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The Business and Politics of Passenger Rail; 2011-11-17

November 17th, 2011

Volume 1, Number 21

William Lindley of Scottsdale, Arizona has penned a Business and Politics guest column. Enjoy his insights.

Overcoming The Fallacy of Allocated Costs

By William Lindley

“As ye sow, so shall ye reap.” — see Galatians 6:7

What happens when you base business decisions on meaningless numbers?

From the 1870s on, the Pullman sleeping car was the premier first-class transportation on this continent. Pullman also operated parlour chair cars, lounge cars, and dining cars. These cars were operated by the Pullman Company, generally as part of the host railroads’ trains, but occasionally in an all-Pullman consist behind the railroad’s locomotives. In any case, a passenger effectively bought a regular coach ticket as the base part of their first-class fare.

For this service, Pullman entered into an agreement with each host railroad.The economics of it went like this:

“When revenue from a Pullman line exceeded expenses, the railroad generally kept 75 percent of the profit and Pullman got the remainder. Yet when expenses exceeded revenues, the railroad was required to make up the deficit to Pullman.” – “The Cars of Pullman” Welsh, Howes, and Holland, Voyageur Press, 2010, p. 15.

That little snippet gives us a clue of what contributed to the demise of the American passenger train. Such a formula, which became a permanent edict after the 1940s anti-trust breakup of the original Pullman Corporation, led to the inevitable downfall of the American passenger train.

And derivatives of this economic formula, including Amtrak’s “Route Profitability System” and its successors, continue to strangle passenger trains today.

But, wait! you say; it all sounds so sensible. Perhaps – until you look at what happens when you start plugging in numbers: Once the system as a whole has the slightest downturn, anything you do (adding capacity, removing capacity) can be construed as deepening the perceived loss. Obviously, adding capacity increases expenses; so, logically, the response is to cut capacity; however, when you divide the high fixed costs of the system across the remaining services, the effect is to make those remaining services look even worse. This occurs because attempting to divide relatively fixed costs against a fluctuating demand ignores economies of scale and other non-linear business realities.

This is the same sort of fallacy that leads traffic engineers, and frustrated commuters, to widen highways. The exact opposite of the expectation happens: Widening a highway tends to increase traffic: “…our data suggest the following law of road congestion: adding road capacity will not alleviate congestion on any sort of major urban road or rural [highway]…” (“The Fundamental Law of Road Congestion: Evidence from US cities” by Gilles Duranton and Matthew A. Turner) As you may have seen in your city, widening one bottleneck only makes the next one glaringly obvious; widening an interchange only leads to jam-ups at the top of the off-ramp above a traffic light; and so as we spend billions of dollars to “improve” our roads, things only get worse… and ever more expensive to maintain.

Even worse, even the railroads’ nonsensical numbers were sliced, diced, and well-cooked. At a 1990s convention of the National Association of Railroad Passengers, I witnessed an Amtrak official, in answer to my question, admitting that expenses were allocated to trains “subjectively.” That means that they “felt” that the Sunset Limited should be given the highest per-passenger loss, based on a holistic reading of the numbers, I suppose.

It was more Pullman’s and the railroads’ failure to come to grips with the accounting principles necessary to continue the business, and less the traveling public’s desire for a two-tone Bel Air or a new jet-liner (in the days before Gestapo “your papers please” security, dangerous irradiation scans, and dignity-crushing body searches) that led to the downfall of Pullman, and the passenger train business in general. Coupled with the traditional railroad mentality of “We’ve always done it this way” and “The public be damned,” [1] the old-style railroad passenger train was an entity that deserved to vanish into obscurity.

Yet this is no damnation of the passenger train itself; only of the way they were run. Ask the retirees who had a fair chunk of their retirement funds in General Motors stock, and lost it all when GM Liquidation Corp. cashed out at the grand total of $0 (zero, zip, nada): that reflects on the former General Motors, not automotive technology.

Another case in point: The Bell System. Alexander Graham Bell’s company prided itself for a hundred years on running the world’s best telephone system. By all accounts, they did. However by their “always done it this way” outlook, they failed to see the prospects for what became today’s Internet. Indeed they actively discouraged and prevented the early adoption of many technologies which could have brought us an Internet, perhaps in the 1960s or 1970s instead of twenty years later. In this, the “Ma Bell” may have helped cede America’s competitive computer and communications advantages precisely by running the best telephone lines in the world. (See also, “Did Ma Bell Delay the Information Revolution by Decades?” by Mark Whittington)

Back at that same 1990s convention, Union Pacific’s Tom Mulligan responded to Amtrak’s plan to run an express freight service. The Amtrak presentation included a photograph of a U.P. train in the 1950s with numerous loaded express boxcars. Absent from Amtrak’s plan, however, was any involvement of the host railroads. Mulligan asked the audio-visual operator to please flip back to that slide, and asked everyone: “What color are those boxcars? Yellow.”

Perhaps Amtrak should have involved the freight railroads in their scheme? Hmm. Gene Skoropowski recently summed it up best: “The private railroads are not in the business of running trains. They are in the business of making money. Running trains is simply how they do it. This is the hallmark of our capitalist system.”

Is the time now right for the start of the new golden age of passenger trains? Will one of Europe’s profitable operators run trains here? In what part of this will the host railroads make their money? My crystal ball is a little hazy, but there’s a bright light approaching.

[1] Attributed to New York Central’s William Henry Vanderbilt in 1883

Gil Carmichael, former FRA Administrator during the Bush I years, and former Chairman of the Amtrak Reform Council, as well as the Founding Chairman of the Board of Directors of the Intermodal Transportation Institute at the University of Denver has started a new series of reports, entitled the Gil Carmichael Report, Investing in Interstate 2.0. The reports are free, informative, and a must read for anyone serious about the future of railroads in the United States. Contact the report distributor at geoff@jdmandassociates.com for your very own copy.

J. Craig Thorpe, noted Amtrak and railroad illustrator is available for all railroads, railroad-related companies, and organizations for his dramatic illustrations on a custom basis. Mr. Thorpe’s impressive gallery of work and contacts for engagement may be viewed on his web site, which is listed below.