Executive Summary Union Pacific is the largest freight railroad in North America. In 2007 they transported over one trillion ton-miles of freight earning revenues of $16.28 billion. They operate on 32,000 miles of rail covering the United States west of the Mississippi. Union Pacific is a successful firm both externally and organizationally. The Class I Freight Railroad industry encompasses the seven largest railroads in North America. In the U.S., where Union Pacific operates, Class I Freight Railroads move more than 40% of the freight transported per year, measured in ton-miles. The industry is in the maturity stage, experiencing slow consistent growth. For companies in this industry, it implies tightened operations and good human resource management are essential for success. The industry incumbents benefit from high barriers to entry due to the amount of capital requirements. Substitutes play a moderate role in the industry, while buyers and suppliers are on neutral ground with the railroads. Lastly, rivalry varies from area to area, but is average as a whole. This is shown in the analysis of captive versus noncaptive customers. Union Pacific mainly transports commodities in five primary industries; agriculture, automotive, chemical, energy, and industrial. These customers look for competitive pricing, on time delivery, and good customer service. In order to be successful in this industry, a railroad must have the resources to serve all the needs of these customers. Since Union Pacific operates west of The Mississippi, its main competitor is Burlington Northern Santa Fe which also operates in this region. At times they also compete with CSX and Norfolk Southern in intermodal transportation. At other times they are the only railroad servicing an area. The amount of power they have depends on the competitive atmosphere within each unique environment. Union Pacific is trying to grow to meet the increasing demand for freight transportation. The main way they have done this is through increasing the efficiency of their existing routes more so than creating new ones. They do this through such methods as intermodal transportation and technological improvements. Union Pacific faces two major challenges to meeting their goals and remaining a successful company. These are preventing government regulation that loom over the industry and finding a way to grow without increasing the threat of such regulation.

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Table of Contents
1. Executive Summary .....................................................................................................1 2. Industry Analysis .........................................................................................................3 2.1. Industry Overview ..................................................................................................3 2.2. Industry Life Cycle .................................................................................................4 2.3. Porter’s Five Forces Analysis .................................................................................5 2.4. Emerging Trends ....................................................................................................9 2.5. Customer Analysis ................................................................................................10 2.6. Key Factors of Success .........................................................................................13 2.7. Competitive Analysis............................................................................................14 3. Company Analysis .....................................................................................................16 3.1. Performance Summary .........................................................................................16 3.2. External Performance ...........................................................................................16 3.3. Organizational Health ...........................................................................................18 4. Strategy Analysis ........................................................................................................19 4.1. Organizational Goals ............................................................................................19 4.2. Competitive Premise .............................................................................................20 4.3. Value Chain Analysis ...........................................................................................21 4.4. Sustainability Analysis .........................................................................................26 4.5. Challenges.............................................................................................................28

Table of Exhibits
Exhibit 1 – Life Cycle ..............................................................................................4 Exhibit 2 – Five Forces Model.................................................................................5 Exhibit 3 – Revenue Per Ton Miles .........................................................................7 Exhibit 4 – Intermodal Growth ................................................................................9 Exhibit 5 – Industry Average Captive Rates..........................................................12 Exhibit 6 – Industry Average Non-Captive Rates .................................................12 Exhibit 7 – Union Pacific vs. BNSF System Maps ...............................................14 Exhibit 8 – Union Pacific vs. BNSF Key Financials .............................................15 Exhibit 9 – North American Intermodal Traffic ....................................................15 Exhibit 10 – Performance Grid ..............................................................................16 Exhibit 11 – Union Pacific Financial Performance Comparison ...........................17 Exhibit 12 – Key Financial Ratios .........................................................................18 Exhibit 13 – Value Chain .......................................................................................22

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Industry Analysis: Class I Freight Rail
Class I Freight Rail is an industry that transports freight via railroad throughout the United States, Mexico, and Canada.

2.1 Industry Overview
The status of Class I Freight Rail is currently very strong. Demand for rail transportation in ton-miles has grown by 84% since 1980, and is projected to grow another 55% by 2020.1 The health of the industry is positively correlated to the growth of the domestic economy, since Class I Freight Rail accounts for more than 40% of the ton-miles of freight transported in America each year.2 The railroad transportation industry is comprised of about 350 companies with combined annual revenues of $50 billion. Union Pacific is a Class I Freight Rail Company, which is defined as a company with revenue of at least $346.8 million in 2006. The Class I Freight Rail industry is highly capital-intensive. Track, land and equipment are very expensive and are necessary to run a large railroad. For this reason, Class I carriers comprise only 1% of freight railroads but account for over 90% of the overall freight rail revenue.3 Class I railroads combine to operate nationwide on high-density intercity traffic lanes. Demand in this industry is driven by several factors. As the economy grows, the need for freight transportation increases. Also, as the cost of alternative transportation increases, the demand for freight rail increases. The profitability of individual companies depends on how much rail they operate on and how efficient their operations are. Large companies have advantages in owning substantial miles of railroad track connecting major cities. Small companies can compete effectively by servicing local routes and transporting a wide variety of commodities. Before 1980, the government regulated the freight rail industry so highly that many of the firms in the industry were going bankrupt. Recognizing the problem, the Staggers Rail Act of 1980 was passed to decrease federal control over freight rail operations.4 Since then railroads have become much more profitable. Currently, customers of railroads have been raising concerns about various aspects of rail services and have involved the government. The Railroad Competition and Service Improvement Act of 2007 is a bill currently in Congress that would reregulate parts of the industry. With worries of

1 2

Simpson, Tom. 2006. Strong Railroads Need Strong Suppliers. Railway Age. 207-9 Association of American Railroads (AAR). 2003. Railroad Facts 2003 Edition. Railway Age. 207-9 3 Simpson, Tom 4 Winston, Clifford. 2005. The Success of the Staggers Rail Act of 1980. Brookings Institute. Regulatory Impact Analyses Database.

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reregulation, railroads are forced to find a balance between growth and acting in what could be perceived as a monopolistic way.5

2.2 Industry Life Cycle
The Class I Freight Rail industry is currently in the maturity stage of its industry life cycle as seen in Exhibit 1. The four largest railroads have averaged 4.54% compound annual growth rate (CAGR) of revenue over the last 10 years.6 This number can be misleading because the revenue does not correlate as much with the volume of goods transported. Because rates have decreased annually since 1980, there has been a decrease in revenue as well. In 2006, the Surface Transportation Board determined that the industry return on investment hit an all-time high, with an average return of 10.36%.7 Exhibit 1: Life Cycle

Implications Human Resource Management In order to tighten and control operating costs, significant restructuring has occurred. Although the tonnage transported has increased over the last 10 years, the amount of employees has decreased slightly. According to the Surface Transportation Board, the numbers have gone from approximately 187,000 in 1997 to 168,000 in 2007.8 The industry remains a labor-intensive operation. Thus, it is important for these companies to properly manage their relationships with the unions due to the risk of strikes.
5 6

Young, Jim. 2007. http://www.uprr.com/newsinfo/srps/letter_091407.shtml Data gathered and compiled from individual annual reports 7 Surface Transportation Board. 2008. Railroad Revenue Adequacy. Online. Available from Internet, http:www.stb.dot.gov, accessed 6 May 2008. 8 Ibid.

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Tightening of Operations Since the Staggers Act of 1980, the railroad companies have been free to cut unprofitable routes, reducing overall track from 270,000 miles to 170,000 miles. As a result of this, they have been able to increase the traffic flow on their remaining routes and become more efficient. In fact, they have increased their traffic density, which is millions of tonmiles per mile of track, from 3.4 to 8.9.9 This means they have increased overall traffic volume by 60% while decreasing the amount of track. These two implications have been consistent for the last twenty years, and the maturity stage implies this trend will continue.

2.3 Porter’s Five Forces Analysis – North American Freight Rail
The Class I Freight Rail industry is very attractive to incumbents. Using Porter’s five forces analysis, we show that the industry deserves 3 out of 5 stars. Exhibit 2: Five Force Framework

9

AAR

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Barriers to Entry – Full Star Barriers to entry earns a full star because of the large amount of land and track needed to enter the industry. In order to operate and compete with the major players, a company needs a vast network of rail. A new company trying to enter this industry would not be able to profit from the large investment in the land and rail that is necessary to compete. Bargaining Power of Suppliers -- Half Star Supply needs in the railway industry can be broken into three main categories: fuel, equipment, and materials. In each category the main contributor to the cost is identified and shown if that supplier has bargaining power. Fuel – Diesel Fuel Fuel suppliers have complete bargaining power. The demand for oil on a global level sets the price. Railroads are not a large enough customer to have any bargaining power on a commodity with such large global demand. Equipment – Freight Car and Locomotive Leases Equipment suppliers have moderate bargaining power. Due to demand expected to grow 55% from 2000 to 2020, railroads have focused on doing more with limited resources. In this market, efficient equipment can have big payoffs. Due to this trend, demand is high giving suppliers moderate bargaining power.10 Materials – Materials Used to Maintain Lines and Equipment Material suppliers have low bargaining power. There is little differentiation of the materials and since the rail companies are such large customers, the material suppliers have little bargaining power. The suppliers of fuel have complete bargaining power, and fuel costs are approximately 24% of a given rail’s operating expenses. On the other hand, the rail companies are not at the mercy of their other suppliers. For this reason the Class I Freight Railroad industry has a half star. Substitutes – Half Star The freight transportation industry is a combination of five main modes. Railroad and barge dominate the longer-distance higher bulk freight, while trucking dominates the intercity door-to-door movement. On the other hand, air transportation has found its niche in long distance, time sensitive, and low bulk products. Lastly, the pipeline business only transports oil goods on fixed routes. Trucking acts as the most direct competitor because it can perform the same services that railroads do, and is more versatile in its routes. Below is a chart of the respective market share distribution for freight transportation. As you can see, railroads transport the most ton-miles out of any method, while trucks hold a
10

Simpson, Tom. 2006. Strong Railroads Need Strong Suppliers. Railway Age. 207-9.

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solid second place with almost a third of the market share. Since railroads mostly deal with transporting commodities and bulk goods, we will only analyze the impacts of truck and water transportation on their operations. Exhibit 3: Revenue Per Ton-Mile

Source: Bureau of Transportation Statistics

Trucks As stated before, trucking acts as the most direct competitor to the Railroad industry. Trucks tend to provide local and regional services, with an average of less than 300 miles per truck shipment. On the other hand, the average rail shipment is more than 500 miles.11 This is because railroads are more fuel-efficient. On a train, each gallon of fuel can transport one ton of goods 202 miles, with trucks this figure is only 59 miles.12 Thus, rail is usually a better decision for longer distance shipments because that efficiency has the ability to override the convenience trucks have to offer. The growing use of intermodal transportation systems, which we will discuss more in the emerging trends section, helps combine the efficiency of long distance rail freight with the convenience of trucks to create a better, cheaper service to the customers.13 In this way, trucking is slowly transitioning from a direct competitor to a compliment as they both find their respective niches. Water Water transportation by barge via the Great Lakes and inland waterways serve as an additional substitute to rail freight. This method of transportation is geographically limited and significantly slower, thus making it a regional competitor.14 Water transportation acts as a viable substitute for transporting heavy machinery and bulk

11

Bryan, Joseph, Glen Weisbrod, and Carl D. Martland. 2007. ―Rail Freight Solutions to Roadway Congestion - Final Report and Guidebook‖. Transportation Research Board. Online. Available from Internet, http://www.trb.org/news/blurb_detail.asp?ID=8459, accessed 6 May 2008. 12 Nachtmann, Heather. 2002. ―Economic Evaluation of the Impact of Waterways on the state of Arkansas‖. Online. Available from Internet, http://www.waterways.dina.org/impact.pdf, accessed May 2008. 13 Carmichael, Gilbert. 2007. Intermodalism: A New Science of Transportation. University of Denver Intermodal Transportation Institute. Online. Available from Internet, http://www.nationalrailpassengersummit.org/carmichael.html, accessed 23 May 2008. 14 Ibid.

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agricultural goods. Barges are less expensive per ton-mile since one gallon of fuel can transport one ton of goods 514 miles.15 The Class I Freight Rail industry has substitutes in several different aspects of their operations. The most direct substitute to the freight rail industry is trucking, which has the ability to provide the door-to-door convenience that freight rail cannot. Railroads have the clear price advantage in long distance heavy freight transportation. Additionally, intermodal freight has allowed railroads to participate in door-to-door shipping as a compliment to trucking. Therefore, substitutes receive a half star. Buyer Power – Half Star Railroad customers can be divided into two categories. Non-captive customers are those shippers served by more than one railroad. Captive customers are those limited to a single railroad. Non-captive customers average paying $19.67 per ton, while captive customers are forced to pay an average $42.41 per ton.16 Therefore, captive customers have very little power over the railroads. However, the competition in captive markets gives these customers a significant amount of power, since they can get the exact same service from any of the competing railroads. Rivalry – Half Star The industry earns a half star because the railroad companies are highly competitive in geographic areas where several firms compete. The services themselves have very little differentiation. In areas where only one firm serves the customers, the closest competitor is trucking. This is shown by the price differences in captive versus non-captive customers shown above. The capital expenditure necessary for a railroad to enter one of these markets generally makes it unrealistic, so the rivalry remains low. Brand loyalty plays a role in this industry, as most contracts are long-term and high in value. Since there is very little differentiation, customers have no incentive to endure the costs involved with switching suppliers. With a stable three stars, the Class I Freight Railroad industry is a very good industry for incumbents. The industry benefits from high barriers to entry due to the high capital requirements. Substitutes play a moderate role in the industry, while buyers and suppliers are on neutral ground with the railroads. Lastly, the rivalry depends on certain areas, but is average as a whole.

15 16

Nachtmann, Heather. Davidson, Paul. ―Freight railroad customers complain about prices, service.‖ USA Today. 27 Sept. 2007.

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2.4 Emerging Trends – Intermodal transportation
Exhibit 4:

The 21st century has been labeled ―The Integration and Information Era.‖ Nowadays, products not only need to be shipped around the country, but they need to be done efficiently and in a timely manner. Intermodal transportation combines the efficiency of methods such as rail and barge with the door-to-door convenience of trucking. Using a generic container as the sole storage method, a customer can have the peace of mind to know their product cannot be lost when it is transferred between the methods of transportation. The use of this method is especially important in dealing with imports and exports, as a customer can easily transfer to and from large ships with very little time or capital expenditures. In addition to these factors, intermodal containers can also be stacked on top of each other during rail shipment, therefore cutting shipping costs almost in half.17 That being said, rail plays a critical role in the success of intermodal transportation. Conversely, the increase in intermodal transportation helps railroad turn potential substitutes like barge and trucking into complements because shippers realize they can minimize costs and maximize convenience through the use of intermodal containers. Currently, approximately 21% of the Class I revenue is through intermodal transportation with CSX leading at 30% of their revenues in intermodal transportation.18 As you see in Exhibit 4, intermodal transportation has grown significantly since 1980 and now accounts for a significant amount of revenue. This is only the beginning, as it allows for the most efficient use of fuel and increases the volume of products that can be shipped without the capital requirements necessary to lay more track.19

17 18

Carmichael, Gilbert. Data gathered and compiled from individual annual reports. 19 Carmichael, Gilbert.

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2.5 Customer Analysis
Class I Freight Rail services customers from many industries. As mentioned in the substitutes subsection of the Five Forces Analysis, it is by far the most financially efficient means for transporting large quantities of goods across land. Companies that use Class I Freight Rail to transport goods can be classified into five primary industries: agricultural, automotive, chemical, energy and industrial. The following charts identify the types of companies serviced within these industries and the chief goods transported for these companies. Agricultural Customers Companies Grain processors Animal Feeders Ethanol Producers Consumer Centers Consumer Center Distributors Goods Whole Grains Commodities Produced from Grains Food and Beverage Products*

*Many food and beverage goods are perishable, requiring refrigeration and express options. Automotive Customers Companies Vehicle distribution centers Automotive assembly plants Goods Assembled Vehicles* Automotive Parts

*Many assembled vehicles are very large, requiring high-volume transport services. Chemical Customers Companies Plastic Production Facilities Glass Production Facilities Agricultural Users Energy Customers Companies Utilities Facilities Industrial Facilities Goods Coal Goods Plastics, Petroleum Products, Soda Ash Fertilizers

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Industrial Customers Companies Home Construction, Repair and Remodeling Commercial and Highway Construction Consumer Center Consumer Center Distributors Industrial Manufacturers Goods Lumber Rock, Cement and Steel Paper and Consumer Goods (Furniture and Appliances) Nonferrous Metals Industrial Minerals

Source: A.A.R.

General Needs While goods such as food and beverage products require special transport needs, all customers of Class I Freight Rail share three universal needs: Cost-effective Price Price is the primary reason customers purchase Class I Freight Rail service. It is substantially less expensive per ton of goods transported than its primary substitute, trucking. On-time Delivery Transportation is about moving goods from point A to point B. On-time delivery of these goods is an essential need of every customer and a primary concern for Class I Freight Rail companies. Customer Service Customers need the ability to access personal services within their Class I Freight Rail provider to accommodate fluctuations in their demand or problems that may arise. Purchasing Decisions Customers choose freight rail because it is more economical than trucking. Since there is little differentiation between the services of Class I Freight Rail companies they compete for orders on one of two fronts: routes or price. In markets where they compete based on routes, the largest factor in the decision making process of customers seeking Class I Freight Rail services is the geographic ability of the freight company to transport their goods from point A to point B. Class I Freight Rail is limited geographically by the physical railroad track that defines their scope of service. Many areas of the United States do not have access to the service of more than one Class 11 | P a g e

I Freight Rail company, leaving those customers with no choice between multiple freight services for the transportation of their goods. In these ―captive‖ circumstances, most Class I Freight Rail companies charge much higher prices for their services than in areas where they face direct competition from other freight companies. To be a viable option for their customers, they must only offer a price point more effective than their nearest substitute, trucking. Exhibit 5 below lists the industry averages for captive rates on four primary industries. Exhibit 5: Good Agriculture Coal Chemicals All Commodities Industry Average Captive Rates $45.68 $21.24 $43.46 $48.19
Source: USA Today Money

In markets that are in ―non-captive‖ areas of the United States serviced by more than one Class I Freight company, price plays a role in the decision-making process. Since there is little differentiation in the service, if a freight rail company’s prices are too high customers will look to alternatives based on pricing. Exhibit 6 below lists the competing non-captive prices for Burlington Northern and Union Pacific. Exhibit 6: Good Agriculture Coal Chemicals All Commodities Burlington Northern Non-Captive Rates $25.54 $9.01 $21.48 $22.32
Source: USA Today Money

Union Pacific Non-Captive Rates $24.82 $9.24 $21.94 $22.38

A convenient purchase process is also a typical order winner in similar industries, but because there are no new players within the Class I Freight Rail industry, there is little room for differentiation in the purchase process. Competing companies are well developed and established with advanced online interfaces and integrated purchasing services. Another important aspect of the Class I Freight Rail is the prolonged lifecycle of the industry. Any customer possessing the option to purchase services from two or more companies has little incentive to switch companies after receiving satisfactory service. They have become familiar with the logistics of the company and the people with which they interact within that organization. With no incentives to switch services, repeat customers and long-term contracts are common within this industry.

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2.6 Key Factors of Success
Incumbent—Scope The amount of land and track needed to be in this industry are so costly that a company could not succeed by building a new rail system. Therefore the biggest key factor of success is simply having these assets. Having the land is a market qualifier. Having the strategic routes between major cities and into regions where other railroads do not operate is a competitive advantage. The incumbents were able to get into the position they have because the government endowed them with the track in the late nineteenth century in order to help stimulate the economy20. Government Relations Government relations are vital to the railroad industry. The government has had a large hand in the industry from the beginning, and through regulation can make or break the profitability of the industry. Railroads must keep close ties with government in order to keep regulatory legislation like the Railroad Competition and Service Improvement Act of 2007 mentioned in the industry overview from passing. Asset Utilization Effective use of assets has large affects on the profitability of a railroad. Railroad companies have become much more profitable in the last decade by eliminating unprofitable routes. Running the most efficient routes is an important business function. Other ways to increase asset utilization are by reducing terminal dwell for trains, improving car utilization and increasing train speed. If a company is to be profitable, they need to manage their assets effectively. Relationships — Employees, Suppliers The existence of unions presents a formidable challenge for railroad companies to deal with. Since worker size has been steadily decreasing over the last half century, unions play a strong role in job security and negotiations for their members. Currently, the industry has 168,000 blue-collar workers involved in 14 major unions. The demands of these unions are unique and the possibility of strikes means the railroad companies need to deal with them effectively in order to avoid labor problems.21 Having efficient locomotives and cars is very important to the industries profitability. Therefore, working closely with these suppliers to ensure innovation for the future is necessary. The importance of this is shown by major relationships with companies like GE, and by the example of TTX Corporation, a supplier that the major railroads own.22

20

Cox, Terry. 2007. Railroad Land Grants. Online. Available from Internet, http://www.coxrail.com/landgrants.htm, accessed May 2008. 21 Hilmola, Olli-Pekka. 2006. Deregulation of Railroads and Future Development Scenarios in EuropeLiterature Analysis of Privatization Processes Taken Place in US, UK, and Sweden. Lappeenranta, Finland: Lappeenranta University of Technology. Online. Available from Internet, 22 Unknown Author. Online. Available from Internet, http://www.ttx.com, accessed May 2008.

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2.7 Competitive Analysis
Competitors Union Pacific competes with all other Class I Freight Railroads. While there are seven railways in the Class I sector, we have chosen to focus on Union Pacific’s largest and most direct competitors; Burlington Northern, CSX and Norfolk Southern. Exhibit 7: Union Pacific Burlington Northern Santa Fe

Sources: http://www.uprr.com & http://www.bnsf.com

Burlington Northern Santa Fe Burlington Northern Santa Fe (BNSF) acts as Union Pacific’s only fully direct competitor. BNSF and UP operate in both geographically captive and non-captive markets west of The Mississippi. It is neither one nor the other for reasons surrounding intermodal transportation, which will be discussed later. Due to the strong dependence of the market on location, there are many areas west of the Mississippi that only contain UP or BNSF lines and are therefore areas considered to be geographically captive. UP and BNSF have even made some agreements to keep these regions, so that there is little aggressive competition, including an agreement in 1999 to coordinate dispatching operations covering Southern California, the Kansas City area, and the Powder River Basin of Wyoming.23 BNSF operates on 31,910 miles of railroad over 28 states and Canada. Their presence is much stronger in northern states and Canada, while UP is more prevalent in the south and Mexico, making BNSF the dominant Canadian transporter. Their freight includes consumer products, industrial products, coal, and agricultural products. Burlington Northern Santa Fe is Union Pacific’s primary competitor. It is both its largest and most direct competitor. As shown in Exhibit 7, they run very similar routes focused
23

Orshal, Jody. 1999. UP, BNSF Dispatching Agreement. Chemical Week, 161-7:48.

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primarily in the United States west of The Mississippi. The following financials emphasize the similar size and landscape of the companies. Exhibit 8:
Burlington Northern Market Cap: Revenue: Gross Margin: EBITDA: Operating Margins: Net Income: 36.34B 16.42B 30.44% 5.00B 22.36% 1.94B Union Pacific 38.48B 16.70B 37.41% 4.78B 20.62% 1.91B

CSX and Norfolk Southern CSX and Norfolk Southern (NSC) are only partially direct competitors with Union Pacific because they both operate mainly east of the Mississippi River. In this respect, both are classified as indirect competitors. However, within intermodal transportation, CSX and NSC are very present and can provide very similar services as UP. NSC and CSX have the cross-continental ability to transport intermodal goods and compete with UP. NSC is only slightly behind UP in intermodal capacity and could be seen as a threat; however, in May 2007 UP and NSC launched an east bound and west bound service that guarantees to cut time of transport by one day.24 Exhibit 9:

Source: http://www.wikinvest.com

24

Business Wire. ARINC Managed Services Adds Pro-Active Monitoring for Airport Devices On-Site and Off-Site. Online. Available from Internet, http://findarticles.com/p/articles/mi_m0EIN/is_2007_Oct_1/ai_n20526494, accessed June 2008.

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Company Analysis – Union Pacific 3.1 Performance Summary
Union Pacific earns high ratings in both external performance and organizational health making it a successful firm. Their financial performance indicates their success over the peer average. Organizational health is very good with the exception of inherent limitations to the company. This suggests that Union Pacific’s management is making the right decisions and executing on them well. Exhibit 10: Successful External Performance Low High Troubled

Crisis

Complacent

Low High Organizational Health

3.2 External Performance
Market Share Revenues: Union Pacific had the highest revenue of any railroad with revenues in 2007 of $16.28 billion or 30.7% of the industry25. However it has a close competitor in Burlington Northern, which had nearly as high revenue of $15.80 billion. Having the largest market share is an indicator of high external performance for Union Pacific. Analyst and Investor P/E Ratio: Union Pacific was trading at a P/E ratio of 18.40% at the end of FY 2007. This shows investor confidence that Union Pacific is a company with strong financial performance and growth prospects. Financial Performance The chart below shows the 1-year, 3-year, and 10-year compound annual growth rates of revenue, net income, and investor return for Union Pacific, its closest competitors, and the peer group as an average.

25

A.A.R.. 2008. Class I Railroad Statistics. Online. Available from Internet, http://www.aar.org/PubCommon/Documents/AboutTheIndustry/Statistics.pdf, accessed 13 May 2008.

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Exhibit 11: Union Pacific Financial Performance Comparison to Direct Competition 2007
Union Pacific Revenue 1 year CAGR 3 year CAGR 10 year CAGR Net Income 1 year CAGR 3 year CAGR 10 year CAGR Investor Return 1 year CAGR 3 year CAGR 10 year CAGR 4.53% 10.05% 3.93% 15.50% 45.36% 15.69% Peer Group Average 3.78% 6.92% 4.54% 1.19% 34.34% 7.65% Burlington Northern 5.45% 1.13% 6.51% -3.18% 32.23% 7.53% Norfolk Southern 4.85% 7.65% -0.57% -6.40% 43.14% 0.04% CSX 0.27% 8.86% 8.30% -1.15% 16.62% 7.34% 0.30% 11.70% 5.16%

19.33% 12.76% 27.74% 36.51% 22.12% 20.72% 29.95% 26.11% 6.94% 10.39% 5.00% 7.21% Source: Big Charts & Compiled from individual annual reports

The chart clearly shows several positive aspects of Union Pacific’s financial performance: 1. Union Pacific has above average growth compared to its peer group in every category. The consistency of Union Pacific’s growth shows that it has solid financial performance. 2. Union Pacific has seen increased growth rates in recent years. The more recent, the more important. This is a very positive trend, showing that Union Pacific is doing things better than ever. 3. Net Income is growing faster than revenue. This shows that Union Pacific is increasing its profit margins. In fact its profit margins have increased from 3.90% in 1997, to 4.49% in 2004, to 11.39%26 currently. This is a good sign of strong external performance. Union Pacific is a company with high external performance. Union Pacific has the largest share of the North American railroad market by revenue. In addition it has been increasing its revenue and profitability at a rate faster than its competitors. This shows that the company is becoming increasingly higher performing. Investors have recognized this and pushed the stock price up at a rate faster than its peer group average, further enforcing the notion that Union Pacific has strong external performance.

26

Ibid.

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3.3 Organizational Health
Land holdings and Ownership: (+) Union Pacific is the second largest owner of land in the United States of America, second only to the U.S. Government itself. Within its land holdings, the company owns 26,949 miles of track and has rights to use a total of 32,426 miles of track. Union Pacific also owns the right to use every major railroad gateway into Mexico. They extend as far out as the Mississippi River and branch all the way into Canada. Their massive land rights and usage place Union Pacific in an advantageous position over its land-based competitors. Management: (+) The management team at Union Pacific is highly experienced and specialized in the transportation business. For example, the President and CEO of the company, James Young, held various management positions within Union Pacific starting in 1978 and J. Michael Hemmer, who is the Senior VP of Law and General Counsel, joined the company in 2002 after spending two and a half decades as a legal consultant to many of the industry’s companies. The shared vision and strategy of the executive team is a definite strong point of the organization as a whole. Financials: (+) Union Pacific has had steady growth over the past five years and all of the significant ratios have improved. Between 2002 & 2007, the current ratio improved by 6%, showing that the company has increased its liquidable assets, while at the same time decreasing their short term commitments, as shown in the annual reports. This allows for more cushion in the event of reregulation or times of economic hardships. Another notable ratio is the total asset turnover. UP is yielding more dollars per asset at an increasing rate. This is a sign of operational efficiency. One prominent financial feature of the industry is the consistent return on assets. In a highly capital intensive industry, such as Class I Freight Rail, the year over year return on assets is not expected to be high, nor is it expected to shift. The capital value of rails and land is so high that a change in returns is minimal to the ratio.27 Exhibit 12: Key Ratios Current Ratio Total Asset Turnover Return on Assets Market Value, Mar. 2007 2002 0.797 0.381 6% 2007 0.853 0.428 6% $28,212,400,000

27

Union Pacific. Annual Reports 2002 & 2007. Online. Available from Internet, www.up.com/investors/annuals, accessed May 2008.

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Unions: (-) 86% of the 50,000+ employee force of Union Pacific is represented by 14 different rail unions. During contract renegotiations, it is rare for employees to go on strike, but it is a looming liability for the company. Dealing with so many different unions raises costs for the company but is a minor threat to the organization’s health. Organizational limitations: (-) The company is in operation 365 days of the year with few limitations to its success. However, the company, and industry as a whole, is depended on factors such as diesel prices or something as simple as the weather. High diesel prices will tend to run up costs to operate locomotives while bad weather and natural disasters can delay shipment of a good. These two elements are the most important in terms of organizational limitations due to design. Union Pacific has high organizational health due to a combination of strong land and asset holdings, highly specialized and goal oriented management, and improved key financial ratios. Although the unions and organizational limitations could hinder the overall health of the company, they have been calculated into the company’s business model and are minimal compared to the strengths of the organization.

Strategy Analysis 4.1 Organizational Goals
Union Pacific utilizes its network capacity to provide a transportation rail service. The following are Union Pacific’s organizational goals: Maximize shareholder value As a publicly held company, Union Pacific has the obligation to its shareholders to maximize value. All other organizational goals are directly related to this premise. Develop positive relations with unions The workforce is involved in activities such as engineering, mechanics, and transportation. As a result, safety and security are at the cornerstone of Union Pacific’s goals. There was an average of two safety or security incidents reported by UP employees for every 200,000 hours worked. Given that employees worked 25.6 million hours in 2007, 128 cases were reported last year alone. As stated before, strong ties with all of the 14 labor unions are integral to successful operations and avoiding any holdups. 28 Thus, it is important to ensure the safety of their workers.
28

Department of Transportation. 2008. Safety Data. Online. Available from Internet, http://safetydata.fra.dot.gov/OfficeofSafety/publicsite/Query/rrchart.aspx, accessed June 2008.

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Maximize customer convenience and efficiency Union Pacific has coupled e-commerce with its business strategy to provide a clear and quick transaction process for its customers. Customers are granted a personal ―myUPRR‖ account, allowing them to order cars over the Internet and track their movement anytime.29 Everything from service area maps to emergency contact lists to news bulletins to billing are provided online for customers whenever they need it. Consequently, the more customers utilize the e-commerce accounts, the more UP is able to manage resourceful data on their customers and suit the growing needs of the online UP customer.30 Continue to build key business relationships Union Pacific is based on reliable relationships guaranteeing business. UP focuses on serving profitable industry supply-chains like chemical and energy to function as strategic links in obtaining long-term legacy contracts. For example, UP and DOW Chemical Company outlined an agreement to reach collective goals that will bind both companies beyond 2020.31 UP’s relationships are founded on bringing long-term opportunities and a diverse service mix to their customers. Union Pacific looks to maximize shareholder value. They position themselves to meet demands of nearer and longer goals. They aim to improve service through funding appropriate capital expenditures and building key relationships.

4.2 Competitive Premise
Union Pacific demonstrates a sustained competitive edge over other Class I Railroads west of the Mississippi by maintaining and updating their assets. They are able to sustain this competitive edge not only through a continuous emphasis on the content to follow, but also through a capability to adjust to market demands. Accessibility—Assets Second only to the United States Government, Union Pacific is the largest land holder in the United States.32 UP links every major West Coast and Gulf Coast port to some of the
29

Unknown Author. 2006. Union Pacific uses online order system of refrigerated cars for Idaho shippers. U.S. Rail News, 27 September. 30 Toy, Boy. 2001. E-Business from the Front Line of a 140-Year-Old Brick and Mortar Company, Transportation Journal 40-4: Database used Academic Search Elite. 31 Union Pacific. 2007. Union Pacific Railroad and Dow Chemical Company Announce Goals to Improve Rail Safety and Security. Online. Available from Internet, http://www.uprr.com/newsinfo/releases/safety/2007/0306_updow.shtml, accessed June 2008. 32 ESRI. 2005. GIS and Mapping Software. Online. Available from Internet, http://www.esri.com/news/arcnews/spring05articles/union-pacific.html, accessed June 2008.

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fastest growing population centers west of the Mississippi River.33 UP leverages these land holdings against competitors in two ways. First, they offer more routes than their competitors. Secondly, they can lease out or withhold leasing their rails to their competitors depending on strategic positioning. They operate on 32,000 miles of track and own 27,000 of those miles outright. 34 Technology Investment—Long-term Planning Union Pacific invests in technology for long-term planning. Mainly, they have continued investment in locomotive technology. When the technology moved from steam to diesel, the focus has always been to increase fuel efficiency. From 1980 until present day, UP has helped the fuel efficiency of diesel locomotives to increase by 61%.35 Having moved into an era of environmental health, UP is working with General Electric on technology that could save railroads and average of $425 million each year.36 With savings like this, the current investment is worth the competitive edge it will provide in the future, which is important in a mature industry such as this one. Customer Relationships—Contract Negotiations There are two segments of customers in Union Pacific’s line; captive and non-captive. The captive customers are limited to UP for rail transportation. However, the non-captive customers, located mainly in the Midwest, have an advantage over captive customers because they have the ability to induce competition between Union Pacific and competitors. Customer satisfaction combined with competitive pricing is a selling point for Union Pacific and is essential for the non-captive customer segment.

4.3 Value Chain Analysis
A detailed examination of the value chain for Union Pacific highlights their focus on organizational goals. Union Pacific’s service activities provide the basis for creating economic value and a competitive advantage for itself and customers, respectively. A strong focus on quality and strategically advantageous route structure enables the company to serve customers in critical and fast growing markets. Union Pacific’s rail system is a tangible resource that allows UP to compete with other carriers in the transportation of freight rail. The value chain will describe the economic means by which it can take advantage of opportunities or fend off threats to their success. Aside from their land resources, UP adds more value than their competitors through the following methods:

33 34

Data Monitor. 2007. Company Profile: Union Pacific. Database used Investext Plus. June 2008. Ibid. 35 Unknown Author. Diesel Technology Forum: Railroad—Diesel. Online. Available from Internet, http://www.dieselforum.org/where-is-diesel/railroad, accessed June 2008. 36 General Electric. Hybrid Products. Available from Internet, http://ge.ecomagination.com/site/products/hybr.htm, accessed June 2008.

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Exhibit 13:

Primary Activities Inbound Logistics Union Pacific’s core business is freight rail transportation. It also acts as a key link in the intermodal process for many companies. UP adapts a flexible capacity model in its railroad facilities to meet the forecasted demands of their customers. With the increasing cost for their customers, dependability on UP’s inbound logistics is important when analyzing their capability to handle their existing resources. Growing in importance, UP’s intermodal system adds more value to UP and their customers. UP has approximately 25 intermodal park facilities that are designed to improve transfer times and create more services for their customers. These logistic centers are designed to direct their freight rail routes and are in close proximity to major interstate highways. The largest intermodal terminal is the 1,200 acre Global III Terminal located just outside Chicago in Rochelle, Illinois. Global III is strategically located to cater to the demand schedule for intermodal train.37 Facilities such as Global III are technologically equipped to handle the receiving, material handling, and vehicle scheduling regarding rail and waterway transportation. These yards are integral to the health of UP and any disruption to these major gateways affects the entire U.S. rail network. To highlight how reliant UP’s inbound logistics are to the company, in 2005
37

Unknown Author. 2003. UP’s Global III in operation—industry outlook. Online. Available from Internet, http://findarticles.com/p/articles/mi_m1215/is_9_204/ai_108788388, accessed June 2008.

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when Hurricanes Katrina and Rita hit the South, UP utilized its gateways around New Orleans and kept downtime to only two days.38 Operations Union Pacific’s inputs are broken into the three following components: Mechanics, Engineering, and the Transportation. Mechanics involves material operations, testing and reworking of the locomotives. This activity keeps the fleet of 8,000 diesel electric locomotives and 107,000 freight cars in top mechanical condition. Engineering includes the support to the locomotives in case any train malfunctions. UP’s capability to build and maintain tracks, bridges, buildings, and communication systems throughout their system is certainly added value for their customers. For example, a mudslide in UP’s Cascade Mountain corridor wiped out 3,000 feet of track. UP operations activities were able to remove 1 million tons of unsuitable material and save 42-76 hours of customer delay.39 Finally, transportation activity is the process of managing the safe and efficient movement of trains throughout the system. Operations add economic value to customers by improving the existing resources and handling any external issues it may face. Outbound Logistics Union Pacific created a wholly owned subsidiary called Union Pacific Distribution Services (UPDS) to handle their outbound logistics. This logistical arm is responsible for the distribution of services to customers and the collection of payments. UPDS is based out of Nebraska and their activities range from invoice generation to scheduling to inventory handling. UPDS provides door-to-door transportation of products by combining the economies of long-haul rail service with the flexibility of road transportation. Such logistics services are vital to the capabilities of UP. UPDS categorizes their services in three sectors: retail intermodal (auto parts), carload solutions (network solutions and logistics) and carrier services (truck brokerage). These tasks that UPDS performs are saving non-rail customers 30% of their existing transportation costs.40 Outbound logistics such as UPDS deliver customers a value added service to meet the customer requirements.41 Marketing & Sales Union Pacific’s activities to attract customers involve pricing, advertising, marketing channel selection, and promotions. The company is unique in that it focuses shipments not only in the western half of the United States, but into Mexico as well. This gives them the ability to cater to customers who want that ability to import from Mexico. Most

38

Case Study on the Transportation Sector’s Response to and Recovery from Hurricane Katrina and Rita http://onlinepubs.trb.org/onlinepubs/sr/sr290GrenzenbackLukmann.pdf 39 Unknown Author. 2008. Union Pacific Moves Mountain to Restore Train Service. Online. Available from Internet, http://www.businesswire.com/portal/ 20080506006024, accessed on June 2008. 40 Transcentric. 2007. Shipment Vision. Online. Available from Internet, http://www.transentric.com/attachments/newsletter.pdf, accessed from May 2008. 41 Transload Distribution Association. 2008. Relay. Online, Available from Internet, http://www.transload.org/relay/TDARelaySpring08.pdf, accessed from May 2008.

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importantly, UP is able to align their capabilities with their marketing strategies to target the right customers. Also, UP’s ―Building America‖ campaign, implemented in 2002, creates a brand image that is recognized throughout the country. This marketing strategy focuses on the images of railcars traveling through distinctive American backdrops. This makes it clear that UP is a valuable resource for business-to-business transactions and the wealth of the nation.42 The ad campaign combines the nostalgia of a longstanding history in America with the growing technologies designed to save the environment.43 Services The activities providing customer support, including the tasks related to customer help and problems, gives Union Pacific a value added activity for customers. To highlight the company’s ability to maintain relationships, UP designed an online service ―myUPRR‖ with the market research company ―Eleven19‖. The purpose is to compliment the wave of businesses using the internet and up-to-minute tracking of their products and pricing.44 Regardless of the customer size or type, UP recognizes there is more to a customer than a simple contract. My UPRR serves this purpose by giving them constant access to the data they need. Supporting Activities Infrastructure Headquartered in Omaha, Nebraska, Union Pacific has the prime location to serve their customers. The company is centralized in America. Decisions from headquarters are respected across the organization as the fundamental values and expertise. The rail yard facilities are strategically located in the country to enhance performance, productivity, and partnerships (refer to exhibit 7). To ensure shipments arrive as quickly and consistently as possible to customers, inside or outside their existing infrastructure, UP leverages freight that travels on two major railway systems.45 This type of arrangement is called an ―interline routing agreement‖ and is in coordination with the east coast competitors, namely CSX and NSC.46 Union Pacific is actively participating in transportation talks with government agencies in Washington D.C., namely with the Department of Transportation (DOT), Surface
42

Core Brand. 2000. Union Pacific. Online, Available from Internet, http://www.corebrand.com/index2.php?option=com_content&do_pdf=1&id=75, accessed from May 2008. 43 Unknown Author. 2007. Union Pacific Building America Ad Campaign. Online. Available from Internet, http://www.youtube.com/watch?v=ZEPgg4xcEe0&NR=1, accessed June 2008. 44 Eleven19. 2008. Corporate Identity. Online. Available from Internet, http://www.eleven19.com/corporate_identity/myuprr.html, accessed June 2008. 45 Joy, D.S. and Johnson, P.E. 1994. Highway and Interline Transportation Routing Models. Online. Available from Internet, http://www.osti.gov/bridge/purl.cover.jsp?purl=/10152513-1VZXNP/native, accessed June 2008. 46 Union Pacific. 2003. Routing and Blocking Regions (UP-CSX). Online. Available from Internet, http://www.uprr.com/customers/shortline/attachments/up_csx_routing.pdf, accessed June 2008.

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Transportation Board (STB), and Federal Transit Administration (FTA). With an office in Washington D.C., UP’s legal counsel is an active advocate for railroad proceedings and legislation in corporate affairs.47 Human Resources Union Pacific recognizes their employees are the driving force behind their service activities. They want to provide a working environment that is conducive to continuing this trend. Although still mainly labor-intensive, Union Pacific’s training allows for those employees without a college education to perform professional jobs. Union Pacific’s Operations Management Program allows the degree-educated training in their specific engineering, mechanical, and transportation logistics. The company’s aggressive recruitment process grows at a time where they expect 40% of their current workforce to retire within 5 years.48 Due to the capital intensive nature of the business, Union Pacific is constantly developing their employees’ skill sets with technology training and job-specific safety procedures. For example, in a partnership with Bellevue University operating managers are enrolled in interactive online training courses. These courses minimize training costs and improve productivity.49 The company uses incentive and feedback tools to support the active involvement of their employees. Union Pacific believes that their community service involvement, charitable activities, and employee health networks are designed to increase value for new and current employees. Specifically, the Union Pacific Foundation is a national organization designed to support community activities where employees live and work. Procurement UP’s range of procurement activities covers everything from purchasing major equipment inputs to fuel. Union Pacific’s supplier diversity program is the oldest of the nation’s railroads. To support economic growth, UP encourages suppliers and contractors to compete for business relationships. They utilize their e-Procurement and Electronic Data Interchange (EDI) to keep track of the diverse relationships and schedules they have with suppliers. In order to add the most value to the firm, UP makes it a point to test and upgrade the inputs they receive from their commodity and service suppliers. These include, but are not limited to the following: mechanical engineering for trains, fuel pricing, and employee safety.50

47 48

Ibid. Unknown Author. 2008.UP Hiring ―several thousand‖. Railway Age. 209-3. Database used Business Source Elite. 49 Myers, Thomas, and Echols, Michael. 2008. Partnership in Educating Black Belts. Online. Available from Internet. http://www.isixsigma.com/library/content/c040614a.asp, accessed May 2008. 50 Union Pacific. 2008. Our Mission. Online. Available from Internet, http://www.uprr.com/suppliers/sup_ovr/stov01.shtml, accessed April 2008.

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Knowledge Development/Technology To produce the service needed to maintain Union Pacific’s goals and demands, UP aims at various product and process improvements. The company improves track routes, freight yard facilities and rail equipment to provide a more efficient and safer environment. The annual replacement of locomotives and freight cars cost them approximately $2.2 billion in 2007. The increase in traffic density highlights the need for capacity expansion and quick information exchange throughout the company. These activities include the replacement of mainframe software systems and funding for rail logistics such as Radio Frequency Identification Tagging System.51 This type of technological processes supports growth, and totaled approximately $45 million in 2007.52 Union Pacific's resources and capabilities, as illustrated through the activities of the value chain, convey their potential to achieve a competitive advantage in terms of pricing, providing dependable service, and accessing information at all times during the process. Not only is UP able to cover the cost of capital, but also is able to sustain customers for the long haul. The essential function of the business, as outlined by their aforementioned organizational goals, reflects their pursuit to serve every customer to create the best value added service possible.

4.4 Sustainability Analysis
Union Pacific faces several challenges to sustaining its successful performance. The five threats to sustainability, that any firm faces, are imitation, saturation, substitution, holdup, and slack. This section analyzes the possible threats, and then shows what Union Pacific is doing about them. The threats that are not being properly addressed are the challenges that Union Pacific faces in order to remain a successful company. Possible Threats Imitation Imitation is not a threat to sustainability. As mentioned in five forces analysis, the cost of land and track make the barriers to entry in this industry insurmountable. This removes the threat of imitation.

51

Butler, Randy. 2007. Freight Information Highway and Cargo Visibility Prototype. Online. Available from Internet, http://ops.fhwa.dot.gov/freight/freight_news/info_highway/freight_info.htm, accessed April 2008. 52 Union Pacific. 2008. Fact Book. Online Available from Internet, http://www.up.com/investors/attachments/factbooks/2007/factbook.pdf, accessed June 2008.

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Saturation Saturation is not a threat to sustainability. As the economy grows, so does the demand for freight transportation. If the economy continues to grow at a modest 3%, by 2020 there will be an estimated 55% increase in the freight rail tonnage53. Substitution Trucking has the possibility to threaten sustainability. Several substitutes exist including trucking, pipelines, barges, and aircraft. Of these, trucking is the biggest threat. Trucking can perform all the services that railroads do and are more versatile in its routes (refer to substitutes in the five forces analysis). Holdup There are two possible threats to sustainability due to holdup. They are unions and the government. 86% of Union Pacific’s workers are members of 14 major unions. Unions have forced Union Pacific to agree to wage increases of 4% in 2008 and 4.5% in 200954. Besides increasing labor costs, unions are expensive to bargain with and create the possibility of strikes (refer to organizational health). The government threatens to hold up Union Pacific by imposing regulations on the routes it runs and prices it charges. The ―Railroad Competition and Service Improvement Act of 2007‖ mentioned in the industry overview would effectively do this55. This is a major threat to Union Pacific because such regulation could take the industry back to its pre1980 state where Union Pacific was nearly bankrupt. Slack Slack could be a threat to Union Pacific’s sustainability. Union Pacific’s capacity has fallen behind the demand, and is not building to meet the future demand. Union Pacific’s Response Substitution Union Pacific has responded to the threat of trucking and we do not see it as being a threat to Union Pacific’s sustainability as a successful firm. The first thing that Union Pacific has done is work to increase its efficiency in order to increase its price advantage over trucking (refer to competitive premise under asset utilization). Another major step that Union Pacific has taken to help with the threat of trucking is to change it from a substitute to a compliment. Union Pacific has increased the amount of intermodal transportation (refer to emerging trends).

53 54

Simpson, Tom. Data gathered from Union Pacific annual report 55 110th US Congress. 2008. Railroad Competition and Service Improvement Act of 2007. Online, Available from Internet, http://www.govtrack.us/congress/bill.xpd?bill=h110-2125, accessed June 2008.

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Holdup Union Pacific has dealt with unions well, making them not a threat to the sustainability of their successful performance. While the unions increase labor costs, it is strikes that are the larger threat, and there has not been a strike in the recent past. Holdup from government regulation remains a threat to Union Pacific’s sustainability as a successful firm. Union Pacific spends millions of dollars every year lobbying the federal government against regulation, $9.7 million in 200756. While these efforts have killed past regulation bills57, new efforts continue to be brought to congress. Slack Union Pacific has not dealt with the problem of falling behind demand, so this remains a threat to their sustainability as a successful firm. Capital expenditures to create new track are so high that expanding is not profitable.

4.5 Challenges
The sustainability analysis shows that the challenges Union Pacific faces are holdup from the government and slack in the form of falling behind demand. Holdup from government is an ongoing challenge because customers who have a lot at stake will continue to lobby the government for regulation. Even when one bill is killed, Union Pacific is not safe because a new one will undoubtedly be brought forward. These bills will find continued support from politicians, because railroads have the ability to act monopolistically in certain regions (refer to buyer power in the five forces analysis), and because freight rail is a vital part of our nation’s economy. There is an argument that regulation is the answer to stopping monopolistic behavior and can ensure that this vital part of our infrastructure continues to operate efficiently. Slack in the form of falling behind demand does not make sense economically. If the demand is there, Union Pacific should be able to invest in the track and charge a price that will create an acceptable return on investment. All else is not constant however, the third factor of government regulation is effecting Union Pacific’s decisions about increasing their capacity. If Union Pacific were to create new routes, they could not charge high enough prices without being seen as taking advantage of their customer. The challenge here is being able to grow to meet demand in a profitable way without increasing the threat of government regulation.58

56

Associated Press. 2008. Union Pacific spent $2.4 million lobbying in 1Q. Online. Available from Internet, http://www.cnbc.com/id/24776682/for/cnbc, accessed June 2008. 57 110th US Congress 58 Union Pacific. 2007. Letter to the STB Regarding Peak Season. Online. Available from Internet, http://www.uprr.com/newsinfo/srps/letter_091407.shtml, accessed June 2008.

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