The Business Of

Transportation | Union Pacific | Trains vs Trucks

Morning All!

TGIF! Christmas is so close! But before we get there, we’ve got one final newsletter to round off The Business Of Union Pacific Corporation. Let’s have a quick recap of some of the fun, surprising things we’ve learnt about the railroad industry this week…

• Heyday - Back in the 1880s, before cars, trucks, and planes - railroad stocks were the most popular US stocks! The semiconductors of their day!

• Pay day - Quite extraordinarily, the average employee at Union Pacific receives an annual compensation + benefit package of $151k! Mamma Mia!

• Mayday - There are ~3 train derailments a day in America. Because of this sad statistic, railroads invest billions a year in replacing worn out track and trains.

Okay so for today, we’ve got a couple of topics to get through. One, it’s the great debate on trains vs trucks - which is the better method of transportation? And two, we’re going to prove how pricing power helps margins!

But just before we crack on, I wanted to say a little something…

… Thank You!

The Business Of is going to take a few weeks off over Christmas, and return on Jan 15. But I just wanted to say a HUGE thank you to everyone who’s been reading the newsletter. It’s crazy to think, but TBO started back in Feb 2023 and over the last 10 months, we’ve gone through the business models of 24 companies - see all the amazing logos below! And the number of people subscribed to TBO has grown from 0 to >7,000!

Thanks to everyone for the kind messages and feedback. I’m super glad that the newsletter has helped students and professionals understand businesses and learn more about the world. I’ve had a load of fun writing TBO and I’m looking forward to us going through more business models in 2024!

There’s some cracking companies we’ve looked at here!

And speaking of 2024… I thought it might be nice to see what we’ve got in store! So, to kick off the new year, we’re going to be exploring The Business Of Cars.

We’ll start the series by diving into the world of car dealerships. And we’ll be analysing the largest car dealership company in the world - AutoNation ($6bn market cap). We’ll then look at the first car manufacturer to ever really break the mould and who don’t sell through dealerships - Tesla ($797bn). And we’ll end the series looking at the biggest car wash company in the world - Mister Car Wash ($3bn)!

Next up, we’ll get into a series that I know a lot of readers will be very keen on. It’s The Business Of Eyeballs. And we’ve got some huge names in this series!

To kick us off, we’ll look at the king of digital advertising - the parent of both Google and YouTube - Alphabet ($1.8tn). We’re then going to check out the king of social media - the parent of Facebook, Instagram and WhatsApp - Meta ($910bn). And finally, we’ll end the series looking at another popular company, with lots of potential - Pinterest ($25bn)!

And last but not least, the third series we’ve got planned so far is one I think that will be super relevant for everyone - The Business Of Holidays.

Most of us have searched for holidays on online travel agent sites. And so, to kick off the series, we’ll look at how the largest online travel agent - Expedia ($21bn) - does its thing. We’ll then take a peek at the largest low-cost airline in the world - Ryanair ($24bn). And then finally, we’ll end the series by looking at the second largest golf company in the world - Topgolf Callaway ($3bn). Slightly random, but I love Topgolf… and people go on golf holidays, so I guess there’s a link to holidays aha!

Final thing. If anyone has any suggestions for new series that they’d like to see - or if anyone has any ideas for how we can improve and grow TBO - then we’d love to hear them! Please feel free to message me on Linkedin!

Alrighty, introduction and plan for 2024 over. Let’s crack on!

‘Why’d You Have To Go And Make Things So Complicated’ - Avril Lavigne

Alright let’s crack on with understanding more about why some companies choose to transport their goods via truck vs rail. And the first factor we’ll look at is ease. How easy is it to use truck or rail for a particular journey? Well, in some cases - it’s very easy!

We saw on Tuesday, that Toyota have rail tracks basically inside their San Antonio assembly plant. And we also saw how Union Pacific’s rail tracks are right alongside several coal mines. And so for Toyota and these coal mining companies, using rail seems the most obvious and easiest choice!

But that’s not the case for everyone. Most companies don’t have a rail station (aka rail yard) right next to them! And so for these companies, if they wanted to transport goods via rail, they’d have to first use a truck to take their goods to the rail station. Which is very interesting. Most companies that use rail to transport their goods… also have to use a truck at some point in the journey!

Now, a lot of companies may think - ‘why do I have to organise 2 forms of transport when I can just organise 1? I mean - why make things so complicated?’ And so to make things easier for themselves, a lot of companies actually decide to use only a truck instead of a truck/rail combo!

Now, another factor - which is becoming increasingly important when companies decide between truck vs rail - is the environment. Transporting goods by either truck or train contributes to climate change because trucks and trains release carbon emissions! But one method is actually a lot ‘cleaner’ - and that’s trains!

Railroad companies say that this environmental benefit is one of the main reasons why companies should be switching more of their freight transport away from truck to rail. In this article, Union Pacific say that railroads are on average 3-4x more fuel-efficient than trucks. And it’s not just railroad companies who are saying that! As the screenshot below shows, the environmental department of the German government said that rail freight actually had a 6x better impact than trucks!

Could Driverless Trucks Drive Trains Out Of The Picture?!

Alright, so we’ve seen that ease and the environment are two big considerations when it comes to choosing between truck vs rail. But by far, the biggest consideration for companies when deciding between the two transportation methods is cost. ‘Which method is going to let me transport my goods from point A to point B at the cheapest price!’

The chart below comes from research done by ARK Research - Cathie Wood’s company. And what the chart is telling us is that - if you wanted to transport one ton of product, a distance of one mile via plane, it would cost you $1.36. However, if you wanted to transport one ton of product, a distance of one mile via truck it would cost dramatically less at $0.12. And this reduces even further to just $0.04 if you wanted to use rail! So, advantage rail, right?

Well, yes - the above chart shows a huge advantage in terms of cost for rail. Now, for short distances, this cost advantage may not be that significant. Because remember, companies that use trains, also probably need to use a truck for their first-mile bits (getting goods to the rail station) and last-mile bits (getting goods from rail station to final destination). But for long distance trips (>500 miles), where you’re carrying several hundred tons or product - this $0.08/ton-mile cost advantage for trains starts to add up!

But here’s a question - the biggest costs for trucks is people (the drivers) and fuel (diesel). Is there a way trucks could lower their people and fuel costs - and hence make themselves cheaper than rail?

Well the answer is a big, whopping, yes! Enter - autonomous EV trucks! Autonomous trucks means no need for actual drivers - so no people costs! And EV trucks means the cost of running the trucks will be cheaper too! And this isn’t something that’s in the distant future by the way. Several companies like Einride (Sweden) and Kodiak Robotics (USA) have already released their own self-driving EV trucks!

Now, why is this interesting? Well, because in the ARK research paper we mentioned earlier, their analysts believe that autonomous EV trucks could lower the cost per ton-mile to just $0.03… making them even cheaper than rail!

But hold on - if transporting things by autonomous EV trucks is going to be cheaper than using trains, and better for the environment (EVs have zero direct emissions) - then what’s the need to use trains?! Well, it’s a super interesting point and I don’t have all the answers. I doubt anyone does right now! But for those of us who are interested in learning more - I recommend giving these articles (here and here) a read!

Pricing Growth vs Volume Growth: Which Is Better?

Alrighty, let’s wrap up for 2023! And this final bit is just to make clear the connection between pricing power and margins. To do this, we’re going to go through a couple of scenarios using Union Pacific as an example. And we’ll use very basic numbers!

Okay so, let’s say Union Pacific transport just 10 containers and they do it at the measly price of £10 per container! So, revenue equals £100 (10 x £10). Now, for costs, we’ll use the same ratio as Union Pacific in real life. We've seen this week that the company had an EBIT margin of 40% in 2022. So, we’ll put our costs (fuel + employees + everything else) at £60, which gives us a profit margin of 40%! This will be our base case below.

So now, let’s look at a scenario where we have some volume growth. Union Pacific wins a contract for an additional container and so next year, Union Pacific will increase their volume from 10 to 11 (an increase of 10%). The price however stays the same at £10. So, what does that mean for our revenue? Well it means our revenue is now £110 (11 x £10).

Now, whilst it’s great our revenue’s gone up - will our costs stay the same? No! Because transporting that additional container will require more fuel and perhaps more people. So, let’s say our costs go up by 5% (from £60 to £63). As we can see from the table below, our profit is now £47 (£110 - £63). And our profit margin has risen to 42.7% (47/110). Lovely!

Okay, so that’s the scenario where we have volume growth and some cost growth. Now, let’s look at a second scenario where Union Pacific don’t increase the number of containers they’re transporting. But they increase the price they charge per container from £10 to £11 (an increase of 10%). What does that mean for revenue? Well, it means our revenue again becomes £110 (10 x £11).

But now, here’s the trick. What happens to costs? Will we see an increase of 5% like we did in Scenario 1? Well, the answer is no! Because we’re transporting the same number of containers, we don’t need to spend any more than we did before on fuel, employees, etc. So, our costs stay at £60. And as a result, profit becomes 50 (£110 - £60). Which means that our profit margin has risen to 45.5% (50/110). Nearly 3% higher than the margin in Scenario 1!

So, what’s going on here? How comes a 10% increase in volume brings about a smaller increase in margin than a 10% increase in price? Well, it’s all about the costs! Growing revenue through increased volumes almost always brings with it an increase in costs. But growing revenues through pricing increases, doesn’t often bring an increase in costs. How great is that!

And this should hopefully clear up any doubts you may have had from the chart below - which we saw on Tuesday. Union Pacific transported less volume in 2022 than they did in 2001. But the pricing power the company has, has meant they’ve been able to put prices up every year by around 4%. And this - along with their employee cuts - has led to the incredible margin growth over the last 2 decades!

22nd Dec 2023

Nigel Jacob CFA