oversight

Railroad Regulation: Economic and Financial Impacts of the Staggers Rail Act of 1980

Published by the Government Accountability Office on 1990-05-16.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

    GAO

1 May l!NO
I            RAILROAD
i
1
             REGULATION
             Economic and
             Financial Impacts of
             the Staggers Rail Act
             of 1980
                                    -
                                             s

                              Ill        I
                                141435
     Resources, Community, and
     Economic Development Division

     B-224113
     May 16,199O

     The Honorable Ernest F. Hollings
     Chairman, Committee on Commerce,
       Science,and Transportation
     United States Senate
     The Honorable John C. Danforth
     Ranking Minority Member,
       Committee on Commerce,
       Science,and Transportation
     United States Senate

     In response to your request and subsequent agreementswith your offices, this report
     presents our analysis of the Staggers Rail Act of 1980. The report details the economic and
     financial impacts of the StaggersRail Act on railroads and shippers, analyzes the financial
     performance of the railroad industry, and compares railroads’ financial performance with
     that of other transportation modes.
     As arranged with your offices, unless you publicly announce its contents earlier, we plan no
     further distribution of this report until 30 days from the date of this letter. At that time, we
     will send copies to the appropriate congressionalcommittees,the Chairman of the Interstate
     CommerceCommission,and the Secretary of Transportation. We will also makes copies
     available to others upon request.

     This work was performed under the direction of Kenneth M. Mead, Director, Transportation
     Issues,(202) 276-1000. Major contributors are listed in appendix III.




:J   J. Dexter Peach
     Assistant Comptroller General
Executive Summary


                   The Congresspassedthe StaggersRail Act of 1980 to improve the finan-
Purpose            cial health of the nation’s railroads, While reducing regulation of the
                   railroad industry, the act continued Interstate CommerceCommission
                   (ICC)regulation in areas where competition was absent.
                   At the request of the SenateCommittee on Commerce,Science,and
                   Transportation, GAO identified how the StaggersRail Act has affected
                   railroads and shippers, determined whether the railroads’financial per-
                   formance has improved since the act’s passage,and compared the rail-
                   roads’financial performance with that of other transportation modes.

                   During the 197Os,the profitability of Class I railroads-the nation’s
Background         largest railroads-was among the lowest of major industries. A number
                   of railroads had gone, or were on the verge of going, bankrupt, and rail-
                   roads had accumulated over $4 billion in deferred maintenance and
                   delayed capital spending. The constraints of regulation, development of
                   competing transportation modesthat enjoyed subsidized rights-of-way
                   (such as trucks and barges), changesin the industries that use railroads,
                   and inefficient labor practices all contributed to the railroads’decline.

                   Before 1980, almost all rail rates were regulated and published in public
                   tariffs (a schedule of rates, practices, and services). In contrast, the
                   StaggersRail Act made it federal policy to rely on competition and the
                   demand for rail services, rather than on regulation, to establish reasona-
                   ble rates. In addition, the act (1) allowed railroads to enter into confi-
                   dential contracts for their services with shippers, (2) permitted
                   railroads to canceljoint rates- single rates for the movement of goods
                   over two or more railroads-that did not earn certain minimum revenue
                   levels, and (3) set time limits on the line abandonment process,ICCwas
                   to regulate how high rail rates could be when effective competition was
                   absent.

                   Overall, the StaggersRail Act has helped improve Class I railroads’
Results in Brief   financial health and rehabilitate rail facilities-the legislation’s two pri-
                   mary purposes. For example, profitability increased during the 1980s
                   compared with the 1970s and increased capital spending on track and
                   structures, in combination with declines in accidents caused by track
                   defects during the 1980s suggestsimprovement in the condition of rail
                   facilities. In addition, the shipping industry has gained from lower rail
                   rates and improved service. However, not all shippers have benefited
                   becauserates have not changed to the same degree for all commodities.


                   Page 2                       GAO/RCED-99439   Impacts of the Staggers Rail Act of 1990
  ,
                               Executive   Summary




                               Moreover, someshippers have complainedabout ICC’s relief procedures
                               and questioned whether ICChas adequately protected their interests. In
                               responseto shippers’concerns,ICC has adopted new policies and proce-
                               dures since 1985.
                               By most measures,ClassI railroads’financial health has improved since
                               1980. Profitability, as measuredby return on investment, averaged4.9
                               percent during the 198Os,comparedwith 2.6 percent during the 1970s.
                               In addition, debt has generally declined from about 36 percent of capital
                               in 1980 to about 24 percent in 1988, and the ability to pay long-term
                               obligations has improved. Cost reductions and increasedefficiency con-
                               tributed to improved financial health. However, the railroad industry is
                               still not in robust health. Financial improvementshave not been shared
                               industrywide, and most railroads have not achieved revenue ade-
                               quacy-that is, their return on investment has not equaled or exceeded
                               the current cost of capital.

                               The railroad industry continues to lag behind other transportation
                               modesin profitability. GAOcomparedrailroads’financial performance
                               with that of the trucking and natural gas pipeline industries-the two
                               transportation industries for which sufficient financial information was
                               available for analysis. Both the trucks and gas pipelines selectedpro-
                               vided transportation servicesfor others. Between 1980 and 1988,
                               returns on investment for the trucking and gas pipeline industries
                               ranged between 8.0 and 17.0 percent, while the railroad industry’s
                               returns ranged from 3.5 to 5.9 percent. Two factors contributed to these
                               results: railroads must build and maintain their own rights-of-way,
                               while trucks do not, and railroads have higher cost structures than gas
                               pipelines.


GAO's Analysis

Impact of the Staggers Rail   1By exercising the new flexibilities the StaggersRail Act provided-in
Act                            particular, greater rate-setting and contracting freedoms-the railroads
                               have becomemore competitive. Cost reduction measures-including
                               abandonments,salesof unprofitable lines, and productivity improve-
                               ments, all at least partially attributable to the act-also played a role.
                               Improved competitivenesshas allowed the railroads to stem the decline
                               in their share of the intercity freight transportation market.



                               Page 3                      GAO/RCED-90-90   Impacta of the Staggers Rail Act of 1930
                                                                                                        c
                         Executive   Summary




                         Shippers have benefited from reduced railroad regulation. Since 1980,
                         rail rates, adjusted for inflation, have declined an averageof about 22
                         percent. In addition, service has improved: train reliability has increased
                         and freight car shortages,which might interrupt a shipper’s business,
                         have declined. Shipper trade associationsGAO contacted said that, in
                         general, the StaggersRail Act had improved shippers’competitiveness
                         and, in particular, openednew markets for someof their members.

                         The transition to a more market-oriented system under regulatory
                         reform was not expected to affect all shippers the same.In keeping with
                         this expectation, GAO found that rates have not changedto the same
                         degreefor all shippers and that, becauseof line abandonmentsand joint
                         rate cancellations,some shippers have experiencedincreasedcosts or
                         reduced rail service.
                         Someshippers have expresseddissatisfaction with ICC’Srelief proce-
                         dures and questionedwhether ICChas adequately protected their inter-
                         ests. For example, all five of the shipper trade associationsGAO
                         contacted criticized ICC’Srelief procedures as being burdensome,time-
                         consuming,and expensive. Four of the five trade associationsalso told
                         GAO that ICC’S implementation of the act’s provisions designedto protect
                         captive shippers-shippers that must use rail to transport their goods-
                         or promote railroad competition have been the most detrimental aspect
                         of the changein railroad regulation. GAO found that since 1985, in
                         responseto shippers’concerns,ICC has adopted new policies and proce-
                         dures for mediating rates and other disputes.


Railroads’Financial      By most measures,the railroads’financial condition has improved since
Performance Since 1980   enactment of the StaggersRail Act. By reducing costs and increasing
                         efficiency, the nation’s largest railroads have increasedtheir profitabil-
                         ity, improved their ability to pay long-term obligations, and reduced
                         their debt levels. Their short-term solvency generally improved through
                         1984, but then beganto decline becauseof changesin tax laws and
                         reduced cash flow. Since 1980, railroads’return on investment has aver-
                         aged about 4.9 percent, up from the 2.5-percentaverage during the
                         1970s.Debt has generally declined from about 36 percent of total capital
                         in 1980 to about 24 percent in 1988.
                         These financial gains have been concentrated amongthe five largest
                         Class I railroads. Since 1980, the average annual return on investment
                         for the other 11 Class I railroads has been about 2 percentagepoints less



                         Page 4                      GAO/RCED-90-80   Impacts of the Staggers Rail Act of 1980
                        Jbcutlve   Summary




                        than that of the larger railroads -3.5 percent comparedwith 5.7 per-
                        cent-although 2 of these 11 railroads improved their returns. In addi-
                        tion, while ICChas deemedsomeindividual railroads to be revenue
                        adequate,the railroad industry as a whole has not achieved revenue
                        adequacy-that is, its return on investment has not equaled or exceeded
                        the current cost of capital.


Railroads’Performance   GAOcompared the     financial performance of railroads over the 1980-88
Compared With That of   period with the financial performance of the trucking and natural gas
                        pipeline industries-the two transportation industries for which suffi-
Other Transportation    cient financial information was available for analysis. Both the trucks
Modes                   and gas pipelines selectedprovided transportation services to others.
                        Railroads lagged behind both trucks and natural gas pipelines in profit-
                        ability. Returns on investment for trucks and natural gas pipelines
                        ranged between 8.0 and 17.0 percent, whereas railroads’returns ranged
                        from 3.5 to 5.9 percent. Railroads must build and maintain their own
                        rights-of-way, while trucks do not, and railroads have higher cost struc-
                        tures than gas pipelines. Both factors contributed to the railroads’
                        inability to match the financial performance of these other transporta-
                        tion modes.In addition, GAOfound that since the 1981-82recessionrail-
                        roads have improved their average annual return on investment by only
                        about 3 percent, compared with 16- and 6-percent improvements for
                        trucks and gas pipelines, respectively.

                        This report makes no recommendations.
Recommendations

                        GAOmet with ICCto discussthe contents of this report. ICCgenerally
Agency Comments         agreedwith both GAO'Sfindings and conclusions.However, as requested,
                        GAOdid not obtain official agency commentson a draft of this report.




                        Page 6                      GAO/RCED-90-80   Impacts of the Staggers Rail Act of 1980
Contents


Executive Summary                                                                                          2

Chapter 1                                                                                                10
Introduction           Railroads’Status Before 1980                                                      10
                       Causesof Railroads’Problems                                                       11
                       Reduction in Railroad Regulation                                                  13
                       Objectives, Scope,and Methodology                                                 16

Chapter 2
Railroads Are More     Competition Among Transportation ModesIncreased in
                            the 1980s
Competitive and Have   The StaggersRail Act Enabled Railroads to BecomeMore                              22
Stabilized Their            Competitive
Market Share           Railroads Have Had to Cut Costs                                                   24
                       Railroads Have Improved Their Facilities                                          29
                       Railroads Have StemmedTheir Decline in Market Share                               30
                       Conclusions                                                                       33

Chapter 3                                                                                                34
Railroads’Financial    Industry Financial Health Has Improved
                       Improved Financial Health Has Not Been Shared
                                                                                                         34
                                                                                                         41
Health Has Improved,        Industrywide
but Most Railroads     Most Railroads Are Not RevenueAdequate                                            41
Are Not Revenue        Railroads Lag Behind Other Transportation Industries in                           44
                            Financial Performance
Adequate               Conclusions                                                                       50

Chapter 4                                                                                                52
Most-Though Not        Shippers Have Benefited From Better Rates and Service
                       ReducedRailroad Regulation Has Affected Shippers
                                                                                                         52
                                                                                                         66
All-Shippers Have          Differently
Benefited From         Shippers Have Voiced Concern Over ICC’s                                           60
Reduced Railroad           Implementation of the StaggersRail Act
                       Conclusions                                                                       63
Regulation

          Y




                       Page 6                     GAO/lZCED-90-80   Impacts of the Staggers Rail Act of 1980
                       Contents




Appendixes             Appendix I: 1988 Profile of Class I Railroads Included in                         66
                          GAO’s Study
                       Appendix II: List of Trade Associations Contactedby                               67
                          GAO
                       Appendix III: Major Contributors to This Report                                   68

Related GAO Products                                                                                     69

Tables                 Table 2.1: Average Annual Growth Rates of Intercity                               22
                           Freight Tonnage
                       Table 2.2: Tonnagesand Market Sharesof Selected                                   31
                           Transportation Modes
                       Table 3.1: RevenueAdequacy of Class I Railroads                                   42
                       Table 3.2: Comparisonof 1988 Returns for Railroads and                            47
                           Other U.S. Businesses
                       Table 4.1: Average Real Rail Rate Changes                                         53
                       Table 4.2: Freight Car Shortagesas a Percentageof the                             65
                           Railroad Freight Car Fleet

Figures                Figure 2.1: Class I Railroad Employment (Without                                  27
                           Amtrak)
                       Figure 2.2: Class I Railroad Productivity                                         28
                       Figure 2.3: Market Sharesof SelectedTransportation                                32
                           Modes
                       Figure 3.1: Return on Investment for Class I Railroads                            36
                       Figure 3.2: Return on Equity for Class I Railroads                                36
                       Figure 3.3: Operating Ratio for Class I Railroads                                 37
                       Figure 3.4: Current Ratio for Class I Railroads                                   38
                       Figure 3.6: Fixed Charge CoverageRatio for Class I                                39
                           Railroads
                       Figure 3.6: Long-Term Debt as a Percentageof Total                                40
                           Capital for Class I Railroads
                       Figure 3.7: Returns on Investment for Railroads, Trucks,                          45
                           and Gas Pipelines
                       Figure 3.8: Returns on Equity for Railroads, Trucks, and                          46
                           Gas Pipelines
                       Figure 3.9: Current Ratios for Railroads, Trucks, and Gas                         48
                           Pipelines
                       Figure 3.10: Fixed Charge CoverageRatios for Railroads,                           49
                           Trucks, and Gas Pipelines



                       Page 7                      GAO/RCED-90-80   Impacts of the Staggers Rail Act of 1980
Contenta




Figure 4.1: Index of Wheat Price Spreadsin the Plains                            68
    States




Abbreviations

AAR        Association of American Railroads
COFC       container-on-flatcar
DOD        Department of Defense
DOT        Department of Transportation
FRA        Federal Railroad Administration
GAO        General Accounting Office
GNP        gross national product
ICC        Interstate CommerceCommission
TDFC       trailer-on-flatcar


Page8      *                GAO/RCJCD-90-80 Impacts of the Staggers Rail Act of 1980
Page 9   GAO/RCJZD-90430 Impacts of the Staggers Rail Act of 1980
Chapter 1

htroduction


                   Railroads are a principal mode of transportation for many bulk com-
                   modities, such as coal and grains. In 1988,railroads carried about 37
                   percent of all intercity freight revenue ton-miles-more than any other
                   transportation mode.1However, between the 1930sand the 1970sthe
                   long-term viability of the railroad industry was in seriousjeopardy
                   becauseits financial health was in decline. Return on invested capital
                   was amongthe lowest of major industries. Earnings were insufficient for
                   necessarycapital improvements,and plant and equipment had deterio-
                   rated becauseof deferred maintenance.The causesof these problems
                   were many, including regulatory constraints that hindered manage-
                   ment’s ability to changerates and reduce costs, changesin industries
                   that traditionally dependedon railroads for transportation, the develop-
                   ment of competingtransportation modes,and poor labor productivity.

                   In 1976 and 1980,the Congresspassedlegislation to reform railroad reg-
                   ulation. The 1976 legislation encouragedrailroad competition and
                   allowed railroads greater freedom to changerates. The 1980 legislation
                   also encouragedrailroad competition and made it government policy to
                   have railroads rely more on competition and the demand for services,
                   rather than on regulation, to establish reasonablerailroad rates. How-
                   ever, the Interstate CommerceCommission(ICC) continued to play a role
                   in protecting shippers and the public against unreasonablerail rates and
                   practices.

                   The financial status of the railroad industry before 1980 was poor and
Railroads’Status   seeminglygetting worse. The railroads’share of intercity freight traffic
Before 1980        declined from about 76 percent in 1929 to about 38 percent in 1980.
                   Furthermore, during the 1970sthe profitability of ClassI railroads-the
                   nation’s largest railroads-was amongthe lowest of major industries.
                   According to the Association of American Railroads (AAR), a railroad
                   trade association,railroads’1975 rate of return on net investment-the
                   relationship of net railway operating incometo averagenet investment
                   in transportation property-was only 1.2 percent, and return on share-
                   holders’equity was only about 1.9 percent. From 1976 to 1979, we
                   found that return on equity averagedonly about 2.6 percent. By con-
                   trast, manufacturing companiesand utilities earned rates of return of



                   ‘Railroad Facts, Association of American Railroads, 1989 Edition. A revenue ton-mile is 1 ton car&d
                   1 mile for which a fee is charged. Except where noted otherwise, in this report “railroads” refers to
                   Class I railroads. ICC uses three classifications of railroads baaed on annual operating revenues.



                   Page 10                                 GAO/RCED-90-80     Impacts
                                                                                   of the     Staggers Rail Act of 1980
                      Chapter 1
                      Introduction




                      about 16 and 1‘2percent, respectively” In 1976, according to the Depart-
                      ment of Transportation (nor), railroads that were earning returns on
                      investment of more than 6 percent accountedfor only about 30 percent
                      of the industry’s revenues.3The railroad industry also faced cash flow
                      difficulties, marginal credit ratings, and concern within the financial
                      community about its long-term viability.
                      Many railroads had gone,or were on the verge of going, bankrupt. In a
                      1978 report to the Congresson the status of the railroad industry, DOT
                      indicated that in 1976 about one-third of Class I railroads (11 of 36)
                      were earning a negative return on investment and that at least three
                      companies-Boston and Maine; Chicago,Rock Island, and Pacific; and
                      Chicago,Milwaukee, St. Paul, and Pacific-were in bankruptcy reorgan-
                      ization.4In addition, several northeast railroads, which eventually
                      becamethe ConsolidatedRail Corporation (Conrail), had entered bank-
                      ruptcy in the early 1970s.Becauseshipments of goodsfrequently travel
                      over more than one railroad, railroad failures have the potential to
                      affect the financial condition and performance of other railroads.
                      Not only were railroads going bankrupt, but the condition of rail plant
                      and equipment was poor. Years of declining profits led to deferred main-
                      tenanceof rights-of-way, and over time plant and equipment deterio-
                      rated. Prolonged deferrals in maintaining and replacing worn-out capital
                      stock affected safety and the quality of rail service. According to the
                      1978 DOTreport, by June 1976 the nation’s Class I railroads had accumu-
                      lated over $4 billion in deferred maintenanceand delayed capital
                      expenditures. The Federal Railroad Administration estimated that if
                      poor financial performance continued, the industry would accumulate a
                      capital shortfall of between $13 billion and $16 billion by 1985.

                      Regulation, demographic and economicchanges,the development of
Causesof Railroads’   competing transportation modes,and poor labor productivity were some
Problems              of the reasonsfor the railroads’deteriorating financial health. Regula-
                      tion reduced the managerial control and flexibility the railroads needed

                      2These returns may not be directly comparable because before 1983 the railroad industry used the
                      retirement-replacement-betterment accounting system for reporting on rail track and structures. In
                      1983, ICC adopted the depreciation basis of accounting for these items.
                      “A Prospectus for Change in the Freight Railroad Industry, DOT (Oct. 10, 1978).

                      4Reorganization permits a bankrupt railroad to prepare a plan for court acceptance showing, among
                      other things, all payments to be made; assets to be sold; and the extent to which, as well as the means
                      by which, the railroad will continue service.



                      Page 11                                 GAO/RCED-90-90     Impacts of the Staggers Rail Act of 1980
Chapter 1
Introduction




to react to changing market conditions. Rate changes-whether
increasesor decreases-were sometimessubject to lengthy ICC review
and possible suspension.”Rate bureaus were often used to set rates,”a
practice that inhibited individual railroads from setting rates in a timely
manner and in responseto marketplace demands.Furthermore, from
1962 until 1978 ICCpolicy prevented the railroads from negotiating con-
tract rates with shippers. This restriction limited the ability of railroads
to effectively market their services through tailor-made rates and ser-
vices. Railroads tried to reduce costs by abandoningunprofitable lines.
However, ICC’S abandonmentprocedureswere often lengthy; it was not
unusual for an abandonmentproceedingto last several years, In addi-
tion, before 1976 ICCroutinely suspendedthe cancellation of joint
rates-single rates applicable to the movement of goodsover two or
more railroads-and reciprocal switching agreements,7thereby inhib-
iting the elimination of uneconomicrates and routes.
Demographicchanges,a growing reliance on imports, and a move
towards smaller, lighter, and lower-cost products also affected the rail-
road industry. Shifts in population and manufacturing activities from
the northeast and north-central sections of the United States to the west
and south, as well as shifts in population from rural to urban areas, hurt
the railroads by making portions of the rail network obsolete and alter-
ing the balance of commodity flows between areas of the country, In
addition, population shifts from central cities to suburban areas, where
greater reliance is placed on highway access,hurt the railroad industry.
Firms no longer wanted to locate on rail rights-of-way but near high-
ways. The growth of imports and the move towards smaller, lighter
products whose values by weight are relatively high also reduced the
demand for rail transportation services.While domestic production and
consumption may require several shipments by rail, imports generally
require transportation only from a port to a point of sale. Likewise,
smaller, lighter products require less transportation of raw materials
and finished goods.
The development of the interstate highways and inland waterway sys-
tems helped the trucking and barge industries grow. Both industries

“Suspension prevents a tariff action from taking effect pending the results of an investigation. A
tariff is a schedule of rates, practices, and services.
“Rate bureaus allowed railroads, under an ICC-approved grant of antitrust immunity, to collectively
discuss and, among other things, set railroad rates.

7Reciprocal switching agreements allow railroads, for an agreed-upon charge, to interchange cars
originating or terminating on their track.



Page 12                                 GAO/RCED-90-80      Impacts of the Staggers Rail Act of 1980
                        Chapter 1
                        Introduction




                        have also benefited from less regulation than railroads. The Transporta-
                        tion Association of America estimated that in 1975 all railroad activities
                        were regulated, comparedwith only about 44 percent of truck activities
                        and 15.5 percent of inland waterway activities. Furthermore, the cost
                        structures of these industries give them a competitive advantage over
                        railroads. In particular, while railroads build and maintain their own
                        rights-of-way with minimum federal aid, highways and waterways are
                        built and maintained by federal and state governments.Before 1978,
                        waterways operators paid none of the costs of using the inland water-
                        way system.RWhile trucks contribute to building and maintaining high-
                        ways through license fees and taxes, nor has reported that large trucks
                        may pay less than their full share of costs.
                        Finally, poor labor productivity also played a role in the problems rail-
                        roads faced. In the 1970s labor costs constituted more than 50 percent
                        of total railroad operating expenses.However, during the 1970s labor
                        productivity was often governed by such factors as narrow craft and
                        class divisions among unions, work rules that based compensationon
                        the distance traveled, and restrictions on the tasks various types of
                        employeescould perform. These factors detracted from efficient deploy-
                        ment of the work force, increasedcosts, and prevented more efficient
                        operations. Safety and job security concerns,however, led organized
                        labor to opposechangesin these practices.

                        In 1976, the Congresssought to eliminate needlessor harmful regulation
Reduction in Railroad   of railroads by enacting the Railroad Revitalization and Regulatory
Regulation              Reform Act (4R Act). Its purpose was to restore the financial stability of
                        the rail system and to improve the operation and structure of the rail-
                        road industry through rate-making and regulatory reform. In particular,
                        the 4R Act encouragedgreater railroad competition, allowed railroads
                        greater freedom to changerates, and, in general, reduced ICC’S regulation
                        of the industry.
                        Before 1976, ICC regulated almost all rail rates. The 4R Act allowed ICC
                        to regulate rates only where there was an absenceof effective competi-
                        tion (called “market dominance”).YThe 4R Act also required ICCto
                        exempt any person or class of persons,or any services or transactions of

                        “In 1978, legislation was passed imposing a tax of 4 cents per gallon on fuel used by inland water-
                        ways carriers.

                        “This applied to rates equal to, or exceeding, variable costs (called “going concern value”), which
                        were presumed to be reasonable.



                        Page 13                                 GAO/RCED-9080       Impacts of the Staggers Raii Act of 1980
Chapter 1
Introduction




railroads from regulation where such regulation was not necessaryto
implement the national transportation policy, representedan undue bur-
den, and served little or no useful public purpose. Finally, ICC was
required to develop standards for determining whether railroads were
earning revenues adequateto cover their operating costs and provide a
reasonablereturn on capital (called “revenue adequacy”). The 4R Act
did not directly link the determination of revenue adequacyto the rate-
making process,but rather encouragedICCto assist railroads in attaining
adequaterevenues.
Despite the reforms of the 4R Act, the Congressfound in 1980 that rail-
road industry earnings were still insufficient to generatethe funds nec-
essary for capital improvements, Consequently,it enactedthe Staggers
Rail Act, which further deregulatedthe railroad industry and made it
federal policy to have railroads rely, where possible,on competition and
the demand for services (called “differential pricing”), rather than on
regulation, to establish reasonablerates.
The StaggersRail Act maintained ICC regulation over how high rail rates
could be when effective competition was absent or inadequate. While
the 4R Act restricted ICC’Sreview of how high rail rates could be to situ-
ations in which a railroad was market dominant, the StaggersRail Act
tied market dominanceto rail rates exceedinga specified threshold.*”
The StaggersRail Act also elevated the importance of revenue ade-
quacy. Whereas the 4R Act required ICC to develop revenue adequacy
standards, the StaggersRail Act required ICCto use these standards to
determine annually which railroads were earning adequaterevenues.
The StaggersRail Act also required ICC to consider revenue adequacy
when it reviewed the reasonablenessof rates. Finally, the StaggersRail
Act maintained ICC’s authority to exempt portions of the industry from
regulation.
The StaggersRail Act went beyond the changescontained in the 4R Act.
It restricted the role of rate bureaus by limiting collective rate-setting to
only those railroads actually participating in the joint movement of
goods,It permitted railroads to automatically changetheir rates, with-
out challenge,in accordancewith a rail cost adjustment factor-an
inflation-adjusted index of rail costs. Furthermore, revenue-inadequate


“‘The Staggers Rail Act specified revenue-to-variable-cost thresholds for establishing ICC jurisdiction
over maximum rail rates. Variable costs are costs that change according to the quantities shipped.
The current threshold is 180 percent.



Page 14                                 GAO/RCED-90-80      Impacts of the Staggers Rail Act of 1980
Chapter 1
Introduction




railroads could increasetheir rates-including rates on market-domi-
nant traffic-an additional 4 percent each year over the rail cost adjust-
ment factor. ICC could not suspendzone-of-rate-flexibility increases,but
such increasescould be protested by shippers and investigated by ICC.
Revenue-inadequaterailroads could also add surchargesto light-density
rail lines-lines carrying small amounts of traffic.
To allow railroads to more effectively market their services,the Stag-
gers Rail Act permitted railroads to negotiate shipper contracts with
confidential terms and conditions. The railroads were to file such con-
tracts with ICC.The Commissionwas required to approve them unless
they unreasonably discriminated against certain agricultural shippers or
particular ports, or unduly impaired a railroad’s ability to perform its
common carrier responsibilities.l1OnceICC approved a contract, only
courts had jurisdiction to hear breach-of-contract disputes.

The StaggersRail Act imposedtime limits on the line abandonmentpro-
cessby requiring ICCto approve uncontested abandonmentapplications
within 46 days of filing. The act also set an overall time limit of 255
calendar days on the abandonmentprocess.The time limits helped speed
abandonmentsand therefore helped railroads reduce costs. Before 1980,
no time limits on the overall abandonmentprocessexisted. The Staggers
Rail Act also contained new provisions allowing railroads to canceljoint
rates that did not achieve certain minimum revenue-to-variable-cost
levels. Theseprovisions sought to ensure that railroads earn certain
minimum revenues on their joint rates.
ICC maintains a role in protecting shippers against unreasonablerates
and practices. To implement its authority, ICC has established proce-
dures for filing protests and complaints. According to ICC officials, pro-
tests are generally filed before a rate or practice changehas taken effect
and are designedto prevent the change.Complaints are generally filed
after the effective date of a changeand are designedto overturn the
change.Either railroads or shippers may file protests or complaints. In
deciding protests, ICC can suspendand investigate a change,investigate
but not suspend a change,or take no action. According to ICC officials,
ICCmust act on complaints and, after investigating, can award damages
to the complainant, request that rates be changed(if rates are found
unreasonable),or allow the rate to remain in effect.


’‘Railroads, as common carriers, are required to provide rail services to any shipper upon reasonable
request.



Page 16                                GAO/BCED-90-80     Impacta of the Staggers Rail Act of 1980
                            Chapter 1
                            Introduction




                            The Chairman and Ranking Minority Member of the SenateCommittee
Objectives, Scope,and       on Commerce,Science,and Transportation asked us to review certain
Methodology                 aspectsof the railroad industry, including the financial and competitive
                            conditions within the industry. As agreedwith the Committee’soffice,
                            we
                        l identified the economicand financial impacts of the StaggersRail Act on
                          railroads and shippers,
                        . determined how the financial performance of the railroad industry has
                          changedsince passageof the StaggersRail Act, and
                        . identified how the railroads’financial performance compareswith that
                          of other transportation modes.
                            To identify the StaggersRail Act’s economicand financial impacts on
                            railroads and shippers, we reviewed (1) legislation enactedin 1976 and
                            1980, (2) selectedICC policies issued since 1980 on rail rates, (3) litera-
                            ture available in professional and trade journals dealing with railroad
                            deregulation and the economicand financial impacts of the StaggersRail
                            Act, and (4) studies and/or congressionaltestimony on railroad deregu-
                            lation prepared by ICC; D(JT; the Departments of Energy, Justice, and
                            Agriculture; the Federal Trade Commission;and the Congressional
                            ResearchService. In addition, we used reports we had previously issued
                            on various aspectsof the railroad industry and the StaggersRail Act
                            and reviewed selectedposition papers railroad and shipper trade
                            associationshad prepared.
                            We also interviewed officials of 11 railroads (7 Class I and 4 Class II and
                            Class III railroads)‘2 and 5 shipper trade associationsabout the economic
                            and financial impacts of the StaggersRail Act on them or their members.
                            We selectedthe railroads and trade associationsto obtain a cross section
                            of organizations. The railroads were a mix of large and small carriers,
                            carriers operating in different areas of the country, and carriers estab-
                            lished both before and after passageof the StaggersRail Act. The trade
                            associationsrepresentedshippers that were diverse in terms of size,
                            their level of dependenceon rail transportation, and the type of goods
                            transported (agriculture, manufacturing, coal, etc.).
                            To determine changesin the railroads’financial performance over the
                            last two decades,we (1) collected financial information for the years

                            121n1988, Class I railroads earned annual revenues of $92.0 million or more for 3 consecutive years,
                            Class II railroads earned between $18.4 million and $92.0 million, and Class III railroads earned less
                            than $18.4 million.



                            Page 16                                 GAO/RCED-90-80      Impacts of the Staggers Rail Act of 1980
chapter 1
Introduction




1970 to 1988 from ICC’S publication Transport Statistics for both the
railroad industry and individual Class I railroads; (2) selected-in con-
sultation with ICC, the Federal Railroad Administration, AAR, the Ameri-
can Trucking Associations, and the Federal Energy Regulatory
Commission-measures of financial performance; and (3) discussedthe
financial performance of both the industry and individual railroads with
the railroads included in our study. ICCused to require the retirement-
replacement-betterment accounting system to account for rail roadways
and structures, but in 1983 it adopted depreciation accounting. Using
data the railroads prepared, ICC developed financial data adjusted to the
depreciation accounting basis for the 1978-82 period.13According to ICC
officials, financial data based on depreciation data were not available
before 1978. As a result, the data we used for the 1970s are not strictly
comparable to the data we used for the 1980s. We included 1988 infor-
mation where available.
Since ICCreclassified several railroads from Class I to Class II between
1978 and 1986, we excluded these railroads from our financial totals for
the industry. We also excluded railroads comprising Guilford Transpor-
tation Industries becauseICCwas unable to develop depreciation data
before 1983 for these railroads. Someof the remaining Class I railroads
were acquired by, or merged into, other railroads during our analysis
period. We asked representatives of these railroads to review the data
we had developed and, to the extent possible, made adjustments based
on these reviews.‘4 However, we did not verify the accuracy of this sup-
plemental information.

To compare the railroads’ financial performance with that of trucks and
natural gas pipelines, we (1) collected annual financial information from
the American Trucking Associations’publications Financial Analysis of
the Motor Carrier Industry and 1988 Motor Carrier Annual Report and
from the Energy Information Administration’s publication Statistics of
Interstate Natural Gas Pipelines Companies;(2) compared financial
ratios for the railroad industry with those for the trucking and natural

‘:‘ICC provided us restated financial information for both the railroad industry and individual rail-
roads for the 1978-82 period. The 1983 ICC Form R-l, Annual Report, included for each railroad a
schedule restating financial information from the retirement-replacement-betterment to the deprecia-
tion accounting basis for the preceding 4 years. Using this schedule ICC developed data for 1978.

14The following railroads acquired subsidiary railroads during the study period: Burlington Northern
Railroad, CSX Transportation, Grand Trunk Western Railroad Company, Norfolk Southern Corpora-
tion, Soo Line Railroad Company, and Union Pacific Railroad Company. We treated the Missouri-
Kansas-Texas Railroad Company as a separate entity because it was not acquired by Union Pacific
until 1988.



Page 17                                GAO/RCED-90-80
                                                   Impacts          of the Staggers Rail Act of 1980
                   Chapter 1
                   IntroducUon




                   gas pipeline industries; and (3) discussedthe results of our analysis with
                   ICC,the American Trucking Associations,AAR, and the Federal Energy
                   Regulatory Commission.Each of these organizations provided opinions
                   about differences in financial performance between railroads and the
                   trucking and natural gas pipeline industries.

                   We included in our analysis only Ice-authorizedmotor carriers with
                   annual revenues of $1 million or more. These carriers included general
                   freight carriers as well as specializedcarriers that typically carry
                   freight in full truckloads from shippers to receivers. Excluded from the
                   analysis were (1) motor carriers with annual revenues of less than $1
                   million, since they are not required to file annual financial reports with
                   ICC; (2) firms excusedby ICC from filing annual reports; and (3) firms
                   that the American Trucking Associations found filing incomplete, incon-
                   sistent, and/or inaccurate data. We also included in our analysis only
                   natural gas pipelines that derived at least 75 percent or more of their
                   revenues from transporting gas for others. Our aim was to focus on gas
                   pipelines providing transportation services for others and eliminate
                   pipelines with primarily production and/or merchandising functions-
                   activities that have no counterpart in the railroad industry. We
                   attempted to include the barge, air cargo, and oil pipeline industries in
                   our analysis, but the financial information available did not provide a
                   representative overview of these industries.
                   Appendixes I and II contain profiles of the railroads and trade associa-
                   tions included in our study. “Related GAOProducts” includes a list of
                   reports we have issued on the railroad industry and the StaggersRail
                   Act of 1980.


Data Limitations   The information presented in this report represents our analysis of
                   available data and may not identify all the individual economicand
                   financial impacts on railroads and shippers. We did not attempt to mea-
                   sure the economicand noneconomiceffects of the StaggersRail Act or
                   establish cause-effectrelationships. Factors other than regulatory
                   reform may have contributed to the reported effects. To the extent pos-
                   sible, we tried to acknowledgethese other factors.

                   We also did not contact all railroads and/or shippers potentially affected
                   by the StaggersRail Act. Instead, we selecteda sample of railroads and
                   shippers to obtain a wide spectrum of views. Their views and exper-
                   iences,however, may be different from those of other railroads and



                   Page 18                     GAO/RCED-90-80   Impacts of the Staggers Rail Act of 1980
,


    Chapter 1
    Introduction




    shippers. As a result, the information we obtained cannot be projected to
    the universe of railroads and shippers.
    We conductedour work between August 1988 and February 1990. GAO
    met with ICCto discussthe contents of this report. ICC generally agreed
    with both our findings and conclusions.However, as requested,GAOdid
    not obtain official agency commentson a draft of this report.




    Page 19                     GAO/RCED-99439 Impacts of the Staggers Rail Act of 1990
Railroads Are More Competitive and Have
StabilizedTheir Market Share

                         The freedoms railroads gained under the StaggersRail Act have enabled
                         them to becomemore competitive in the 1980s. By exercising greater
                         control over rate-making and the ability to offer contracts, railroads
                         have becomemore responsive to the marketplace and have exploited
                         new businessopportunities. Faced with growing traffic since 1982 but
                         declining rates and revenues, railroads were successfulin reducing costs
                         more than revenues declined by abandoning or selling lines, reducing
                         their work force, and improving productivity. Such measureswere nec-
                         essary for railroads to becomemore profitable. In addition, the evidence
                         suggeststhat railroads increased capital spending and improved the
                         condition of their track and structures in the 1980s. By becoming more
                         competitive, railroads have been able to stem the decline in their share
                         of the intercity freight transportation market.

                         The transportation market becameincreasingly competitive in the
Competition Among        1980s. The railroads faced two major rivals-trucks and barges-both
Transportation Modes     of which underwent changesthat increased their competitiveness.
Increased in the 1980s   The Motor Carrier Act of 1980 substantially reduced federal regulation
                         of the trucking industry. It easedentry restrictions for new firms, elimi-
                         nated restrictions prohibiting a motor carrier from operating as both a
                         common and contract carrier, increased the number of exempt commodi-
                         ties,’and eliminated certain operating restrictions placed on regulated
                         carriers (such as route restrictions and the number of shippers they
                         could serve). This act also encouraged greater price competition among
                         motor carriers in general by phasing out ICC’s authority to grant anti-
                         trust immunity for certain rate-setting activities. The Surface Transpor-
                         tation Assistance Act of 1982 also increased competitiveness by
                         allowing the use of both heavier truck trailers and two trailers per truck
                         on interstate highways. As a result of these changes,new trucking com-
                         panies entered the business,existing firms expanded their markets, and
                         price competition intensified in the 1980s.
                         The barge industry is largely unregulated. As of 198’7,only about 8 per-
                         cent of the ton-miles handled by barges was subject to ICC regulation.
                         Barges tend to have lower unit costs than the competing intercity freight
                         transportation modes, and they becameeven more competitive in the
                         early 198Os,when a grain embargo and overinvestment in barges cre-
                         ated overcapacity in the industry; consequently, rates fell. Although the

                         ‘Truck transportation of some agricultural products is exempted from ICC’s jurisdiction. These prod-
                         uc%.sinclude livestock, feed, seeds, and unprocessed agricultural commodities.



                         Page 20                                GAO/RCED-90430     Impacts   of the Staggers Rail Act of 1980
Chapter 2
ltakoads     Are More Competitive   and Have
Stabilized   Their Market   Share




overcapacity situation easedtoward the end of the decade,railroads
still competevigorously with barges for such commodities as coal and
grain2

Competition among railroads also increasedafter passageof the Stag-
gers Rail Act. Before 1980, railroads knew what their railroad competi-
tors were charging for their services, since rates were published in
tariffs and rate bureaus frequently set the price for shipping goodsby
rail. According to railroad officials we spoke with, having to go through
rate bureaus often delayed the establishment of new rates, and certain
railroads could block rate changesthey did not consider favorable to
them or the industry.3 For example, one official told us that rate
changes-even increases-were often blocked by railroads wanting to
keep their shippers competitive. Documentsfrom another railroad indi-
cated that becauseICCwanted to avoid price competition among rail-
roads offering alternative routes between a particular origin and
destination, rates were collectively set to ensure equal rates over all
routes. If a railroad tried to reduce rates to capture traffic, it would be
blocked by potentially disadvantagedrailroads. The StaggersRail Act
restricted collective rate-setting by these bureaus and allowed railroads
to negotiate shipper contracts with confidential terms. As a conse-
quence,railroads were forced to competeharder amongthemselvesto
attract and/or retain business.

At the sametime that the transportation sector was becomingmore com-
petitive, the economywas expanding. After a recessionin 198182, real
gross national product (GNP)-an inflation-adjusted measureof the
value of the output of all goods and services produced by the econ-
omy-increased at an average annual rate of 4.2 percent between the
fourth quarter of 1982 and the third quarter of 1988. In comparison,GNP
grew at only a 2.2-percentaverage annual rate between the fourth quar-
ter of 1973 and the third quarter of 1981. An expansion in industrial
production also required more intercity movement of freight, offering
new businessopportunities to all transportation modes-including rail-
roads. Between 1982 and 1.988,intercity freight transportation tonnage
grew, on average, about 3.7 percent annually, comparedwith an average


“Bulk commodities, such as coal and grain, have low value-to-weight ratios and are often transported
over long distances. Principal commodities carried by barges include coal, gram, and chemicals.

3Regardlessof rate bureau actions, railroads maintained a right of independent action in setting rates.
However, several railroad officials told us that rate bureaus still hindered railroads from setting their
own rates.



Page 21                                 GAO/WED-90-80       Impacts of the Staggers Rail Act of 1990
                                         Chapter 2
                                         Railroads Are More Competitive      and Have
                                         Stabilized Their Market Share




                                         annual decline of about one-tenth of 1 percent between 1973 and 1981
                                         (seetable 2.1).”
Table 2.1: Average Annual Growth Rates
of Intercity Freight Tonnage                                                                            Percent growth in tonnage
                                         Period                                                    All modes                   Railroadsa
                                         1973-81                                                       -0.12                           -0.45
                                         1982-88                                                         3.67                            3.00
                                         %cludes all classes of railroads.
                                         Source: GAO analysis of Transportation in America data.



                                         Faced with an increasingly competitive transportation market, railroads
The Staggers Rail Act                    have taken advantage of the new flexibilities created by the Staggers
Enabled Railroads to                     Rail Act to enhancetheir own competitiveness.Through greater rate-
&come More                               making freedoms and the ability to offer contra.ctsfor their services,
                                         railroads have becomemore responsive to the market. This has resulted
Competitive                              in both reduced rates and contracts with rate and service packagestai-
                                         lor-made to shippers’needs.Consequently,railroads have been better
                                         able to retain businessand exploit new market opportunities.


ReducedRegulation                        The StaggersRail Act has allowed railroads to charge more competitive
Enhanced Rate-Mak:ing                    rates. In April 1989, ICC reported that average real rail rates had
                                         declined 22.4 percent between 1980 and 1987.5In contrast, real rail
Freedoms                                 rates had increasedabout 9 percent between 1978 and 1980. ICC figures
                                         indicated that the declines affected rates for transporting a number of
                                         commodities-including farm products, coal, and chemicals-and
                                         ranged from about 10 percent for coal to about 44 percent for farm
                                         products. Representativesof the eight railroads we contacted that were
                                         in existence before 1980 said that their firms have set more competitive
                                         rates since passageof the StaggersRail Act. One railroad representative
                                         told us that before 1980 rates were always raised but, at least in his
                                         opinion, never lowered.
                                         The ability to offer more competitive rates has helped railroads take
                                         advantage of market opportunities, such as the trailer-on-flatcar (TOFC)

                                         4Exceit where noted, averages discussed in this chapter are average annual rates of change calcu-
                                         lated by dividing the total value of unweighted rates of change for individual years by the total
                                         number of years indicated. While this approach may mask changes in any specific year, it allows
                                         comparisons of the average annual rates of change from one period to another.

                                         “ICC put rail rates in 1987 dollars to determine real rate changes.



                                         Page 22                                 GAO/RCED90-80 Impacts of the Staggers Rail Act of 1980
                                                                                                          -
                            Chapter 2
                            Itaihda    Arc More Competitive     and Have
                            Stabilized Their Market Share




                            and container-on-flatcar (COFC) markets-one of the fastest-growing
                            segmentsof the railroad business.Goodsnot carried in lWC/cOFC service
                            would likely be carried by trucks6 Spurred in part by greater rate-mak-
                            ing flexibility and ICC’Sexemption of this traffic from regulation under
                            the StaggersRail Act,’ railroads were able to design price packagesthat
                            made this businessattractive to shippers and others. As a result, this
                            businesshas grown steadily during the 1980s.In 1988, railroads loaded
                            about 6.7 million trailers and containers, comparedwith only about 3.1
                            million in 1980.
                            Railroad boxcar service also illustrates how competitive rate-making
                            has allowed railroads to take advantage of increasedpricing flexibility
                            to retain and/or regain business.In May 1983, ICCused its StaggersRail
                            Act authority to exempt boxcar traffic from regulation. In November
                            1988, ICC’SOffice of Transportation Analysis reported that aggressive
                            pricing had enabled railroads to retain boxcar traffic they otherwise
                            would have lost to trucks.8Somesmall railroads, by being responsive to
                            the market, have even been able to regain somelost boxcar traffic.
                            Although the boxcar businesscontinues to diminish, according to ICC,it
                            retains a role in the transportation marketplace becauseof the railroads’
                            pricing flexibility.


Contracts Permit Tailored   Railroads have also increasedtheir competitivenessby negotiating con-
Rates and Services          tracts with rates and services tailored to customers’needs.According to
                            one railroad official we spoke with, contracts are useful businesstools
                            becausethey can specify not only rate levels, but also such items as
                            claims, damagereporting, service standards, and service guarantees,
                            none of which are published in tariffs. ICC’SOffice of Transportation
                            Analysis found in March 1984 that contracts filed with ICCcovered
                            almost all commodities and included a variety of rate and service provi-
                            sions.9The majority of the contracts, according to ICC, involved reduced
                            rates or allowancesin exchangefor volume commitments.

                            6Although a large portion of ‘IOFC/COl?Ctraffic is diverted from highway transportation, some por-
                            tion of this traffic may also be diverted from other types of rail transportation.

                            ‘The Staggers Rail Act required ICC to exempt persons, a class of persons, or a railroad transaction or
                            service from regulation when ICC found that such regulation was not necessary to carry out the
                            transportation policy of the act and regulation was not necessary to protect shippers from the abuse
                            of market power.

                            sEffects of the Boxcar Exemption, ICC, Office of Transportation Analysis (Nov. 1988).

                            “Report on Railroad Contract Rates Authorized by Section 208 of the Staggers Rail Act of 1980, ICC,
                            Office of Transportation Analysis (Mar. 13, 1984).



                            Page 23                                 GAO/RCElMO-fM      Jmpacta of the Staggers Rail Act of 1930
                                                                                                                        ,
                        Chapter 2
                        Railreads Are More Competitive       and Have
                        Stabilized Their Market Share




                        Railroads have made widespread use of contracts. According to an AAR
                        official, AAR’S1989 survey of eight ClassI railroads found that in 1988
                        about 60 percent of all these railroads’shipments moved under contract
                        rates. Officials of all 11 of the railroads we contacted said their firms
                        have used contracts and expect to make equal or greater use of con-
                        tracts in the future. Someof these officials said, among other things,
                        that contracts provided railroads both greater flexibility in setting rates
                        and guaranteed volume. Ten of the 11 officials also believe that con-
                        tracts made their railroads more competitive.10
                        Contracts have been important tools in attracting and retaining busi-
                        ness.ICC’S survey of 11 railroads for its March 1984 report on contracts
                        (see above) found that 10 of the 11 railroads had been successfulin
                        using contracts to attract businessfrom other transportation modes.
                        Traffic gains for four of the railroads were estimated to range from
                        6,400 to 66,000 carloads annually.ll All 11 railroads also reported both
                        gaining and losing traffic to other railroads becauseof contracting,
                        although ICC was unable to gaugethe extent of intramodal shifts in traf-
                        fic. ICC also found that contracts (1) helped railroads weather the 1981-
                        82 recessionby enabling them to obtain volume commitments in return
                        for rate concessions,(2) helped railroads to quickly meet market condi-
                        tions by providing flexible pricing, and (3) allowed railroads to develop
                        innovative rate features, such as short-term “economy specials,”to
                        stimulate movementsof certain commodities.

                        Faced with growing traffic since 1982 but falling rates and revenues and
Railroads Have Had to   a desire to remain profitable, railroads have reduced costs by aban-
cut costs               doning lines, selling lines to other operators, reducing employment, and
                        increasing productivity. Using such measures,the railroad industry has
                        been successfulin reducing costs at a iaster pace than revenues have
                        declined. Between 1981 and 1988, the inflation-adjusted operating reve-
                        nues of Class I railroads included in our analysis declined, on average,
                        about 4.3 percent annually, whereas operating expensesdeclined, on
                        average, about 4.8 percent annual1y.l”




                        “‘One official did not discuss the matter.
                        “Information   was not available for the other railroads.

                        12Not all railroads were included in our analysis. See chapter 1 for more information.



                        Page 24                                  GAO/RCED-90-80     Impacts of the Staggers Rail Act of 1980
                       Chapter 2
                       hiko8d#    Are More Competitive     and Have
                       Stabilized Their Market Share




Lines Have Been        To reduce costs, railroads abandonedlines that were unprofitable or
Abandoned or Sold to   duplicative. As mentioned in chapter 1, the StaggersRail Act imposed
                       time limits on ICC’S processingof abandonmentapplications. Thesetime
ReduceCosts            limits helped speedabandonmentsand, therefore, cost reduction.
                       Between 1981 and March 1989, railroads-excluding Conrail and cer-
                       tain exempted railroads13-applied for approval to abandon about
                       16,000miles of line-about 6 percent of the track they owned in 1980.
                       ICCapproved the abandonmentof about 16,800miles.‘4Between 1982
                       and March 1989, Conrail filed applications to abandon about 4,600
                       miles. ICC approved about 3,900 miles-about 12 percent of Conrail-
                       owned track.‘6
                       Abandonments reduce costs by eliminating the maintenanceand operat-
                       ing expensesassociatedwith continuing service on a line. Railroads find
                       abandonmentattractive when the revenues a line generatesfall short of
                       the costs incurred to serve it. Officials of five of the railroads we con-
                       tacted said abandonmentshad played an important role in reducing
                       costs since 1980. Two officials said abandonmentswere critical to the
                       survival of their railroads. Another said profitability increasedsignifi-
                       cantly becauseabandonmentseliminated unproductive and redundant
                       track. Documentsfrom this railroad indicated that abandonmentswould
                       play a key role in its financial planning becauseof their significant
                       value in reducing costs.
                       Salesof lines to other operators, instead of abandonments,have enabled
                       railroads to reduce costs while maintaining traffic. Once a line is sold,
                       the previous owner generally no longer incurs the operating and mainte-
                       nance costs associatedwith the line. Should the line continue to be via-
                       ble, it may continue to provide traffic to the previous owner. Since 1980,
                       approximately 200 new shortline and regional railroadsI have come into
                       13The4R Act gave ICC authority to exempt carriers from the routine abandonment process. ICC
                       procedures permit abandonment approval when no traffic has moved over the line for at least 2
                       years and ICC finds no valid user complaints. Between 1984 and March 1989, railroads filed to aban-
                       don about 7,600 miles under the exemption authority. ICC granted approval for about 6,900 miles.
                       ICC did not accumulate data on exemption authority abandonments until fiscal year 1984.

                       14Themileage granted in any 1 year may not be the same as the mileage filed for abandonment
                       because of delays in the abandonment process and appeals of previous ICC decisions.

                       16TheNortheast Rail Service Act of 1981 established different abandonment procedures for Conrail.
                       ICC was required to approve Conrail abandonment applications filed on or before October 3 1,1986,
                       unless the lines were purchased or received a subsidy for continued operation.

                       ‘“There are no strict definitions of the terms “shortlme” and “regional.” ICC defines these railroads
                       as being similar to Class III and Class II railroads, respectively. However, a joint Federal Railroad
                       Administration and ICC report defined shortline railroads as operating less than 260 miles of track
                       and regional railroads as operating 260 miles or more of track.



                       Page 25                                 GAO/RCED-SO-80 Impacts of the Staggers Rail Act of 1980
                           Chapter 2
                           Ibllrods   Are More Competitive    and Have
                           Stabilized Their Market Share




                           existence from such sales,comparedwith only 66 between 1970 and
                           1980. A 1987 ICC survey of shortline and regional railroads formed since
                           1980 found that, for the most part, these railroads started by taking
                           over track that had been abandonedor was targeted for abandonment.
                           According to ICC, most of these railroads were operating as low-cost
                           feeder and distribution systems connectingwith larger railroads.
                           ICChelped create these railroads   by exempting most line sales from its
                           approval. In January 1986, ICCadopted new proceduresto expedite
                           purchasesof shortline and regional railroads. Theseprocedures required
                           a potential purchaser to file with ICConly a brief notification of
                           purchase. A sale could be consummatedin as little as 7 days after this
                           notice.I7Previous regulations required potential purchasers to file more
                           information and generally took longer to process.Eighty-nine of the esti-
                           mated 200 new shortline and regional railroads that have come into
                           existence since 1980 were created under the new procedures.ICC
                           believes its exemption policy has been beneficial in preserving rail ser-
                           vice as well as railroad jobs and investment.


Work Force Declines Have   In responseto falling rates and revenues,railroads have reduced the
Further Reduced Costs      size of their work force to reduce costs. According to AAR statistics,
                           employment for Class I railroads (excluding Amtrak) fell more than 48
                           percent between 1980 and 1988-from about 458,000 employeesto
                           about 236,000.In contrast, employment declined by only about 16 per-
                           cent during the 1970s-from about 666,000 in 1970 to about 476,000 in
                           1979 (see fig. 2.1).18As our April 1989 report discussed,there were
                           many reasonswhy railroad employment declined.lgBefore 1980, the loss
                           of freight traffic to trucks and changesto a more service-orientedecon-
                           omy contributed to employment declines.Since 1980, however, factors
                           associatedwith regulatory reform, the 1981-82recession,organizational
                           changesresulting from mergers and consolidations,managementinitia-
                           tives (such as buyouts of employeesand outside contracting for ser-
                           vices), and technological changeshave played a role.

                           171nFebruary 1988, ICC again modified its procedures for Class I and Class II railroad acquisitions to
                           require a 21-day, rather than a 7-day, delay after notification before the acquisition would be effec-
                           tive. The additional time was to allow a more m-depth evaluation of the transaction.
                           IsRailroad employment, in general, has been declining since about 1929, when employment was about
                           1.7 million employees. However, the periods in the text were selected to indicate the impacts of regu-
                           latory reform.

                           ‘“Railroad Retirement: Future Rail Employment and Trust Fund Solvency (GAO/HRD-89-30, Apr. 6,
                           1989).


                           Page 20                                 GAO/RCED-90-80
                                                                              Impactaof           the Staggers &ail Act of 1989
                                             chapter 2
                                             RaUroade Are More Competitive   and Have
                                             Stabilized Their Market Share




Figure 2.1: Clarr I Railroad Employment (Without Amtrak)
809     Thowands




899
476
4sa
428
4w
878
)o
928
100
278
889
m8
am

 1070     1on      la72   1073   1974


                                            Source: AAA.


                                            Railroads have reduced employment in order to cut their labor costs.
                                            Since 1981, Class I railroads have reduced their real labor costs (total
                                            wages and fringe benefits), on average,about 6. I percent annually. In
                                            1987, real labor costs of Class I railroads were about $10.7 billion, com-
                                            pared with about $16.3 billion in 1980. However, labor costs still com-
                                            prise almost half of operating expenses-only marginally below the
                                            proportion they accountedfor in 1980. This small decline reflects the
                                            fact that average annual earnings per employeehave increasedfrom
                                            about $24,700 in 1980 to about $39,400 in 1988.
                                            Further employment reductions are likely. Employment could fall from
                                            about 300,000 employees(including all classesof railroads and passen-
                                            ger employees)at the end of 1988 to between 71,000 and 185,000
                                            employeesby the year 2010. AAR has estimated that about 50,000
                                            employeesare unneededbut have been retained becauseof outmoded
                                            labor agreements,changesin technology, or other factors.


Productivity”Has                            Railroads registered substantial productivity gains in the 1980s.Fewer
Improved                                    employees,lower fuel costs, increasedabandonmentsand line sales,
                                            technological advances,and a more competitive environment have all


                                            Page 27                             GAO/RCED-90-80   Impacts of the Staggers Rail Act of 1980
                                                              Cllapter 2
                                                              Railroad@ Are More Competitive     and Have
                                                              Stabilized Their Market Share




                                                              contributed to productivity growth. Basedon numbers indexed to 1970,
                                                              between 1980 and 1988, revenue ton-miles per employeehour increased
                                                              from 148 to 288 and revenue ton-miles per gallon of fuel consumed
                                                              increasedfrom 98 to 131 (see fig. 2.2). Net ton-mileszOper train-hour has
                                                              also generally increasedduring the 1980s.While not all productivity
                                                              gains are attributable to changesfrom the StaggersRail Act, the increas-
                                                              ingly competitive environment the act encouragedput pressure on rail-
                                                              roads to increase productivity to remain profitable. Productivity gains
                                                              were not as great in the 1970s.


Figure 2.2: Class I Railroad Productivity
390     Index Valua
275
                                                                                                                                                        /




so
2s
 g    .     .. -       ..-    .-    .._.
                                      -    ,,- ._.-     ..

 1979       197-l      1972        1973    1974       197s   1976   1977    1970    1979    1999     1991    1992    1999     1994    1995    1955    1997    1999
 Ymr

        -           Revenue Ton-Miles per Employee Hour
        I - - -     Revenue Ton-Miles per Gallon of Fuel Consumed
        m           Ton-Miles per Train Hour
                                                             Source: GAO analysis of AAR data.




                                                             2”Net ton-miles is the movement of revenue freight or non-revenue freight, or both, a distance of 1
                                                             mile.



                                                             Page 28                                GAO/RCED-90430 Impacts of the Staggers Rail Act of 1980
                 Chapter 2
                 Rallronde Are More Competitive       and Have
                 Stabilized Their Market Share




Railroads Have   A stated purpose of the StaggersRail Act was to improve rail plant and
                 equipment. The evidencesuggeststhat the condition of rail facilities has
Improved Their   improved. Railroads have increasedtheir capital spending on track and
Facilities       structures. AARfigures show that railroads increasedspending for track
                 and structures from approximately $960 million in 1980 to about $3.6
                 billion in 1985.2’Since 1985, capital spending for these items has
                 declined, but it is still above the average spending levels of the 1970s.

                 Small railroads could be expected to have deteriorated physical facilities
                 becausemany small railroads took over lines that had been,or were
                 scheduledfor, abandonment.However, in February 1989 the Federal
                 Railroad Administration (FRA) reported on a survey of the deferred
                 maintenanceand delayed capital spending of 458 regional, local, and
                 switching and terminal railroads .22More than half had begun operations
                 since 1970.Of the 458 surveyed, 358 responded,listing grain, coal, and
                 lumber as their principal commodities.FRA found that most of their
                 track did not require substantial repair, replacement,or improvement.
                 In addition, railroads reporting no need for rehabilitation to correct
                 deferred maintenancehandled the majority of traffic.
                 According to the Department of Defense(DOD), track necessaryto meet
                 national defensepurposes is in very good condition. In April 1989, an
                 official with DOD’S Military Traffic ManagementCommandsaid he
                 believed track condition was the best it had been since the 1920s.In
                 January 1988, DOD informed the Congressthat “the rail network was in
                 its best readinesscondition in two decades.”DOD attributed this condi-
                 tion to the railroads’improved financial health, the StaggersRail Act,
                 and railroad deregulation in general.
                 FRAsafety statistics also indicate that rail facilities have improved since
                 1980. The number of accidents causedby track defects declined almost

                 “These figures are not completely comparable because in 1983 ICC adopted depreciation accounting
                 for track and structures.
                 22Deferred Maintenance and Delayed Capital Improvements on Class II and Class III Railroads, A
                 Report to Congress,DOT, FRA (Feb. 1989).

                 AAR defines switching and terminal railroads as companies performing switching services; furnish-
                 ing terminal trackage, bridges, or facilities, such as union passenger or freight stations; and/or operat-
                 ing ferries.

                 FRA defines deferred maintenance as a reduction in maintenance below the level necessary to meet
                 annual replacement requirements for rails, ties, and other track materials. Delayed capital spending is
                 defined as any expenditure on any addition to, or betterment of, the physical plant that is not under-
                 taken at the time it becomes necessary to keep the track and structures in the desired operating
                 condition.



                 Page 29                                  GAO/RCED-90-80      Impacts of the Staggers Rail Act of 1980
                    Chapter 2
                    Railroads Are More Competitive      and Have
                    Stabilized Their Market Share




                    60 percent between 1982 and 1987. Such accidentsincreasedin 1988;
                    however, they were still well below the levels in the early 1980s.FRA
                    cited railroad deregulation- in particular, its impact on cash flow-as a
                    major reason for the improved condition of rail facilities. Nevertheless,
                    defective track still accountedfor nearly one-third of all train accidents
                    in 1988, down only slightly from about 39 percent in 1982.

                    Increasedcompetitivenesshas enabled railroads to stem the decline in
Railroads Have      their share of the intercity freight transportation market. By offering
Stemmed Their       better rates and improved service to shippers, as well as by taking
Decline in Market   advantage of greater market opportunities from an expanding economy,
                    railroads have maintained their share of traffic volume (tonnage) during
Share               the 1980s.However, becauseother modesoffer better prices and ser-
                    vice, railroads have not fared as well in market share as their major
                    transportation competitors. Both trucks and barges increasedtheir mar-
                    ket share in the 198Os.23
                    Between 1980 and 1988, railroad tonnage (tons carried) grew at the
                    same rate as in the 1970s.However, railroads were able to stem the
                    decline in their share of the intercity freight transportation market.
                    From 1929 to 1980, the railroads’market share generally declined from
                    about 75 percent to about 38 percent (see fig. 2.3). But after dropping so
                    dramatically, railroads’average market share in the 1980swas only
                    slightly below its average in the 1970s.(Seetable 2.2.)




                    ““As table 2.2 illustrates, the intercity freight transportation market primarily comprises railroads,
                    trucks, oil pipelines, and barges. Great Lakes shipping and airplanes play lesser roles.



                    Page 30                                  GAO/RCED-90-80     Impacts of the Staggera Rail Act of 1990
                                        chapter 2
                                        ltdhada    Are More Competitive        and Have
                                        Stllbillmd Their Market Share




Table 2.2: Tonnages and Market Shares
of Selected Transportation Modes                                                    Average annual growth
                                                                                    rate in freight tonnaae              Market share
                                                                                            (per5ent)     -               (percent)’
                                        Transportation mo                            1970-79         1980-88b          1970-79    1980-88
                                        Railroads                                            CI.3        0.3               37.3         36.7
                                        Truck9                                               2.5         2.8               22.9         24.0
                                        Oil oioelines
                                        -   I-   I-
                                                                                             2.5
                                                                                             --           1.0              23.3         23.2
                                        Bargesd                                              1.4         1.5               11.4          12.7
                                        Great Lakes shippinge                             -0.1           0.4                5.0              3.1
                                        Airplanes                                            3.0         6.2                0.2              0.3
                                        aAverage percentage of intercity revenue ton-miles during the period. Market share numbers may not
                                        add to 100 because of rounding.

                                        b1988 numbers are preliminary

                                        %rcludes regulated and unregulated motor carriers of freight.
                                        dlncludes all river and canal water carriers of freight

                                        BOomestic and foreign US. traffic moving on the Great Lakes
                                        Source: GAO analysis of Transportation in America data.




                                        Page 31                                    GAO/RCED-90-80   Impacts of the Staggers Rail Act of 1990
                                                       Chapter 2
                                                       ltdmada    Are More Competitive   and Have
                                                       Stabilized Their Market Share




Figure 2.3: Market Shares of Selected Transportation Modes
loo      PeKmnt




      loz0                       1939 40        1946    1950        lQ56         loB0        1sBLT    1970        lQr8        1980       1986 868788
      Vow

             -           Railmads
             -           Trucks
             -   l   -   Barges
             111 I       Great Lake8 Shipping
             .----       oil Pipeline8
             ---         Airplanes
                                                       Note: Figures for 1988 are preliminary.
                                                       Source: Transportation in America and AAR


                                                       Despite the growth in the freight transportation market and railroads’
                                                       static growth in tonnage during the 198Os,railroads could not cut into
                                                       their competitors’market shares.Trucks and barges have been aggres-
                                                       sive competitors during the 1980sand have fared better than railroads
                                                       in terms of increasing market share (seetable 2.2). The growth rate in
                                                       truck freight tonnage during the 198088 period was about 6 percent
                                                       higher than during the 197Os,and the trucking industry’s market share
                                                       increased from 22.9 to 24.0 percent. Barges also increasedboth their
                                                       tonnage growth rate and market share in the 1980s.


                                                       Page 32                               GAO/RCED=9080   Impacts of the Staggers Rail Act of 1980
              chapter 2
              ltailroads Are More competitive   and Have
              Stabilized Their Market Share




              A closer analysis reveals that railroads are more competitive in some
              markets, but not in others where trucks and barges offer better prices
              and/or services.Railroads have maintained or increasedtheir market
              share in shipping commodities such as finished motor vehicles and some
              bulk products (e.g., coal), but have lost relative market share in shipping
              other commodities.

              Faced with an increasingly competitive transportation market in the
Conclusions   198Os,railroads have used the additional flexibility the StaggersRail
              Act provided to becomemore competitive. Exercising the increasedrate-
              making freedoms and the ability to contract for their services,railroads
              have attracted more businessand exploited new market opportunities.
              Consequently,they have been able to stem the decline in their share of
              the intercity freight transportation market, although they have not been
              able to increasetheir share relative to that of other transportation
              modes.
              Improvement in the condition of rail facilities has also been achieved, in
              part through the railroads’improved financial health and increasedcap-
              ital spending.The Federal Railroad Administration reported that most
              of the track covered in its survey of Class II and Class III railroads did
              not require substantial repair, replacement,or improvement to meet
              operational needs.The Department of Defensebelieves track conditions
              are the best they have been in decades.In addition, safety statistics indi-
              cate that the number of track-caused accidents has generally declined,
              although track defects continue to account for a significant portion of
              accidents.




              Page 23                              GAO/RCED-9O-gO Impacts of the Staggers Rail Act of 1980
Chapter 3

Railroads’Financial Health Has Improved,but
Most R&oads Are Not RevenueAdequate

                         The overall financial health of the railroad industry has improved since
                         1980. Profitability has increased,and railroads are generally better able
                         to meet their long-term obligations. Short-term solvency improved dur-
                         ing the early 1980s although it beganto decline later in the decadeas
                         cash flow decreased.Despite these improvements,most railroads still do
                         not earn sufficient revenuesto generatea rate of return that equals or
                         exceedsthe current cost of capital. Furthermore, the five largest rail-
                         roads generally have shown greater financial improvement than the rest
                         of the industry, and railroads continue to lag behind other transporta-
                         tion modesin profitability.

                         As a number of financial indicators demonstrate,the railroad industry’s
Industry Financial       financial health has improved since 1980. Profitability is higher, and
Health Has Improved      railroads are better able to pay their long-term obligations than they
                         were in the 1970s.Railroads’short-term solvency improved in the early
                         1980s although it later beganto decline and, on average,was generally
                         lower than in the 1970s.The StaggersRail Act, modifications in the tax
                         law, and other factors contributed to the overall improvements.


Industry Profitability   Railroads’return on investment and return on equity-key indicators of
                         profitability-were higher in the 1980sthan in the 1970s.Return on
                         investment measuresthe profit made on assetsused to provide trans-
                         portation servicesand is calculated by dividing net income from railway
                         operations by the net investment base,which is the depreciatedcost of
                         track and equipment plus 16 days’working capital. Railroads’return on
                         investment has averaged4.9 percent since 1980, comparedwith about
                         2.6 percent between 1970 and 1979 (seefig. 3.1)’


                         ‘Because we used depreciation data to calculate financial measures for 1980 to 1988, the ratios used
                         in this chapter to compare financial performance between the 1970s and 1980s are not strictly com-
                         parable. However, comparison between these two periods adds perspective on the railroads’ financial
                         pcrformancc since 1980.
                         We adopted generic ratio definitions where possible to ensure that data for all transportation modes
                         were comparable. As a result, our financial results may not be comparable with financial results
                         reported by ICC or other organizations. In addition, in calculating return on investment and other
                         measures, we did not subtract deferred taxes from the investment base; include certain “special
                         charges” that railroads took between 1986 and 1988 for work force reductions, asset write-offs, and
                         court judgments; or make other adjustments ICC makes to determine revenue adequacy.
                         Except where noted, all averages discussed in this chapter for each financial measure were calculated
                         by dividing the unweighted specific ratio results for each individual year by the total number of
                         years in each period. While this approach may mask changes in individual ratio results from year to
                         year, it allows comparisons of financial results between periods.



                         Page 34                                GAO/RCED-90-80     Impacts of the Staggers Rail Act of 1980
                                               Chaptera
                                               Railmade’ Financial Health HR~ Improved,
                                               but Most Railroads Arc Not
                                               Revenue Adequate




Figure 3.1: Return on Investment for Class 1 Railroads
7      Perch




1970      1971   1972   1972   1974   1975   1976   13-n     1978    1979 I 1990       1991     1992    1992     1994     1995     1999    1997   1999
Year

                                              Note: In this and subsequent figures, the dotted line separates retirement-replacement-betterment   data
                                              from depreciation data.


                                              Two factors influence investment returns: the ability to generate reve-
                                              nues from assets(called “asset turnover”) and the ability to earn a
                                              profit on every dollar of revenue generated (called “profit margin”).2 As
                                              discussedin the previous chapter, increased competition, contracts, and
                                              other factors during the 1980s have driven rail rates down, causing rail-
                                              road revenues to decline about 4.3 percent per year-even though traf-
                                              fic volume (tonnage) has increased since 1982. Falling revenues reduced
                                              asset turnover. However, becauserailroads reduced costs and increased
                                              efficiency, their profit margin increased. Higher profit margins offset
                                              the decline in asset turnover, allowing return on investment to improve.
                                              Railroads’return on equity fluctuated but generally improved during
                                              the 1980s (see fig. 3.2). Return on equity measuresthe profit made on
                                              funds provided by stockholders and is the ratio of net income to year-
                                              end book value of stockholders’equity. Return on equity has averaged
                                              about 9.0 percent since 1980, compared with only 2.3 percent in the
                                              “Asset turnover is calculated by dividing tatal railroad operating revenues by net investment in road
                                              and equipment (year-end), Profit margin is calculated by dividing net income from rail operations by
                                              total operating income. One method of computing return on investment is to multiply asset turnover
                                              times profit margin.



                                              Page 35                                  GAO/RCED-90-80      Impacts of the Staggers Rail Act of 1980
                                              Chapter 3
                                              Railroads Nnancial Health Haa Improved,
                                              but Most Railroads Are Not
                                              Revenue Adequate




                                              1970s.Revenuedeclines affected equity returns, as they did investment
                                              returns, but other factors offset these declines,including the faster
                                              decline in costs than revenues,lower taxes, and less debt at lower inter-
                                              est rates. In addition, ICC suggestedthat railroads have been investing in
                                              more profitable nonrail operations.


Figure 3.2: Return on Equity for Class I Railroads
12   Percmll




Industry Efficiency and                       The operating ratio for the railroad industry, the ratio of operating
Solvency                                      expensesto operating revenues,has averagedabout 88.2 percent since
                                              1980. Since 1982, it has shown a downward trend, reaching 86.4 percent
                                              in 1988 (see fig. 3.3). During the 197Os,the operating ratio averaged
                                              about 82.8 percent. However, this figure may be understated because
                                              railroads deferred maintenanceduring this time. If normal maintenance
                                              had occurred, the additional operating expenseswould have led to
                                              higher operating ratios.




                                             Page 36                             GAO/RCRD-90-30   Impacts of the Staggers Rail Act of 1980
                                              chapter 3
                                              R.aUmh’ F’inancial Health Has Improved,
                                              but Most Railroads Are Not
                                              Revenue Adequate




Flgure 3.3: Operating Ratio for Class I Railroads
110     Pofcmt




                                                                             I
 1979      1971   1972   1972   1974   1975   1976   1977     1979    1979   I 1969    1991    1982     1993    1994     1999    1996     1987       1998
 YUf



                                               During the 198Os,the operating ratio has improved becauserailroads
                                               have reduced operating expensesfaster than revenueshave fallen.
                                               According to officials in ICC’S Bureau of Accounts, a l-percentage-point
                                               decline in the operating ratio is a significant improvement for the rail-
                                               road industry. Although the operating ratio has fluctuated during the
                                               198Os,the average annual operating ratio declined about 1,7 percentage
                                               points between the first and secondhalves of the decade.However, both
                                              ‘the 88Spercent averageoperating ratio since 1980 and the 87.3-percent
                                               averagebetween 1985 and 1988 exceededthe 85-percent guideline that
                                               ICC officials believe is satisfactory.

                                              The current ratio, the ratio of current assetsto current liabilities, mea-
                                              sures short-term solvency and the ability to pay short-term obligations.”
                                              The railroad industry’s current ratio generally improved during the
                                              early 1980s but it beganto decline towards the end of the decade(see
                                              fig. 3.4). According to ICC, a current ratio of 100.0 percent generally is
                                              consideredadequate for railroads to cover short-term obligations.


                                              “Current assets generally consist of cash and accounts receivable, and current liabilities generally
                                              consist of loans and accounts payable. Current liabilities also include long-term debt due within 1
                                              year.



                                              Page 37                                 GAO/RCED90-80       Impacts of the Staggers Raii Act of 1980
                                              Chapter 3
                                              RaIlroads J?iuauciaI Health Has Improved,
                                              but Most Railroads Are Not
                                              Revenue Adequate




Figure 3.4: Current Ratio for Class I Railroads
180




                                              Between 1981 and 1984, the current. ratio averaged about 120.8 per-
                                              cent-that is, railroads averagedabout $1.21 in current assetsfor every
                                              $1 in current liabilities. Since 1984, however, the current ratio has
                                              declined as cash flow has declined. Between 1985 and 1988, the current
                                              ratio declined from about 113.9 percent to about 98.0 percent-below
                                              ICC’Ssuggestedguideline. In comparison,the current ratio averaged
                                              about 119.9 percent during the 1970s.

                                              Cash is an important componentof current assets.Changesin the tax
                                              laws helped railroads increasetheir cash flow4 in the early 1980s.The
                                              most significant impact resulted from provisions of the Economic Recov-
                                              ery Tax Act of 1981. This law, among other things, permitted railroads
                                              to write off the total capitalized cost of track (that had not previously
                                              been depreciated) over a period of 5 to 50 years using an accelerated
                                              depreciation method and reduced the depreciation period for rolling
                                              stock (freight cars). Thesechangesincreaseddeferred taxes, which sig-
                                              nificantly increasedcash flow. According to AAR,changesresulting from
                                              this law allowed the railroad industry an estimated $2.5 billion net gain
                                              in cash flow between 1981 and 1985. By 1986, however, most of the tax

                                              4Cash flow equals net income, depreciation, deferred taxes, and income from affiliate companies.



                                              Page 38                                GAO/&CID-90430     Impacts of the Staggers Rail Act of 1980
                                            chapter 3
                                            Rallroade’ FlnanciaI Health Ha0 Improv*
                                            but Most Railroada Are Not
                                            RevenueAdequate




                                            benefits were no longer available. The Tax Reform Act of 1986, among
                                            other things, repealedthe investment tax credit, imposed a corporate
                                            alternative minimum tax, and increasedthe depreciation period for
                                            track. Consequently,cash flow declined.
                                            The fixed charge coverageratio, the ratio of income available for fixed
                                            chargesto interest expense,measureslong-term solvency. ICC suggested
                                            that a 3.5 or greater ratio is satisfactory for the railroad industry.
                                            Although this ratio fluctuated during the early 198Os,it has steadily
                                            improved since 1986, exceeding3.6 in all years except 1982, a recession
                                            year (see fig. 3.6). In comparison,the fixed charge coverageratio aver-
                                            aged about 1.7 during the 1970s and did not equal or exceedICC’s sug-
                                            gestedguideline in any of these years.


Figure 3.5: Fixed Charge Coverage Ratio for Class I Railroads
7   llmw   Flxed Charges Coved
                                                                      i




                                            Improvements in the fixed charge coverageratio can be attributed to,
                                            among other things, a reduced debt load and lower interest rates. Long-
                                            term debt has generally declined since 1980 (see fig. 3.6). In 1980, debt
                                            as a percentageof total capital was about 36 percent, comparedwith




                                            Page 39                              GAO/RCED-90-80   Impacts of the Staggers Rail Act of 1930
                                            Chapter 3
                                            RaRroads’ FlnanclaI Health Has Improved,
                                            but Moat Railroads Are Not
                                            Revenue Adequate




                                            about 24 percent in 1988.6During the 197Os,debt averagedabout 41
                                            percent of total capital. ICCofficials suggestedthat a debt level of
                                            between 20 and 60 percent of total capital is reasonablefor railroads.
                                            Lower debt levels indicate the ability to add more debt, which is gener-
                                            ally a less costly form of financing than selling equity. ICCofficials sug-
                                            gestedthat becauserailroads are not an expanding industry, they have
                                            not required much debt. Instead, railroads have used internal funds,
                                            such as deferred taxes, to meet financing needs.


Figure 3.6: Long-Term Debt as a Percentage of Total Capital for Class I Railroads
6oPeranl
                                                                         i




                                            “The railroad debt referred to here is based on the debt of individual railroad companies as reported
                                            to ICC. This may differ from the debt levels of railroad holding companies. Cur calculation of long-
                                            term debt includes, among other things, funded debt unmatured, equipment obligations, and capital-
                                            ized lease obligations. However, it excludes such items as long-term debt due within 1 year and accu-
                                            mulated deferred tax credits.

                                            Total capital is equal to stockholders’ equity (year-end) plus long-term debt, excluding that portion
                                            due within 1 year.



                                            Page 40                                 GAO/RCED-90-80      Impacts of the Staggers Rail Act of 1980
                       chapter 3
                       l&ibads’  Financial Health Has Improved,
                       but Most Railroads Are Not
                       Revenue Adequate




Improved Financial     The five largest Class I railroads-each with $3 billion or more in reve-
                       nues and together earning about 72 percent of the industry’s revenues-
Health Has Not Been    have outperformed the rest of the industry.6 Since 1980, they have gen-
Shared Industrywide    erally been more profitable and solvent than the other 11 Class I
                       railroads.


Profitability          As a group, the five largest Class I railroads earned greater profits.
                       Their return on investment averaged about 5.7 percent between 1980
                       and 1988. By comparison, the returns of the 11 smaller Class I railroads
                       averaged only about 3.5 percent in the 198Os,although the returns of 2
                       of these railroads did improve.


Short- And Long-Term   The five largest Class I railroads had a higher collective current ratio
Solvency               than the 11 smaller Class I railroads. From 1980 to 1988, the current
                       ratio of the five largest railroads averaged 126.4, compared with 110.0
                       for the smaller railroads. While both groups’average current ratios
                       exceededICC’S suggestedstandard of 100.0 percent, the smaller rail-
                       roads’ratio dropped below the standard in 1987, when it was 93.8
                       percent.

                       The five largest Class I railroads had a lower collective fixed charge cov-
                       erage ratio than the 11 smaller Class I railroads. Between 1980 and
                       1988, the five largest railroads’ fixed charge coverage ratio averaged
                       only 6.0, compared with 12.0 for the smaller railroads. However, the fig-
                       ure for the smaller Class I railroads was influenced by one railroad with
                       little debt. If this railroad is excluded, the 10 remaining railroads’ aver-
                       age fixed charge coverage ratio was about 3.2.

                       While the railroad industry’s financial health has improved, the indus-
Most Railroads Are     try’s return on investment has not equaled or exceededthe current cost
Not Revenue Adequate   of capital-that is, the industry is not revenue adequate. Furthermore,
                       most individual railroads are not revenue adequate, although in some
                       years ICC found that a few railroads had achieved revenue adequacy.


                       “On the basis of 1987 total operating revenues, the five largest railroads are CSX, Burlington North-
                       ern, Consolidated Rail Corporation, Norfolk Southern, and Union Pacific.

                       Cur analysis included all Class I railroads that reported to ICC during 1987 except those railroads
                       comprising Gullford Transportation Industries. Because of incomplete information, 1988 data for the
                       smaller Class I railroads exclude the Missouri-Kansas-Texas Railroad Company.



                       Page 41                                 GAO/RCEDBO-80      Impacts of the Staggers Rail Act of 1980
                                         Chapter 3
                                         Bsllroade’
                                                 F+InanciaI
                                                       He&b HasImproved,
                                         but Moat Railroads   Are Not
                                         Revenue Adequate




                                         Without adequaterevenues, a railroad has difficulty attracting and/or
                                         retaining the funds neededto operate.


Industry’s Return on                     ICCconsidersrailroads to be revenue adequateif their return on invest-
Investment Lags Behind                   ment is equal to or greater than the current cost of capital for the indus-
                                         try. We recomputed the railroads’return on investment and excluded
Current Cost of Capital                  certain adjustments (such as deferred taxes) ICCmakes for regulatory
                                         purposes.According to our calculations, the railroad industry was not
                                         revenue adequate at any time during the entire 1980-88period. Since
                                         1980, the industry’s return on investment has averaged about 4.9 per-
                                         cent per year, compared with an average cost of capital of 13.9 percent.
                                         Despite the improved financial performance of large Class I railroads,
                                         neither the larger nor the smaller Class I railroads have achieved reve-
                                         nue adequacy.The gap between return on investment and the cost of
                                         capital grew in 1981 and 1982, a time when the cost of capital reached
                                         its peak (see table 3.1). However, from 1983 to 1988 the gap steadily
                                         narrowed. Except for the larger railroads, though, the difference
                                         remained greater than it was in 1980. A lower cost of capital, not higher
                                         earnings, largely contributed to the improvement.’
Table 3.1: Revenue Adequacy of Class I
Railroads                                                        Average return on                                  Degree of revenue
                                                                     investment                                          inadequacy
                                                                5 largest        11 other                           5 largest       11 other
                                         Year                   railroads       railroads            %$ tZ          railroads      railroads
                                         1980                           5.23           5.45              11.2           -5.97            -5.75
                                         1981                           5.96           5.34              16.5          -10.54           -11.16
                                         1982                           4.36           2.40              17.7          -13.34           -15.30
                                         1983                           5.62           2.01              15.3           -9.68           -13.29
                                         1984                           7.09           4.21              15.8           -8.71           -11.59
                                         1985                           6.02           2.81              13.6           -7.58           -10.79
                                         1986                           5.05           2.13              11.7           -6.65            -9.57
                                         1987                           5.60           3.18              11.6           -6.00            -8.42
                                         1988                           6.71           3.61              11.7           -4.99            -8.09




                                         ‘In March 1981, ICC revised its revenue adequacy standards and began using the current cost of
                                         capital rather than an embedded (historical) cost of capital for comparison with return on invest-
                                         ment. This revision may account for increases in the cost of capital in 1981 and 1982.



                                         Page 42                                 GAO/RCED9W3O       Impacts of the Staggera Rail Act of 1980
     .


                            chapter 3
                            Railroads’ FlnanciaI Health Hns Improved,
                            but Most Railroads Are Not
                            Revenue Adequate




ICC Revenue Adeq.uacy       ICChas employed two standards for determining a railroad’s revenue
Determinations              adequacy.The first standard, adopted in 1978, required the use of three
                            measures:(1) return on investment equal to the cost of capital, (2) vari-
                            ous financial ratios intended to measurea railroad’s financial condition,
                            and (3) a flow-of-funds model designedto determine whether net income
                            is adequateto support a railroad’s capital needs.ICC found that this
                            approach indicated only short-term financial viability and that its con-
                            tinued use could prevent railroads from achieving the long-term revenue
                            adequacy the StaggersRail Act envisioned.The secondstandard,
                            adopted in 1981, based revenue adequacyon return on investment equal
                            to the current cost of capital. The new standard required that the cur-
                            rent, rather than the embedded,cost of capital be used to calculate reve-
                            nue adequacy.
                            In 1986, ICC further revised its revenue adequacystandards. Although
                            ICCretained the standard of comparing return on investment with the
                            current cost of capital, it changedits method for calculating the various
                            componentsof return on investment. In particular, ICC required that
                        l accumulateddeferred taxes be subtracted from the net investment base;
                        l depreciation data, rather than retirement-replacement-bettermentdata,
                          be used;
                        9 various adjustments be applied to consolidateon a system basis all Class
                          I railroads under commoncontrol; and
                        l the calculations include the financial results of majority-owned ClassI
                          subsidiaries that were integral to rail operations, income taxes related
                          only to rail operations, and interest income associatedwith working cap-
                          ital investment.

                            In October 1988, ICC once again revised its standards to, among other
                            things, enhancecompliancewith cost-accountingprinciples adopted by
                            the Railroad Accounting Principles Board.8The 1988 revenue adequacy
                            determination was the first to incorporate all of the changesto ICC’S
                            standards.Q



                            *The Railroad Accounting Principles Board was created by the Staggers Rail Act to, among other
                            things, establish cost-accounting principles that ICC was to use in implementing regulatory provisions
                            involving cost determinations.

                            ‘For more information on ICC methods for evaluating the revenue adequacy of railroads, see our
                            report Railroad Revenues: Analysis of Alternative Methods to Measure Revenue Adequacy (GAO/
                            NED-87-lSBR, Oct. 2,1986) and Railroad Accounting Rrinciples: Final Report, Railroad Accounting
                            Principles Board (Sept. 1, 1987).



                            Page 43                                GAO/RCED-90-80      Impacts of the Staggers Rail Act of 1980
                          Chapter 3
                          Rallroade’ Financial Health Has Improved,
                          but Most Railroads Are Not
                          Revenue Adequate.




                          Using the multi-indicator standard, ICCfound 13 of the 36 Class I rail-
                          roads to be revenue adequatein 1978. However, using the current cost
                          of capital standard, ICC found only three railroads to be revenue ade-
                          quate in 1979 and 1980, only two in 1981, and none between 1982 and
                          1987.“’In 1988, ICCconcludedthat four Class I railroads were revenue
                          adequate-two only tentatively, pending commentson certain adjust-
                          ments ICChad made to their financial statementsll ICC deemed12 other
                          Class I railroads revenue inadequate.


Effects of Revenue        Revenueinadequacy affects the ability of a railroad to attract and/or
Inadequacy                retain capital. Insufficient profits not only make it difficult to cover
                          costs and maintain operations but also may induce investors to place
                          their funds elsewhere.The StaggersRail Act allows revenue-inadequate
                          railroads to increaserates within the zone of rate flexibility and add
                          surchargesto rates for traffic on light-density lines. We reported in 1986
                          that ICC had not collected data on tariffs filed under the zone of rate
                          flexibility or on the use of light-density surcharges.12 ICC still does not
                          collect these data; however, one ICC official told us he believes that rail-
                          roads have had little need for these provisions.


                          Railroads continue to lag behind other transportation modes and indus-
Railroads Lag Behind      tries in profitability. We found that railroads’rates of return not only
Other Transportation      are lower than those for the intercity trucking and natural gas pipeline
Industries in Financial   industries but also are among the lowest for major U.S. industries.13
                          Other financial indicators we used to compare these transportation
Performance               modes showed mixed results.


Railroads Have Poorer     Trucks and gas pipelines have generatedhigher returns on investment
Profitability             than railroads (see fig. 3.7). The trucks’ returns on investment ranged
                          between about 8.0 and 17.0 percent from 1980 to 1988 and were more
                          than 10 percent in all years except 1982, while the gas pipelines’returns

                          “‘The number of Class I railroads generally declined between 1978 and 1987 from 36 to 18.
                          “The railroads found revenue adequate were Burlington Northern, Chicago and North Western,
                          Florida East Coast, and Norfolk Southern. The Burlington Northern and Chicago and North Western
                          determinations were tentative.

                          “Railroad Revenues: Analysis of Alternative Methods to Measure Revenue Adequacy (GAO/
                          Rm-87-lm,      Oct. 2,1986).

                          i3The natural gas pipeline companies included in our analysis are those that derive at least 76 per-
                          cent or more of their revenues from transporting gas for others.



                          Page 44                                 GAO/RCED-90-80     Impacts of the Staggers Rail Act of 1980
                                        Chapter 8
                                        RaRroadr’ Flnanclal Health Has Improved,
                                        but Most Railroads Are Not
                                        Rmenue Adequate




                                        ranged between about 9.8 and 13.2 percent. The returns on investment
                                        for railroads, on the other hand, ranged between about 3.6 and 5.9 per-
                                        cent and have historically laggedbehind those for trucks and other
                                        transportation modes.In addition, railroads did not improve their
                                        returns as much as trucks and gas pipelines following the 1981-82reces-
                                        sion Between 1983 and 1988, railroads’average return on investment
                                        was only about 3 percent higher than returns between 1980 and 1982-
                                        4.9 percent compared with 4.8 percent. Trucks and gas pipelines, how-
                                        ever, improved their returns by 16 and 6 percent, respectively.

Figure 3.7: Returns on investment for
Railroads, Trucks, and Gas Pipelines
                                        20     Percant




                                        2

                                        0

                                        1980             1961       1992   1983     1984       1995       1988        1967       1999
                                        Year

                                               -         Gas Pipelines
                                               -1-1      Trudta
                                               -         Railroads


                                        As discussedearlier, return on investment performance dependson both
                                        asset turnover and profit margin. During the 198Os,railroads’asset
                                        turnover ranged from 0.6 to 0.8 percent, which was lower than the
                                        trucking industry’s 4.1 to 5.3 percent but higher than the gas pipeline
                                        industry’s 0.3 to 0.5 percent. Railroads’profit margin during the 1980s
                                        ranged from 5.3 to 9.1 percent, while trucks’ profit margin ranged from
                                        1.9 to 4.6 percent and gas pipelines’from 25,l to 38.5 percent.




                                        Page 46                              GAO/RCED-90-80   Impacts of the Staggers Rail Act of 1980
                                       chapter 3
                                       Railroads Pinancial Health Has Improved,
                                       but Most Railroads Are Not
                                       Revenue Adequate




                                       Two factors contributed to the railroads’inability to match the financial
                                       performances of these other transportation modes:railroads must build
                                       and maintain their own rights-of-way, while trucks do not, and railroads
                                       have higher cost structures than gas pipelines. Right-of-way ownership
                                       affects asset turnover performance, while higher cost structures influ-
                                       ence profit margin performance.

                                       Railroads’returns on equity showed mixed results compared with those
                                       of the other modes(see fig. 3.8). In general, railroads did better than
                                       trucks but not as well as gas pipelines. Between 1980 and 1988, trucks’
                                       returns on equity ranged between -2.0 and 13.6 percent, while gas pipe-
                                       lines’returns ranged from 14.1 “;o24.4 percent. Railroads’returns on
                                       equity ranged between 6.9 and 11.6 percent and lagged behind the
                                       returns of the other two modesin 4 of the 9 years. Railroads were able
                                       to increasetheir average return about 4 percent following the 198182
                                       recession.In comparison,trucks’ equity returns increased84 percent,
                                       while gas pipelines’returns declined 12 percent.

Figure 3.8: Returns on Equity for
Rallroads, Trucks, and Gas Pipelines   26      Percent
                                       24
                                       22




                                        1960             1991       1992   1992     1994       1985       1966        1997       1999
                                        Ymr

                                               -         Gas Pipelines
                                               -1-1      Trucks
                                               m         Railroads




                                       Page 46                              GAO/RCED-90-80   Impacts of the Staggers Rail Act of 1989
        ,


                                         Chspter
                                              3
                                         ltalhub’   Financial Health l-ha Improved,
                                         but Moat Ihilmda     Are Not
                                         Revenue Adequate




                                         Finally, railroads lag behind other U.S. businessesin profitability. Rail-
                                         roads’return on investment in 1988 was the lowest of a sampleof 21
                                         industries we chosefor comparison(seetable 3.2). All but three of the
                                         industries earned returns on investment greater than 10 percent, while
                                         the railroads’return on investment was only 6.6 percent. Railroads did
                                         not fare much better in terms of return on equity, which in 1988 was
                                         higher than the returns on equity of utilities and telecommunication
                                         companies,but lower than those of the 18 other industries.
Table 3.2: Comparbon of 1888 Return8
for RaIlroad and Other U.S. Buriner8es   Figures in percent
                                                                                                    Return on             Return on
                                         Industry                                                 investment                 ww
                                         Banks                                                            32.5                   16.6
                                         Health care                                                      27.5                   23.6
                                         Consumer products                                                23.7                   22.6
                                         Discount and fashion retailing                                   21.3                   15.8
                                         Chemicals                                                        19.3                   21.5
                                         Metals and minina                                                19.1                   24.0
                                         Leisure time products                                            18.4                   18.2
                                         Nonbank financial                                                18.3                   14.2
                                         Food                                                             15.9                   20.7
                                         Paper and forest products                                        15.9                   17.2
                                         Electrical and electronics                                       15.6                   12.8
                                         Fuel                                                             14.3                   12.3
                                         Manufacturina                                                    14.2                   15.2
                                         Aerospace                                                        13.7                   13.3
                                         Office equipment and services                                    12.6                   15.0
                                         Telecommunications                                               12.6                   10.3
                                         Publishing and broadcasting                                      12.3                   15.7
                                         Insurance                                                        11.8                   12.7
                                         Automotive                                                        9.6                   16.8
                                         Utilities                                                         8.9                   10.2
                                         Railroads                                                         5.5                   11.0
                                         Source: Business Week, ICC.

                                         Railroads have lagged behind other businessesin profitability for a long
                                         time. Our 1986 report on the revenue adequacyof railroads found that
                                         their return on equity in 1984 lagged behind the returns of five indus-
                                         tries, including the trucking and oil and gas industries, and exceeded
                                         only that of the steel industry. In November 1986, ICC also found that




                                         Page 47                              GAO/RCEDW-80   Impacts of the Staggers Rail Act of 1980
                                            Chapter 3
                                            Railroads’ Financial Health Has Improved,
                                            but Most Railroads Are Not
                                            Revenue Adequate




                                            Class I railroads’returns on investment and equity between 1979 and
                                            1983 were less than those of electric utilities and all manufacturers.14


Other Financial Indicators                  Railroads generally lag behind trucks and gas pipelines in their ability to
Show Mixed Results                          pay short-term debt (see fig. 3.9). The railroads’current ratio has aver-
                                            aged about 113.0 percent since 1980, comparedwith 126.9 percent for
                                            trucks and 171.6 percent for gas pipelines. The current ratio has fluctu-
                                            ated for all three transportation modessince 1980. However, as their
                                            performances before and after the 1981-82recessionshow, railroads did
                                            not do as well as the other two modes.Between 1983 and 1988, trucks’
                                            average current ratio was about the same as during the 1980-82period,
                                            while gas pipelines’ratio improved about 27 percent. By contrast, rail-
                                            roads’current ratio declined about 6 percent-from an average of about
                                            117 percent to an average of about 111 percent.

Figure 3.9: Current Ratios for Railroads,
Trucks, and Gas Pipeline8
                                            220
                                            220
                                            210
                                            200
                                            190
                                            180
                                            170
                                            160
                                            150
                                            140
                                            190
                                            120
                                            110
                                            100
                                             90
                                             80

                                              1980          1951        1992   1993       1954       1955       1995       1997       1959
                                              Year

                                                     -       Gas Pipelines
                                                     -1-1    Trucks
                                                     m       Railroads




                                            “Evaluation of Studies Prepared by Consumers United for Rail Equity (CURE) and Consumer Feder-
                                            ation of America (CFA), ICC, Bureau of Accounts (Nov. 1986).



                                            Page 48                              GAO/RCED90-80    Impacts of the Staggers Rail Act of 1980
        .


                                        Chapter 8
                                        ItaUmd~’ FY.namcial Health Has Improved,
                                        but Most IUlmade Are Not
                                        Revenue Adequate




                                        Railroads comparefavorably with these two industries in long-term sol-
                                        vency, as a comparisonof their fixed charge coverageratios shows (see
                                        fig. 3.10). Since 1980,the railroads’ratio has averagedabout 4.6 annu-
                                        ally, comparedwith 3.4 and 2.8 for trucks and gas pipelines. These
                                        results largely reflect debt levels. According to an official at the Federal
                                        Energy Regulatory Commission,most of the transport-only pipelines in
                                        our analysis were new projects, which are financed typically by 76-per-
                                        cent debt and 26-percentequity. As a result, they carried about twice as
                                        much debt as railroads and trucks. We found that over the 1980-88
                                        period, the gas pipeline industry’s debt averaged about 61 percent of
                                        capital, comparedwith about 31 percent for trucks and 29 percent for
                                        railroads. According to a Federal Energy Regulatory Commissionoffi-
                                        cial, gas pipelines’debt levels are expectedto gradually decline as busi-
                                        ness develops and more revenuesare generated.This official said that a
                                        debt of no more than 60 percent is good for the gas pipeline industry.

Figure 3.10: Fixed Charge Coverage
Ratios for Railroads, Trucks, and Qas
Pipelines                               6.5   Tima Flud Charges Covered

                                        6.0

                                        6.0

                                        5.0

                                        4.8

                                        4.0

                                        3.6

                                        3.0

                                        2.5

                                        2.0

                                        1.6



                                         1989          1981        1902   1983      1964       1985       1986       1987       1988
                                         Yur

                                                -       Gas Pipelines
                                                -1.1    Trucks
                                                m       Railroads


                                        Railroads have lower operating expenses,measuredas a percentageof
                                        operating revenues,than trucks but higher operating expensesthan gas
                                        pipelines, as a comparisonof their operating ratios shows. Between


                                        Page 49                             GAO/RCED-90-90   Impacts of the Staggers Rail Act of 1980
              Chapter 3
              Ralhads’ Fhancial Health Ha.9 Improved,
              but Most Rahiade  Are Not
              Revenue Adequate




              1.980and 1988, the railroad industry’s operating expenseswere about
              88 percent of operating revenues,compared with about 97 percent for
              trucks and about 68 percent for gas pipelines. After the 1981-82reces-
              sion, railroads improved their operating ratio more than trucks but not
              as much as gas pipelines. The railroads’averageoperating ratio between
              1983 and 1988 was about 1.4 percent less than the average ratio
              between 1980 and 1982-87.8 percent comparedwith 89.1 percent. By
              contrast, trucks improved their average ratio by slightly less than 1 per-
              cent, while gas pipelines improved their average ratio by almost 13
              percent.
              Differences in operating ratios among the modeslargely reflect the
              industries’structural differences. According to the American Trucking
              Associations, since trucks do not own the highways and lease much of
              their equipment, less earnings are neededto replace assets.Conse-
              quently, the trucking industry’s operating ratios are higher than those
              of the railroad and gas pipeline industries. Gas pipelines, however, are
              very capital intensive, and their tariffs are regulated to cover the cost of
              doing businessand to provide an acceptablerate of return. According to
              a Federal Energy Regulatory Commissionofficial, labor costs for gas
              pipelines are only about 6.6 percent of operating expenses.In compari-
              son, railroads’labor costs averaged about 49 percent of operating
              expensesin the 1980s.As a result, gas pipelines’operating ratios are
              generally lower than those of railroads.

              One of the primary purposes of the StaggersRail Act was to improve the
Conclusions   railroads’financial health. Progresshas been made in achieving this
              goal.
              To remain competitive, railroads have improved their financial health
              by reducing costs and becomingmore efficient. They increasedtheir
              profitability, improved their ability to meet long-term obligations, and
              reduced their debt levels. Short-term solvency improved in the early
              part of the 198Os,although it later declined. Railroads improved their
              financial health largely by cutting costs-abandoning lines, selling lines
              to other operators, and reducing their work force-as well as by
              improving productivity. Although railroads have benefited from tax leg-
              islation (which improved their cash flow) and declining interest rates
              (which reduced their debt costs), the StaggersRail Act played a role in
              stimulating their financial health by facilitating cost reduction measures
              and inducing productivity.



              Page 60                            GAO/RCED-SO-80 Impacts of the Staggers Rail Act of 1980
.


    chapters
    Bailtoads’ YYnanclal Health Haa Improved,
    but Most Railroada Are Not
    Revenue Adequate




    Despite gains in many financial measures,the railroad industry is still
    not in robust financial health. Its financial performance lags behind that
    of other transportation modes,and financial gains have not been shared
    industrywide, In addition, even though the railroad industry has become
    more profitable, most railroads have not achievedrevenue adequacy,
    Revenueinadequacy hampers their ability to attract and/or retain capi-
    tal and, in the long run, may hurt their ability to finance the capital
    acquisitions they need to provide competitive service. While someof the
    smaller ClassI railroads have improved their profitability, others may
    be especially hindered in their ability to attract and/or retain capital
    becausethey are not as financially sound as the larger railroads.




    Page 51                             GAO/RCED-90-90   Impacts of the Staggers Rail Act of 1980
Chapter 4                                                                                                          ,

Most-Though Not All-Shippers Have
BenefitedFYomReducedRaboad Regulation

                                Shippers have benefited from reduced regulation of the railroad indus-
                                try and increasedcompetition. Rateshave declined,service has
                                improved, and railroads have becomemore flexible in meeting customer
                                needs.However, becauseof shippers’individual circumstances-such as
                                the type of commodity shipped, the degreeof competition within a mar-
                                ket, and the availability of contracts-the impact of reduced railroad
                                regulation has varied. Somerates have declined more than others, and
                                someshippers have experiencedincreasedcosts in the wake of railroad
                                actions to eliminate uneconomicalservice. Disparities in rates and ser-
                                vice were expectedin the shift under regulatory reform to a market-
                                oriented system.
                                While most shippers are generally satisfied with the StaggersRail Act,
                                someshipper groups have expresseddissatisfaction with the way ICC
                                has handled its remaining regulatory functions under the StaggersRail
                                Act. In particular, someshippers cite continuing burdensomeregulatory
                                processesand the difficulty in obtaining relief from harmful railroad
                                actions as evidencethat ICChas not acted to protect their interests. Since
                                1985, in responseto shippers’concerns,ICChas modified someof its pol-
                                icies and proceduresfor balancing the interests of railroads, shippers,
                                and the public.

                      The increasedcompetitivenessof railroads, encouragedby the Staggers
Shippers Have         Rail Act, was advantageousfor most shippers. Overall, real rail rates
Benefited From Better have declined.Rail service has also improved: train service is more relia-
Rates and Service     ble, and freight car shortages,which might interrupt a shipper’s busi-
                      ness,have declined. In addition, the creation of new shortline and
                                regional railroads has provided continued rail service, often at better
                                rates, in areaswhere it might have been interrupted. Thesechanges
                                have helped shippers to be more competitive in their own markets.


Rates Declined                  Shippers have benefited from the fall in real rail rates since 1980. In
                                April 1989, ICCreported that real rail rates-as measuredby revenues
                                per ton and deflated to 1987 dollars-fell an averageof about 22 per-
                                cent between 1980 and 1987 (seetable 4.1). Rates fell for shipping seven
                                of the nine commodity groups ICCstudied. The declinesranged from
                                about 10 percent for coal to about 44 percent for farm products. In con-
                                trast, between 1978 and 1980-the comparisonperiod ICCused-real
                                rail rates increasedabout 9 percent, with coal rates rising about 9 per-
                                cent and farm product rates about 14 percent. During the sameperiod,



                                Page 62                      GAO/RCED-90-80   Impacts of the Staggers Rail Act of 1980
         ‘




                                    Chapter 4
                                    Most-Though   Not All-Shippers Have
                                    Benefited From Reduced RaRroad Regulation




                                    the rates for shipping other com m oditiesalso increased,except for rates
                                    for lum ber and wood products, which declined 0.74 percent.
Table 4.1: Average Real Rail Rate
Changes                             Figures in percent
                                                                                                               Rate change
                                    Category                                                  1978-80             1980-87             1978-87
                                    Farm products                                                14.23               -44.01             -36.05
                                    Gal                                                              9.36            -10.19              -1.78
                                    Food and kindred                                             14.09               -37.82             -29.06
                                    Lumber and wood                                             -0.74                   1 .Ol              0.26
                                    -~-.-
                                    Pulp and paper                                                   9.13            -19.40             -12.05
                                    Chemicals                                                        4.49            -20.06             -16.47
                                    Transportation       eauioment                                   5.60               3.83               9.64
                                    IntermodaP
                                    _-  _..- ---                                                 13.93               -25.44             -15.05
                                    All                                                              8.16            -33.14             -27.68
                                    -- others -------.

                                    Average     rate chanReb                                         8.55            -22.35             -15.71

                                    aTrailer-on-flatcar and container-on-flatcar.

                                    bAnnual rate changes for each category weighted by their share of revenue
                                    Source: ICC.


                                    Shippers, through negotiated contracts, have also been able to obtain
                                    lower rates and guaranteed service in return for predictable traffic
                                    volum es. Generally, the larger the volum e to be transported, the larger
                                    the rate discount. According to a M arch 1984 ICCstudy, the m ain benefit
                                    of contracting for m ost shippers was discounted rates.’ICCfound that
                                    contracts particularly benefited shippers with com petitive transporta-
                                    tion alternatives, who, faced with intense com petition for their traffic
                                    during the 1981-82 recession,were able to negotiate significant rate con-
                                    cessionsfrom railroads. Contracts have also benefited grain shippers.
                                    For exam ple, in Septem ber1986 the U.S. Departm ent of Agriculture
                                    reported that contract rates for shipping wheat by rail from Kansas to
                                    port destinations in the Gulf of M exico averaged about 17 percent less
                                    than published tariff rates in effect on the dates of the contracts.”




                                    ‘Report on Railroad Contract Rates Authorized by Section 208 of the Staggers Rail Act of 1980, ICC
                                    (Mar. 13, 1984).

                                    ‘Impacts of Rail Deregulation on Marketing of Kansas Wheat, U.S. Department of Agriculture (Sept.
                                    1986).



                                    Page 53                                         GAO/RCED-90-80     Impacts of the Staggers Rail Act of 1980
                   Chapter 4
                   Most-Thou&     Not All-Shipper~      Have
                   Reneflted From Reduced Rdlroad       Regulation




                   The creation of new shortline and regional railroads also brought rate
                    benefits to many shippers. ICC’S October 1987 testimony before the Sen-
                    ate Committee on Commerce,Science,and Transportation on shortline
                   and regional railroads indicated that these smaller railroads not only
                   continue rail service where such service could have been lost but that
                   they also have operating cost advantagesover Class I railroads. Because
                   they have flexible work rules and lower wages,these railroads can offer
                   competitive rates and still make a profit. According to an August 1989
                   joint FRAand ICCsurvey of 627 shippers served by shortline and regional
                   railroads created since 1980,94 percent reported that service levels had
                   been maintained or had improved and 88 percent believed rates had
                   improved or stayed the same.3Three railroad representatives we inter-
                   viewed, whose companieswere created since 1980, said that the Stag-
                   gers Rail Act enabledtheir firms to provide customersboth competitive
                   rates and improved service.


Service Improved   Shippers have also benefited from more reliable train service and fewer
                   car shortages.In 1983, we surveyed 42 shippers that ICChad found
                   likely to be in a market-dominant situation-that is, shippers that
                   lacked effective transportation alternatives for certain movementsof
                   their goodss4Despite this potential competitive disadvantage,about 86
                   percent of these shippers reported that their rail service had not
                   changedor had gotten better since passageof the StaggersRail Act. Our
                   1985 resurvey of these shippers found that almost 91 percent reported
                   equal or better service under the StaggersRail Act, including over 80
                   percent of coal shippers. Those that did report service concernsmost
                   often singled out transit time as a problem.
                   The improvement in rail service is illustrated by the decline in freight
                   car shortages.According to a 1974 DOTsurvey of 193 manufacturers, a
                   problem cited by about one-third of the shippers was the unavailability
                   of railroad equipment.”Between 1973 and 1980, car shortages-ship-
                   pers’inability to obtain freight cars when needed-ranged to slightly
                   over 2.6 percent of the serviceable freight car fleet. Since 1980, how-
                   ever, there have been few or no shortages(seetable 4.2). According to

                   “A Survey of Shipper Satisfaction With ‘Service and Rates of Shortline and Regional Railroads, Joint
                   Staff-,     DUF, FRA; ICC, Office of Transportation Analysis (Aug. 1989).
                   41nformation on Regulatory Reform Under the Staggers Rail Act of 19SO(GAO/RCED83-174, Aug.
                   lr;lQW.
                   “Industrial Shipper Survey (Plant Level), conducted by DUl’ as a part of the 1974 National Transpor-
                   tation Study.



                   Page 64                                GAO/RCED-90-80      Impacts of the Staggers Rail Act of 1980
                                              chapter 4
                                              Moat-Though       Not All-Shippen   Have
                                              ReneftW From Reduc~~IWlroad B0gulatton




                                              AAR,shortageshave declined becauseof such factors as the use of con-
                                              tracts-which allow better car planning-and railroads’better coordi-
                                              nation of train service. Fewer car shortagesmean improved car
                                              utilization, which is reflected in the declining car cycle-the time
                                              between trips.0 In 1978, the average car cycle was 26.7 days, compared
                                              with about 17 days in 1988. As we reported in 1980, surplusesand
                                              shortagesof freight cars fluctuate cyclically and geographically,as well
                                              as by car type.’W ith fewer shortages,cars are more readily available to
                                              shippers, thereby improving service.8
Table 4.2: Freight Car Shortages as a
Percentage of the Rallroad Freight Car                                                                          Car shortages
Fleet                                                            Number of freight cars                                                Percent of
                                                                    (in thousands)             Number (in         Percent of          serviceable
                                          Year                     Total      Serviceable      thOUSatId8)        total fleet                fleet
                                              1973                1,711.3           1,604.6             34.;              2.00                  2.13
                                              1974                1,710.z           1,607.g             10.0              058                   0.6?
                                                                                                                               --
                                              1975                1.725.1           1579.7               4.9              0.26                  OS31
                                              1976                1,701.a           1,550.3              5.6              0.33                  0.36
                                              1977          -     1,670.7           1,524.3             17.0              1.02                  1.12
                                              1978                1.651.3           1513.5              38.3              2.32                  2.53
                                              1979                1,689.2           1,594.6             16.0              0.09                  1.00
                                              1980                1,703.2           1,598.6                .9                0                     0
                                              1981                1,676.8           lS95.8                  0                0                     0
                                              1982                1.617.0           1.529.3              0.1                 0                     0
                                              1983                i551.9            1:451.7              0.1                 0                     0
                                              1984                1,498.5           1,403.o                 0                0                     0
                                              1965                1,433.6           1,346.8              3.4              0.02                  0.03
                                              1986                1,355.2           13279.6              3.0              0.02                  0.02
                                         “~




                                              1987                1,286.l           1,213.3              2.7              0.02                  0.02
                                              1968                1,247.7           1,179.6              1.5              0.01                  OE
                                         Note: Numbers are for the fourth quarter of each year
                                         Source: GAO analysis of AAR data.




                                         “Car cycle is the time (m days) between freight car trips. If the car cycle decreases(i.e., the number of
                                         days between trips declines), then cars are more readily available to shippers and can make more
                                         trips per year. If the car cycle increases (Le., the number of days between trips increases), cars are
                                         not as readily available to shippers and cannot make as many trips per year.
                                         7There Is No Shortage of Freight Cars-Railroads Must Make Better Use of What They Have
                                         (CED-81-2,Nov. 10, 1980)

                                         “As table 4.2 illustrates, the total railroad freight car fleet has declined since 1980. In July 1989, the
                                         U.S. Department of Agriculture reported that without improvements ln cycle times and future addi-
                                         tions to the grain car fleet, grain car shortages could begin as early as 1990.



                                         Page 66                                    GAO/RCED-90-80     Impacts of the Staggers Rail Act of 1980
                    Chapter 4
                    Most-Though    Not All-Shippers       Have
                    Reneflt43d Prom Reduced Rakoad        IkgUhdiOIl




                    Representativesof shippers we spoke with also believe service has
                    improved as a result of the StaggersRail Act. Representativesof four of
                    the five associationswe contacted said that, in general, the act has
                    improved shippers’competitivenessand openednew markets for their
                    membersthrough improved service and reduced rail rates9 Representa-
                    tives of all five associationssaid that, to at least some degree,their
                    membersused, or previously had used, contracts. One representative
                    said that contracts provided better service and prices, as well as
                    reliability.
                    Rail service, although improved, does not compare favorably with the
                    service provided by trucks. A recent survey of 125 shippers found that
                    although rail service had generally stayed the same or improved in the
                    last 6 years, trucks rated higher than railroads in both price and service
                    attributeslo Over 75 percent of the shippers surveyed reported that rail-
                    roads’reliability and equipment quality were the same or better over
                    the last 5 years, and 49 percent reported that rail transit time had
                    improved. However, trucks maintained an advantage over railroads in
                    14 of 16 price and service attributes the survey measured,ranging from
                    transit time and reliability to customer service and equipment quality
                    and suitability. Railroads rated better than trucks only in their informa-
                    tion systems and ability to interchange data electronically. For those
                    attributes the shippers ranked of highest importance, trucks rated a
                    higher advantage in 7 of 13 categoriesbut a somewhat lower advantage
                    in the other 6 attributes.”

                    The transition under regulatory reform to a more market-oriented sys-
Reduced Railroad    tern was not expected to affect all shippers the same.While most ship-
Regulation Has      pers have gained from the StaggersRail Act, not all have. Individual
Affected Shippers   circumstances,such as the type of commodity shipped and the degreeof
                    inter- and intramodal competition, have determined which shippers
Differently         have benefited from reduced railroad regulation. Rates have not


                    eConsumers United for Rail Equity qualified its response by saying that where there is adequate
                    competition, the Staggers Rail Act haa worked to provide reasonable rates and better service. How-
                    ever, where there is a lack of competition, shippers have not been treated fairly.

                    r”Temple, Barker, and Sloane, Inc., “Understanding and Meeting Customer Needs” (Lexington, Mass.:
                    Nov. 1989).
                    I ‘These seven attributes were reliability, timely notice of delays, customer service, ease of doing busi-
                    ness, accurate estimated times of arrival, single-carrier service, and transit time. The other six attrib-
                    utes were price, billing accuracy, loss and damage, equipment quality, claims, and equipment
                    suitability.



                    Page 66                                  GAO/RCED-90-80      Impacts of the Staggers Rail Act of 1980
                               Chapter4
                               Moat-Though    Not All-SNppers       Have
                               Benefited From Reduced Railroad      Regulation




                               changed to the same degree for all shippers, and areas with less compe-
                               tition-the wheat market, for example-have seen fewer benefits than
                               other areas. Marketplace competition was designed to replace regulation
                               as the primary determinant of prices and services, with regulatory over-
                               sight reserved for casesin which markets did not produce competitive
                               results.


Competitiv ‘e Factors Affect   Rail rates for different commodities reflect both competitive market
Rail Rates                     conditions and the commodities’different transportation requirements.
                               Less regulation has given the railroads more flexibility in meeting com-
                               petition from trucks and barges, which typically compete with railroads
                               for the shipment of different types of traffic. Barges compete for low-
                               value commodities that are less sensitive to delivery times, such as grain
                               and coal, while trucks more often compete for the transportation of
                               high-value finished goods, such as automobiles and other manufactured
                               goods. In some parts of the nation, however, water transport is not
                               available and truck transport is not a viable means by which rates will
                               be constrained to competitive levels.

                               To study how railroad competition has affected rates, we examined
                               rates for shipping wheat in sections of the country that differed in the
                               number of railroads serving the area. Wheat is a bulk agricultural com-
                               modity for which railroads generally face less competition from barges;
                               consequently, competition among railroads is a key determinant of rail
                               rates for wheat shipments. Rail rates for wheat can be closely approxi-
                               mated by the spread between prices paid for wheat at grain elevators in
                               the Plains States and delivered prices at Portland and Houston-repre-
                               sentative transfer points for export wheat.12We found that inflation-
                               adjusted spreads for both spring and hard red winter wheat have
                               declined since 1980, indicating that rail rates have fallen (see fig. 4.1).
                               However, the spread has declined less in areas like the Northern Plains,
                               where there are relatively few railroads, than in areas like the South-
                               Central Plains, where there are more railroads offering service.13In
                               recent years, the spread has increased becauseof increased grain


                               ‘“As of January 1987, about two-thirds of the nation’s wheat farms are in the plains states from
                               Texas to North Dakota, including Colorado and Montana.
                               %eclines in these spreads may also indicate the use of multiple-car or unit train discounts-that is,
                               shipments of a single commodity to one destination in units of 26 rail cars or more at a reduced rate.
                               Multiple-car discounts originated before passage of the Staggers Rail Act. However, the use of such
                               discounts may have accelerated since 1980 because of the increased pricing flexibilites introduced by
                               the reduction in railroad regulation.



                               Page 67                                 GAO/RCED80-80      Impacts of the Staggers Raii Act of 1980
                                           Chapter 4
                                           Moat-Though   Not All-Shippers            Have
                                           Jkneflted Fkom Reduced Raikoad            Regulation




                                           exports, among other factors, but the spreads are still lower in real
                                           terms than they were during the late 1970s.

Figure 4.1: Index of Wheat Price Spreads
In the Plaina States
                                           Index (1977d99)
                                           130

                                           129

                                           110

                                           100

                                            w

                                            80

                                            70

                                           90

                                           80

                                           40

                                           30

                                             1977        1979     1979     1999      1981    1992   1993      1994    1985    1996    1997    1999
                                             Ymu

                                                    -         Northern Plains
                                                    - - - -   Southern and Central Plains


                                           Rail rates for coal have declined only about half the average for all com-
                                           modities. Moreover, according to ICCstatistics, the percentageof coal
                                           shipments moving at rates exceedingthe current threshold for ICCregu-
                                           lation of maximum rail rates-a revenue-to-variable-costratio of 180
                                           percent-has generally increasedfrom about 20 percent in 1980 to
                                           about 46 percent in 1987.
                                           Whether railroads have exercised market power to extract higher prof-
                                           its from coal shippers is unclear. On the one hand, according to a May
                                           1986 Department of Energy draft report, although a large number of
                                           coal shippers lacked competitive alternatives and were therefore vulner-
                                           able to potential railroad market abuse,there was little evidence that




                                           Page 58                                      GAO/RCED-90-80     Impacts of the Staggers Rail Act of 1980
                Chapter 4
                Moot-ThoughNot      All-SNppers   Have
                BenefIti    From Reduced Railroad Regulation




                railroads had imposed excessiverates on coal since passageof the Stag-
                gers Rail Act.‘4 On the other hand, of the 30 ICCdecisionsissued between
                1980 and May 1989 in which rates were found unreasonable,15
                involved coal rates. According to a National Coal Association official,
                greater railroad competition, contracts, and increasedrailroad efficiency
                since 1980 have benefited the coal industry, but deregulation has not
                decreasedcoal captivity to railroads and rate moderation has not meant
                reasonablerates.


Other Impacts   Not all shippers have been able to obtain rail contracts and the rate and
                service benefits that come with them. ICC’S February 1987 study of 152
                small- to medium-sizegrain shippers (up to 2,000 rail carloads annually)
                and 29 large grain shippers (over 2,000 carloads annually) found that
                the smaller shippers were largely unable to secure rail contract rates
                becausethey lacked the necessaryvolume.16As a result, some country
                grain elevators becamenoncompetitive, since contracts allowed the
                high-volume shippers to offer higher prices to farmers.‘6Farmers often
                bypassedthe low-volume shippers to obtain better prices at the high-
                volume locations. Thus, high-volume shippers benefited from lower
                transportation rates, and farmers benefited from higher prices, while
                smaller shippers paid higher rates to move their products.
                Line abandonmentshave also adversely affected someshippers. In Feb-
                ruary 1986, ICCreported the results of an informal survey of state,
                county, and community leaders and shippers affected by 16 line aban-
                donments between 1981 and 1983. ICC found that there were no business
                closings and that most civic and electedofficials noted only minimal
                impacts on their communities. However, 33 of the 45 shippers reported
                sometype of adverse effect, such as increasedtransportation costs and/
                or additional expensesto modify facilities to accommodatetrucks. In
                July 1987, we reported the results of our survey of 163 protesters of

                i4Effects of Railroad Regulatory Reform on Coal and Electricity, Staff Working Draft, Interim Tech-
                nical Report, U.S. Department of Energy (May 1986).

                ‘6%
                tocongre
                       f%ICC(Feb. 18,1987).
                The 162 small- to medium-size shippers represented 214 country gram elevators, 10 feed mills, 6
                grain firms, and 1 farmer. Collectively, the 29 large shippers shipped and/or received over 1.3 million
                carloads of grain annually.

                L”Accordiig to ICC, the price farmers receive for their grain is generally the prevailing market price
                minus transportation costs and elevator handling charges. The primary function of the country eleva-
                tor is to buy farmers’ grain and sell it to processors, exporters, and livestock and poultry feeders.



                Page 59                                 GAO/RCED-90-80      Impacts of the Staggers Rail Act of 1980
                        Chapter 4
                        Most-Though    Not All-Shippers     Rave
                        Reneflted Prom Reduced Raiboad      Regulation




                        line abandonments,64 of which classified themselvesas independent
                        shippers or receivers or as representatives of an independent shipper or
                        receiver.” About 54 percent of the shippers reported that shipping and
                        other costs had increased as a direct result of an abandonment.Further-
                        more, 12 shippers that transported such bulk commodities as grain and
                        fertilizer found it necessaryto relocate their businesses.
                        Finally, cancellations of joint rates and of reciprocal switching agree-
                        ments have also negatively affected someshippers. Our June 1987
                        review of 18 joint rate and reciprocal switching cancellationslsfound
                        that 8 of 12 shippers had experienceda deterioration in service, such as
                        longer transit times.19Captive shippers-shippers that must use rail-
                        roads to transport their goods-experienced both increasedcosts and
                        reduced service. Someshippers reported that cancellations had limited
                        their shipping alternatives and reduced competition. According to an
                        August 1987 FRA survey, shippers generally characterized cancellations
                        as moderately disruptive and temporary, although some shippers had
                        experiencedintermittent impediments in the flow of their goods and/or
                        fewer rail transportation alternatives.20


                        Shippers that believe they have been disadvantagedby the StaggersRail
Shippers Have Voiced    Act are dissatisfied not so much with the legislation as with the policies
Concern Over ICC’s      and procedures ICC follows in addressingtheir grievances.They believe
Implementation of the   that difficulties in bringing protests or complaints, the burden of prov-
                        ing their cases,and the time and expenseinvolved all hinder their abil-
Staggers Rail Act       ity to obtain relief from railroad actions they believe are harmful to
                        their interests. Someshippers also believe that ICC has failed to protect
                        them against unreasonablerates and practices, as required by the Stag-
                        gers Rail Act. In responseto shippers’concerns,ICC has adopted new
                        policies, procedures, and rules since 1985.




                        “Rail Abandonments: Abandonment Activity and Shipper Views on Rail Service loss (GAO/
                        RCED-87-82, July 17,1987).
                        isThe total number of such cancellations is unknown. However, we examined 9 joint rate and 9 recip
                        rocal switching cancellations of the 93 protested joint rate and reciprocal switching cancellations
                        between October 1980 and September 1986.

                        lsRailroad Regulation: Competitive Access and Its Effects on Selected Railroads and Shippers (GAO/
                        RCE?&l’,-109, June 18, 1987).
                        20Joint Rate Cancellations Study, DCI, FRA, Report No. DCi’-PRA-RRP-87-02 (Aug. 1987).



                        Page 60                                GAO/RCED-90-80     Impacts of the Staggers Rail Act of 1980
                           Chapter 4
                           Meet-Though   Not All-Shippers  Have
                           Benefited From Reduced Railroad Regulation




Difficulties With Relief   Although representatives from all of the trade associationswe contacted
Procedures and ICC’s       supported the StaggersRail Act and felt it has benefited their members,
                           all five associationscriticized ICC’Sprotest and complaint procedures as
Protection of Shippers’    time-consuming,expensive, and burdensome,especially for small ship-
Interests                  pers. In addition, representatives of two associationssaid that shippers,
                           not railroads, bear much of the burden of proof in relief cases.In our
                           September1987 report, we found that the average length of five pend-
                           ing rate caseswe reviewed was about 7 years. The costs for legal and
                           other fees for 5 of the 19 caseswe reviewed were over $1 million.21Offi-
                           cials of 8 of the 19 shippers we contacted said they would probably not
                           use the complaint processagain, in part becauseof the cost and time
                           involved.
                           Shippers also believe that ICChas not protected their interests. Accord-
                           ing to representatives of four of the trade associationswe contacted,the
                           most detrimental aspectsof the changesin railroad regulation have been
                           ICC’Simplementation of the StaggersRail Act provisions designedto pro-
                           tect captive shippers or promote railroad competition.22In particular,
                           ConsumersUnited for Rail Equity, a coalition of electric utility compa-
                           nies and coal producers, has allegedthat ICC’S actions have nullified the
                           protection for captive shippers contained in the StaggersRail Act. This
                           organization also contendsthat captive shippers pay rail rates in excess
                           of what is neededto provide railroads with a competitive rate of return.
                           In addition, the Procompetitive Rail Steering Committee, an ad hoc
                           organization of industrial and agricultural companies,believes ICChas
                           failed to preserve and promote competition between railroads in mar-
                           kets where railroads are not subject to competitive pressures.The com-
                           mittee cites, among other things, ICC’Srefusal to curtail blanket
                           cancellations of joint rates. Finally, the National Industrial Transporta-
                           tion League,representing both rail and nonrail shippers, has complained
                           that joint rate and reciprocal switching cancellations have reduced rail-
                           road competition and hurt shippers’ability to market their products.
                           Despite these concerns,some shippers have been successfulin obtaining
                           relief at ICC.For example, as our review of ICC decisionsbetween 1980
                           and May 1989 showed, complainants (generally shippers) have won 80



                           “‘Railroad Regulation: Shipper Experiences and Current Issues in ICC Regulation of Rail Rates (GAO/
                           Rm-S’/-119, Sept. 9, 1987).
                           “The Committee Against Revising Staggers identified no major problems with the Staggers Rail Act.



                           Page 61                               GAO/RCED-90-80     Impacts of the Staggers Rail Act of 1980
                          Chapter 4
                          Most-Though   Not All-Shippers Have
                          Benefited From Reduced RaUroad Regulation




                          of 96 market dominancecasesand 30 of 66 rate reasonablenessdeci-
                          sions.23ICChas granted monetary relief in several cases,including $23
                          million in one casez4and $22 million in another.26


ICC Has Modified Its      Since 1986, in responseto shippers’concerns,ICChas adopted new
Policies and Procedures   guidelines for determining market dominance,new criteria for evaluat-
                          ing the reasonablenessof rates, and new rules regarding the cancellation
                          of joint rates.
                          In August 1981, ICC adopted evidentiary guidelines for determining rail-
                          road market dominance.The guidelines required shippers to prove that
                          four types of competition were absent before a railroad would be consid-
                          ered market dominant. The four types of competition were intramodal
                          (between railroads), intermodal (railroads against other transportation
                          modes),product (substitute products were available for the one being
                          shipped), and geographic(alternative sourceswere available for the
                          product being shipped). In responseto shippers’concernsabout this
                          burden of proof, in October 1986 ICCagreedin principle to a compromise
                          reached by AAR,the National Industrial Transportation League,and the
                          American Paper Institute, which shifted from shippers to railroads the
                          burden of proof on product and geographiccompetition.
                          In September1985, ICC adopted the Constrained Market Pricing method
                          for evaluating the reasonablenessof rates for captive coal shipments.26
                          ICCbelieved that this approach would allow railroads to attain revenue
                          adequacy,while protecting captive coal shippers from monopolistic pric-
                          ing. However, recognizingthe burden and expensethe Constrained Mar-
                          ket Pricing method could causesmall shippers transporting commodities
                          other than coal, in March 1987 ICC proposed two alternative methods.
                          One method would use replacementcosts and the other revenue-to-vari-
                          able-costratios, rather than stand-alonecosts,27to determine maximum

                          23The remaining rate reasonablenesscases were still awaiting ICC decisions.

                          240maha Pub. Power Dist. v. Burlington N.R.R., 3 ICC. 2d 123 (1986).
                          2”Arkansas Power and Light v. Burlington N.R.R., 3 I.C.C. 2d 767 (1987).

                          2”Constrained Market Pricing allows railroads to set rates in all markets according to the demand for
                          rail service. To prevent the overcharging of captive shippers, rates are subject to constraints that ICC
                          believes simulate the pricing of competitive markets.

                          27Stand-alonecosts estimate the theoretical maximum rate that a railroad can charge a captive ship-
                          per without diverting substantial traffic to a hypothetical new competitor organized to provide rail
                          service.



                          Page 62                                 GAO/RCED@O-SO Impacts of the Staggers Rail Act of 1980
              Chapter 4
              Most-Though    Not All-Shipper8 Have
              Benefited From Reduced RaUroad Regulation




              reasonablerates. According to an ICCofficial, both alternatives are gen-
              erally easier to apply than Constrained Market Pricing. As of February
              1990, ICChad not adopted these alternatives in final, but ICChas applied
              them in several casesto evaluate the reasonablenessof rates.
               Finally, in October 1986 ICCadopted new rules for joint rate cancella-
              tions.28AARand shippers negotiated these rules, as they did the changes
               shifting the burden of proof in market dominancecases.These rules
               required, among other things, that railroads notify affected parties ear-
               lier of proposedjoint rate cancellations,that railroads explain and jus-
              tify cancellations, and that railroads and shippers pursue negotiations
               of their disputes before bringing them to ICC. ICC believed these changes
              would allow more time for shippers and railroads to review proposed
               cancellations and would promote better cooperation between railroads
               and shippers. ICC would also have more information available should a
              cancellation be protested. The rules also easedthe criteria for suspen-
              sion of a joint rate cancellation. Under these rules, ICCwill suspend a
              joint rate cancellation if the protester can show that the cancellation
              would eliminate effective railroad competition for the affected traffic
              and that the protesting shipper or railroad has used, or would use, the
              joint rate for a significant portion of its traffic. ICC officials said that as
              a result of this change,it could be easier to obtain a suspension.


              Shippers have benefited from the StaggersRail Act in a number of
Conclusions   ways. Real rail rates have declined on average about 22 percent since
              1980, rail service has improved for many shippers, and railroads are
              generally more responsive to shippers’needs.One of the most signifi-
              cant benefits has been contracts, through which shippers receive
              reduced rates and improved service in return for volume commitments.
              With the greater predictability contracts afford, shippers can better
              plan their operations and investments and thus enhancetheir competi-
              tiveness. The creation of new shortline and regional railroads has also
              benefited shippers by allowing rail service to continue-often at lower
              cost-in areas where it could have been lost.
              Someshippers, however, have not benefited. Shippers transporting cer-
              tain commodities-coal, for example-have found that their rail rates
              did not decline as much as the average or that rates increasedafter pas-
              sageof the StaggersRail Act. Somesmall shippers have been unable to
              obtain contracts from railroads or negotiate terms as favorable as those
              ““IntramodaI Rail Competition, Ex Parte 446 (Sub-No.l), decided October 29, 1986.



              Page 63                               GAO/WED-90-30      Impacts of the Staggers Rail Act of 1980
Chapter 4
Most-Though   Not All-Shippers  Have
Reneflted From Reduced Bailroad Regulation




offered to larger shippers. In some cases,this situation has made these
shippers less competitive, Other shippers have experiencedincreased
costs and/or lost transportation alternatives becauseof line abandon-
ments and the cancellation of joint rates. These outcomeswere not unex-
pected in the transition to a more market-oriented, economically
efficient system of railroad regulation.
Someshippers have complained about ICC’Simplementation of the Stag-
gers Rail Act. In particular, they believe that ICC’Srelief procedures are
burdensome,time-consuming,and expensive. Someshippers also believe
ICC has not acted affirmatively to curb market power abuse and/or
increase railroad competition, actions they believe would protect their
interests. While we did not evaluate ICC’Sperformance in balancing the
interests of railroads and shippers, we did find that ICChas revised some
of its policies and proceduresto addressshippers’concernsand to more
accurately evaluate the many issuesinvolved in deciding the reasona-
blenessof rates and other matters.




Page 64                            GAO/RCED-90-80   Impacts of the Staggers Rail Act of 1980
    .

L




        Page 65   GAO/RCED-O-90   Impacts of the Staggers Rail Act of 1990
Appendix I                                                                                                           G

1988 Profile of ClassI RailroadsIncludedin
GAO’sStudy

               Dollars in billions
                                                         Operating revenue0                  Revenue ton-milerb
                                                                      Percent of                         Percent of
                                                                     total for all                      total for all
                                                                          Class I                            Class I
               RailroadC                                    TOtal      railroads                Total     railroads
               Atchison Topeka and Santa Fe                     $2.1              7.5               77.3               7.7
               Burlinaton Northern                               4.5             16.1              223.5              22.4
               Chicaao and North Western                                          3.2                                  3.0
               Conrail                                           3.4             12.1               85.4               8.6
               csx                                              4.4              15.7              143.2              14.4
               Illinois Central                                  0.6              2.1                17.0               1.7
               Union Pacific                                    4.3              15.4              176.6              17.7
               Total for railroads contacted                  $20.2              72.1              753.4              75.5
               Total for Class I railroads                    $28.0              100.0             997.5             100.0
               ‘Operating revenues are monies received for the transportation of passengers and property.
               bRevenue ton-mile represents 1 ton carried 1 mile for which a charge is received.
               ‘We also contacted the following Class II and Class III railroads: Iowa Interstate, MidSouth Rail Corpora-
               tion, Wisconsin Central, and Genesee and Wyoming Industries.




               Page 66                                   GAO/RCED-99-99      Impacts of the Staggers Rail Act of 1999
       .

Appendix II

l&t of Trade AssociationsContactedby GAO


Committee Against           Membership:462 corporations that use railroads for their transporta-
Revising Staggers           tion needs,Member companiesvary in size from Fortune 600 companies
                            (16 percent) to companiesearning less than $100 million per year (70
                            percent). Purpose:To addressthe major issuesrelating to the Staggers
                            Rail Act and inform the public that the act is working and achieving its
                            overall goal of keeping the country’s railroads viable in the private
                            sector.


Consumers United for Rail   Membership:90 dues-payingmembers,including 40 investor-owned util-
Equity                      ities, 12 public power utilities, and 16 to 20 coal production companies.
                            Prerequisite for membershipis the exclusive use of rail service for
                            transportation needs.Purpose:To encouragemore competition in the
                            railroad industry and better protection by ICCof captive shippers-ship-
                            pers without transportation alternatives.


National Coal Association   Membership:86 membersrepresenting both eastern and western coal
                            producers. Membersproduce about 66 percent of all domestic coal pro-
                            duced. Purpose:To represent the interests of the coal industry before
                            the Congress,federal agencies,and the courts. The National Coal Associ-
                            ation has been involved with ConsumersUnited For Rail Equity in legis-
                            lative initiatives to addressrailroad competitive accessand rate
                            reasonablenessissues.


National Grain and Feed     Membership: 1,300 companiesinvolved in the processingof grain and
Association                 feed. Member companiesrange in size from $1 million to $30 billion in
                            annual revenues.Purpose:To, among other things, advance and protect
                            the interests of the grain and feed industry, including issuesrelated to
                            the railroad industry.


National Industrial         Membership: 1,300 to 1,400 membersrepresenting industrial and com-
Transportation League       mercial shippers, boards of trade, chambersof commerce,and similar
                            groups. Its membersuse all modesof transportation and directly or indi-
                            rectly represent 86 percent of the freight traffic that moves in the
                            United States.Purpose:To attain and preserve a safe, adequate,and
                            efficient national transportation system,privately owned and operated,
                            and to protect and promote shippers’interests in transportation devel-
                            opments and issues.




                            Page 67                     GAO/RCED-90430 Impacts of the Staggers Rail Act of 1980
Appendix III

Major Contributorsto This Report


                           JamesD. Noel, Assistant Director
Resources,                 Francis P. Mulvey, Assistant Director
Community, and             Richard A. Jorgenson,Evaluator-in-Charge
                           Mary L. Dietrich, Evaluator
Economic                   Edwin H. Woodward, Evaluator
Development    Division,   StephenM. Brown, Economist
Washington, D.C.           Sharon E. Butler, Writer-Editor




                           Page 68                   GAO/RCRD-99.89   Impacta of the Staggers Rail Act of 1980
    .

.




        Page 69   GAO/RCED-90-80   Impacts of the Staggers Rail Act of 1980
Page 70   GAO/RCED-9O-SO Impacta of the Staggers Rail Act of 1980
    .

c




        Page 71   GAO/RCED-90-80   Impacts of the Staggers Rail Act of 1980
RelatedGAO Products


             Railroad Retirement: Future Rail Employment and Trust Fund Solvency
                          Apr.
             (GAO/HRD-89-30,   5, 1989).
             Railroad Regulation: Shipper Experiences and Current Issues in ICCReg-
                                                  Sept. 9, 1987).
             ulation of Rail Rates (GAO/RCED-87-119,
             Rail Abandonments: Abandonment Activity and Shipper Views on Rail
             Service Loss (GAO~RCED-87-82,
                                       July 17,1987).
             Railroad Regulation: Competitive Accessand Its Effects on Selected
             Railroads and Shippers (GAO/RCED-87-109,
                                                   June 18, 1987).
             Grain Shipments: Agriculture Can ReduceCosts by Increased Use of
                                                 Jan. 21, 1987).
             Negotiated Rail Rates (GAO/RCED-87-42,
             Railroad Revenues:Analvsis of Alternative Methods to Measure Reve-
             nue Adequacy (GAO/RCED-87-16BR,Oct. 2, 1986)

             Shipper Rail Rates: Interstate CommerceCommission’sHandling of
             Complaints (GAO/RCED-86-64Fs, Jan. 30, 1986).
             Information on Regulatory Reform Under the StaggersRail Act of 1980
                            Aug.
             (GAO/RCED-83-174,   17, 1983).




(843808)     Page 72                    GAO/RCED&WO   Impacts of the Staggers Rail Act of 1990
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