Railway Age, September 1995

Value for All Stakeholders

Anyone who follows the business news these days knows about organizations that streamline themselves into the hearts of Wall Street.

Restructurings, cost containment, retrenching to core businesses -- all of these techniques add value to the bottom line, pleasing stock analysts and stockholders. It's one of the kinds of value that any publicly traded company must consider: value to the stockholder. But stockholders aren't the only stakeholders in a business. As short line marketers we know this very well. Savvy investors know it, too.

In the overall field of goods movement the clear leader, unsurprisingly, was the trucking industry. The average trucking firm earnings for the last three years grew at an annual rate of 43%, according to Standard & Poor's. The Class I rails' average -- absent extraordinary items -- was half that. On the other hand (and perhaps surprisingly), the smaller publicly-traded rail lines' earnings have been growing at a rate in excess of 30% a year. How is Wall Street reacting to this? Transportation has had a good year, and Class I stock prices are up 32% on average. The three leading publicly traded feeder line stocks, on the other hand, are up a startling 60% -- and the lowest performer of the group is gaining fast as more investors discover this thinly-traded stock.

Looking ahead, Standard & Poor's projects trucking earnings-per-share growth at 47% for this year and at an average annual rate of 18% five years out. By comparison, the Class I rails are in the 10-15% range for this year and not much better for the longer term. These Class I forecasts, moreover, are based on revenues that are essentially flat. How are they going to do that?

Class I watchers know very well how they're going to do that. The Class Is are enhancing shareholder value by cutting spending -- 500 managers furloughed here, 200 locomotives stored there, train starts reduced, the list goes on. But cutting expenses ultimately means not running trains, which means cutting service opportunities. In turn, this means less chance to add value to the service package, and less chance to grow the top line. A cost-containment strategy ultimately reaches a point beyond which there are no efficiencies to be gained. It also runs a significant risk of stripping away the resources necessary to improve the bottom line by growing the revenue side. Finally, it caters to the needs of one set of stakeholders -- the investors looking for ROI -- at the expense of other very important stakeholder groups such as customers, co-workers, and communities.

Remember those Class I numbers -- 22% growth over the past three years, and projections in the 10-15% range. Now let's take a look at specific publicly traded Class II and Class III lines. How are they doing? According to Morningstar, they're doing substantially better: in the last three years, RailTex, for example, had an average annual compound earning gain of more than 30%. Wisconsin Central's was double that, and Providence and Worcester triple. Looking forward, we see similar stories.

There is an element of apples to oranges here. Comparing earnings of a new small company with those of a mature big outfit is bound to give then new kid on the block an edge. However, the critical observer will note RailTEx and others are growing earnings partially by acquiring the very lines the class Is are selling off, and revenue grows as mileage grows. Class Is are trying to increase revenues as mileage -- and the numbers of customers -- shrink. Unfortunately, the only way to do this is to charge fewer customers more money. How long can you keep that up?

The high-performing short lines have some characteristics in common, whether publicly traded or not. They all have a major emphasis on providing customer value -- by following Henry Ford's lead, saying, "I can sell this product for X. If I can make it for Y, I can build the top line." Note that Ford took *market price* as the given, not his costs. Rather than walk away from business where the margins are too thin -- or raise their price to raise their margins -- feeder line managers are almost fiendishly clever in the ways they stretch their resources to deliver the service, meet their customers' pricing objectives, and still garner an acceptable return.

This diabolical inventiveness, though, demands a customer orientation that's alien to many hard-core railroaders, to whom the softer, people-focused side of the business has never been part of their comfort zone. Rails and wheels cast in steel and numbers cast in stone are controllable; how a customer reacts to a proposal is not. So rather than deal with the fuzzy side of the business, many asset-based managers focus on what they can control: costs. And when they can't make costs behave they walk away. From revenue.

Worse yet, some Class I managers don't necessarily walk away with grace or even simple good manners. Lest this degenerate into Class I bashing, let me hasten to praise those many Class I managers who try very hard to be responsive to customer concerns. Still, there are plenty of former rail shippers on feeder lines who talk about the predecessor railroads in the same tones our grandfathers used to talk about Sherman's march to the sea. They recall diminishing service, promises made and not kept, phone calls not returned, as lines were demarketed on the way to sale or abandonment. This adds up to a lot of stakeholders sacrified in the name of shareholder value.

Most shortlines may not have shareholders the way Railtex and Wisconsin Central do, but they certainly have stakeholders -- their customers, employees, communities and connecting Class Is. While the Class Is continue to "grow earnings mostly through cost cutting and only marginally through carload growth" (that's Edwards again), the Class II and III lines are uniquely suited at -- and proven adept at -- following the lead of other true growth industries. They've provided customer value first and their stakeholder value follows.

What's more, the publicly-traded Class II and III lines who consider the needs of all their stakeholders are consistently outperforming the slash-and-burn Class Is It's only a matter of time until shareholders put their money where the stakeholder value is.

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Created December 6, 1995. Send comments to lblanchard@aol.com