A Performance Turnaround? CP Rail

Admire him or loath him, Hunter Harrison certainly makes no bones about his approach to turning around poorly performing businesses. Harrison was brought in 2 years ago by activist-investor Bill Ackman with a  plan to turn “the worst performing railroad in North America” into one of the best.

As David George-Cosh wrote in a WSJ article recently

Two years later, Hunter Harrison, the railroad veteran Mr. Ackman hired as CEO, is close to delivering on that promise. Mr. Ackman’s Pershing Square Capital Management LP has already tripled the value of its initial $1.07 billion investment, and Mr. Harrison has notched a third railroad turnaround based on a cost-cutting formula he says has changed little in two decades.

“I’ve been [a] CEO for 22 years now, and it’s not been any different than in 1992,” the Tennessean said of his aggressive drive to boost efficiency at CP.

But as Mr. Harrison hits the home stretch of his push toward Mr. Ackman’s targets, his time-tried rail-management methods face new tests. Driven by growth in shipments of shale oil by rail, the industry is undergoing a period of rapid change that is spurring tougher regulation and putting pressure on rail operators across North America.

On both sides of the border, regulators are taking action after a string of derailments of crude-carrying trains, including one in Lynchburg, Va., last month and one that killed 47 people in Lac Megantic, Quebec, last summer. Measures so far include stricter standards for the testing and transportation of crude, lower speeds for trains carrying hazardous materials and, in Canada, a deadline to phase out or retrofit 65,000 tank cars. CP’s crude business has boomed, making it the second-biggest rail shipper in North Dakota’s Bakken region after BNSF Railway Co. That places it among the companies that will be most affected by the new safety rules, as well as by measures aimed at preventing growth in crude shipments from displacing other commodities.

Revenue at CP, driven by grains as well as crude, climbed to C$6.1 billion in fiscal 2013, an 8% increase from the year before. CP’s adjusted earnings for the year were C$1.1 billion, a 48% increase from fiscal 2012, as costs fell 2% to C$4.3 billion.

Mr. Harrison, now 69 years old, is credited with turning around CP rival Canadian National a decade ago, before he retired to run horse farms in Florida and Connecticut. His retirement was short-lived. Paul Hilal, a partner at Pershing Square, cold-called him after researching Canadian railroads for investment, looking to develop his thesis that CP was struggling because of weak leadership and culture.

“People familiar with the companies said CP’s culture was very weak,” Mr. Hilal recalled recently. “Under Mr. Harrison’s leadership CN had developed a ‘go-getter culture characterized by an urgency to win, attention to detail, conscientiousness, and deep respect for safety.'”

As with many industries, operating ratio, or the ratio of operating costs divided by revenues, is one way to gauge overall effectiveness of process and people. CP’s efficiency improvement has many lean flow elements such as steady and quick-flowing use of assets:

When Pershing Square launched its proxy fight, the firm argued that CP had structural advantages to Canadian National, including shorter routes through the Rocky Mountains. And, Pershing Square said, CP should have benefited from shipping higher-margin bulk items and its access to the Bakken shale. Instead, the activists said, it was less efficient than Canadian National. When Pershing Square said it believed CP could hit an operating ratio of 65%, the company paid $5 million for a study that claimed Pershing Square’s targets were “unrealistic and unachievable,” Mr. Hilal said.

Now, CP is close to hitting that target. Mr. Harrison quickly made cuts across the railroad’s 14,700-mile network in Canada and the U.S., sidelining 400 locomotives and 12,500 rail cars, consolidating terminals and cutting 4,700 jobs.

He also shut down unused railcar sidings and hump yards in four of CP’s metropolitan hubs in Canada. To improve transit times, he instituted a system to eliminate idling empty rail cars and to instead run fewer but fuller cars on a tighter schedule. That approach, farmers say, led to delays in delivering cars to grain terminals when cold weather slowed the network this winter.

Gerrid Cust, who runs a 17,000-acre farm in Davidson, Saskatchewan, says he missed filling an order to ship canola to Japan in January, foregoing a $10-a-bushel premium and putting his future orders at risk. “Japanese customers won’t forget about a missed shipment for the next 50 years,” he said.

Cuts to the network helped reduce CP’s operating ratio—operating costs as a percentage of revenue, a key industry performance measure—to 69.9% in the last fiscal year from 81.3%, where it stood at the end of 2011 when Mr. Ackman called CP the “worst-performing” railroad in North America. Indeed, Mr. Harrison says he is within reach of cutting the operating ratio to the low-60% range by next year, which would make it the top-performing North American Class 1 railroad. “That’s a hell of a change, to go from worst to first in not even two years,” said Mr. Harrison, speaking with an easy-going Southern drawl and repeatedly banging his large gold ring on a table to emphasize his point.

To further improve efficiency, Mr. Harrison said he is negotiating with North American railroads to streamline rail traffic and thus reduce congestion in Chicago, a major rail gateway. He also said he’s overhauling CP’s shipping protocols to schedule the railroad’s railcars by the hour instead of daily.

It was a final vignette in this article that also caught the attention of xray-delta, a scene from a trail derailment that saw the CEO at the gemba to get to the reality of the situation:

When a CP train carrying crude derailed on a bridge near the company’s headquarters in Ogden, Alberta, last June, Mr. Harrison arrived at the scene to inspect the damage himself.
“I crawled under the cars. I determined the cause in about 10 minutes,” he said. “The first responders hadn’t been there. The [Transportation Safety Board] hadn’t been there. I’m not being critical, I’m just naming facts.”

How the CP Rail story ends only time will tell, but tracking the progress and overall results at CP over the next few years will prove interesting for performance improvement professionals.