INTRO: Before 1992 Canadian National was a bloated public corporation haemorrhaging cash. Successful privatisation in 1995 launched a major turnround, and shareholder value has since increased by 300%. Now CN has the best operating ratio of any North American railroad

BYLINE: Paul M Tellier

President & Chief Executive Officer, Canadian National Railway

BY ANY MEASURE CN is a success. In the past five years, it has had the best operating ratio, the best on-time performance and best share-gain performance of any North American railroad. So what does CN do next?

The answer is to take its play to the next level. CN must now measure itself against, and be ranked among, the best-run, best-managed, best-performing corporations in North America. This objective will require market share gains and better profit margins generated by still greater service improvements, plus sound strategic investments in the network and in technology. At the same time we need to operate under fair, equitable regulatory and tax regimes in Canada and the USA.

It won’t be easy, but CN has the right tools to meet its targets. We have a scheduled railroad service plan that works - carload on-time performance exceeds 90%, and productivity improvements have vastly improved asset utilisation. We have a network franchise that is capturing new traffic opportunities created by the North American Free Trade Agreement, and a management team that knows that innovation is central to growth.

The CN of today is the product of a series of revolutions - a sweeping financial turnaround followed by privatisation; Nafta-driven expansion in the USA; and CN’s emergence as North America’s only scheduled freight railroad.

The first revolution began in 1992 when I arrived at CN as President & Chief Executive Officer. The situation was dire. CN was a bloated Crown corporation haemorrhaging cash. It had too many employees, too many unproductive assets and too little strategic focus. For years CN had generated meagre profits during boom times. In downturns, it lost money big time.

We moved aggressively to turn CN around. We knew CN had to be sized and shaped into an enterprise that could generate acceptable profits throughout the ups and downs of the business cycle. Getting it right required tough, painful decisions, including the elimination of thousands of jobs.

More significantly, it required a fundamental change in CN’s corporate culture. Bureaucratic management layers were eliminated, and long-held mindsets were cast away. New managers from inside and outside the corporation - managers eager for risk and reward - were given positions of influence. The changes took hold, and CN’s performance began to improve.

Amidst the upheaval it became clear to me, my colleagues and the Canadian government, most notably the then Federal Transport Minister Douglas Young, that CN could stand on its own as a publicly-traded corporation.

With the backing of the government and the promise of further rail deregulation in the Canada Transportation Act, CN was privatised in 1995. It was the most successful initial public offering of shares in Canadian history. The wisdom of the privatisation is evident in the 300% increase in shareholder value since 1995.

The Nafta imperative

The second major force that has shaped, and continues to shape CN and its strategic direction, is the North American Free Trade Agreement. CN recognised early on that Nafta would fundamentally alter trade flows and rail traffic patterns throughout the continent. We were right.

Today, seven years after Nafta was implemented, north-south trade is growing at 10% annually, while east-west trade is expanding at 3 to 4% per year. For a railroad whose east-west orientation reflected the economic and political forces of 19th century Canada, Nafta demanded a network reorientation to extend CN’s reach beyond its traditional US endpoint at Chicago.

CN knew that greater penetration of the US and Mexican markets would improve its competitive standing with the advantages of more seamless, single-line service. Thus Nafta drove CN to embark on a series of strategic initiatives.

First, CN acquired Illinois Central in 1998. In the same year it signed a comprehensive marketing alliance with Kansas City Southern Railway Co. With the IC purchase, CN gained greater access to the US Midwest and first-time access to the Gulf of Mexico and the US South with its trove of high-revenue chemical traffic in Louisiana. The KCS marketing agreement enabled CN to enter markets in the US Southwest and fast-growing Mexico.

The impact of Nafta is readily apparent in CN’s business. Today, 52% of its traffic moves between Canada and the USA or within the USA. More than three-quarters of CN’s top 20 customers, with accounts representing one-third of company revenue, have plants in at least two of the three Nafta countries.

Nafta, again, was a central reason for CN’s planned combination with Burlington Northern Santa Fe Corp. Unfortunately, opposition from competing railroads prompted a merger moratorium that forced CN and BNSF to terminate their combination agreement in July 2000. The decision to end the CN/BNSF combination did not derail CN’s north-south strategy, however. When Wisconsin Central Transportation Corp’s management approached CN in the autumn of 2000 about a potential acquisition of WC, CN saw the value of securing ownership of another link in its Nafta network.

The transaction makes sense for several reasons. First, CN and WC have strong ties. Under a 1998 agreement, WC hauls CN intermodal, bulk commodity and merchandise traffic from Western Canada to the US Midwest over its main line between Superior and Chicago. We believe single-line service under CN ownership will improve the competitiveness of CN/WC and its customers in Canada - US trade. Second, the acquisition offers the prospect of enhancing CN’s top-line growth in the domestic US marketplace by 30%.

The bottom line is that the CN/WCTC transaction, already supported by more than 300 parties, including shippers, local governments and officials, chambers of commerce, public agencies and other railroads, is a simple, straightforward, pro-competitive, end-to-end combination. Of significance to shippers, the merger will generate service and efficiency gains and enhance competition. In addition, CN will maintain existing rail gateways affected by the transaction, and its service assurance plan will ensure that service on the combined CN/WC network is as good as, or better than, today’s service. Lastly, workforce reductions as a result of the merger will be relatively minor, and employee impacts will be mitigated by normal attrition and CN’s commitment to retrain and/or relocate employees.

CN and WCTC filed a common control application with the US Surface Transportation Board on April 9 2001. We were pleased to learn on May 9 that the STB had agreed to treat the transaction as a minor one. A final STB decision on the merger is expected by September 7.

Given CN’s Nafta focus, it expects WCTC to carry out its commitment to sell its minority equity investments in overseas rail ventures as soon as possible. The sale process for WCTC’s 42·5% equity interest in English, Welsh & Scottish Railway Holdings Ltd may take longer, as it will be guided by the progress of EWS management in improving the railroad’s operating and financial performance.

Nafta and regulation

CN strongly believes the realities of Nafta must be reflected in the railroad regulatory and tax environments of Canada and the USA. So, too, there must be balanced treatment of all modes of transport.

The problem for Canadian railroads and their customers is the lack of a national transport policy. Today, conflicting federal and provincial fiscal policies treat truck and rail differently and many are inconsistent with those in the USA. Moreover, they have produced increasingly congested highways, while railroads have unused capacity.

Here are two specific problems.

Taxes on rail inputs - fuel, material, equipment purchases and railroad rights-of-way - are 50% higher in Canada than in the USA. As a percentage of revenue, the US rail industry’s tax burden is 7·5%, compared with 13·8% in Canada. For example, a Seattle - Buffalo freight train pays approximately C$7000 less in federal and regional taxes than does a like-sized train operating from Vancouver to Toronto. There is also a disparity between Canadian rail taxes and taxes paid by Canadian and US truckers. The tax burden for Canadian truckers as a percentage of revenue is 10·4% and 6·9% for US truckers.

Shipper protection provisions in the Canada Transportation Act far outweigh those available to US shippers and receivers.

To help rectify some of the serious policy imbalance, CN is urging Canadian governments to adopt a road relief and shipper tax credit to encourage shippers to move freight by rail rather than by truck. The tax credit, utilising C$160m in annual locomotive fuel taxes already levied on railroads in Canada, would go to shippers, not railroads, and would have enormous economic and environmental benefits. It would: