Sunday, July 31, 2011

Short lines and new revenue streams

Written by  Roy Blanchard

Your short line faces higher fuel prices, health costs escalating at a rate you can’t predict, limited ability to increase per-car divisions with your Class I connections, and has about worn out its first-generation GP7s and GP38s. Where’s the money coming from?

You have three choices:

• Raise it yourself by increasing revenues and lowering expenses.

• Seek outside funding in the forms of equity or debt.

• Apply for government subsidies. But in order to qualify any outside financial assistance, you have to show you’re a solid citizen capable of providing a reasonable return on the outsider’s investment.

Showing solid same-store sales is Step One. It’s a truth universally accepted that the best prospect for new business is always the current customer—the guy who keeps coming back because your brand has no surprises, is affordable, and is reliable. Solid same-store sales are the lifeblood of any company, from McDonald’s to Brooks Brothers, and are the first place any investor looks before making a commitment.

There is one hitch, however. Another generally accepted truth is that one customer in ten goes away every year, so, unless there’s new business coming in at the top faster than old businesses falling out the bottom, you’ll be out of business in ten years.

It’s still a crummy economy. Short line carloads at the end of 2010 were still 19% behind what they were at the end of 2007, generally regarded as the peak year for railroad industry revenue units. Estimates from the Feds suggest that it will take another two years to recover jobs lost during the recent downturn. And so it’s going to be a long slog for the short lines—unless they go about new business development in a business-like manner. Len Kellermann, Director of Short Line and Regional Railroad Development at CSX, sums it up most eloquently: “It’s about nurturing anything we can find that’s not moving on rail. It’s about collectively selling value. It’s about deploying and moving all car types better.”

Many short lines are doing well in what Kellermann calls the short line “sweet spots”—corn, ethanol, coal, LPG, or frac sand. Many more have service areas where basic manufacturing is starting to rebound and are well-positioned to recover single-car moves in metals, linerboard for packaging, auto parts, and chemicals. Still others are finding success in truck-to-rail conversions.

Which brings us back to the outside funding sources. A healthy balance sheet and increasing operating income will always make applying for that line of credit easier. But for the short line that has neither, options are limited. The FRA RRIF loan program for Class II and III railroads has not been a resounding success, and state grant programs are running into trouble.

Fact is, federal, state, and local governments are hard-pressed for funds even for basic services, and something will have to give. Economist Noel Perry, in a recent presentation for short line officers, said governments at all levels are running out of money and significant funding conflicts are inevitable.

Given this state of affairs, it follows that short lines betting on continued government support may shortly be out of luck.

Which leads us back to increasing top-line sales. Winning new revenue streams, whether from existing customers or new business development, requires three things: a competitive advantage, a price you and the customer can afford, and sustainability. The competitive advantage comes in designing a supply-chain-oriented product that nobody else can duplicate. The affordable price is the highest price the customer is willing to pay and one where you begin to earn your cost of capital. And the ability to keep out competitors comes from service design, consistency, and reliability.

In other words, you have to build a sustainable business model that is never dependent on government largesse, supports existing customers, and is, above all, in the words of Warren Buffett, “a cash-generating business with little debt, a substantial share of the market in your sector, and solid management.”

Railway Age Contributing Editor Roy Blanchard is principal of The Blanchard Company.