Union Pacific Gets Back on Track

By Jeffrey Rothfeder  |  Posted 07-19-2002

Union Pacific Gets Back on Track

 

Back on Track

Company | Union Pacific
Headquarters | Omaha, Neb.
Year founded | 1862
CIO | L. Merill Bryan Jr.
IT employees | 1,124
Revenues | $12 billion in 2001
Net income | $966 million in 2001
Return on equity | 10.6%
Return on assets | 3.1 %
Recent share price | $ 61.24
52-week high/low | $65.15/$43.39

It was a real train wreck. In 1996, Union Pacific Corp. had acquired Southern Pacific, making the 140-year-old railroad the nation's largest, with more than 33,000 miles of track stretching from Chicago to the Gulf Coast to the Pacific. But UP had badly underestimated how difficult it would be to mesh the two railroads' information and communications networks. Flying blind for more than a year, without a working computer system that could provide a clear idea of where its rail cars were, Union Pacific literally misplaced cargo as abandoned trains were backed up through the Southwest. Some deliveries were as many as 40 days late, and shippers suffered $2 billion in lost sales.

With customers deserting UP in droves, the railroad lost half of its market value as its stock plunged between mid-1997 and mid-1998, the year it posted a loss of more than $600 million. Its bond rating dipped, making loans more expensive and raising the specter that capital investment to upgrade and maintain the company's huge rail system and mend fences with customers would have to be put off.

But instead of publicly blaming the IT group for UP's problems and shying away from technology initiatives, CEO Dick Davidson took the opposite tack. He stressed that UP's identity should continue to be linked with technology, not separated from it; after all, the company's 20-year-old central tracking network, the Transportation Control System, has always been considered the best railroad management system in the industry. Still, it's an expensive and chancy course in an industry where companies need all the cash they can muster just to maintain their key assets like trains and tracks.

But UP management insists it had no choice. There were two options: change, or become just another second-tier, Rust Belt behemoth barely scraping out a return to shareholders that isn't worth the investment. "[CEO Davidson] said at the time that we have all this technology at the company and all this knowledge about technology, and that we just have to use it more," says a former employee who now works for a systems supplier that does business with UP. "He told us that he never wanted to be in the position again where we make one wrong move and suddenly the term 'Chapter 11' has entered our vocabulary."

High

-Tech Tracks">

High-Tech Tracks

Davidson's strategic gambit is driven by more than just the difficulties the company confronted during the SP acquisition; it's also a reaction to intractable industry conditions. The railroad business is no free ride. The amount of track owned by the major railroads has gone down in the past two decades, from 164,000 miles in 1980 to 100,000 miles, as carriers have tried to save money by focusing on their most profitable lines. So meaningful growth through expansion is not a possibility. Industrywide, while overall revenue has gone up in the past 20 years, partly due to an increase in intermodal transportation in which railroads carry containers that can be transferred to ships, barges or trucks for other parts of the trip, revenue per mile for each ton shipped has dropped to 2.26 cents in 2000 from 2.87 in 1980 as railroads continue to slash prices to remain competitive with other forms of transportation. That, in turn, has weakened their profit margins, as has a series of downturns in the value of primary commodities hauled by trains—coal, grain and chemicals. As a result, like all railroads, for the past couple of decades UP's growth has mostly been driven by acquiring competitors.

Meanwhile, stealing market share from trucks for other products shipped by big outfits like major retail chains has been tough. Based on revenues, trucks control about 88 percent of overland shipments in North America. The railroads' biggest handicap is the perception, often well-deserved, that they're slow, allergic to technology and utterly ignorant of words like "supply chain," "logistics" and "just-in-time inventory." And further consolidation isn't an option for the time being, in part because the federal Surface Transportation Board, which oversees the railroads, after a 15-month moratorium on industry mergers has instituted rigid guidelines for acquisitions after the railroads botched a series of them, among them the SP debacle. "Business as usual is no longer an option," says Davidson, "In this landscape, we have to use technology to enhance our core businesses and be progressive."

The dozens of technology efforts in the works at UP all have one goal in common: Use UP's stance as the dominant railroad—its $12 billion in annual revenue exceeds No. 2 Burlington Northern by about $3 billion—not only to be the first to develop new technology but also to position these applications as a standard for the industry. This is a critical element for success in the low-margin, labor- and materials-intensive transportation business: Half of all shipments that move on Union Pacific trains are also carried by other rail lines for part of the trip, and frequently by trucks as well. By linking its communications and networking applications with the software and hardware used by other transporters, UP stands to play a bigger part in more shipments and take a larger slice of revenue from the point-to-point deliveries that it is only partially responsible for.

Express Lane, one of Union Pacific's most unrailroad-like undertakings, is an apt example. In this two-year-old partnership with CSX Transportation, the nation's third-largest railroad, the two companies are promising guaranteed, expedited delivery of perishable goods from the West Coast to big cities in the Midwest and the East. The goal: eight days from the West Coast to Boston and seven days to New York, or the railroads reimburse customers for some of their costs. It's not quite as fast as trucks, but it costs about a third less and, most importantly, like trucks, assures on-time shipments. An attractive transportation alternative, Express Lane revenue rose 12 percent in 2001 compared with the year before—and it was on schedule about 90 percent of the time.

For UP, though, Express Lane means more than just increased carloads for its trains before the cargo is passed to another railroad. The company's communications network, including a growing global positioning system that monitors the movement of rail cars via satellite, and its logistics subsidiary, Union Pacific Distribution Services, are the centerpiece of most of Express Lane's technology systems from one coast to the other—spreading UP's reach into parts of the country where its own tracks don't venture. "We're a unique industry of companies that are dependent on one another," says UP CIO L. Merill Bryan Jr. "That's an opportunity for cooperation and cross-selling of technology even with the competition."

Win

-Win Technology">

Win-Win Technology

Last year, the railroad surprised transportation experts by teaming up with DaimlerChrysler to launch an aggressive Web-based delivery-management system as cutting-edge as any the railroad industry has ever seen. Under the terms of the agreement, Union Pacific formed Insight Network Logistics, whose sole purpose is to set up a 20-person network control center to track every car Chrysler makes in the U.S. from the factory to the dealer. Expected to go online by the end of this year, INL will coordinate the mix of railroads and trucks that Chrysler uses to distribute its vehicles, managing the schedules of the companies involved to be sure they're tightly synced and that the automaker receives the most efficient and cost-effective timetable for its shipments. INL will post this information on an intranet so every car and truck in distribution can be tracked simply by typing in the vehicle identification number. Because Union Pacific will essentially be overseeing much of Chrysler's distribution logistics, whether UP rail cars are carrying the vehicles or not, the railroad is, in effect, taking on the unlikely role of a technology services provider. The benefits to Chrysler? The automaker claims it will save about $280 million over six years and reduce by 25 percent the 12 days it takes to move a vehicle from assembly plant to dealership. "This is a nimble move for a railroad, to set up a subsidiary to create a logistics system so quickly," says Tony Hatch, independent railroad analyst and owner of ABH Consulting in New York. "It shows a commitment to technology to help the top and bottom line, and it also shows an understanding of customer needs."

The architect of UP's makeover is Bryan. UP's 57-year-old CIO, who has been at the railroad for more than two decades, cut his teeth in the complex integration of the computer systems of UP, Western Pacific and Missouri Pacific in the early 1980s. Bryan, who heads up an IT organization with more than 1,000 employees and a $250 million-plus budget, has an almost blasé attitude about UP's recent strategic embrace of technology. "When you have management that's not willing to let a company fail, you'll always see a lot of technology programs being developed," Bryan says. "In today's world, the two—company growth and new technology—go hand in hand. What we're doing at Union Pacific should be the norm for most companies, not the exception."

Perhaps, but there are so many technology initiatives at UP these days that it's easy to lose track of them. The company was the first railroad to install a full-fledged EDI system to handle electronic billing and shipping orders, and it's the only railroad that uses a sophisticated yield management system—similar to the airlines'—to balance customer deliveries with available space in trains to make sure that the shipper gets on the next trip and that UP's rates are in line with supply and demand. The railroad has also built a 30,000-mile fiber-optic and microwave telecommunications network along its right-of-way, some of which is used by other railroads as well, that provides bandwidth for train-to-train communication anywhere in the system.

In addition, for an industry whose idea of customer service traditionally has been a roomful of people with access to file cabinets, UP's newly installed customer relationship management system is an eye-opener. By tracking customer activities using virtually any search criteria, UP marketing and sales staff can actively seek out additional business from customers based on prior shipping activity. On top of this, in 2000, UP invested in Arzoon Inc., a San Carlos, Calif., start-up that makes a logistics program that lets companies compare rates, delivery times and scheduling for their shipments over any mode of transportation. Previously, companies would have to look up separately the prices and timetables for truckers and railroads because the data has never been integrated in one place. Potentially, Arzoon could result in lower transportation prices for shippers, because trains are 20 percent to 30 percent cheaper than trucks. It could also mean greater market share for the railroads.

It's difficult to determine exactly how much the technology renaissance is responsible for Union Pacific's recent uptick in financial performance and share price, but railroad analysts say technology has helped it outscale its competitors. In the first quarter of 2002, even as the manufacturing, mining and agricultural business in the U.S. was at a crawl, Union Pacific revenue increased nearly 1 percent, and operating income rose almost 14 percent over the same period the year before. By contrast, Burlington Northern's sales fell more than 5 percent, and its operating income tumbled about 12 percent. Securities analysts haven't yet focused on UP's New Economy push, because there aren't overwhelming tangible results yet. But the railroad's visibility on Wall Street has increased quite a bit, because it's getting high marks for improving dependability and customer service—two by-products of its emphasis on new technology, UP management would argue. So while overall rail shares were flat or down for the 12 months through May 2002, UP's stock ended the period near its high of $65, up from about $50 the year before. "With recent improvements in service and reliability, customers are returning, and UP is finding it easier to boost prices," says Jonathan Schrader, an analyst at Morningstar. "We think Union Pacific is back on track."

Dot

-Com Dreams">

Dot-Com Dreams

Maybe. But one recent development is raising renewed concerns that no matter how much a railroad tries to shed its old culture, the constraints of its business model may make this impossible.

As an outgrowth of the increasing emphasis on technology, in mid-2000 Union Pacific created a holding company called Fenix to manage four separate business units whose main product lines were a portfolio of UP-developed communications networks and applications: work force management programs, supply chain and logistics software, wireless data products for remote computing, and broadband mobile and fiber-optic telecommunications. The idea was that the subsidiary would sell these products and services to railroads as well as companies in other industries such as trucking, mining and heavy construction.

To give Fenix its bona fides, Osmo Hautanen, a top executive at Nokia, was hired as CEO, and he immediately put on the agenda a plan to take the company public—a move that would both capitalize on the dot-com IPO boom and burnish Union Pacific's name as a technology player. But none of this happened. The technology crash ended any hopes of selling Fenix's shares on the open market, and the recession limited the number of takers for Fenix's products. In 2001, according to UP's annual report, operating revenue in the company's "other product lines," which includes Fenix, was $4 million less than the year before, while operating expenses had risen by $6 million "due to increased spending at Fenix to develop new products and services." Unable to sustain these operating losses, Union Pacific scaled back its own investment in the company. Ekanet, the telecommunications unit of Fenix, was shelved in the middle of last year, and Hautanen left the company at the end of 2001. In May, Fenix fired most of its remaining employees, leaving the holding company little more than a shell.

"With capital markets drying up, we couldn't sell as many products as we had hoped and couldn't keep the companies at the sizes they were," says Charley Eisele, senior vice president of strategic planning at Union Pacific and a member of Fenix's board. "We've basically refocused the companies on creating positive earnings and cash flow."

Laying Track

Laying Track

More than anything, the embarrassing outcome at Fenix illustrates Union Pacific's—and every railroad's—severe limitations. About 20 percent of a railroad's revenue has to be poured back into its system for track upgrades as well as car maintenance and purchases. That's a fixed cost, and an expensive one: The cost of capital for railroads is 11 percent, while their return on investment is only about 7 percent. Add to that the amount of debt that railroads have to take on to cover capital expenses—Union Pacific's current ratio (current assets divided by current liabilities) is a meager .64 and its debt-to-equity ratio is an alarming .83—and it's easy to see why it would be difficult for a railroad ever to play in the same league as high-tech high-rollers backed by venture capital and equity offerings.

"Union Pacific needs revenue first just to cover its basic costs of doing business—that's a huge issue for railroads before they can consider using capital for other purposes," says John Gallagher, an associate editor at Traffic World, a weekly publication for the freight transportation industry. "There's no doubt that UP has gotten the message that it has to change, and it is changing. But it is still restrained in some ways by industry realities and an old culture."

Despite the Fenix setback, most railroad experts remain bullish on Union Pacific and continue to admire how aggressively it has adopted technology. ABH Consulting's Hatch says he believes the railroads—and especially UP—are already taking market share from trucks, but with the economy as weak as it is, it's less obvious because the amount of overall shipments isn't growing. "When we have a 12-month period of 2 percent growth, UP revenue will grow 3.5 percent or more, and that will be faster than trucks," says Hatch.

That's the sentiment of UP management as well. Executives at the railroad realize that the timing couldn't have been worse to branch out into an expensive area like technology. But making these difficult moves now, they believe, will put them in a position to take advantage of the expanding economy and an upsurge in capital expenditures by other transportation companies when they occur. "We have great opportunities in Mexico and in our core regions of the U.S. as we emerge from the recession and shipping picks up," says Bryan. "To get more and more of this business we must be service sensitive, and to be service sensitive you need technology and systems. We've got that."

For UP, this strategy entails significant risks, but to be considered a risk-taking company is high praise enough. Which is what makes UP so intriguing right now: The next few years will either be a period of remarkable transformation or, well, another train wreck.

Jeffrey Rothfeder writes frequently about business, security, environmental and technology issues.

A High

-Tech Journey Across the Country">

A High-Tech Journey Across the Country

Union Pacific

1. An employee at Amalgamated Computers, a longtime Union Pacific customer, logs onto myUPRR.com to order the shipment of a container full of parts to be off-loaded from a container ship in Oakland, Calif., and delivered to Amalgamated's warehouse in Boston.

The order automatically triggers UP's Transportation Control System (TCS), which schedules a flatcar for the shipment on a particular train. TCS generates a work order organizing transport of the container from Oakland, manages train crew and locomotive assignments, and arranges for transfer of the car in Chicago to a CSX train bound for Boston.

2. Once in transit, Computer Aided Dispatching automatically manages train and car movements. GPS receivers keep track of locomotive movements, and trackside Automatic Equipment Identification (AEI) readers transmit real-time car location information. Voice and data communication from train to headquarters travels over UP's telecommunications network, which includes wireless, microwave and high-bandwidth fiber-optic cables located alongside the track.

3. Transfer of the car to the CSX train and subsequent car movement events are electronically passed by CSX to UP's TCS system. This allows Amalgamated to check myUPRR.com's status inquiry system for the whereabouts of the container and its ETA in Boston.

4. When the container arrives in the yard outside Boston, it is removed from the flatcar and delivered to Amalgamated's warehouse.

5. Completion of the order triggers automated payment through UP's settlement system. Data about the trip is stored as a part of Amalgamated's relationship with UP, to be factored into future pricing decisions and logistics comparisons.

Resources

RESOURCES

Books

Modeling the Supply Chain By Jeremy F. Shapiro., Duxbury Press, 2000

New Directions in Supply-Chain Management: Technology, Strategy, and Implementation Edited by Tonya Boone and Ram Ganeshan Amacom, 2002

Web Sites

www.logisticsworld.com - A directory of logistics resources on the Internet.

www.aar.org - Data, publications, news, trends and fan club information relating to American railroads.