Despite the fact that none of the remaining U.S.-based Class 1 railroads managed to operate above their cost of capital in 2002, Surface Transportation Board (STB) Chairman Roger Nober believes that things are getting better for the rail industry. Nevertheless, he says, growth and improvements in service will be needed before any of those carriers will be able to realize a workable return on their investments.

"Railroads are only going to become revenue-adequate if they grow their businesses," Nober says. "But they're only going to grow them through investment."

Revenue adequacy is a term used by the STB to indicate whether or not a rail carrier has achieved a return on investment that's higher than its cost of capital. That cost is determined by three measures: the cost of corporate debt, payment of dividends, and the cost of attracting preferred stock. In 2002, the cost of capital was 9.8 percent.

None of the Class 1 carriers managed to reach the high bar, but Nober says that all are showing improvements. Norfolk Southern, he notes, has made a comeback in return on investment in the past few years. In 1998, the railroad's ROI was 10.5 percent and the cost of capital was 10.7 percent, he recalls. "The next year they bought Conrail. The debt they incurred was captured as an investment, and they [dropped] to 5.2. But they've brought it up [since then] to 9.1. They've been effective in what they've done."

Similarly, he says, when the Union Pacific bought the Southern Pacific in 1996, its ROI plummeted from 8.3 percent to 2.9 percent in just two years. In the years since, the UP has pulled back up to 8.6 percent, the second-highest ROI in the pack.

Despite those improvements, more change is needed, Nober says. "I think all the railroads are coming to the realization that if you want to do a better job of rewarding your investors, you need to be able to attract new capital and new business by offering a better product," he says. "They need to start thinking of themselves as national transportation companies and not as regulated entities. They need to be smart and creative in how they market, and be more efficient and businesslike. If they do that, they can grow their businesses."