Why Other Railroads are Wooing Conrail

UPS Foundation Professor of Transportation and Professor of Systems Engineering

UPS Foundation Professor of Transportation and Professor of Systems Engineering Edward K. Morlok

After being quoted in several articles on the would-be Conrail merger, UPS Foundation Professor of Transportation and Professor of Systems Engineering Edward K. Morlok seemed like the right man to answer our questions about why we, as nonshareholders, should care about which suitor--CSX or Norfolk Southern--won Conrail's hand. He did answer our questions, and now we do care.

Q. Why are Norfolk Southern and CSX pursuing Conrail?

A. CSX and Norfolk Southern are direct competitors outside of the Northeast where Conrail is almost a rail monopoly, so either one of Conrail's suitors is strengthened considerably by the merger.

The key differences between these two merger proposals were in the railroad lines that would be merged with Conrail, making a single railroad that served essentially the entire United States east of the Mississippi.

Q. Does CSX's failure mean that Norfolk Southern will get Conrail?

A. It looks like neither of the original proposals will emerge victorious and intact.

The nay vote by Conrail stockholders on the CSX proposal was certainly very dramatic, but there are many obstacles to a merger with NS now, including Conrail's poison pill.

Right now, the path of trying to come up with a plan acceptable to the three firms seems to hold most promise. If a merger does take place, and of course all parties are still pushing hard for this, then it is likely to realign major routes so that more competition is introduced.

Of course, each CEO must look out for his firm's interests first, and each may have very different ideas on what is adequate competition and a strong rail competitor.

Q. What other interests might affect the merger?

A. These mergers must be approved by the federal Surface Transportation Board. The Chair of that body, Linda Morgan, has sent signals to the effect that this will not be a "rubber stamp" merger, so the STB may impose many conditions that attempt to protect the public interest.

Shippers have become increasingly nervous of large rail mergers in recent years, and they can be a very powerful force. Rails carry about 37 percent of all intercity freight in the United States, measured by ton-miles, considerably more than trucks, or ships and barges, and thus rail service is crucial.

And shippers and major groups like the National Industrial Transportation League can be expected to make their own counterproposals to insure competition.

The same is more and more likely from states and regions, given that their economic destiny is influenced by whether they have adequate rail service. This now has the force of federal legislation--the Intermodal Surface Transportation Efficiency Act of 1991--which mandated governments to consider freight transport in their regional transportation planning.

We're now starting to see states spending some money to improve infrastructure other than highways and ports. An example is Pennsylvania's contribution to increasing clearances on the major freight lines in this state so that the efficient double stack trains--carrying containers stacked two-high--could enter the Philadelphia port, so it could compete for business with New York, and other ports.

No government worth its salt is going to let its investments be diminished by a merger that bypasses its area.

Q. Is there a significant difference, other than a monetary one, for the interests of stockholders in the two mergers?

A. Although ultimately some stockholders--like the arbitrage firms that have come into play--may have a more short-term outlook, freight railroads are an investment for the long term, given the nature of the technology and the freight market, and in the long term the interests of the stockholders are tied to the consolidation trend in the industry.

Q.. What consolidations do you forsee?

A. We are likely to see mergers of Western and Eastern railroads in the next few years, creating for the first time truly transcontinental railroads. In fact, it could lead to one or more railroads that connect to virtually all major U.S. markets. Positioning your firm for this eventuality is very important. Profitability, access to major--ideally growing--markets, and few direct competitors all make for a more attractive system.

Q. Will Conrail survive and prosper?

A. Given its strategic location and exclusive access to many markets, Conrail is not going to be lost in the shuffle. It would take an incredible set of strategic errors for Conrail to lose out somehow. The differences are in how much value is added by the merger or mergers, and whether it is sooner or later.

Q. How is Philadelphia's regional prosperity affected by Conrail's?

A. It is difficult to say. Both NS and CSX promised much to the Philadelphia area in their proposals, as these emerged in the fighting. Some were very intriguing, including proposals for major freight yards, possibly on the Navy Yard site, and associated industrial development land, and NS' promise to relocate its corporate headquarters here, but one can not count on these. They were part of initial jockeying, and the intense fighting that took place.

Also, the world of freight transport is rapidly changing, around and within railroads, so the more important question is how the firm will respond to new demands, and new opportunities.

Q. What are those changes in how rails must compete?

A. Production and distribution are becoming more global; firms are shipping and competing on a world-wide scale. And products are becoming more specialized--customized--and we're moving toward very small inventories.

This changes the demand for freight transportation dramatically.

Shipments move over long distances, often by two or more modes, and shippers demand better and better service. Deliveries must be made in a two-hour time window, or a factory that no longer has an inventory of raw materials or parts will have to shut down.

Railroads are only beginning to adapt to this world, and often it is with other transportation companies, notably truck lines and container steamship lines taking the lead in integrating the services, maintaining the close ties with the customers, deploying new technology, etc.

So the railroad needs to be reinvented, to replace the old slow warehouse on wheels with a full range of services, from slow grain trains carrying 10,000 tons, which we do very well, to a smorgasbord of successively faster, guaranteed services that mesh with modern high-value manufacturing and warehousing, and that take goods door to door.

Q. Is this a part of Amtrak's high speed investments in the Northeast Corridor?

A. Amtrak's investment is really directed toward passenger service only, upgrading the line from New York to Boston, and buying faster luxury trains for the entire line.

But nowhere is the opportunity greater than here in the Northeast Corridor, where there is no freight rail service directly competing with trucks and barges along the Washington-New York-Boston axis, partly as a result of the dumb way we carved up that railroad to serve passengers, by the way.

In addition to all the global trends I've mentioned, we also have very congested roads, with unreliable and high-cost truck service, and enormous environmental problems created by all the road traffic. High speed freight trains carrying containers and truck trailers along the corridor would go a long way to alleviating these problems.

And for local distribution, regional rail passenger lines could be used, as might the subways. Of course, a lot of engineering work would be necessary to overcome obvious problems, like the need to transfer containers quickly from truck to rail cars so as to not block the lines, but many ideas on how to do that exist.

The point is that the key innovation is not in running the trains, but in designing and integrating the whole system so that the service given the customer is what is needed.

An example is the FastShip concept, where ocean cargo could be taken from Philadelphia to Europe in half the time of a conventional boat, and at half the cost of air. This is a real boon for shippers, who often need something between the two extremes now. And Philadelphia is the proposed U.S. port. So there are tremendous opportunities, for this area specifically and across the country.

Originally published on February 18, 1997