Which track will the STB take?

While the Surface Transportation Board keeps the BNSF/CN merger on hold, the debate sharpens over the industry's future.

By -- Logistics Management, 6/1/2000

The decision by the Surface Transportation Board (STB) to declare a 15-month moratorium on rail mergers while it reconsiders merger guidelines has stoked the political fires of virtually every constituency and critic of the North American railroad industry-shippers, stockholders, intermodal companies, and the railroads themselves. Many industry observers believe that whatever the STB decides may have as much historical significance as the enactment of the Staggers Rail Act of 1980.

The immediate issue that the STB will consider during the moratorium period is whether to allow the Burlington Northern Santa Fe (BNSF) and Canadian National (CN) railroads to pursue their plan to form the largest rail system in North America. But according to many observers, that's not really the point. A carload of other issues must be addressed, they say, including the fallout from recent rail mergers, poor service quality, unresolved bottleneck and gateway questions, NAFTA trade objectives, and the threat of reregulation. On top of that is the looming "duopoly" question-what will happen if the BNSF/CN merger ultimately leaves only two railroad systems in North America?

These and other questions, says Robert Fort, a spokesman for the Norfolk Southern, lead him and many others to believe that it will be difficult in the future to view any railroad consolidation in isolation. Instead, he says, analysts will have to consider a merger proposal's impact on the entire transportation and distribution culture of the emerging North American trading bloc.

Strong Opposition

With so much at stake, industry opinions vary markedly and are seldom understated. Not surprisingly, the two carriers involved are among those who most strongly oppose the STB's moratorium decision. "We do not feel that there were any grounds for the moratorium, we think it's illegal, and both Canadian National and we have applied for a stay with the STB and the U.S. District Court of Appeals," says Richard Russack, a BNSF representative. "We think the moratorium is unlawful and unnecessary," adds Mark Hallman, a CN spokesman.

Hugh Randall of Mercer Management Consulting, a Lexington, Mass.-based firm that specializes in freight transportation, sides with the moratorium's critics. "We [don't support] postponing the merger process," he says. "[T]here are good mergers and bad mergers. Everything depends on what value is created by a merger in terms of service to the customer and the improvement of efficiency-and also how that merger is executed."

Many observers oppose the STB's 15-month-long timetable. Some charge that this schedule is extraordinarily long; one even describes it as a delaying tactic that is simply a "cave-in to the political pressures of other railroads."

There are some organizations, on the other hand, that support the moratorium. Michael Haverty, chief executive officer of the Kansas City Southern Railway (KCS), believes that the Surface Transportation Board should use that time to look at the industry as a whole. "I testified before the STB that we favored the moratorium and new guidelines for mergers," he says. "What was in the public interest 80, 50, 30, or even four to five years ago may no longer be in the public interest today."

Remembrance of Mergers Past

Regardless of whether they support or oppose the moratorium and the proposed BNSF/CN merger, it appears that almost all industry observers view the proposal in the context of past mergers. That's unfair, railroad executives believe. "We feel that we're being punished for the sins of others," says Russack of the BNSF.

It seems impossible, though, to avoid comparisons given shippers' previous experiences. "We do not have a problem with mergers and acquisitions per se," says Norman Black, manager of national media relations for United Parcel Service. "But unfortunately, over the last five years or so, the rail industry has been unable to demonstrate that [it] can make mergers work in terms of service to the customer. That's where our concern lies." Before the Conrail carve-up, he continues, customers were promised that there would be true integration, improvement in customer service, and real competition. "None of the above transpired," he contends. "Only since last June have we been seeing timetables and service getting back to pre-split-up levels. So we believe the rail industry and those who regulate it need to step back and figure out what they can do to improve this integration process."

Randall of Mercer Management Consulting argues that it's not valid to compare the BNSF/CN proposal with earlier mergers. "The Conrail split-up was an enormously complicated task, taking an integrated system and molding pieces of it onto two existing railroads. And the Union Pacific-Southern Pacific situation was difficult because it was a parallel merger involving overlapping networks with a lot of people displaced and facilities closed. But the proposed BNSF/CN combination, like the earlier Illinois Central-Canadian National merger, would be largely end to end. Its value would have to do with the improvement of North American rail service," he insists.

Concerns that the mistakes of the past may be repeated are the main reason why many observers are pushing the STB to look toward the future and address much broader policy matters. "The STB has to create and then protect an environment that fosters competition and innovation," says Michael Galardi, a partner in Andersen Consulting's North American rail practice. "If [it doesn't] do that, there will simply be a continuation of consolidations, not more reliability."

Promoting and protecting competition should indeed be a primary focus of the STB's deliberations, believes attorney Martin Bercovici of Keller & Heckman, a law firm that represents shippers. "The basic outcome I would like to see from these STB deliberations," he says, "is [the acknowledgment] that in the past, the agency has taken an unduly narrow view of competition and that it will accordingly change its policies to protect shippers against competitive loss."

Diane Duff, executive director of the Alliance for Rail Competition, agrees. "Our view is that overall, the STB has to start addressing some of the major policy issues before [board members] talk about mergers at all, and they're not doing that via this moratorium."

One such issue is the problem of rail "bottlenecks"-situations in which rail shippers can choose from competing carriers on part of a route, but either the origin or destination is controlled by a single railroad. Under current regulations, those controlling railroads may quote only through rates.

Shippers believe that this is an important issue that has wide implications for competitiveness in rail transportation, and they want the STB to reconsider current regulations. "What we would like to see is a change in the bottleneck policy and increased access in terminal areas so that shippers have the competitive environment that was intended as part of the 1980 Staggers Act," says Duff. "These are the real issues."

"The bottleneck issue is of particular concern to us," adds Bob Szabo, executive director of Consumers United for Rail Equity (CURE). "Shippers believe it's outrageous and inconsistent with any other regulatory policy in American industry. We support a policy that would require railroads to quote rates to interchange points when [the shipper requests that they] do so."

Szabo cautions that policy changes relative to the bottleneck issue shouldn't be linked exclusively to mergers. The policies have to apply across the board in the rail industry, he says; otherwise, shippers' problems won't be solved.

"A Negative Spiral"

At the same time that shippers are asking the STB to examine competition and other major policy issues, they also are hoping that the board will look at the deterioration of rail service in the United States. Shippers attribute this service shortfall in large part to railroad mergers, but the impact on the U.S. economy has been so widespread that some say it merits attention separate from the merger considerations.

It's critical that railroads continue to improve service, but some observers are pessimistic about the prospects for serious change. "I see an industry that is unfortunately very inwardly focused," says Bercovici. "Rail transportation seems to be the only industry in this country that is at war with its own customers. And if things don't change, the [railroads will] drive themselves into a negative spiral."

The railroads clearly are aware of their poor relations with customers. "What the railroad industry needs to do is develop a fundamental change in its thinking and focus on the customer," says Hallman of CN. "... The industry has to concentrate on quality service and develop significant strategies for e-commerce. These are both key issues in maintaining competitive viability; otherwise, the industry will continue to experience erosion of its market share."

Technology and electronic commerce, in fact, are likely to drive improvements in the customer-service arena, suggests John Bromley of the Union Pacific Railroad. "The e-commerce movement will [affect] railroads along with every other industry. Most of us have gotten into e-business and have found that it tends to make us more responsive to our customers," he says. "This is a question of improving the way we administer our business, and it provides a tremendous opportunity to enhance service."

Galardi agrees. "I don't think [railroads'] attitudes toward the customer will change a lot, but I do think they'll be easier to do business with because of technology. They'll be using the electronic media much more effectively, streamlining their internal processes, and providing better information to customers."

Headed for Reregulation?

When asked for their views on the future shape of the industry, most observers say they want policymakers to focus more on maintaining competition than on how many railroads there will be. "The actual characteristics of the railroads two to five years from now will probably be less important than the policies that govern them," says Duff. "For example, we wouldn't be in favor of a two-railroad system under the existing policy structure. But if we could have policies introduced that raise the level of competition to a point that makes today's system work the way it should, then ... maybe a two-railroad system wouldn't be so terrible. As things stand now," she adds, "competition is dwindling before our eyes."

Szabo holds a similar view: "We're less worried about how many railroads there are than about the need for competition," he says. "Shippers view current policy as protective and feel it has allowed railroads to broaden their universe of captive traffic to the extent that they can dictate the level of service and price."

Although a two-railroad system may be acceptable to some shippers as long as adequate competition is maintained, that possibility is troubling to many-troubling not only because of the kind of industry it might create, but also because of the regulatory reaction it may set in motion. "We are concerned that the political fallout [from the proposed BNSF/CN merger] might prompt a movement in Congress toward some sort of reregulation ...," says Bromley of the Union Pacific. "That is the single biggest threat to the railroad industry today."

"If we go to a two-railroad system, there are going to be new regulations because legislators will try to impose contrived competition," worries Haverty at KCS, who says his company is neither for nor against the BNSF/CN merger. "So I'm concerned there would be reregulation, which would not be good for the industry, for shippers, or for investors."

Regulators, therefore, should very carefully weigh any actions that would promote further industry consolidation, Haverty warns. "The market has [made it] clear that it's concerned about anything that would cause the reregulation of this industry. And I don't see continued consolidation without the potential of reregulation."

Freelance writer John Paul Quinn reports on a broad range of business issues for journals in the United States and Europe.

Service issues bedevil shippers