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PRECISION PUSHBACK: HOW CSX IS CHANGING THE RULES OF RAILROADING

As the rail industry moves to mimic CSX’s operating model, shippers are calling foul — arguing with the company’s numbers and asking for more regulation


By Will Robinson

Reporter, Jacksonville Business Journal

Sep 17, 2019


https://www.bizjournals.com/jacksonville/news/2019/09/17/special-report-how-csx-is-changing-the-rules-of.html?ana=yahoo&yptr=yahoo


As the hours wore on, the mood in the Surface Transportation Board hearing room grew more tense.

Outside, a major storm was sweeping through the region, bringing tornado warnings that at one point shut the hearing down.

Inside, representatives from some of the largest companies in the country were bringing their own storm: So many shippers had signed up to complain about the railroad industry at the May hearing that federal regulators had to add a second day to the proceedings.

The shippers were angry — angry about?higher fines being imposed on them?by?railroads, angry about changes in the service railroads provide, angry about railroads’ refusal to share information, angry about what they see as monopolies run?amok.?

“Fundamentally, this is a situation of one dominant party that enjoys a clear monopoly over its customers, using that power position to take advantage of the customer,” said Ben Abrams, CEO of Scrap Resources Inc., a scrap recycler in Central Pennsylvania.?

Mostly, they were angry about precision scheduled railroading, the operating model brought to the United States by Jacksonville-based CSX Corp., the country’s third-largest railroad by market capitalization and by miles of track.

“There is no valuing of the customers,” said Steve DeHaan,?CEO of the International Warehouse Logistics?Association,?which?represents?360 third-party logistics providers. “It’s all about their business.”

The anger that erupted at the hearing has been simmering among shippers over the two years since CSX introduced the new model, with DeHaan?and?others throughout the industry?saying they believe rail shipping?had reached a breaking point.?

Over the course of?the?two-day hearing,?customers big and small voiced the same message: Railroads are abusing monopolistic power to drive record profits under the guise of creating operational efficiencies.?

Corporate giants like?mega-brewer?Miller-Coors and Olin Corp.,?the world’s largest chemical manufacturer, sat?alongside small businesses?like?Shea Brothers Lumber.?Trade associations representing?U.S. grain processors, paper?manufacturers, warehouse?operators, energy companies, food and beverage corporations, chemical suppliers?and more decried the behavior of America’s largest railroads.??

But the railroads, by contrast,?assured the board their service was better than ever.?Following?the?changes initiated by CSX Corp.?(Nasdaq: CSX),?the railroads had become leaner, faster and more reliable, they told the board.?

“Customers are benefiting from the best performance in CSX history,” said Arthur Adams, CSX vice president of sales.?

The hearing, convened by the regulator to examine surging?fees imposed by railroads, became a trial of precision scheduled railroading, the operating model E. Hunter Harrison brought to CSX two years ago, a model that?is sweeping the country.?

While the hearing was a public airing of shipper anger, the customers’ complaints – and their push for regulatory action – is now a constant drumbeat, expressed in private conversations and interviews with the Business Journal.

Wall Street loves the model.?Investors?have sent?CSX’s?stock price up about?160 percent over the past three years. By comparison, the Dow Jones Transportation Average, an index of 20 large transportation companies, has grown only 37 percent. The S&P 500 grew about 32 percent over that period.

But while investors cheer, customers?say railroads?are crippling their businesses.?Shippers say they?have borne the weight of reduced service days, more frequent and higher fees, increased rates, higher storage costs and higher legal fees to dispute railroad fines, all prompted by operating changes made by the railroads.?

The?railroads point to their service metrics as proof that performance has improved – but a Business Journal analysis of those metrics shows the picture they paint might not be as rosy as it appears.

At CSX,?performance?is?now measured by metrics?the company?implemented as federal regulators began monitoring?its performance. These new?metrics?differ significantly from industry standards, and customers?claim they are?disconnected from the reality they experience.?

CSX has also reformulated?how it calculates?its?operating ratio – the metric that's improvement is held up as proof the new model works. That improvement?has been helped in part by statistical changes that have gone largely unnoticed.?

As the rest of the American railroad industry — responsible for carrying millions of tons of goods, including 22 commodities, many vital to manufacturing and agriculture – races to follow CSX’s lead, shippers are pressing regulators to hit the brakes, saying the new approach is making the cost of?manufacturing and?shipping everyday goods more?expensive.?

Ray Neff, logistics manager for Lhoist America, warned regulators in a written filing that the industry’s changes, if left uncorrected, would accelerate an exodus from rail.

“My fear is that our 16-mile Industrial Spur in Tennessee will suffer the same fate (closure and abandonment) that our facilities in Florida and Texas have seen, and that Lhoist North America will eventually be forced to abandon rail,” Neff wrote.

Maverick CEO?

Former CEO E. Hunter?Harrison?was not recruited to CSX. He was installed. Already a?three-time railroad CEO and two-time Railroader of the Year, Harrison had a Steve Jobs-like following in the industry.

As creator and evangelist of precision scheduled railroading, Harrison touted the model’s ability to make railroads more efficient. It was supposed to be a win-win: Doing more with less would make the railroad more profitable, which would please investors, and better service such as more on-time trains would benefit customers.?

The model had worked?at Canadian National Railway, where?Harrison?spent seven years as CEO turning a bloated, inefficient company into one of the most efficient rail companies in North America — albeit with some customer complaints.?

He did it again at Canadian Pacific: Between 2012 and 2015,?that railroad’s revenue grew 18 percent?while earnings per share increased 133 percent and free cash flow surged to $1.155 billion – up from just $93 million in 2012. ?


Harrison had been brought to Canadian Pacific by an activist investor,?Pershing Capital,?which famously backed?Valeant Pharmaceuticals through a boom-to-bust run characterized by drug price surges.?

The private equity fund?positioned Harrison at Canadian Pacific in much the same way it positioned Valeant’s former CEO, Michael Pearson: Pushing the narrative that maverick CEOs had cracked the code to outperform?the rest of their industries. Both CEOs raised prices in areas where their companies had no competition, among other changes.

Jacksonville-based CSX would offer Harrison his biggest stage yet, and it afforded him the chance to prove skeptics wrong, something he relished. Many questioned whether precision scheduled railroading could handle the East Coast’s spaghetti-like rail network, since it had only been attempted on the straight, grid-like Canadian network.

After helping Pershing make?$2.6 billion in profit at Canadian Pacific,?Harrison left the company in January 2017. The plan: to partner with Pershing second-in-command Paul Hilal, who had left Pershing to start his own fund —?a fund formed specifically to bring Harrison to CSX.

In March 2017,?after Hilal’s fund triumphed over a reluctant CSX board, Harrison?took?the helm.?

Newly installed and dealing with health issues that would lead to his death later that year, Harrison moved quickly to make sweeping changes.?He laid off thousands of employees and contractors, shuttered railyards and sold hundreds of locomotives and railcars.?

The results five months later were dismal.?

By August 2017, the average train?spent?three more hours sitting in rail yards and?traveled?two miles per hour slower, according to data reported to the Surface Transportation Board. Only 55 percent of shipments arrived within two hours of their expected delivery. Customers called CSX’s helpline?with complaints?563 times a day, more than twice their normal rate.

The rate of train accidents rose 68 percent in the third quarter to the?railroad’s highest level in 12 years, according to data reported to the Federal Railroad Administration. On 20 occasions that quarter, CSX train accidents caused more than $100,000 in damages, the most since 2004.?

Customers were devastated by CSX’s service implosion, they told?regulators in?a 2017 hearing focused solely on CSX, sharing a range of mishaps with the board.

A Tennessee Pringles factory with 1,300 employees narrowly avoided several closures when CSX was late to deliver raw materials. Other factories, including a North Carolina Kellogg Co. factory, suspended production because of late deliveries.?Florida dairy cows?would have run out of feed if six federal and state agencies hadn’t intervened.

In one instance, CSX lost a railcar carrying chlorine, a regulated toxic substance, for three days. Shortline railroads — smaller companies that deliver shipments to the major railroads —?that relied on CSX interchanges lost as much as a quarter of their annual revenue due to CSX delays. An Amtrak passenger line running on CSX track in Indiana saw a 2,200 percent increase in CSX-caused delays.?

In testimony at the 2017 hearing, Harrison blamed his railroad’s poor performance on employees who resisted change, saying he “overlooked the people side of the ledger.” Precision scheduled railroading was not to blame, he told the regulator.

In response to customers’ complaints, the regulators began weekly monitoring calls with CSX executives.?

The same week monitoring began, CSX announced it had reinvented how it measured performance.

Redefining?performance?

In August 2017, CSX rolled out new ways of calculating standard performance indicators. The changes?— which the company touts on its website and to investors —?made the railroad’s 2017 meltdown appear less severe and its improvements more dramatic than the measures used by the rest of the industry.?

In August 2017, industry standard measurements ranked?CSX No. 6 out of?seven railroads?in how long its in-service trains?sat in railyards, a measure known as dwell time. Its trains?dwelled?for 29.3 hours?on average, by the standard calculation.?

CSX’s new formula calculates how long in-service trains sit at any point of their journey, not just in railyards. Because this methodology averages the time trains sit still over more stops, CSX’s average dwell time dropped dramatically. In the month the new methodology was introduced, trains dwelled?13.1 hours, ranking CSX No. 1.

Velocity undertook a similar transformation. In August 2017, the standard measure showed CSX’s trains going 1.9 miles per hour slower than?they did before Harrison?arrived.?CSX’s formula indicates velocity?dropped only 0.8 mph. This, too, was accomplished by including data formerly excluded, creating a larger denominator for the average.

The spread between the velocity metrics defined by CSX and the STB has narrowed, going from a 30 percent difference when introduced to about a 16 percent difference today. By coming more in line with the STB’s math, CSX has been able to show investors a 56 percent improvement in velocity since August 2017, while regulators have seen only a 36 percent improvement.


Adam Smith, CSX’s?head of operations planning, told the Business Journal?in May?that including end-to-end data in these measures?better?reflects total performance. This enables?CSX to more accurately find what needs improvement, Smith said.?For example, the new dwell metric would detect a frequent cause of delays 20 miles away from a yard, whereas the old metric would not.

The metric for cars online was also redefined in August 2017, with the company using a running average instead of a daily total. Using CSX’s formula, the number of cars online came in 33 percent less than the industry-standard equivalent, helping the railroad make the claim that it was doing more with fewer assets.

In three letters to the STB, CEO Jim Foote touted the progress CSX’s customized metrics showed. In January 2018, Foote — who took over after Harrison's death in December 2017 — noted a “remarkable rate of positive change” in dwell and velocity, then in a letter sent weeks later, he argued that because CSX’s statistical improvement was so great, “We believe we have earned the right to end STB monitoring.”

The STB disagreed, continuing to monitor CSX through March 2018.

The railroad presented its custom metrics in 30 presentations to the Surface Transportation Board from August 2017 through March 2018, and these are the only metrics it provides in quarterly earnings materials and investor conference calls. It also separately submits regulator-defined?metrics in mandatory filings to federal regulators.

The difference remains between the metrics defined by the Surface Transportation Board and those defined by CSX. CSX’s dwell, velocity and cars online are about 52 percent, 16 percent and?37?percent?apart from their?industry-standard?equivalents.

The railroad has also stopped reporting some of its long-standing measures – metrics it is not required to disclose – such as train lengths, local service measurement (the percentage of cars placed at a customer location based upon daily customer request) and right-car, right-train (percentage of cars that leave railyards according to plan).

In addition to offering investors a different sense of CSX performance, the metrics?make it harder for shippers to contest CSX fines for delays, plan capital investments, seek regulatory intervention and more, according to the American Chemistry Council,?a trade association representing most of the $526 billion?U.S.?chemical industry.??

"Railroads’ ability to change the methodology they use to calculate their performance data threatens the usefulness of that data,”?Chemistry Council attorney Jason?Tutrone?wrote in a filing submitted to regulators.?

Jim Blaze, an independent economist with decades of experience in railroading, sees the changes?as a way to?make the railroad look good, regardless of what customers are experiencing.?

“There is some gamesmanship going on,” Blaze told the Business Journal. “It’s not illegal or immoral, but?it’s harder to see if things are better or worse … .?They’re in a rush to report statistics that have a wow impact on Wall Street but no wow impact for shippers.”

Other CSX statistics have improved, shippers say, because of policy changes and data omissions.?

In Harrison’s first five months, for example, the number of customers who received the full number of cars they ordered plummeted, which led?the Surface Transportation Board?to monitor the percentage of orders CSX fulfilled.

During that monitoring period, CSX’s metrics show the fulfillment percentage improving, a sign that its network became more efficient — but customers say that was a mirage.

In 2017, a Packaging Corp. of America executive told?regulators CSX had capped how many cars his company could order at a fraction of the number it usually requested. That means order fulfillment improved?because customers could only order fewer cars, not because CSX was fulfilling more?orders, the executive explained.?

Two years later, the monitoring is no longer being done and the situation is reversed; customers told regulators in May they often are sent more cars then they need. Providing a surfeit of cars enables the railroad to charge the customers fines for keeping cars too long —?fines that now generate hundreds of millions of dollars for CSX.

CSX and other railroads have also changed the?number?of days their customers receive cars,?the number of cars in each delivery?and the time of day cars are delivered.?

“They are delivering 33 [percent] to 50 percent more cars to a yard,” Steve?DeHaan,?president of the International Warehouse Logistics Association,?said of all large railroads.?“How do you handle 50 percent more cars to your yard?”?

Customers are frequently rebuffed when they ask railroads for supplemental data, especially data customers could use to dispute fines, they told the Surface Transportation Board.

“Right?now,?it seems like all the data we have, we beg for from the railroad,”?DeHaan said.?

Redefining success?

The operational metrics aren’t the only ones that have changed. Some of the financial ones have, too.

The true sign that precision scheduled railroading works, Harrison told investors at every railroad he ran, is a drop in operating ratio.?

Operating ratio, an industry-accepted barometer of efficiency, measures how much it costs to generate?a dollar of?revenue. The lower the number,?the higher the profit.?

Jim Foote continues to hold up?operating?ratio as the single most important metric CSX reports.?

“It tells you by looking at one number whether or not you are running the company effectively and efficiently,” Foote said at an investor conference in May.?

CSX posted North America’s lowest annual operating ratio last year at 60.3 percent, a U.S. record. It also boasted?a?record?57.4?percent operating ratio ?last?quarter. Its quarterly operating ratio stood at 75.2 percent in the first quarter of 2017, the quarter before Harrison arrived.

These figures suggest that CSX has an operating profit margin of about 40 percent, and that it has improved its profit margin by 9 percentage points in just two years.?

But for CSX, this figure includes different datapoints than it did before CSX adopted the new model.

In 2017, CSX?reclassified?all real estate sales as operating income. In doing so, it eliminated a distinction between real estate with an operating impact and real estate with no operating impact – a distinction its competitors still make.?

All profits from real estate sales now?impact?operating ratio, with the profits – $236 million in the last 2.5 years – subtracted from the railroad’s expenses.?For example, CSX’s sale of the Westin Savannah Harbor Golf & Spa helped lower its operating ratio.

Without the $154 million in real estate gains last year, CSX’s operating ratio would have been 61.5, not 60.3. It would no longer have been a U.S. record.?


CSX considers the difference inconsequential. “Most Class I rails account for property sales in their operating income, including our direct peer, Norfolk Southern,” spokesperson Cindy Schild said by email. “Our reporting is very transparent, and it is easy for anyone to back out the real estate gains and get an adjusted [operating ratio].”

While Norfolk Southern does include real estate gains against expenses, it only includes income from operating properties –?the delineation CSX removed in 2017.

Blaze, the economic consultant, sees the accounting as unique.?

“It may make them look good to Wall Street, but it’s not what other railroads do,” he said.?

The methodology is also disconcerting to Chris Rooney, a former deputy administrator of the Federal Railroad Administration, since it includes unrepeatable sales of assets with no operating impact.

“While CSX is not unique in including operating real estate gains in operating earnings, it seems aggressive to remove the distinction between operating and non-operating assets,” said Rooney.

That means?CSX’s operating ratio is?improving?while CSX has assets to sell, but?it?is likely to rise once CSX becomes asset light. The railroad has sold or solicited for sale more than 1,500 miles of track.??

CSX set a target in 2018 of selling $300 million in real estate and $500 million in rail lines by the end of 2020. It has sold $562 million-worth of property over the past 2.5 years, according to its filings with the SEC.?

“There is no question these sales have?generated, and will continue to generate, sustainable income for the company,” Schild said.

CSX has also?been aggressive in selling locomotives and railcars, lowering its fleets by 12 percent and 18 percent respectively since 2017. CSX does not report how much money it has made from such sales, but Schild said the revenue from these sales is not included in operating ratio.

Railroad ripples?

The impact of the changes at CSX goes far beyond investors and customers.?

CSX moved 6.5 million units of goods last year across a 20,500-mile network that links every major metro area east of the Mississippi. Changing how it operates has ripple?effects?across that entire region.?

For example, CSX has been steadily increasing train lengths, with the length of trains growing more than 10 percent to 7,241 feet in the first five quarters in which precision scheduled railroading was implemented, between March 2017 and June 2018. Trains on some segments, such as the?Elsdon?Line between Chicago and Munster, Indiana, have grown to span more than three miles, according to CSX filings with the STB.?

CSX stopped reporting train length after the?second quarter of 2018,?but?the effect of longer trains, a practice many railroads are adopting, can be seen on the ground.?

In the Village of Evergreen Park, a Chicago suburb, trains spanning multiple miles have blocked intersections throughout the town, making school children late to class and hospital staff late to a major trauma center, residents there?have told the Surface Transportation Board. Some of the children have taken to crawling under the trains to get to school, according to Mayor James Sexton.??

“I quiver every time I see kids crawling under the train,” Sexton told the Business Journal. “It’s only a matter of time until someone is seriously hurt.”

CSX views Evergreen Park as an aberration. Shild said last month that “former issues” were due to “the complexity of Chicago” and equipment that has since been modernized.

“CSX’s goal is to serve customers reliably and minimize the impact of our operations on the surrounding community,” she said. “If we fall short of that goal, we work to understand how those situations can be improved and we coordinate closely with the city and local first responders to ensure the safety of the public while we work through such challenges.”

Evergreen Park said it has not found CSX so responsive, prompting the town to seek federal intervention, according to the town’s filings with the STB.?

“They really don’t seem to give a hoot,” Sexton said.??

Evergreen Park is not alone. In Jacksonville, for example, CSX trains were ticketed for blocking intersections 161 times in 2018 and 130 times in 2017 – up from just one ticket in 2016.?CSX has collected 30 tickets in Jacksonville so far in 2019.

No alternatives

Many of the changes?CSX made?over the past two years would have been impossible, customers told the STB in 2017 and again in 2019, if they could take their business elsewhere.?

The majority of?rail customers in the U.S. – two-thirds of rail-served chemical facilities, for example – have no alternative rail carrier, meaning their options are to ship by one railroad or to ship by truck. Trucks are expensive, given a nationwide driver shortage, and carry about a third as much as a railcar. For some materials, like hazardous chemicals, trucks are not an option.?

This gives railroads significant market power, even over corporate giants like Miller-Coors, Cargill Inc.,?Kinder Morgan?and others that testified before the?STB?in May.?

“We wouldn’t be having this conversation if shippers had other options,” testified Justin?Louchheim, director of government affairs for The Fertilizer Institute.?

That market power has allowed CSX and other railroads to increase the fees it assesses. These fees are major money makers?for CSX and railroads across the country, all of which changed their rules last year in ways that charge customers more when cars are held too long and give customers less time to return cars.??

Across the industry, fines per car per day have risen as high as $200, four times the size of the typical fine six years ago, while customers now often get half the time — just 24 hours — to unload cars, testified the International Warehouse Logistics Association's DeHaan.

“I view this as flogging the back of every American who has to pay the increased price for goods where the railroads are involved,” he said.

Railroads collected $1.2 billion from these fees last year?–?led by CSX with $371 million billed,?a 94 percent increase from 2017.?CSX led again in the first quarter of 2019 with more than $100 million billed.?It collected another $78 million in the second quarter, the second highest behind Norfolk Southern. At about 3 percent of its revenue, CSX has called such revenue insignificant.

Fees have become unavoidable because of?rule changes and?unpredictable railcar?deliveries,?customers told?the STB.?

“They created their own issues of yard congestion, and now they’ve developed a fee for it,” DeHaan said. “It’s amazing.”?

Customers told the regulators in May that they were charged fees even when railcars weren’t ready, were sent in higher numbers than requested, were improperly switched, were the wrong railcars, were late, were not delivered, were not picked up on time and were delayed because of service failures.??

Some?shippers have accused the railroads of using the fees simply as a revenue?generator.?

“Do they want the money, or do they want the improved efficiency and performance?” asked?Scrap Resources CEO?Ben Abrams. “Because it seems like they want the money.”?

The nation’s seven largest railroads, including CSX, defended the changes as an insignificant percentage of their revenues and as a means to incentivize?slow customers to move faster,?which benefits?all customers on the network.?

Surface Transportation board member Martin?Oberman?questioned the logic of this argument, noting that to avoid fees, customers would need to make major capital investments — investments that might not even be feasible.

“What we’re being told is it’s an incentive to make you move faster,” said?Oberman. “What it sounds like is it’s an incentive for you to stop using the railroad.”?

Another money maker: raising rates.? Foote has described higher prices as a virtue of the new model, since it allows railroads to compete as a premium service instead of a commodity, making them more like FedEx than the postal service. The railroad increased revenue per unit by 6 percent last year, resulting in $693 million in new revenue. CSX collected 11 percent more per unit in 2019 than it did in 2016.

Customers contend they have gotten no new value for the higher prices they’re paying.?

“The railroads are effectively doing much less and charging far more for reduced service,” Etzel testified on behalf of Kinder Morgan.??

Regulatory action?

The trail blazed by?CSX?is one?that most U.S. railroads have began to follow?– the nightmare scenario for many shippers.?

“That was the concern when CSX did it,” said the American Chemistry Council’s Scott Jensen. “Everybody worried it would be picked up by the?others.”??

Harrison brought precision scheduled railroading to Canadian National, Canadian Pacific and CSX. Norfolk Southern, Union Pacific and Kansas City Southern have all since adopted the model, leaving?Burlington Northern Santa Fe?as the only abstainer –?although perhaps not for long.?

Berkshire?Hathway?(NYSE: BRK) chairman and CEO Warren Buffett, whose firm owns BNSF, said in May he would be willing to consider some form of the operating model.?

“We?are not above copying anything that is successful, and I think there’s been a good deal that’s been learned by watching these four railroads,” Buffett said.?

Ackman’s Pershing Capital, meanwhile, bought a $688 million stake in BNSF last month.

But in May, STB board members seemed to share?customers’?view of precision scheduled railroading.?

“It has not been lost on me that the two railroads that seem to have the fewest concerns directed at them in the these two days of?hearings are BNSF, which has not adopted precision railroading, and KCS, which has just started adopting some parts of it,” said Chairwoman Ann?Begeman.?

Oberman, too, acknowledged customers’ disappointments with the operating model.? “The room is full of shippers who say PSR [precision-scheduled railroading] has made their lives worse,” he said.

The question remains: Will the regulator step in to curtail the railroads’ changes???

The board has yet to enact any concrete actions, investigations or rule changes, although?members?said in May the board?would hold meetings to determine next steps. It has not held a public meeting on the subject since May.

“Things can be better than they are,” Begeman said.?“The shippers and carriers need each other, and if we need to be the marriage counselor, we will be.”?

Customers, meanwhile, continue to leave rail.??Railroads’ monthly carloads?through May are down 4.7 percent from last year and down?12.2?percent from a decade ago, according to data from the Bureau of Transportation Statistics?—?despite the fact that?trucking is more expensive.?

CSX, however, says it is gaining in market share. Wolfe Research asked shippers this summer which rail carriers would it increase volumes with and which would it decrease volumes with, and CSX netted a 60 percent gain among respondents, while its East Coast rival Norfolk Southern netted a 33 percent loss.

Customers also gave CSX performance a higher rating in the second quarter, 64 percent, than the same quarter a year ago, 49 percent, according to a Cowen Equity Research report.

While CSX has?blamed the overall economy for a recent?drop in?carloads and revenue — with Foote calling?the “present economic backdrop one of the most puzzling I have experienced in my career” —?analysts had expected the railroad’s efficiency gains to bolster the bottom line for at least a few more quarters.

Customers, by contrast, say the changes are driving shippers away.?For Ray Neff, logistics manager for?Lhoist?North America,?the exodus was enough to prompt him?to?contemplate?the end of U.S. freight rail.??

"These charges are accelerating the demise of rail shipments at an alarming rate,” Neff wrote in an STB filing.?“Once it is gone, it is gone."

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