing much higher costs. According to the Alliance for Rail Competition (ARC), these "captive" shippers account for about one-third of the Class I railroad revenues in 2000. Jerry R. Ellig, a senior rail-research fellow at George Mason University, estimates that captive shippers commonly pay rates 20% higher than shippers with competitive alternatives.

In some cases, it's much higher. A group of captive shippers in the Buffalo (N.Y.) area say recent mergers have left them paying rates three times higher than the national average. "When you only have one carrier and you have to go by rail, you have no choice," says Ronald W. Coan, executive director of the Erie County Industrial Development Agency, which represents aggrieved shippers.

Railroads maintain that, like airlines, they must price differentially to maintain and improve their infrastructure. And any change in regulations would make investors nervous. "If we don't charge customers with options a lower rate, we won't get their business. The people who pay slightly more are better served in the long run," says Tom White, spokesperson for the American Railroad Assn., a Washington lobbying group representing Class I carriers.

Captive shippers' hands aren't completely tied. They can bring unreasonable rate cases before the STB. Or they can partner up with other Class I carriers to lay additional track--something Burlington Northern Santa Fe recently announced it will do to provide competition to a captive Dow Chemical plant in Texas. Likewise, Coan in Buffalo is trying to establish links from the region to Canadian National's network. However, it's no secret both options are expensive, cumbersome, and rarely used.

Since the early 1980s, shippers have looked to lawmakers for relief. Groups such as ARC and Consumers United for Rail Equity have renewed their perennial lobbying efforts. The wish list for 2001: for Congress to overturn a string of recent STB decisions that allegedly make competition along the nation's rails difficult. Their second wish: Require railroads to submit service performance reports to the government.

UPHILL BATTLE. At the end of March, a Senate subcommittee will hold hearings on the state of the rail industry. In June, the STB will finalize new rail-merger guidelines, to ensure that outages that occurred in the wake of past rail mergers don't happen again. It's a good chance for shippers to push their case, but it will likely be an uphill battle. "Congress jumped when they heard the airlines may collapse into three major carriers. But it's like pulling teeth to get anyone talking about railroads," gripes Dianne Duff, executive director of ARC.

Most captive shippers have been slow to air their grievances out of fear the railroads could retaliate with price spikes. Plus, the carriers have done a better job of cementing their political ties. Rail lobbyists have been in Washington since the mid-1800s, when the continent was first girded. In 2000, the rail industry gave $6 million in campaign contributions, mostly to the GOP. That eclipses giving by the trucking and airline industries, and most shipping groups.

Washington politicians know it would be foolish to re-regulate the railroads. Even peeved shippers don't want to see that happen. Still, if the Class I rail carriers don't beef up service soon, they'll have other problems to ponder: fed-up shippers who abandon the tracks for the highway.

By Nicole St. Pierre in Washington

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