Industry supply chains have constantly had to respond to business needs for overall cost reduction.  This author can recall numerous supply chain executive surveys dating back to the early part of this decade, all pointing to supply chain cost reduction as one of any top three organizational challenges. While the severity of such pressures tended to vary, the extreme being the global of recession that began in 2008-2009, they have since established numerous structural supply chain changes. These changes included transferring more cost risk into lower tiers of the supply or value-chain as well as the shedding of assets.  The consul of CFO’s was to avoid, as much as possible, the ownership of hard assets. A clear byproduct of the implications of shedding assets or outsourcing asset management was who owns overall accountability for risk management.

This relentless pressure to improve return-on-assets has, as this community well knows, led to far different industry supply chain structures.  Shedding of capital-intensive manufacturing related assets led to the resurgence of the contract manufacturing model.  Today’s dominant contract manufacturers hold production plants in multitudes of countries and regions. In semiconductor related manufacturing, the termed fabless model emerged where many semiconductor suppliers shed their super highly expensive capital intensive chip manufacturing plants into today’s smaller concentration of global fabricators such as TSMC. Fabless semiconductor firms’ in-turn, outsourced chip assembly and test to other lower-cost Asian locations.

Similar asset transfer trends occurred in logistics and transportation.  Manufacturers and retailers shed transportation assets to third-party logistics providers (3PL’s), and have since added technology and services augmentation which are the basis of termed fourth-party logistics providers (4PL).  Each of these providers themselves discovered enhanced opportunities for profitability growth by transferring transportation assets to mega-carriers or IT infrastructure to leasing or IT hosting firms. 

Like any game, the unwritten gaming rules seem to be, hold no assets.

In this specific commentary, we want to focus on a current development capturing the attention of general and business media that being the U.S. railroad industry. By its nature, this industry is completely capital-intensive and ROA driven and must further adhere to continual regulatory standards and practices. 

In April of 2011, a Supply Chain Matters commentary focused on how U.S. railroads were attempting to bounce back from years of industry setbacks as well as severe recession across the economy.  A previous decade or so of asset transfer and outsourced maintenance strategies had the bulk of railcars, especially those related to the transport of bulk cargo, under the ownership of leasing, financial services or bulk shippers themselves. In essence, the railroads served as service providers to ship customers’ bulk cargo, utilizing primarily non-owned bulk transport railcars.  In 2009, railroad shipments had declined by a whopping 64 percent, the worst year since 1988. An estimated 28 percent of rail fleets were parked and idle storage on unused track, some stretching as much as 30 miles in places. The crisis of asset management was acute and leasing companies and railroads jointly bore the brunt of that crisis. Another reality was that a large percentage of the bulk transport railcar fleet remained dated and proper maintenance did not appear to be financially viable in times of severe downturn.

That brings us to today and in particular the current manufacturing and energy boom occurring across the United States.  The U.S. economy is rebounding and utilization of bulk transport railcars has now increased significantly to the point of periodic lack of availability. The massive new discoveries of shale oil deposits and the new technologies of fracking have led to today’s oil exploration boom, but with a certain bulk transportation challenge.  The existing north to south oil pipeline networks existing across the United States did not account for current booming sources of crude oil production such as the Bakken region in North Dakota. That region alone is producing what is estimated to be 1 million barrels of crude production per day. In December alone, rail transport accounted for nearly three-fourths of crude production stemming from the Bakken region. With the lack of pipeline infrastructure, and with new options for higher profitability depending upon which refinery or which port ultimately receives such crude, energy companies have now re-discovered rail as the preferred shipment mode.

The rest of this story has occupied general and business media headlines, namely a tragic series of tanker car explosions and fires endangering property and human life.  There have been revelations that Bakkan crude is far more volatile and unstable than allegedly believed. The railroads have been finger-pointing toward tank car owners for holding liability for such accidents. Two major railroads have filed lawsuits against asset maintenance contractors over who is liable for derailments caused by broken axles.  Of further contention is which entity is responsible for proper safety inspections and which is responsible for necessary safety modifications to strengthen railcar axles and to contain a potential tank car explosion from spreading to other cars.  Maintenance contractors claim the railroads are far exceeding weight limits and overlooking the hazardous nature of today’s crude oil shipments. Both are balking at who will pay the overall expense, with the implication being which party is accountable for risk?

This entire situation has resulted in an oil safety deal reached in mid-January when federal regulators were forced to step-in and demand railroads and energy companies agree to forms of voluntary changes to improve the safety of tanker rail cars.  Railroads must now take more proactive steps to avoid derailments, reduce speeds and reroute tanker laden trains around high risk areas such as major cities.  Both parties agreed to come up with recommendations for improved safety of tank car fleets.

One railroad is going a step further. The BNSF railroad is seeking bids for investing in 5000 next-generation tank cars that will meet higher safety and cargo load standards. However, for the current remainder of the rail industry, and perhaps many industry supply chains, is an open question of which party holds ultimate risk when the bulk of assets and asset management services are outsourced. We believe it is a timely and rather important question, one that will occupy the mindshare of CFO’s, insurance providers and industry supply chain leaders in the months to come.

What’s your view?  Does outsourcing of assets and asset management include the outsourcing of risk accountability? Is the current trend sustainable?

Bob Ferrari