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 The first. five copies of each report are free. Additional copies are .yiLOOWC’h. ‘I’ht~rta is a 25% discottnt on orders for 100 or tttore copies mailed to a sittg;le address. Orclt~rs tttrtst be prepaid by cash or by check or mottey order made ottt. to the Sttltt’rittl,~tttlttt~ of Documents. r --~ --. I i IJnited States First-Class Mail ‘8 <hwral Accounting Offiw -“I Postage & Fees Paid iI’ Washington, I).(:. 20548 / Official Hushwss I Permit No. GlOO Penalty for Private 1Jsth$300 i
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)