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HOW THE MIGHTY DID FALL

Thoughts on the fall of Southern Pacific
By Lawrence Walsh

How could the Southern Pacific Railroad, once the third largest U.S. Corporation and mighty developer of the great southwest and especially California, have fallen so fast? In the l940’s and 1950’s, Southern Pacific was at its zenith, envied by the transportation world for its plant, equipment and strategic dominance of the golden west. The future seemed secure for the Southern Pacific. But big challenges lay ahead and the railroad’s executives and directors managed these rather poorly. Specifically, the managers and directors, beginning in about 1970, made four strategic errors in judgment, (1) loss of faith, (2) lack of vision regarding impending mergers. (3) Putting all the eggs in one basket, and (4) unwillingness to partner.

Loss of Faith

The executives and directors of 1970 were a frustrated lot. Their massive investment in passenger trains following the travel boom of World War II had come a cropper. The crowds that had kept their passenger trains full during all of the 1940’s and a part of the 1950’s were running on empty. People liked the nice “air-conditioned, fast and streamlined trains. But they liked even more their automobiles and the nice new freeways on which to drive them. How ungrateful of them! Further, the cherished boxcar freight traffic was being challenged by a horde of “gypsy” truckers unfettered by ICC rate regulators. The railroad would file with the ICC a competitive rate to try to stave off the raids, but it would take the ICC up to a year to decide to grant it. By that time, the business was gone and lost. Unions continued to block any efforts to reduce crew size despite technology improvements that would merit such a reduction. Trains would continue to run with cabooses and crews of 4 or 5 people per train. How could you earn a decent return on investment with these constraints? Nor were these constraints likely to go away, having been around for at least the past 75 years.

How could these executives and directors be expected to know that by the end of the 1970’s and into the early 1980’s, these problems would indeed go away. The Harley Staggers Act of 1979 freed the railroads to compete by avoiding the delay of the ICC. And by the early 1980’s, the caboose and all of those “full crew” laws gave way to operation by two or three crew members instead of four of five. The truth is some railroads were more sanguine or tuned into congress than was the Southern Pacific.

Instead of staying the course a bit longer, the Southern Pacific made the decision that there must be an easier way to make a profit than being in the capital-intensive railroad business. The result was a decision to make only a minimal investment in improving their railroad, and to use profits derived from the operation of the railroad to move into other sectors of the economy such as high-end real estate, telecommunications, fiber-optic cable lines and oil exploration and development. Having the term “railroad” in your official title became something of an embarrassment. Thus the Railroad became the Transportation Company, or even Southern Pacific Industries hiding the fact that they were in something as old-fashioned as a railroad. But it was nice to have the railroad around to milk as the cash cow for these other ventures. By 1980, this starving the railroad of capital was apparent in congestion brought on by a lack of track maintenance and expansion of sidings and double track plus a shortage of locomotives. Unreliable service began to drive customers away. The cash cow was starting to run dry!

Lack of Merger Vision

Merger mania was sweeping the railroad industry in the 1960’s and 1970’s. But the arrogant Southern Pacific showed no interest in forming any strategic partnerships or mergers of their own. They figured they didn’t need to. After all they operated in the land of growth and opportunity—the golden west. Other roads needed them but they hardly needed other roads.

As we moved into the 1980’s, the fallacy of such thinking became apparent to the Southern Pacific as the competitive girdle began to tighten around them. Their partner in running the Golden State Route (Los Angeles to Chicago), The Rock Island Railroad went bankrupt. With no hope of a Chapter 11 reorganization, the road simply ceased to exist in a Chapter 7 liquidation under a bankruptcy judge. The S.P.’s highly profitable Los Angeles-Chicago route suddenly ended at Santa Rosa, New Mexico, in the middle of nowhere. Forced to act at last, the officers and directors purchased enough of the old Rock Island to get them to Kansas City and they subsequently purchased a part of the old Alton Railroad to get them from St. Louis to Chicago. But these were hardly strategic moves. They were done under great duress. Further, with their own capital needs frittered away in non-rail ventures, where were they going to get the capital to bring these new additions up to standard? Due to the capital starvation of their railroad, railroad generated profits were getting slimmer and slimmer.

1982 was the “shot across the bow” for the Southern Pacific as Union Pacific announced it was acquiring the Missouri Pacific Railroad. That fellow with the deep pockets was now on the Texas chemical coast and other southwest centers that Southern pacific once considered their own domain. The thought began to settle in that strategic mergers were important, even vital for survival. But it was getting to be late in the game.

In 1983, the Southern Pacific’s original transcontinental route from San Francisco to Ogden Utah was threatened. Union Pacific, the long-time partner of SP at Ogden would no longer exchange cars with SP. They had purchased the parallel Western Pacific Railroad running from Ogden to San Francisco and thus no longer needed to partner with S.P. Almost immediately, the Overland Route of the Southern Pacific lost 75 percent of its business.

Recognizing at last their earlier lack of vision regarding acquisitions and mergers, the officers and directors ran hat in hand to the only available “white knight” to help save their crumbling empire. They proposed a merger with the Santa Fe Railway, their last and best hope. Santa Fe was interested but obviously had the upper hand in the ensuing merger discussions. After all, the Santa Fe was under no duress and was running a profitable railroad.

Putting All of the Eggs in One Basket

Instead of approaching the Santa Fe Railway on bended knee, why did the SP directors not sell some or all of those non-rail assets and use the money to belatedly strengthen their own road? The truth is, many of those non-rail assets performed rather poorly during the 1980-1981 recession, and nowhere was this more obvious than in those upscale real estate acquisitions. The sad fact was the capital-starved railroad had more capital needs than they could fund and their own inability to generate profits shut them out of the capital market. They came up with some stunning innovations, such as the first double-stacked freight train. They could fund some prototypes, but when it came to mass production of the spine cars and the needed container terminals, they were unable to pull it off. Their more capital-endowed competitors seized upon the fruits of the innovations. All of this occurred just as the Long Beach-San Pedro terminals were beginning the container traffic revolution. Southern Pacific then enjoyed 70 percent of the harbor traffic, but the lack of capital soon caused them to lose this leadership.

As a condition to the merger, Santa Fe insisted that the non-rail assets of both company be put into a separate holding company. Southern Pacific agreed to this, so anxious were they to merge. Now over a decade of profits that were denied the Southern Pacific Railroad were locked up in a holding company over which Santa Fe had the majority control. The ICC had better approve of this merger or the Southern Pacific would be left with a capital-starved railroad and an uncertain access to the non rail “crown jewels” which might be sold or used as loan equity. And then the unthinkable happened. After almost three years of operating a merged company, the ICC denied the merger in 1986 and ordered the merged companies to divest itself of one of the two erstwhile separate roads. Ironically, this would be one of the last major decisions of the ICC. This government agency would go out of business in 1995, succeeded by the much more industry-friendly Surface Transportation Board. The timing could not have been worse for the Southern Pacific. The Santa Fe Southern Pacific Corporation (the name of the short-lived merger) decided the Southern Pacific Railroad would be cast out to live on its own, without full access to its former “crown jewels” locked away in the holding company.

Clearly the cast out orphan could not make it on its own. Who would be willing to buy it? One Philip Anschutz would and did. Anschutz, owner of the container company, American Presidents Line and the Rio Grande Railroad would put little of his own money into the purchase, instead cobbling together junk bonds and stock to lure prospective investors. As one pundit observed, it was like the little fish (Rio Grande) swallowing the whale (Southern Pacific). Anschutz controlled the road for 8 years, 1988-1996, managing to sell off another 1.3 billion of Southern Pacific railroad assets before the Union Pacific Railroad made Anschutz a 5.4 billion dollar offer for the almost lifeless Southern Pacific Railroad which offer also included The Rio Grande Railroad. Union Pacific rewarded Anschutz with a generous quantity of its stock plus a seat on its board of directors.

Failure to partner

The great danger of being an officer or a director of a company that had been around for 100 years, always a money maker, never once bankrupt (not even in the great depression), and always a power to be reckoned with and respected was arrogance. Arrogance can lead to such conclusions that “we” are better than “you”; therefore we really don’t need you.

Unfortunately, arrogance must have infected much of the Southern Pacific hierarchy in the late 1950’s and early 1960’s. This was when the whole container and piggyback model was being established and which would soon become a major component of railroad freight traffic. Much of the industry got the model right. The Southern Pacific got the model wrong and too late came to its senses.

In those earlier formative days, Southern Pacific was all for moving containers and piggyback trucks on flat cars—providing those trucks or containers were controlled by the railroad. Southern Pacific wanted to be the company that called on the shipper, that billed the shipper, and whose truck would be seen at the loading dock. Let the truck or container be that of its affiliate, Pacific Motor Freight. The directors reasoned “why should we give our competitors, the J.C. Hunt’s or the Schneider’s or United Parcel Service (stealing business from “our” Railway Express Agency as they were) a leg up by relieving them of the cost of the long haul by putting their containers on our spine cars? This makes us the invisible middleman, and just where does this get you?” And yet, this is the successful model today. How could a railroad with a highly unionized trucking component called Pacific Motor Transport expect to go head to head with non-union independent truckers? For years, Southern Pacific Railroad tried. When they finally discovered their model wasn’t working, their rail competitors had snatched up the big over-the road truckers leaving Southern Pacific in the game of playing catch up.

The attitude that “I can do it better myself” doesn’t always work.

Summary

In summary, the officers and directors of the Southern Pacific Railroad faced the need to make enormous changes in how they operate. Their railroad’s long and glorious past didn’t impress too many shippers. “What can you do for me today” demanded the shipper. History didn’t matter. The above four serious judgment flaws were not caused by fate or how the stars were aligned, but rested squarely on the shoulders of the people charged with making the right decisions in stressful times.

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