In Race to the 21st Century, Banks Have a Lesson to Learn from Railroads

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Charles M. Vincent has seen the future of banking in an unlikely place: the Jacksonville, Fla., rail operations center of CSX Corp.

"From one large semicircular room they are able to control everything in their system with all the information they need to do it, including weather forecasts. It was the most incredible thing I've every seen in any industrial company," the equity analyst at PNC Bank Corp.'s investment management unit in Philadelphia.

Mr. Vincent doesn't see bankers laying track anytime soon. But the high-tech approach to railroading "brings to mind the efficiencies possible in the banking industry," he said.

At first glance the two industries appear very different. But Mr. Vincent, who has a dual speciality in banking and railroads, isn't the only one to note intriguing parallels between them.

Both once held virtually complete dominance over their specialties of finance and transportation. Both came under extensive regulation and later were challenged by new competitors.

Both built a reputation for remoteness from their customers that was compounded by inward-looking management.

Both now operate in a deregulated environment highlighted by mergers and acquisitions unimaginable a few years ago. And both are evolving into more efficient and flexible industries in defiance of long and tradition-bound histories.

In fact, one Wall Street analyst declared earlier this year that the railroads are on the verge of no less than a "second olden era."

No one is quite that enthusiastic about the banks, but veteran industry watchers think the best-run institutions can play a large and perhaps even dominant role in delivering financial services in the future.

"The banks and the railroads as we have known them were both largely creatures of the 19th century," Mr. Vincent said.

Both limped into the last quarter of this century burdened by "huge amounts of useless or at least marginally profitable infrastructure - and hamstrung with far too many people."

The low point of rail industry fortunes occurred 25 years ago with the bankruptcy of the Penn Central Transportation Co. and the subsequent creation by the federal goverment of Consolidated Rail Corp., known as Conrail, to pick up the freight-service pieces.

Earlier the government had created the National Railroad Passenger Corp., or Amtrak, to run passenger train service.

The bankruptcy carried an especially black aura because Penn Central was the failed combination of two humbled giants, the Pennsylvania Railroad and the New York Central System.

In its heyday, the Pennsylvania billed itself as "the standard railroad of the world" and boasted the longest history of uninterrupted dividend payments in American business history. The New York Central, creation of the legendary Cornelius Vanderbilt, was its archrival.

Sweeping economic and demographic changes after World War II radically altered the business climate for the nation's railroads.

Once the beneficiary of favorable government policies, particularly in the West, they suddenly faced more flexible competitors who derived huge benefits from modern public works projects.

The massive interstate highway system was an incalculable boon to the trucking industry. Airports, built largely at public expense, allowed airlines to seize the cream of the passenger business.

Bank have endured similar experiences with new competitors and seen their once nearly exclusive turf as purveyors of financial services steadily eroded. In the 1989-1991 period banks suffered such severe problems that many questioned the industry's future.

The banks have rebounded in the past few years and appear to be have more future-oriented management now. Veteran bank watchers, while not discounting the challenges, are optimistic and compare banks and railroads.

"There's no question that competition and new forms of technology are reshaping many parts of the economy," said James J. McDermott, president of Keefe, Bruyette & Woods Inc.

"These forces are compelling the invention, or reinvention, of many different forms of distribution, whether hard goods or financial services. In retailing, for instance, we've moved from Main Street to shopping malls to catalogues to home shopping," he said.

"The heavily regulated industries like banks and railroads have had to face particular challenges, but better and more efficient ways to serve customers are being devised," he said.

"So while banks have lost a share of the financial pie, I think this will stabilize in the not-too-distant future and the share the industry has will be of higher quality," Mr. McDermott noted. "Being in tune with the customer's needs will provide the cutting edge for banks, or railroads, or whoever is providing the service," he said.

The changes in railroads over the past decade have been dramatic, and could be he same for banks, said Mr. Vincent, of PNC.

"The railroads have gone from the 19th century to the 21st century almost without making a stop in the 20th century," he said recently.

"This industry 20 years ago was made up of a large number of companies, aU competing and none cooperating or coordinating movements with each other." he noted.

"It took weeks for freight to get from one part of the country to another and the railroads could never tell you where any particular shipment was at any particular time," he noted. "As a result they couldn't join the business movement to 'just-in-time inventory' procedures because they couldn't guarantee delivery."

"Today the situation has totally changed and the railroads have really grasped technology to do it. Unprofitable lines have been sold or closed, legions of clerks and middle managers are gone, train crews are down from five to two or three, trains speeds are faster, and newer and more reliable locomotives are on the way."

"The achievements of efficiency are a good parallel," agreed Frank J. Barkocy, a banking analyst at Advest Inc. "The banks and the railroads have been dealing with many of the same issues, with unions being the most obvious difference," he pointed out.

"The railroads have pruned themselves back into much leaner operations and the banks must move further in this direction."

Mr. Vincent noted that CSX and the other major railroads can now instantly locate shipments and rapidly provide data to shippers. More importantly they are able to guarantee timely delivery, he said.

Over the past two decades, the rail industry, like banking more recently, has been the scene of many mergers. A handful of railroads are now the dominant force in a once-fragmented industry.

In the Eastern part of the country, CSX, Conrail, and Norfolk Southern Corp. prevail. Further west, Illinois Central Corp., Union Pacific Corp., Santa Fe Pacific Corp., and Burlington Northern Inc. dominate.

Consolidation is continuing, with both Union Pacific and Burlington Northern trying to acquire Santa Fe Pacific.

Many observers think the banking industry is headed toward a similar power arrangement, but with many more banks surviving than railroads.

Consolidation is important to both these industries for many of the same reasons," Mr. Vincent said. "They both have had cumbersome industry structures, and both shipping and financial services are low-margin business where pricing is important and efficiency critical."

And both are indeed becoming more efficient, he said. On average, the operating ratio of American railroads - operating expenses as a percentage of revenues - has declined over the past decade from nearly 90% to around 80% "and it shows every sign of moving down to the upper 70% range."

Similarly, the typical efficiency ratio at major banks, which is operating expenses divided by fully taxable equivalent revenues, has dropped from the mid 60% range to around 60% currently and some even to the upper 50% level, he said.

"In quite a few ways," he remarked, "It appears as if two different kinds of companies are riding the same curve."