Balancing Competition with Cooperation

Henry Posner III, Chairman Railroad Development Corp.

…For Success in Rail Freight

European Rail Summit  Brussels  November 5, 2014

Don’t worry; I know that I’m in Europe, and even though I’m a North American, I am the Chairman of a German rail passenger company and a French rail freight company. So my views tend to be as European as American because our heaviest investment is currently in Europe. Today I’ll discuss Railroad Development Corporation’s (RDC’s) investment philosophy and why we’re in Europe; some of the differences between North America and Europe; and how, in our own small way, we have translated some North American philosophy to Europe.

Background on RDC RDC is a railway investment and management company based in Pittsburgh, Pennsylvania (USA) and we focus on Emerging Corridors in Emerging Markets. We believe that Europe is an “emerging market” because it is so complex and because there are so many problems and there seem to be so few solutions. But let me add that everything RDC does is based on joint ventures, so our success is more based on who our partners are than who we are. And also, we describe ourselves as “Investors of Last Resort.” We tend to gravitate toward transactions that either are not on anyone else’s radar screen or that have been written off as hopeless, such as the wagonload in Europe. The table shows where RDC is invested, both currently and in the past. In the past we were in 2 countries in Africa—Malawi and Mozambique; 1 country in Europe—Estonia, also the first and only former Soviet railway to be privatized; and 2 countries in Latin America—in the case of Guatemala, we took the abandoned national railway and put it back into operation and ran it for 9 years at no cost to the public sector until we were forced to shut down by the government. Of the 5 countries in which we currently operate, 2 are in Europe—Germany for passenger and France for freight. RDC Investments: Length (Miles) (592) (332)

CURRENT: USA Peru

Entity Iowa Interstate Ferrocarril Central Andino

Km 954 535

Employees 215 588

Germany

Hamburg-Köln-Express

450

(280)

60

Colombia France

Ferrocarril del Pacifico RegioRail

196 (122) Various

135 40

PAST: Malawi

Central East African Railways

797

(495)

Mozambique

CDN-Nacala Corridor

873

(542)

Estonia Argentina Argentina Guatemala

Eesti Raudtee ALL Central ALL Mesopotamica Ferrovías Guatemala

693 5,690 2,704 322

(431) (3,535) (1,680) (200)

417 404 Rail 209 Port 2,345 1,200 300 13

Avg. Annual Tons (in millions) 14.0 1.8 Passengers— start 7/2012 Start 7/2012 Start 12/2012 Tons Last Yr of Investment 0.22 (2008) 0.2 Rail (2008) 0.9 Port (2008) 44.4 (2006) 2.3 1.0 N/A

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Differences between North America and Europe There are of course major differences between North America and Europe, such as distances; that North America is a freight market more than a passenger market; and that interoperability in North America is not really an issue because we are one network. But I’m coming to you today as a European who’s been working here since 2006, originally at the invitation of SNCF; we’ve made lots of mistakes and gone down lots of blind alleys but we have developed a body of experience that is valuable. Based on this morning’s comments, I would add Vision as a Difference. In Europe it comes from public policy; but there is no single “vision” in North America because the market decides what the railways do; the more than 600 private sector railway companies in North America are more of a cloud than a public policy body. One of the reasons for this, which was echoed in Japan’s story this morning, is that North American railways are pretty much independent of the public sector in how they operate and invest in their businesses. This is an important reason for our success; we are not suffering the same trials and tribulations as the airline industry, the barge industry, and the trucking industry precisely because we do not depend on the public sector. DIFFERENCES TECHNICAL:

NORTH AMERICA

EUROPE

Distances:

Long

Short

Traffic Patterns:

Concentrated

Fragmented

Interoperability:

Simple

Complicated

Capacity Constraints:

Line Capacity

Paths

Orientation:

Freight

Passenger

Cloud

Public Policy

Private Ownership

State Ownership

Culture of Optimism

Culture of Hopelessness

Private Ownership

State Ownership

Vertical Integration

Separation

Balance of Cooperation with Competition

Focus on Competition

Diversity

Monoculture

VISION: CULTURAL:

INSTITUTIONAL:

STRUCTURAL (WAGONLOAD):

Other differences that are not often addressed are cultural, institutional and structural. Regarding cultural differences, obviously there is a quite a difference between private and State ownership. But beneath the surface I think that there is also a fundamental difference in business culture between North America and Europe. In North America we’re optimists, but Europe has a culture of hopelessness; please excuse me for saying that, but to date no European audiences have corrected me. Europeans know what can’t be done, but Americans typically go out and try, and make mistakes because we have a business culture that tolerates failure. If you haven’t failed, you’re not trying hard enough. And boy, have we tried in Europe! There was a discussion this morning about vertical integration vs. separation, and the more I think about this, the more I think it is one of semantics. We have many places in North America where you could argue that there is no vertical integration, and in Europe, you use nice words like “Alliances,” “Chinese Walls,” etc. but Europe is more vertically integrated than people are willing to admit. So I would like to suggest that this is very much a gray area.

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Perhaps most importantly, in North America we have a culture of cooperation as much as we have one of competition. I never hear the EU saying that we’ve got to have more cooperation; it’s all about competition. I think that is one of the policies which has afflicted our industry on this continent now for decades. The last point is also important and I’ll use wagonload as an example—diversity vs. monoculture. One of the reasons that the U.S. industry has done so well is not because of the long distances or some of the other things that provide a substantial base, but rather because we are a diverse industry. Since we are a diverse industry we are able to innovate, but we’re also forced to innovate in ways to cooperate. We’ve been doing this for a long time; deregulation was in 1980 and this is the year 2014—so we’ve had several generations of people operating under deregulation; with 600 railway companies all trying to do things in different ways, diversity has really been the strength of our industry. This is in contrast to the monoculture that is present in many European railways where an objective seems to be to make sure there is only one opinion. I think this is toxic, but you can draw your own conclusions.

North America: Competition with Cooperation

Please note that on the map in most markets there are railways running parallel to each other, and vertically integrated at that. This means that for every origination/destination pair, at least in major markets, there are 2 or more competing railways; in fact, our Iowa Interstate Railroad is 1 of 4 main lines running from Chicago to Omaha. But our niche is serving customers between Chicago and Omaha on our line, rather than competing with the bigger railroads like the Union Pacific or BNSF that run parallel to us. Because most rail traffic in North America involves at least 2 railway companies, we are a network business. We do not necessarily have interoperability as Europe defines it, but we hand traffic off to each other based on our culture of balancing competition with cooperation. In some markets we are competing with trucks, which means 3|P a g e

cooperation, and in other markets we are competing with each other; but knowing that one day you are going to be competing with the person who you are cooperating with tomorrow tends to moderate our behavior and results in a very effective and cohesive continental railway culture. To review, (1) it is a cultural thing to know when to balance competition with cooperation, and (2) we are a network business, in both North America and Europe. But in my opinion, the major differences in Europe are (1) a lack of diversity, and (2) lack of a culture of cooperation. Please don’t take this in a negative way: even under 34 years of deregulation, it took us 2 generations to get where we’re going. It is not reasonable to expect that Europe, which is much more fragmented in many respects, is going to do this any faster. It won’t be easy but it does need to happen.

Translation to Europe – Rebalancing? Translation to Europe So, what are my constructive suggestions for Europe? With regard to the cultural examples, some can in fact be addressed

without

permission

from

Brussels.

First,

introduce some participation by the private sector, side-by-

CULTURAL  Private with State Ownership  Culture of Optimism with Culture of Hopelessness INSTITUTIONAL  Cooperation with Competition STRUCTURAL  Diversity

side with State companies; second, aspire to a Culture of Optimism or call it a “Higher Tolerance for Failure” instead of a Culture of Hopelessness. Institutional change can include a balance of cooperation with competition, but first and foremost is diversity. This introduces another kind of competition, which is cultural competition—the marketplace of ideas. The more diversity you have in the market, the better the solutions you are going to get, recognizing that there will be failures along the way.

Vision vs. Reality This illustration is the vision that we had way back in 2011 for France. Notice in the upper right-hand corner that it is “Plan B.2,” meaning that there was a Plan A, and a Plan A.2 and a Plan B.1. This was one of several iterations of what we originally came to do in Europe at the request of SNCF—to come up with some solutions for wagonload traffic. Our original vision was a joint venture at the national level to fill in all the gaps that were being abandoned for wagonload traffic. The idea was to have a neutral, last-kilometer service that could freely interchange with all the line-haul carriers. This was highly conceptual but gives you an 4|P a g e

idea of what the network might look like. The black lines represent clusters of wagonload customers, and the dotted color lines represent the line-haul carriers who might be interested in moving this traffic from A to B. Again, this was Plan B.2 dated 2011. Now, let’s fast forward to 2014. This map is our joint venture with Eurorail in the creation of a last-kilometer business in France called RegioRail where we currently have 3 different companies providing last-kilometer and other types of services. We have gone to great lengths to note on this map the other railways that we connect to, such as DB, SNCF, CFL, SNCB, etc. The point is that the last-kilometer map, in our own small way, is being filled in. The dotted lines represent where we have to run line-haul service because we haven’t been able to get the linehaul carriers interested in handling our traffic. It is not our first choice, but we do so where necessary.

So what is evolving? Note the objective on the original vision—“A national network of commercially-independent rail operators.” Three years later, we have a little bit of a start going on. To conclude, this is a network business, and it is as much based on cooperation as it is on competition. RDC is a small company but I am very proud of how far we have come in earning our position in the community of European railways. Thank you. ###

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