Is profitable revenue growth possible?

Gilles Roucolle
Mercer Management Consulting

Over the past two decades, the North American railroad industry has seen traffic grow. Yet it has lost market share to trucking, and the gap has been accelerating. Even in bulk traffic and commodities-traditionally "friendly" to rail-fierce competition between rail and truck clearly generates suboptimal rail shares in many routes and gateways.

In real terms, average yield in the industry dropped by more than 50% over the past decade, and the yield decline is pervasive throughout North America. A recent analysis conducted by Mercer Management Consulting found that most of the cost efficiencies realized by U.S. railroads after deregulation in 1980 have flowed to rail customers in the form of rate decreases. Through consolidation, North American railroads have managed to raise productivity, lower operating costs, and thus substantially improve financial returns. However, the performance of Class I railroads appears to be stalling; they are unlikely to make the same productivity gains going forward, as incremental cost efficiencies become increasingly difficult to achieve. Growth of operating revenues slowed in the second half of the 1990s, and improvements in operating ratio have also stalled.

In this context, railroad managers have an opportunity to renew their focus on profitable revenue growth. While revenue management has a legacy of complexity, leading carriers are now moving to streamline their commercial, pricing, and back-office practices. As they improve their business processes and build market intelligence supported by the new digital technologies, they position themselves to introduce revenue optimization techniques that have been mastered by the airlines.

Like the airlines, railroads can harness digital technology to transform pricing infrastructures with a more scientific process of margin engineering, or yield management. Demand forecasting, intelligence gathering, and dynamic matching of supply and demand through differential pricing are becoming more sophisticated and attractive to railroads. Moreover, these techniques can offer benefits to both carriers and shippers. But before employing them, railroad managers should start with a deep understanding of customer priorities as well as a thorough assessment of underlying market and competitive dynamics.

Building the foundation of railroad yield management calls for an outside-in, forward-looking approach. Customers are becoming more demanding, their priorities are shifting more rapidly, and the economics of their business is becoming more complex. Traditional railroad information systems and practices generally are ill-equipped to anticipate and respond to the customer's shifting needs.

Logistics and transportation managers, for example, consider not just their rail freight costs, but rather the total economic equation of the logistics chain. While price may remain a leading competitive factor, our research suggests that such other attributes as value-added logistics services, ontime performance, convenience, and total transit time have become increasingly important to customers. For intermodal traffic, where rail and trucking compete most, and for merchandise and bulk carload traffic, we recently demonstrated that the market-share elasticity of rail versus other modes can be significant when reliability improves. Indeed, the effect may be comparable to rate reductions.

Another opportunity for rail managers to improve their competitive position lies in value-added asset management. Several shipper surveys show how shipper buying patterns and requirements have become more sophisticated, regardless of the goods carried. Shippers look for solutions encompassing all aspects of the logistics chain. Greater collaboration and information-sharing between shippers and carriers also serves the railroads' needs. From the late 1980s to 1998, Class I railroads reduced the number of railcars by 23%, while transport performance increased by more than 50%. Going forward, sustaining asset productivity gains will require increasingly sophisticated capacity management and control processes.

Given that shippers may be making their modal decisions based on factors other than price, railroads have an opportunity to change their profit model by better managing demand/supply mechanisms and by delivering high-value solutions to customers.

Managers building yield management strategies must shift their mindset from one of complexity, limited control, and volume toward a customer-centric and value-driven model. The digital technologies are powerful, but managers should avoid the trap of digitizing an obsolete or near-obsolete business model. They should first articulate their most pressing business issues, and their customers' most pressing concerns, and only then invest in technology. This is how rail pricing can be managed in concert with other customer-centered value drivers.

Gilles Roucolle is a vice president with Mercer Management Consulting in Montreal.