Deregulation, Privatization, and the Rebirth of the CNR

Frontier Centre, Publications, Transportation, Uncategorized

INTRODUCTION

The renaissance of the Canadian National Railway offers a singular object lesson in good public policy. A series of changes made by the federal government enabled the troubled company, once the sad sack of continental railroading, to jump onto the success track. The purpose of this backgrounder is to look at what happened, and to explain how and why a series of events contributed to the railway’s remarkable recovery.

THE CNR’S HISTORY

One national railway, the Canadian Pacific, dominated the market in Canada until the formation of the CNR. Successive governments, in an effort to encourage competitors, had used subsidies over the years to create scores of money-losing railways. Ottawa then imposed price controls on railways during World War I, and they were kept in place after the armistice. By 1920, real freight rates were about half what they had been before the war. Many of the railroads went bankrupt, and the federal government cobbled together the Canadian National Railway from these existing lines, about 200 marginal companies in all.

The new enterprise, set up in 1919 as a Crown corporation and assembled over the next four years, over time demonstrated the same low level of financial viability as its constituent parts. The federal government bailed it out by recapitalizing it, forgiving large amounts of debt or trading it for stock in 1937, 1952 and 1977. A review of the CNR’s financial history from 1923 until 1993 estimated the total amount of federal support for the carrier at $96 billion in 1995 dollars. Despite these cash infusions, the CNR had accumulated $2.5 billion in debt by 1995.

THE CNR’S PERFORMANCE AS A CROWN CORPORATION

Why did the CNR perform so poorly, despite all the subsidies? Three factors were important:

  1. Abnormally high operating costs. In seven of the ten years between 1985 and 1995, the CNR’s revenue from freight operations failed to cover its operating costs. To compensate for the shortfall, the railway raised the fees it charges other carriers to use its lines, driving down traffic and increasing shipping costs. But its owner, the federal government, acted as a patron and covered most of the difference. Because it could rely on this support, the CNR was able to avoid taking the steps necessary to become profitable.
  2. Excess trackage. After railroads were deregulated in the U.S. in 1982, they shed 25% of their unprofitable lines. Between 1985 and 1995, the CNR trimmed only 15%. That left one-third of its track carrying only 1% of its freight volume. Less than half of its runs made money. It had failed to close more because of government regulations and its mandate as a service-oriented Crown corporation. Hearings to authorize more closings became political minefields, and the railway was forced to keep many open because of pressure from elected officials and voters.

  3. Labour problems. For decades, the CNR employed many more people than necessary to run its operations. To remain competitive after American deregulation, it was forced to rationalize its workforce. It cut about a third of its workforce between 1992 and 1995 – about 11,000 jobs – but remained overstaffed. Labour costs, which represented 43% of the CNR’s revenue in 1992, had fallen to 38% by 1994, but above the U.S. average of 36%. Arcane rules set up in past negotiations with labour unions made it more difficult and expensive for the CNR to cut staff.

THE DECISION TO PRIVATIZE

In 1993, the National Transportation Act Review Commission recommended that the CNR be privatized. Transport Minister Doug Young took up that cause two years later. In his 1995 spring budget, he announced the government’s intention to sell the railway, saying, “If the government doesn’t need to run something, it shouldn’t . . . and in the future, it won’t.”

Deregulation of railroads in the United States caused a massive restructuring of the industry, and the CNR’s ability to keep pace with rapidly shifting circumstances was compromised by its Crown corporation status. The changes that the CNR needed to implement to become a strong competitor like dropping unprofitable track or reducing its bloated workforce, could not be made without running a political gauntlet.

In September 1995, all shares in the CNR were sold to the public and it became a private company. The conversion was the largest initial public offering of shares in Canadian history. The deal had some conditions:

  • No individual shareholder, foreign or domestic, could hold more than 15% of the stock.
  • The CNR must remain headquartered in Montréal, and must stay under the federal government’s language rules.
  • To ensure the new company did not sink under the weight of its debt, the federal government bought back much of its non-railroad holdings, including real estate, manufacturing companies and shopping centres.

Regarded as one of the most successful privatizations in Canadian history, the sale of shares returned $2.2 billion to the government’s coffers. More importantly, the railway achieved commercial freedom. As a Crown corporation, business decisions made by the CNR had been subject to the oversight of several agencies, and ultimately the federal cabinet. Its removal from the public sector gave it the ability to change policies quickly, and to have the wisdom of those policies adjudicated by standards of profit and loss instead of political ones.

One of the more intriguing elements of the privatization was a generous employee share-ownership program. About 45% of unionized workers at the railroad bought stock in the company. That created a culture change on the shop floor, with a much stronger appreciation by workers of the importance of making the CNR a profitable enterprise.

THE DECISION TO DEREGULATE

Americans had started to deregulate the industry in 1980, and railroads began to rip up unproductive track and cut work forces. The Canadian response was slow and weak. In 1987, the federal government set up the National Transportation Agency to oversee railroads, but its moves towards deregulation were regarded as tentative half-measures. Track abandonment was strictly limited to 4% a year, and still subject to complex regulatory procedures. Consequently, between 1981 and 1986, labour productivity in railroads grew by 231% in the U.S., but only 175% in Canada. U.S. carriers increased their traffic by 75% over the same period, but Canadian volume went up only 59%.

In tandem with the CNR’s privatization, the federal government scrapped the 100-year-old Railway Act and replaced it with the Canada Transportation Act, a wide-ranging deregulation of railways, airlines and ports. It allowed rail companies to rationalize their activities, to play to their strengths and trim their weaknesses. At the same time, it opened up the market on abandoned track to short line companies, who have much lower operating costs. The new act took effect in July 1996.

The bill allowed railways to sell or abandon unprofitable lines without having to prove to the Canadian Transportation Agency that such moves were in the public interest. It codified what an arbitrator had already changed during the rail strike in the winter of 1994-95, that railways no longer had to provide lifetime security for all unionized workers. The agency lost much of its power to interfere with decisions about routes, employment and corporate policy.

After deregulation, investment in the industry increased substantially. Removing the regulatory yoke from railroads made them much more attractive to investors. Capital spending figures for 1995-99 in the railway sector show the trend:

This recapitalization allowed Canadian railways to tap into a new generation of high-horsepower locomotives, 40% more efficient than the old ones. Automation of track maintenance and other functions allowed a few skilled workers to accomplish in hours what used to take days of efforts by whole crews.

Statistics on traffic and efficiency over the period of deregulation prove the wisdom of the policy. By 1997, the railways were hauling 18% more freight than they had in 1988, with 22% less track, 13% fewer freight cars, 38% fewer workers and 9% fewer locomotives.

THE SHORT-LINE PHENOMENON

The new regulatory environment that allowed railways to shed unprofitable track also allowed much quicker approval for short-line railroads. Taking over abandoned lines, these smaller operators are able to make money on them because they have much lower operating costs. They also allow the big carriers to increase traffic by bringing loads into hubs.

Before deregulation, approval for such replacement services took about two years. The new rules allowed such arrangements to happen within a few weeks. The increased speed was vital to the survival of marginal lines like the link to Churchill, Manitoba. Leaving the track idle for months meant that rail beds would deteriorate to the point where massive capital infusions would be needed to revive the service.

The first shortline railway in Canada started in Alberta in 1986. By 1999, there were more than 50. With much more compact management structures, fewer and simpler unions and bedrock operating costs, the shortlines have experienced enormous growth and are generally quite profitable. Between 1996 and 1999, the CNR sold 30% of its track to shortline operators, keeping service alive in hundreds of communities.

THE CULTURE CHANGE AT THE CNR

The beginning of the new performance culture at the CNR refutes the myth of the no-talent civil servant. Formerly a top federal civil servant, Paul Tellier took the helm at the railway in 1989 and found a situation where profitability was almost impossible.

Featherbedding was killing the company. About 2,000 idle employees were collecting full pay-cheques, even though their jobs had been abolished. Previous union contracts had dictated that any worker with eight years of service remained on the payroll until age 65, even if the job disappeared. The company was not even allowed to transfer redundant employees to other cities where they were needed.

After bitter contract talks and a strike in March 1995, Tellier was able to wrest some important concessions. Unneeded employees could only count on six years of salary, at 90%, and workers who refused to transfer were promised only 65% of pay for two years. The CNR also obtained more liberal work rules, stretching train shifts to reduce crew changes and automating train assembly systems. Over six years, the railway cut its workforce by more than 16,000 positions.

After privatization, the CNR modernized its supply and procurement process. Employees in the purchasing department had formerly been guided strictly by the question, “How much are you paying for this item today versus what you paid yesterday?” The new paradigm was, “How much value are you getting for the price?” The doctrine cut the company’s costs and improved the performance of its equipment

As a Crown corporation, the railway had paid little attention to high administrative overheads, including six layers of management. These ranks were thinned and new rules and competitive tendering contained uncontrolled spending on items like photocopiers, cellular phones and hotels. The CNR reduced its costs by hundred of millions of dollars once it landed in the private sector. Productivity increased 14% in the first year of privatization, and the railway began to post healthy profits. Although the company now has a much smaller workforce, salaries for the remaining workers are much higher. Average pay packets in the industry rose from about $39 thousand in 1988 to about $55 thousand in 1997.

GROWTH AND EXPANSION

The changes in ownership structure and corporate culture also prompted the CNR to consider expanding its business. In 1997, it opened a large new intermodal terminal in Chicago to replace the tiny operation that had connected it to the American rail system through its Grand Trunk line. That expanded its capacity by 30%. Its acquisition of Illinois Central in 1998 expanded the company’s southern focus, a smart move considering that north-south rail traffic is growing between 10 and 15% a year, while east-west traffic increases at a rate between 2% and 4%.

The next step in its expansion policy calls for a merger with the Burlington Northern-Santa Fe Railroad, the most efficient carrier in the U.S. That will make the CNR – whose corporate headquarters and identity will remain Canadian – the largest railway in North America, and make the combined system even more efficient. The acquisition will give the railway a number of options in shipping freight south, allowing faster transit and turnaround times. Concerns about industry concentration prompted the U.S. Surface Transportation Board to delay approval of the merger, but CNR executives are confident of eventual success. Some groups in Canada, including farm organizations, have made efforts to stop the merger and to reregulate the CNR, but they have been unsuccessful.

CONCLUSION

Success breeds its own inertia. The rapid rationalization and expansion of the CNR would have been impossible had it remained a Crown corporation. The numbers tell the tale:

1995 1996 1997 1998 1999
Revenue (millions) $3,862 $3,862 $4,283 $4,078 $5.236
Operating Income (millions) $425 $588 $927 $1,008 $1,467
Operating Ratio (expenses/revenues) 89.0% 85.0% 78.4% 75.3% 72.0%
Earnings Per Share $2.48 $6.14 $2.72 $3.08 $3.71

The turnaround in railroad policy created advantages for customers as well. In the eleven years between the deregulation of railways in the U.S. and 1998, Canadian freight rates went down 11% in constant dollars. They are now the lowest in the world, less than two cents per ton-kilometre.

In short, the tandem policies of deregulation and privatization have been an unqualified success. The renaissance of the CNR demonstrates the benefits of private versus public ownership, and the wisdom of creating a regulatory framework that makes commercial sense.