Strategy



Strategy development
Developing a commercial strategy for a commercial railway is the responsibility of the executive management team. Strategy development requires an understanding of customers, the competitive environment, and market requirements, combined with detailed knowledge of all railway assets including employees, organizational structures, and physical assets. After a basic diagnostic is completed, the executive management team will assemble and study all the components required to build a strategy—financial analysis, mission, vision, and core values statements, strategic alternatives, market and pricing strategies, opportunities and threats. Then, they can begin to evaluate cost reduction and investment strategies.

The executive management team should guide the strategy development process, taking direction from the board and reporting back to them. The board of directors may have a dedicated strategy and operations committee. The management team manages assumptions, builds scenarios and alternatives for consideration, and then finalizes the overall commercial strategy.

Financial models
For commercially oriented properties, the ultimate ‘scoring’ for strategy evaluation is done in a financial model, although evaluating strategic alternatives is based in part on company mission and vision statements. A realistic financial model is crucial for managing a commercial railway, developing a strategy, building a business plan, supporting discussions with government on investment and subsidy needs, and discussing debt financing options with banks and investors. The financial analysis conducted during the diagnostic phase of strategy development usually provides the basis for the development of a railway-specific financial model. Analyzing financial results from earlier years can help develop the relationships needed to build and refine a financial model for the railway.

The financial model should align with international accounting standards and the railways’ organizational structure. In a commercial railway, each business unit should prepare its own revenue and expense projections, or at least prepare the inputs for the projections. Each cost center or department should prepare expense projections. Financial models are discussed in of this toolkit, including a description of a sample financial model.

Establish framework and baseline assumptions
To begin, most strategy developments define basic outlines for the time frame under consideration—typically five years, but for railways, since assets have a longer lifespan, a 10-year time frame might be needed. The first few years should be modeled in some detail but a lower level of detail can be used for the latter periods of the model. For example, some commercial railways develop monthly financials for the first year of the projection.

Next, a consistent set of baseline assumptions should be established for all departments to use in developing their inputs or portions of financial projections. These baseline assumptions are macro- and micro-economic factors that relate directly to major drivers of railway demand and costs. For example, baseline assumptions for passenger services would include projections for gross domestic product (GDP), population and employment growth, personal income growth, and inflation. For freight traffic, baseline assumptions would include GDP projections, perhaps industrial production projections, and inflation. Energy and labor cost projections might be treated separately, as might other major assumptions such as steel prices, or world prices for major commodities that affect the railway. Typically, business units and departments prepare more detailed assumptions, and the executive management strategy team provides baseline assumptions and oversight. For example, the executive management team may provide assumptions for world steel prices while the infrastructure unit may develop projections for the price of rail and scrap steel they expect to see.

Baseline ridership and tonnage projections are usually based on their relationship to one or more of macro-economic factors. If sufficient historic data are available, regression analysis can reveal past relationships between key macro-economic factors and key railway parameters. For example, passenger numbers usually correlate with worker population; freight tons usually correlate with GDP. Then, these relationships are used to project passengers and freight tons through the forecast period. Typically, passenger revenue is projected using trends in average travel distance and number of passengers to generate passenger-kilometers; and revenue is computed from average revenue per passenger-kilometer. For freight, the tons projection is translated into ton-kilometers using average haul length, allowing for any increases in distance over time. Freight revenue is based on revenue per ton-kilometer by major commodity. Usually, both projections are supplemented with known developments–for example, opening of a new passenger station, or a major shipper locating a new factory for rail shipment.

Baseline assumptions are used to develop company financial projections, assuming no major strategy initiatives and using the baseline projections. Results from financial model analysis provide further inputs to strategies, and may suggest where strategic investments are needed to contribute to the strategy development process.

During the process, it is useful to test how robust each strategy remains if basic assumptions change. What happens if GDP growth rises? What happens if personal incomes fall? Optimistic and pessimistic scenarios are developed to test various strategies, and scenarios can be further elaborated using specific inputs from the business units and departments about external conditions. For example, will an automotive manufacturing plant or several new mines open on schedule? Or will there be major delays?

The strategy development process considers a range of alternatives regarding markets, railway investments, technology initiatives, and human resource measures. Some strategic initiatives might involve changes in capital structure—changes in debt levels, equity injections from government, or alternatives for financing important investments ‘off balance sheet,’ such as customers buying rolling stock. Each strategic initiative undergoes an iterative analysis that is then compared to the baseline projection to establish which initiatives would move the organization closest to its mission and vision statements.

    
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