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  • Diseconomies and Dysfunctions of Scale

    Posted by David Foster on November 24th, 2019 (All posts by )

    Why are short-line railroads able to survive, and sometimes thrive, in an industry dominated by a few giant companies?  An article at Railway Age suggests some answers. These points are relevant, I believe, in other industries as well.  To excerpt summarize the points in the article:

    –Short lines are formed with a much lower manpower cost structure that includes more-flexible work rules.

    Short lines are very effective at negotiating service and shared capital project business deals with their face-to-face local customers. That was always a hurdle when the corporate headquarters of a railroad like Conrail was hundreds of miles away in Philadelphia compared to sites like Cairo, Ill., or Kewaunee, Wisc. 

    –Short lines are focused directly upon industrial development along their limited geography service tracks. They are not distracted by competitive locations that want their location to be the next job creation site.

    –Short lines have a simple way to calculate customer profitability as a guide for managing their service responsiveness.

    –There is an ease of doing business with short lines. The difficulty of transacting business has long been an internally acknowledged Class I issue. Local small railroads have successfully addressed this with local managers dealing one-on-one with local customers.

    –The short line railroads have worked to grab growth opportunities. They developed local community and state railroad DOT programs that gave them access to development and rehabilitation capital.

    Most of these advantages could, in principal, be achieved by the large railroads through improved organization design and better internal measurements/incentives. And similarly in other industries…but it rarely seems to actually work out that way.  Re the profitability-measurements point, the article notes that Class I’s have tried for decades to calculate and then share with their remote train crews information about branch line financials. The Class I’s even tried to create regional cluster profit centers that would better focus attention on local branch line customers and new business development.  The results were at best a mixed success.

    and hence

    Selling off or otherwise leasing “troubled lines” to a smaller company typically became the favored big railroad divestiture business process.

    Any thoughts on similar factors at work in other industries?

     

    17 Responses to “Diseconomies and Dysfunctions of Scale”

    1. Mike K Says:

      I think very large companies are harder to manage. Short line railroads are probably focused on one market and it is easier to identify the factors that are important. Transcontinental and Western Airlines was probably easier to manage than TWA.

    2. Bill Brandt Says:

      When I read that I thought of a book I read long ago on the most successful of the big corporations – and they all had one think in common – there was enough “bottom up” mgt as to give lower mgrs power to do things as they saw fit for their local circumstances.

    3. Freddo Says:

      One quote I’ll always remember from a telecom magazine: “Q: how do you think you can compete with AT&T. A: Our entire revenue is less than AT&T spends on gold tournaments.”
      Find the customers that want your service/product, but don’t want to pay for the golf tournaments.

    4. David Foster Says:

      Bill….”there was enough “bottom up” mgt as to give lower mgrs power to do things as they saw fit for their local circumstances.”

      Probably more difficult to do this with a railroad, though, given the extent to which the operations of different geographies are interlinked. Easier if there are separate products with substantially different markets, such as elevators and jet engines at United Technologies Corp.

    5. David Foster Says:

      Freddo…”Q: how do you think you can compete with AT&T. A: Our entire revenue is less than AT&T spends on gold tournaments.”

      A very successful CEO remarked to me that “the secret of startup success is that you can have very smart people working on very small things.” By ‘small things’, he didn’t mean *unimportant* things; rather, things that hadn’t *yet* achieved anything like the revenue/profit levels of the other businesses in a larger company.

    6. Steve Korn Says:

      I’m doing this from memory. Recall Jack Welch once remarking GE’s massive Appliance Park in Louisville built for economy of scale was a mistake for some of the reasons mentioned here, as well as allowing too much labor union power to coalesce.

      These are the diseconomies of scale often missed.

      GE Appliance is now owned by China’s Haier that licenses the GE brand for appliances.

    7. Whitehall Says:

      The problem goes back to why the ICC was formed to set railroad rates. – local monopoly working with and feeding into long-distance competition.

      The short lines have a local monopoly on rail transport. Rail is in certain cases much more cost effective than other technologies. Short lines have that local monopoly for certain customers.

      Class 1 roads have much more competition.

      Remember the grangers charging as much for the first 100 miles to haul wheat as a transcontinental did for a 1000. Didn’t appear fair so the farmers could and did make a successful case for federal regulation to cut themselves a better deal.

      The big roads, like the Southern Pacific would insist on seeing their customers books before settling the rates as to capture the better part of the profits.

    8. MCS Says:

      I know from personal experience that it can take weeks to get a single car moved less than 5 miles from a main yard to a private siding. You might think that our being a major supplier of the road would make a difference, you would be wrong.

      The class 1 roads are simply not interested in moving less than full unit trains and the short lines would be in trouble if government rules didn’t force the class 1’s to deal with them.

      Fresh food has disappeared from the railroads because of uncertainty over scheduling. A little might still be moving intermodal.

    9. Anonymous Says:

      “Any thoughts on similar factors at work in other industries? ”

      U.S. public schools.

    10. Gavin Longmuir Says:

      Over the years, I have seen a number of studies looking at Mergers & Acquisitions in various industries. The conclusion is that generally a merged business ends up being worth less than the sum of its parts. Perhaps this is an example of the “Winner’s Curse” — the winning buyer in a competitive auction overpays, because the winner is the one who offers more than anyone else thinks the asset is worth. Or perhaps it is that larger businesses become less profitable by missing opportunities because their overhead becomes too large and slow moving.

      Everyone with an MBA has learned this lesson of history. Yet businesses still try to grow by buying out their peers. Perhaps after a business reaches a certain size, the only way to grow is by acquisition — even though the managers know this is likely the Road to Hell.

    11. Dan King Says:

      From the computer industry.

      In the 1970’s I read a confidential paper from IBM that classified computer departments by size. They broke it down by range and listed the problems each range had. It was very interesting and I really wish I could have copied it because I have seen it played out since.

      The most interesting (and satisfying) instance was when I worked at a headquarters site. We had a smaller satellite site that basically had an independent computer structure. They were very efficient and had a good reputation. Our manager had a couple of missteps (not all his fault) and he, along with some of his direct reports, was replaced by the manager of the satellite site along with some of his crew.

      We endured about 18 months of condescension before the reality that the problems were different and more difficult set in. They were all gone by the three year mark.

    12. Dan from Madison Says:

      Reading your bullet points, sounds a lot like independent industrial distribution, the game that I play. If the manufacturers didn’t have to have us, they wouldn’t. They try, but most fail. Most manufacturers don’t care about the transactional business that we thrive on, but want to send whole truckloads of “x” to “somewhere”. They can barely do this without problems much less try to service tens of thousand of customers all across the US, dealing with all the added AR, warranty, and all that.

      It almost appears to me that the local short line railroads are acting like distribution in several ways (especially dealing one-on-one with local customers).

    13. Jonathan Says:

      Dan King:

      Perhaps one-size-fits-all thinking, and the desire to tie up organizational loose ends, should be given their own subcategories (under anchoring?) in the taxonomy of decisionmaking biases.

    14. Dan King Says:

      Jonathan,

      That is way past my pay grade. I have read that something similar happens as communities grow, but it is not my area and I can’t really comment on it.

      As to your exact point, I think people don’t notice that circumstances are different and are surprised when what used to work not longer does. Certainly the people I referred to never imagined the job would be as difficult and complex as it was. In their minds the only reason we had problems was our hidebound instance on not adopting their simpler and obviously superior methods. They kept explaining how simple it was and we learned to just shut up and try to mitigate the damage.

    15. soapweed Says:

      Mr Foster: Sir ref. your above comment about United Technologies, in particular Otis Elevator and Carrier: When UT bought out these two companies the bell tolled. Both became over time, most unresponsive to complaints of sub par technology, innovation, and materials used in their products. When the retirement losses hit and the previous ‘old school’ manpower moved on, the customer loyalty vanished, and then the employee void filled with newbies whom had no concept of customer service or product quality. So Sad.
      As an aside, remember in the fifties when Trane was a new company and Carrier was dominant to a far distant York Corp, Carrier was caused to divest much technology to the fledgling Trane Company to minimize the risk of being categorized as monopolistic in the building climate/industrial process field.
      Now, even with American Standard long ago having bought Trane, they are enjoying a huge success story over their long, forgotten by most, paternal United Technology competition.

    16. David Foster Says:

      Soapweed, thanks for the comment. Could you add some texture on the details of why things went south?…Were Otis and Carrier maintained as separate strategic business units (including separate sales, engineering, manufacturing, etc) within UTC, or were some of these functions consolidated at the corporate level?

    17. MCS Says:

      A lot of “mergers” are simply buying customers where the purchaser sees no value in the actual business. Sometimes they’re right, sometimes they’re unpleasantly surprised.

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