E-Commerce and its Potential for Shortline Profits

1. E-Commerce and its Potential for Shortline Profits Canadian Pacific Shortline Conference Calgary, Alberta October 17,2000 Roy Blanchard, The Blanchard Company

2. The Facts of Life... • Railroads continue to lose market share to trucks in all but the lowest value, highest volume bulk commodities. • Revenue gains and revenue carloads remain at or below GNP growth rates as shareholder returns grow only as a result of reduced costs. • The focus continues to be on running trains rather than providing a competitive value-adding transportation product. • The Internet has the power to make a difference.

3. Networked markets are beginning to self-organize faster than the companies that have traditionally served them. Thanks to the web, markets are becoming better-informed, smarter, and more demanding of qualities missing from most business organizations. www.cluetrain.com

4. Some Internet Implications • The Internet is rapidly obliterating the differences between manufacturers and suppliers, distributors and producers, delivery channels and content. • Web-based trading networks eliminate bureaucracy and red tape, streamline procurement and supply chain management, and cut the cost of paper and manual processing. • Application service providers (ASPs) running via the internet integrate Enterprise Resource Planning (Oracle), Procurement (Ariba), Supply Chain Management (i2), Customer Relationship Management (Siebel)*. • E-Commerce transactions will account for 90% of all B2B purchases by 2003. • Companies seek continuity among applications, e.g. MS-everything. * Full discosure: positions in all

5. Transportation Buyers Want Painless Transportation Solutions. • Shippers don’t really care how the goods move as long as the transportation is easy to buy, easy to manage, and reasonably priced. • One-click shopping -- pricing the move, ordering the car for loading, launching the trip, watching its progress, arranging for delivery, and paying for it in one seamless motion. • To make all this work there will have to be major structural changes in railroad marketing practices, management style, train operations, and car management.

6. The Shortline E-commerce Challenge • Shortlines are limited in their ability to conduct one-click shopping on own websites • Marketplaces and auctions are of limited value as shortlines can’t control whole route • Most shortline business is carload, not intermodal • But...

7. Merchandise carload railroading does have a future, in spite of what some people say • Merchandise carload traffic (not coal, auto, or IM) accounts for more than half of all class 1 revenues • Shortlines, predominantly carload carriers, grow traffic at twice the annual rate of class 1s • Shortlines increase carloads about 30% following branchline takeovers from class 1 owners • Responsive customer service is the main driver.

8. Shortlines have a major role to play • In marketing and sales: Superior operating performance combined with web-based customer service • In car management: A new paradigm designed to take $billions out of class 1 and shipper car costs

9. What does a railroad do? • Runs Trains • Operates a Right of Way • Provides Railcars • Maintains its Locomotives, Cars and Right-of-Way • Schedules Service for Shippers • Prices that Service for Shippers • Invests in new Locomotives, Cars and Right-of-Way • Pulls all those things together in one package

10. Trains Power Right of Way Yards MoW Marketing/Sales Freight Cars Back Office MoE What is the Core Business Model? What is the “Franchise”?

11. The Model is running out of gas • Volume Growth anemic @ 1-2% per year • Revenue Growth only about 2% • Fortunately, Expenses grew at only 1.2% • But, now Fuel and Labor Costs are rising sharply • CapEx Growing at 7%..faster than GNP • Debt Growing…Debt:Equity up to 55% from 38% • Asset Utilization Unacceptable • Truck Competition Intense • Marketing Hindered by 20:80 Perspective

12. Non-core functions already moving to the Internet • Marketing/Sales: Class 1 “Order-to-cash” websites; FreightWise.com, shortline “brochureware,” where it can go • Freight Cars: TranShopNet.com, RailMatch.com • Back Office: Arzoon.com

13. Tariff or Contract Price? One-Stop Shipping Transit Time? Laptop or Spot RR Website Order, Ship Local Estimates Net-redi Trace Order to Cash Cycle Information Flows Place Pay

17. Benefits of Full-Service Links

20. Where Shortlines can Take This • Strive for Wider links to class 1 websites • Substitute shortline carloads for trucks in the FreightWise model • Create invisible customer links to class 1 “order-to cash” customer service sites • Lap-top pricing and full-service links

21. Non-core functions already moving to the Internet • Marketing/Sales: Class 1 “Order-to-cash” websites; FreightWise.com, shortline “brochureware,” where it can go • Freight Cars: TranShopNet.com (GE Capital), RailMatch.com (neutral)* • Back Office: Arzoon.com *Full disclosure: equity position

23. Railroads Getting Out of the Railcar Business…Sooner or Later

24. The Solution: Take the freight cars out of the railroad business model

25. Changing the Business Model for Cars • Create cooperative pools and for profit car management companies – focus & expertise • Separate car ownership from management and control – sell load capacity not individual carloads • Price transportation and car supply separately • Use ecommerce to: • Allocate surpluses/shortages in a neutral market • Improve utilization with new car mgmt. tools • Finance new capacity for short- and longterm

28. The Current Order RR RR RR Shippers Purchase Bundled Transportation Services from Railroads including Haulage of Lading, Loaded and Empty Car and (Often) Car Supply Shipper Shipper Shipper

29. The Current Order-2 • Shipper leases 2,000 cars, averages 10 turns per car per year (700,000 car-days), 100% empty return, annual cost @ $6000 per car per year = $12 mm. Lease cost $17.14 per car per day for 3 year term • IF service degrades allowing only 7 turns per year, shipper must lease an addtl. 857 cars to cover his 20,000 loads; ($5.1mm) • IF trip time improves permitting 12 turns a year, shipper is stuck with 333 cars for the term of the lease ($2mm) • The current order is good for leasing companies and at best just OK for RRs and shippers

30. The Current Order CPR 1000 miles loaded CPR 1000 miles mty CN 1000 miles mty CN 1000 miles loaded Total Car Miles = 4000 Total Car Days = 40 @ 100 miles per day

31. Cost Components of a Freight Rate Shipper Pays Manager Shipper Pays Railroad for Bundled Services Car Rental Car Rental Shipper Pays Railroad Trans. Lading Trans. Lading Shipper Pays Manager Pays Railroad Trans. Car MTY Trans. Car MTY Trans. Car Ld. Trans. Car Ld. Current Order New Paradigm

32. New Paradigm CPR Shortline A 1000 miles loaded 100 miles mty 100 miles mty CN 1000 miles loaded Total Car Miles = 2200 Total Car Days = 22 @ 100 miles per day Shortline B

33. The New Paradigm RR RR RR Capacity Mgr. Shippers and Mgr. Use Car Source to Openly Allocate Capacity During Shortages/Surpluses Car Source Manager Uses Car Source to Add New Cars or Dispose Surplus Cars Shipper Shipper Shipper

34. The New Paradigm-2 • To cover his 20,000 loads per year, shipper purchases 700,000 car-days at spot market price of $18 per car-day, total cost $12.6 mm vs. $12 mm today (35 days a turn) • IF service temporarily degrades to 50 days a turn, shipper purchases an additional 300,000 car-days; 300,000*$18=$5.4mm extra cost vs. $5.1 mm over 3 years • IF service improves to 12 turns a year, shipper can immediately sell his excess capacity on Railmatch ($6mm) • Car-day prices change according to market forces so a long position could be sold at a gain. Short sales an option • Improved utilization from the car pool will provide substantial additional savings

35. Reduce Future CapEx Requirements Source of Funds Free Up Line Capacity Improve Yields Focus on Core Competence Expand Car Supply Meter Investment into/out of Private Fleet Improve Rate Transparency Reduce Overall Costs Benefits to Railroads and Shippers

36. How big could the numbers be for the RRs? • Avoidable CapEx in Railcars : $30 B. • Potential Asset Sales : $ 12.5 B. • System Gains @ 10% utiliz. improvement • 17.5 m. fewer cars days @ $16 : $280 m. • Many fewer train starts per year • Fewer locomotives and less MoE expense • Reduced line and yard congestion

37. Where Shortlines can Take This • Connecting class 1 prices assume empty backhauls - load ‘em up and get the head-haul rates down. • Supply the cars yourself and pay your own car hire out of higher allowances • Find back hauls on connecting or near-by RRs if you have none. • Become a market-maker in car days

38. How This Fits In the New Economy Communications • Cheap, Fast, Everywhere Central Marketplaces • Neutral, Liquid New Tools • Tracking and Tracing, Back Office New Players Internet Changes Everything…. • Faster, Smaller, Smarter No Change is not an Option

39. Conclusions • The merchandise carload business may change but it isn’t going away • Shortlines will be more important to the carload business going forward • Shortline success is directly tied to the ease of doing business with you • And remember...

40. Service quality is measured by the customer, not you The Internet is your key to being perceived as a quality service provider in the eyes of the customer

41. Go Do It!