When states sell, shippers win

As more governments turn state-owned carriers into private enterprises, shippers are benefiting from lower rates and greatly improved service.

By Toby B. Gooley -- Logistics Management, 10/1/1999

For centuries, governments around the world have jealously guarded what many have considered to be among their most prized possessions: their nations' transportation systems.

In many countries today, railroads, airlines, and ocean carriers still are state-owned and -operated. The reasons are threefold. First, freight and passenger transportation have long been seen as reliable, consistent sources of income for national treasuries. National security interests also have influenced governments' decisions to control transportation. And third, for some countries, state-run transportation has been a means of providing many thousands of jobs and cheap, subsidized freight and passenger service to even the remotest areas.

Today, however, economic conditions have changed and governments of all stripes are finding that their needs can be met by letting private firms manage their transportation systems. As a result, many are turning railroads, airlines, airports, ocean carriers, port operations, and postal services over to private businesses. As the sell-off trend gains momentum, shippers around the world are benefiting from the significant cost and service improvements privatization can bring.

A Change of Heart

The list of countries and trade blocs that already have privatized or are in the process of privatizing their transportation services and infrastructure is growing. This trend cuts across geographic and political boundaries, affecting countries as diverse as South Africa, the United Kingdom, Australia, Guatemala, Argentina, and even the People's Republic of China, to name just a few.

After decades or even centuries of strict government control over transportation infrastructure, why have so many governments had a change of heart? According to experts in the field, it ultimately comes down to money.

In some cases, cash-strapped governments need the annual royalties from private transport operators for a short-term infusion of capital, says Arnold Levine, managing director of GKMG Consulting Services and an adviser to several foreign governments on transport privatization. More often, however, the prime motivation is the desire to spur economic development, he says. "When they look toward the future, they realize they need more capital to make improvements to their infrastructure. ... Greater efficiency and newer infrastructure lead to a better environment for investors to come in and develop tourism, manufacturing, and related facilities."

In many countries, state-owned transportation providers are such a pervasive part of the economy that privatizing them can have an enormous impact on the national economy, says William J. Rennicke, a vice president at Mercer Management Consulting and a consultant to foreign governments on railroad privatization. "Typically, these changes take enormous costs out of the system," he reports. Argentina's privatization of its national railway, for example, helped the government avoid huge deficits while reducing the tax burden on the economy, he says. It also allowed the railroads to reduce rates, he adds, so shippers benefited from reductions in indirect costs like taxes as well as in direct costs.

An analysis by Rennicke's colleague, Mercer Vice President William C. Harsh Jr., found a host of external and internal pressures that led governments to privatize transportation monopolies. In addition to those already mentioned, Harsh includes transport deregulation, changing customer requirements, changing competitive dynamics, the introduction of new technology, unsatisfactory financial returns, and labor pressures among the reasons why governments privatize transportation networks.

Riding the Rails to Profitability

Railroads often are governments' first targets for privatization. Rail networks have been privatized to varying degrees in Argentina, Austria, the United Kingdom, Brazil, Guatemala, Germany, New Zealand, Japan, Colombia, Sweden, Canada, Australia, Chile, Mexico, and Gabon, among others. Rail privatization also is being considered in the Czech Republic, Hungary, Poland, and South Africa.

There are several models for railroad privatization. Some governments retain ownership of the track or the land it sits on and allow private firms to operate passenger and freight services. These companies may own the locomotives and rolling stock, or they may lease them from another private provider. Most often, governments award operating rights as "concessions" to private firms through a bid process. The winner agrees to make specified investments and pays rent or royalties to the government in question.

Not all of these schemes have been equally successful. According to a recent report by Mercer Management Consulting, "open access" models, in which infrastructure is operated as a regulated monopoly and multiple operators are allowed to provide service over the track, have not met performance expectations. In countries that adopted this model, such as the United Kingdom and Australia, competition has not increased markedly and governments continue to subsidize the rail networks heavily, say Mercer analysts. Countries that have adopted a "vertically integrated" model, on the other hand, have been more successful in meeting their objectives. Under this scheme, private operators control access to both track and service, and may negotiate access by other operators.

When it comes to operating newly privatized railroads, the most successful companies without doubt are the U.S.-based short-line and regional railroads. That's because the United States has a legacy of experienced, private-railway operators, explains Rennicke. "The small U.S. players have built a business out of taking over small segments of big railroads. These overseas rails are very similar [to the short lines' U.S. business] in size and the commodities they carry," he says. The short lines and regionals, moreover, are much better suited in terms of management structure, flexibility, and entrepreneurial culture to take over a foreign rail operation than are the Class I railroads, he adds. It's no surprise, then, that companies like Anacostia & Pacific, Genesee & Wyoming, OmniTRAX, RailAmerica, Rail Development Corp., Railtex, and Wisconsin Central all manage railroads overseas.

All of these companies have been successful in reducing operating costs and greatly improving service for the railroads' customers. Usually, they have been able to slash freight rates and in many cases restore service that had been abandoned by the state-owned railroad. An interesting example of the latter is the case of Guatemala, where the government had shut down both passenger and freight operations completely. Pittsburgh-based Rail Development Corp., which was awarded a 50-year concession in 1997, has been repairing and upgrading track, building new operations facilities, purchasing new passenger and freight cars, and working to create connections with railroads in nearby countries. Thanks to these efforts, Guatemalans now have passenger service for the first time in more than five years, and manufacturers that have never even considered using rail service can give it a try.

A closeup look at another such arrangement--that of the New Zealand Railway--shows how privatization can radically change the cost and service picture for shippers. Over the years, the state-owned railway was required to run unprofitable services in support of government programs that encouraged economic development in depressed areas. It also was required to train more apprentices than it needed, and at times was ordered to provide jobs in depressed areas whether the labor was needed or not, recalls Fred Cockram, corporate manager for Tranz Rail, a Wisconsin Central operation that took over the New Zealand Railway in 1995.

The sale was partly motivated by a shift in the political winds away from a "cradle-to-grave" welfare economy in New Zealand. It also gave the New Zealand government cash to pay off some of its overseas debt, removed its responsibility to underwrite the railroad's enormous operating losses, and placed responsibility for upgrading its deteriorating infrastructure on a private party, says Cockram.

Thanks to years of government effort prior to the sale and four years of significant investments by Wisconsin Central, Tranz Rail has been transformed from a seemingly hopeless case into a profitable company that is listed on stock exchanges in New Zealand and the United States. Although total employment has been slashed by approximately 80 percent, efficiency has soared. In 1983, New Zealand railways employed 18,740 people and the number of net metric tons moved per kilometer per employee was 168,839. By June of 1999, the number of employees had dropped to 3,696, but the number of net tons per kilometer per employee had risen to 993,423. The freight-rate index, which measures the rate charged per net ton kilometer, has a base of 100 in 1983. By June of this year, it was down to 35.

According to Cockram, one of the most significant changes privatization has made for shippers is Tranz Rail's expansion beyond simple point-to-point transportation. The company has established one of the largest trucking fleets in the country and has purchased both an international freight forwarder and a refrigerated motor carrier. In some cases, he adds, Tranz Rail has even taken on the role of third-party logistics provider, handling a few customers' distribution and warehousing requirements. Extensive upgrading of information technology has allowed the railroad to improve its information exchange with customers. It's likely that few if any of these investments would have been made if the railroad had remained under government control, Cockram says.

Political Pressure on Airlines

Other modes of transportation--and the shippers that use them--also are benefiting from the global selloff of operating rights. For example, container-terminal operations in the Port of Santos, Brazil, were awarded to private operators last year. Within months, productivity had soared and congestion on the docks and in local warehouses had cleared. Mexico's major ports, under private management for several years now, have become more efficient and competitive, although further improvements are under way. Even China's Communist government has come to recognize that the private sector can do some things more efficiently and cheaply than the state can. China has granted operating authority to P&O Nedlloyd, for example, to run several container terminal operations in that country.

Airlines and airports, including some air-traffic control and ground handling services, are being commercialized in such countries as Mexico, Argentina, Chile, Canada, Australia, Kenya, and Macao as well as in the European Union.

The concerns that led to the privatization of airlines and airports are similar to the conditions that led to the privatization of railroads, says Levine: governments' need to resolve chronic cash shortages, inefficient operations and substandard service, and aging equipment and infrastructure. State-owned airlines also may suffer from management that pays more attention to political pressures than to market demand, he notes. The trend toward airlines forming operating and marketing alliances to reduce costs while expanding services, moreover, is encouraging airline privatization, he believes. "Airfreight and air travel today really is a global game. If private airlines are looking for alliance partners, they generally will be more comfortable working with an airline that's marching to the same beat," he explains.

Any privatization initiative can be highly sensitive, but airlines in particular are subject to extreme political pressure because they often symbolize a country's international prestige. Such was the case with Air France, a national icon in its home country. As a member of the European Union, France was committed to deregulating transportation, including privatizing its national airline. In the early 1990s, however, a partially privatized Air France was suffering enormous losses; the possibility of collapse seemed very real. In 1994, the French government gave Air France the equivalent of $3.3 billion in financial aid. At that time, the European Commission approved the payment, but some already-privatized airlines, including British Airways, Scandinavian Airline System, and KLM, objected to the aid as "distorting competition" in Europe. In 1998 the award was ruled illegal by the European Court of Justice, but Air France was not required to repay the money.

Air France is not the only European airline to receive state subsidies--Spain's Iberia Airlines, Sabena of Belgium, Olympic Airlines of Greece, and Italy's Alitalia also have benefited from such largesse. The plaintiffs in the Air France case did not directly contest those awards but said they expected the decision eventually would result in new rules regarding privatization and state subsidies.

That has indeed been a hot topic in Europe lately, but the current target of the European Union's Competition Directorate is not airlines but privatized postal services. Again, EU policy encourages commercialization of national postal monopolies, and the Netherlands, the United Kingdom, Germany, Sweden, Denmark, and other countries are well down that road. But as far as some express-parcel companies are concerned, the EU has created a monster. Not only are these postal services competing with private express companies, but they also are getting involved in contract logistics services. In some cases, they are buying up so many transportation and logistics companies that competitors fear they may create near-monopoly conditions after their original monopolies supposedly were eliminated.

The Dutch post office was the first to head in that direction when it purchased Australia-based TNT's express and logistics services. Right now, though, all eyes are on Germany's Deutsche Post, which has spent billions of dollars to acquire dozens of companies large and small, including the giant international forwarding and logistics company Danzas. (See "Deutsche Post Creating Global Logistics Giant," Logistics, June 1999.) Deutsche Post and other European Union postal services still retain their letter-delivery monopoly for the time being, and critics charge those monopolies are subsidizing "predatory" activities that are designed to put private, unsubsidized competitors out of business.

How are shippers likely to make out after the smoke has cleared? In the short term, postal service expansions will offer a wide range of lower-priced, widely available new services--a development shippers should welcome. The downside is that postal services have access to cash and infrastructure that private competitors can't match, raising the possibility that a Deutsche Post, for example, could pick off competitors until it had a near-monopoly, say industry observers. And if a privatized postal service is allowed to dominate a particular market, freight rates are almost certain to rise.

A Double-Edged Sword

Transport privatization is a double-edged sword. Although it undoubtedly is a winning proposition for shippers, who benefit from new efficiencies, increased productivity, lower operating costs and freight rates, and new service options, privatization also can create conflicts.

Chief among them is the conflict between seller and buyer. Although a government's motives may be clear, it's common for disagreements to arise during implementation because the private sector's objectives don't always match those of the government involved, says Levine. The buyers know how to make a profit, but those plans can clash with the seller's expectations about how the property will be used. Once the sale or concession has been concluded, it's hard to go back and rewrite the rules. It's crucial, therefore, that both sides state their intentions clearly. "Governments have to think about how they will structure a privatization so public policies will be protected while giving the private sector what it needs," Levine says.

Labor issues also can complicate privatization plans. Transport privatization typically means enormous layoffs, says Rennicke. In both Argentina and Mexico, for example, railroad employment was reduced by more than 80 percent. When governments manage such personnel issues poorly, it can lead to serious civil strife that may disrupt rather than revive an economy. When handled fairly and honestly, it can be achieved with little or no disruption, he says. There were no strikes or other actions in Mexico and Argentina despite the size of the personnel cuts, in part because the labor unions were involved in designing the restructuring, he says. Employees' welfare was a top priority throughout the process, he adds.

Rennicke notes that in South Africa today, where militant labor activism is common, even the unions agree that transport restructuring is vital to future economic development and are considering its adoption. Such union support reinforces the argument that these programs can have an enormous beneficial impact on an economy as a whole, not just on shippers and the transportation industry.

The case for privatization is a compelling one and worthy of the broad-based support it commands. With all the benefits a properly managed program can bring to stakeholders, it's just a matter of time before nearly all of the world's transportation networks are in the hands of the private sector.