How Can Union Pacific Win?

Jim Vena, Union Pacific’s new CEO said this on the recent earnings call:

I could have sat at home doing some exciting hiking or mountaineering, but I decided to come back because I think we can win.

We have the railroad and the network to do that.

The pressure is on this team.

What does winning mean for Union Pacific? 

Before I answer this question, here is a brief background on Jim Vena and Rails.

Jim Vena is a disciple of Hunter Harrison, the pioneer of the Precision Scheduled Railroading (PSR) operating model.  Hunter is a legend in the railroading business for turning around four railroads by using his PSR model. 

In simple terms, PSR means that railroads run longer, faster trains on fixed schedules.  The rail network is simplified by removing custom terminals and using more point-point routes.  PSR also requires reducing the inventory of cars, locomotives, and crews; and increasing the utilization of assets.  The result is lower operating costs and higher return on assets.

During his 40-year tenure at Canadian National, Jim Vena served in various operating positions and was the COO from 2013-2016.  During his COO tenure, Jim improved the operating ratio by more than 5%.

Source: Company Filings

Jim Vena was also brought in as the COO at Union Pacific from 2019-2021 to implement PSR. 

During this time, UNP made remarkable strides in its operating performance.  The operating ratio increased to best in class in three years.  Train velocity increased while dwell time decreased dramatically.  However, the improvement wasn’t without controversy.  The employee count was reduced by 11,000 or 26%.

Source: UP Filings

Railroads are Volume Donors

All Class 1 rails have optimized their cost structure over the past decade.  Profitability has improved across the board.  However, there is a cost to every strategy.  The cost of PSR has been a decline in volume and a share loss to Trucking.  Union Pacific’s volume growth is the worst among all class 1 railroads.  Since 2011, volumes have decreased by 10%, despite a 6% growth in industrial production.  Trucking is a clear beneficiary of the Railroad industry’s volume loss. 

Source: Company Filings, ATA

Show Me the Incentives And I’ll Show you The Outcome

Charlie Munger, the late vice chairman of Berkshire Hathaway believed that incentives are a powerful force that shapes executive behavior.  Most railroads, including UP, have been focused on cutting costs because they are rewarded for doing so.  For UP executives, most of the incentive pay is focused on cost improvement, with very little emphasis on growing revenues. 

Source: UP Proxy Statement

Improve Service. Grow Volumes. Win

We have enough evidence to know that Union Pacific under Jim Vena will excel at operating efficiency. However, if Jim Vena truly wants to win, eventually he will need to balance cost controls with volume growth. Winning means improving train speeds and on-time arrivals.  Winning also means treating your customers as a key stakeholder. Ultimately, winning means delivering exceptional customer service. Union Pacific needs to grow volumes to win.

The Board at UP should also help by explicitly rewarding the entire executive team for volume growth. 

It may make winning easier.