EMPLOYEE BENEFITS

The Continuously Improving CEO

How the CEO of a short-line railroad company responded to the challenges which accompany rapid growth.
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RailTex Service Co. was at a crossroads; the right decision, and the right leadership, would mean astonishing growth. Could founder Bruce Flohr keep learning on the job? Or, as happens to so many entrepreneurs, had his company already left him behind?

For Bruce Flohr, the moment of doubt came in 1989. His 12-year-old RailTex Service Co. stood on the brink of a growth phase so spectacular that it would alter the very nature of the business. And he had to wonder, as most company builders eventually do: Can I take my business to the next stage, or is it leaving me behind?

At the time, RailTex occupied a comfortable niche in the railroad industry. It bought open-top freight cars and leased them to quarry operators to haul rock, sand, and gravel for construction sites. By 1989 it had fielded a fleet of 630 railcars worth $11 million. Flohr had a profitable enterprise doing roughly $8 million a year.

But a second division of RailTex was gaining speed. The division operated short-line railroads, also known as "feeder" lines. RailTex had stepped into the world of short lines in 1984, but by 1989 it owned or leased nine of them around the country. They were doing well. As a group, in fact, they were outearning the railcar-leasing business. And that was the rub.

"We were getting lots of pressure from our leasing people to buy more railcars," Flohr recalls. "But we also wanted to buy more railroads. So we had two factions within the company, both making demands for limited capital. The question was, Do we keep growing the two divisions with high capital demands on both sides, or do we phase one out?"

What clinched the decision for Flohr and his team at RailTex's San Antonio headquarters was a fast-moving revolution in the short-line arena. Fundamental changes in railroad law in 1980 allowed the big railroads -- the class ones -- to slim down to a core system. Over the years, they had built hundreds of feeder lines to pull in freight from off-track factories and farms. By and large, however, the feeders were marginal or losing operations; they required too much management effort for too little payoff. To maximize profitability, the class ones were selling those branches to companies like RailTex, which could provide better local service at substantially lower cost than the big railroads could.

By 1989 it was clear that approach was a good deal for the class ones and the small operators alike. Now the floodgates were swinging open. CSX Transportation was fast shedding its short lines. Union Pacific and Southern Pacific were starting to unload their extensive feeder networks. Conrail, Burlington Northern, and others would follow. There were some 500 feeder lines in the United States, and Flohr foresaw hundreds of them coming onto the market.

He wanted a bigger piece of what he already knew was a lucrative business, and he believed RailTex was well positioned to take it. His nine short lines were growing robustly, and that track record was as important to the class ones with railroads to sell as the price a bidder offered. "RailTex's operators are very effective marketers," says Warren Wilson, senior manager of rail-line planning for Union Pacific, which had sold the first of five branch lines to RailTex in 1989. "We spin these lines off, but we certainly want to continue handling the traffic that comes off them. The whole theory is that the local short-line operator can grow the traffic and thereby provide more business for the main-line carrier. And overall, RailTex does a very good job of building traffic."

Wilson also liked the "go team" Flohr had created. Whenever RailTex launches a railroad, it assembles top people from throughout its system to get the new line up and running. They operate it for several weeks while the permanent crew is being hired and trained. "Other people have tried this, but RailTex is unique in having a formal go team, and they've done it so often they have it down to a science," Wilson says. "That makes for quick start-ups."

Executives at CSX, which had sold three short lines to RailTex in 1987, were equally impressed with the go team. "RailTex has always persuaded existing customers to stick with rail, and it's been proactive in building more business," says John Meeks, CSX's manager of feeder-line development.

With RailTex earning such a good name in the tight-knit railroad community, Flohr was confident he could land "more than our fair share" of the new acquisitions. Thus, he decided to sell all his railcars and bet his entire company on the short-line business. "It was like throwing out the baby with the bathwater, because we took our original line of business and dumped the whole thing," he recalls.

With the proceeds of the 1989 sale of the railcars to Chrysler Corp., Flohr paid down some debt and kept $7 million as seed capital for his next round of acquisitions, which came fast and furious. In 1990, for instance, he added 5 more feeder lines to his stable, for a total of 14. In 1991 he bought 2 others, and last year he purchased 4 more, including a 70-mile route in Ontario, acquired from Canadian National, the first privatization of any track in Canada.

RailTex revenues, meanwhile, surged from $16.5 million in 1989 to $38 million in 1992. With more than 1,700 miles of track and some 100 locomotives, assets were approaching $80 million. The company was becoming something of a short-line juggernaut.

As that boom got under way, Flohr kept recalling a chilling discussion at a Stanford University executive course about the stages of corporate evolution. All the evidence, it seemed, pointed to the existence of some natural limit to the usefulness of entrepreneurial leadership. A founder could take a company just so far up the growth curve; only professional managers, went the theory, could push it to the top.

"That really stuck in my mind," he says. "Growing so rapidly forced me to look inward, to see if I was the right person to remain as leader of the company. And if I wasn't, I wanted to be the first to recognize it and be willing to step aside." Still in his early fifties, Flohr decided he would hang on to the controls. And so with RailTex entering a steeper and entirely new phase of growth, he resolved to do everything he could to keep his creation from outgrowing him.

* * *

By 1989 Flohr was no stranger to big organizations. He had done a stint as an army officer with the Corps of Engineers in Alaska, and he'd cut his teeth on railroads at Southern Pacific, a giant conglomerate. As a management trainee, he started in 1965 as a train-crew brakeman. One of his first jobs was working in the Los Angeles rail yards, trying to keep people from derailing trains during the Watts riots. By 1971 he was superintendent of Southern Pacific's San Antonio division, a post he held until 1975.

In 1977 he raised $500,000 and launched RailTex. His own stake, $50,000, gave him 50% of the equity, with the rest held by venture capitalists and private investors.

The railcar-leasing business was tough. By 1982 RailTex's revenues had reached $2 million, but because of high interest costs, Flohr's equipment-heavy business still wasn't profitable. That same year a recession hammered the construction sector, which in turn depressed the rock-hauling business and with it the railcar-leasing trade.

But adversity turned out to be a break for Flohr and his 10 employees. Most of them had years of railroad experience, and to ride out the downturn they began doing consulting work for feeder lines. "This was a real eye-opener for us," Flohr says. "We'd always assumed that these little railroads were pretty well run, and they weren't. We realized that we could run them a lot better ourselves."

It was a serendipitous insight, and in 1984 it inspired Flohr to bid on a contract to operate the San Diego & Imperial Valley Railroad, a former Southern Pacific line owned by San Diego's transit board. With 145 miles of track, it ran from San Diego down to Tijuana and across the Baja peninsula, and back up into Arizona and a junction with Southern Pacific.

The existing operator, part of another short-line holding company called Kyle Railways Inc., wanted out of its contract -- the line was unprofitable. According to a consulting report by a Big Six accounting firm, in fact, it would always be a loser.

Flohr dismissed the report -- "I didn't think the consultants understood the industry," he says -- and pressed ahead with the deal. He liked that it required little up-front cash. He didn't have to buy the real estate -- the 100-foot-wide corridor though which railroads usually run.

"All we had to do was come up with a locomotive, and we were covered," he recalls. A new locomotive would cost $1 million or more, but remanufactured 1950s-vintage diesels sold for anywhere from $80,000 to $180,000.

The use of refurbished engines was only one reason Flohr's San Diego railroad made money from the time he took it over. Union issues were another. Kyle's San Diego operation, like about half of all short lines, was unionized. RailTex was and remains a nonunion company. Labor-cost savings are significant. (Unionized trains, for example, run with a crew of three or four people paid about $23 an hour. RailTex engines operate with two people paid roughly $9 to $12 an hour, plus benefits and quarterly profit-sharing bonuses that now average $5,000 a year.)

Moreover, RailTex is free of restrictive union work rules. Under those rules, unchanged for decades, members of various unions -- signalmen, electricians, mechanics -- stick rigidly to their own trades. "It is absolutely unheard of on a class one for the engineer to do anything but drive the train," says Robert G. Lewis, publishing director of Railway Age, a major trade journal. "On some of these new short lines, the train crews can go out and paint stations or work on the track. That's all to the benefit of people like Bruce Flohr."

Flohr wanted all his line workers cross-trained, even to the point of making sales calls. But to get the San Diego railroad operation going, he hired three full-time marketing people. He wanted them to generate business not only from shippers along the line but from those 5 to 10 miles off the track. Trucks could bridge the gap.

That kind of marketing was something many cash-strapped short lines couldn't afford to do, and it paid off handsomely. On the San Diego line traffic increased from 1,600 railcars a year when RailTex took control to 6,000 annually three years later. It hauled everything from lumber and lard to cement and plastics. The success was repeated on Flohr's second line, the Austin & Northwestern Railroad. In 1986, when it went operational, it handled 2,700 cars. Three years later it was moving 9,000 of them.

Flohr's emphasis on marketing is such that RailTex has one salesperson for every 4.3 switch-crew members, possibly the industry's highest ratio. Through the first half of 1992 traffic grew 12% on lines RailTex had operated for more than a year.

Much of that success is based on selectiveness. For RailTex, not just any feeder line will do. Flohr likes to buy railroads with annual revenues of $1 million to $10 million. The bigger the railroad, he feels, the stronger the tendency for workers to specialize. He also strives for geographic diversity, so a regional recession can't hurt the whole company; RailTex properties are scattered from coast to coast and from Canada to New Orleans. Freight diversity, too, is important. Flohr makes sure no more than 20% of the company's total revenues derive from one commodity, be it gravel or grain. That adds another economic hedge. To hunt for acquisitions, 4 of the 30 people at the San Antonio headquarters work full-time on finding and analyzing candidates. Again, that sets RailTex apart. "Most short lines can't afford to do that," says Tom Heckard, a Washington State representative of the Regional Railroads of America. "In a lot of instances, the president of the company could also be the guy driving the train. They operate on the margin. Bruce Flohr has built his company to where he can afford a full-blown acquisitions staff and can purchase lines that are going to be profitable from the get-go."

RailTex lines are designed to be almost like autonomous companies. They are separately incorporated entities rather like franchises. The general managers have total authority in everything from hiring and firing to setting prices with shippers and the connecting class-one lines. Flohr wants his field managers to be entrepreneurs, with bottom-line responsibility and profit-based compensation.

"We're building the company with an eye to acquiring a lot more small railroads, and we feel the only way we can manage it is to have this decentralized structure," he says. "Decisions are best made at the local level, where all the information is available." Headquarters' role is to set the policies upon which local decisions can be based.

So far the approach has worked. Last October Railway Age named RailTex the Short-Line Railroad of the Year.

* * *

Throughout the high-growth period of 1990 to 1992, however, Flohr was wrestling with his evolving role. Change was everywhere -- even the cramped start-up quarters were giving way to roomier digs. Money was no longer a big worry. Profits were strong, the company's private stock placements were oversubscribed, and Flohr was drawing on $40 million in bank credit to finance acquisitions. With venture capitalists as investors, a public stock offering was on the horizon.

With solid, seasoned managerial talent in all key positions, RailTex could pretty much run without him. Big internal decisions -- locomotive purchases, for instance -- were routinely delegated to others. While remaining steeped in the acquisition process, Flohr was now untethered from routine business chores.

Outwardly, Flohr himself was unchanged. He was still calm, modest, friendly, and straightforward -- a gentleman, if you will. Impeccably groomed, well-dressed, bright, and articulate, he was a superb figurehead for his company. But inwardly, he saw his new role as policymaker and "visionary." By staying professionally ahead of the company as it grew and challenging it, he thought he could make it stronger and better. In the process, he would grow along with it.

There was nothing fuzzy about Flohr's new mission. The first thing he wanted was a reality check for RailTex, some kind of benchmark. "My thought was, OK, we're heavily into this short-line business and positioned to do a lot more growth through acquisitions. How do we manage it?"

For that matter, how had others answered that question? If he could find some "gurus" who'd traveled the path RailTex was on, it might save him time, money, and headaches.

The short-line world was of no help -- RailTex was already the pacesetter. Bob Lende, Flohr's financial vice-president, suggested another model: Luby's Cafeterias. It sounded off-the-wall -- learn from a restaurant chain? Sure, Lende said, parallels abounded. Luby's has independent managers, incentive-based compensation, and a team concept. Its senior executives are at a remote location.

In that light, Flohr saw the sense. San Antoniobased Luby's already had more than 100 big cafeterias and was adding more than one a month. With explosive growth, it had covered some ground Flohr expected to cover shortly. He invited a couple of its top officials to lunch. "They really enjoyed talking about how they had handled their growth," Flohr says. "They were proud of it. It turned out they had gone to school on American Airlines to see how American had handled its growth."

As they traded notes, Flohr zeroed in on a problem RailTex and Luby's had in common. As the Luby's empire spread, policies from headquarters seemed to be getting less attention out in the individual cafeterias. They had good stores that weren't living up to their potential. The solution Luby's came up with? Install a layer of regional managers to strengthen communication and oversight.

Flohr had a similar situation. With RailTex lines proliferating, he couldn't devote time to them the way he did when there were only a few. And it was showing. "We started seeing lots of little things going wrong," he says. "I really resisted the idea of anything that might infringe on the autonomy of my field managers. But the Luby's story was so persuasive I decided that a regional manager who could focus full-time on our railroads' performance was worth trying."

The logical candidate was Harland M. "Mac" Irvin III. Like Flohr, he was a Stanford graduate who had worked for Southern Pacific. He'd joined RailTex in 1985, after earning an M.B.A. at the University of Texas. Still in his early thirties, he had already held general-manager posts at four RailTex railroads. As a member of the go team, he'd been involved in launching a number of RailTex lines. Keenly knowledgeable about the field, Irvin was a good choice for the job.

After his experience with Luby's, Flohr looked locally for other outside help. He found counsel in the unlikeliest places -- a grocery-store chain and a magazine distributorship. The industry didn't matter so long as there was common ground. Based on ideas gleaned from H. E. Butt supermarkets and Brian Weiner's Periodical Management Group, Flohr implemented changes in everything from hiring and promotions to performance evaluations and compensation.

But if there were major veins of management wisdom to be mined anywhere, Flohr reckoned, they would be at those executive programs run by business schools. He was big on education -- he wanted everyone in RailTex to take at least a week of schooling every year, at company expense. And who better than he to set the example?

In February 1990 he enrolled in the Owner/President Management (OPM) Program at Harvard's Graduate School of Business Administration. The program ran for three consecutive weeks a year in each of three years, at $10,400 per annum. But Flohr calls it "the best thing I ever did, a bargain at twice the price."

It wasn't that he felt inadequate in any specific management skill. Flohr liked the OPM program because it embraced a passel of subjects -- finance, marketing, leadership, human relations, even the matter of "satisfying the owner's goals."

It was part of his new "visionary" role, a way to hear fresh thinking from Harvard professors, bounce ideas off fellow executives, and argue issues with people he respected, all the while insulated from the daily grind. "My people had my phone number," he says, "but nobody ever called."

It was no country club. One of Flohr's classmates, Jay McCabe, president of a Boston-based logistics management firm, INTRAL Corp., calls it "an emotional boot camp, an Outward Bound for middle-aged businesspeople." Flohr lived in what amounted to a monk's cell in a dorm. The work was rigorous and demanding, not only because of what the profs expected but also because of what his colleagues and case-study groups expected of him, too.

Flohr evidently pulled his weight. "I was impressed with Bruce right from the word go," says classmate Derek Oland, president of Moosehead Breweries Ltd., in Nova Scotia. "He was a pretty complete guy when he arrived there. I think he grew during the thing -- we all did -- but certainly he didn't need it as much as some of us."

Jay McCabe seconds that. "Knowing Bruce, I imagine OPM helped him develop new ideas. But more than that, it probably validated some concepts he already had."

It was exactly the idea of reinforcing his convictions that Flohr found most valuable about his Harvard experience. "We were doing some things at RailTex that I wasn't totally confident were the right ways to go," he says. "For one, we were trying to empower the local manager in the field to be his own boss. I believe people perform better when they feel they are the players, not the pawns. That hit home in some classes where we'd study a company going through organizational problems. They addressed the issue of centralized versus decentralized management. And generally, the ones that seemed to work best were decentralized. So it gave me another way to argue my case if anyone challenged our management style."

The faculty, Flohr says, was sharp, experienced, and thought provoking. But the "unpaid faculty," the 120 students in his class, was just as key. The lectures, study groups, and living quarters were all designed to give students a chance to get to know everyone else. "After three years," he says, "you knew everybody's story. At the end you got a certificate of graduation. But what you really got was a network, a group of people you trusted whom you could tap for help."

Flohr doesn't hesitate to use that network. A case in point: RailTex already has the railroad in Ontario, and it's trying to buy one in Nova Scotia from Canadian National. Railroad privatization is a new and emotional issue in Canada; the deal hinges on approval from the provincial and national governments. Aware of the controversy, Flohr called on Derek Oland at Moosehead for guidance. Using his contacts, Oland lined up consultants willing to go to bat for Flohr. "Bruce still has a tough row to hoe because the provincial government is leery about doing this," Oland says. "But at least he now knows who the players are."

Eagerness to help one's classmates is a hallmark of grads of OPM, says McCabe, who likens it to a fraternity. "I'd hate to call it a mystical experience, but there's a lot of emotion."

Perhaps it was that emotional lift that energized Flohr to keep challenging his team. Perhaps not. In any case, the status quo would never do. "We had to keep moving," he says.

Reflecting his lack of complacency, last year Flohr pulled Mac Irvin from his regional-manager post and gave him a new charter: question every single thing RailTex is doing. "We did things one way when we were a little company," Flohr says. "Now that we're much larger, there have to be better ways."

Irvin still works with Luby's and the H. E. Butt supermarket chain, comparing RailTex's operations with those larger fast-growing companies'. He works with other railroads when called on. He analyzes the issue at hand and writes a report, acting almost like an extension of Flohr, who has the final say.

An example: Along its railroad rights-of-way, RailTex leases space for billboards and easements for utility lines, bringing in some $500,000 a year. A consultant had been managing that work on commission. Irvin recommended bringing the job in-house and backed up his conclusion with solid analysis. Flohr agreed with him. The net savings for RailTex? An immediate $50,000 a year.

Irvin has a long list of missions ahead of him, and it keeps growing. He'll be looking at everything from improving the way bonuses are allocated for general managers to saving money by consolidating diesel-fuel purchases. "Mac knows as much or more about these issues as anyone else in the company," Flohr says. "He'll be hitting them off one at a time."

* * *

Nothing Flohr has done as corporate visionary is of mind-bending dimension. But together the moves have given RailTex a firmer foundation for growth and kept it rolling on.

Now his role is evolving yet again. He's preparing for the time when revenues reach $50 million and assets hit $100 million. At that point he plans to take RailTex public in what he hopes will be a $30-million initial public offering. When that day comes, probably early in 1994, he'll be ready. Of late, he has carved out 10% of his time to study other companies' IPO road shows -- he's learning what he'll need to know to create his own presentation.

Flohr and RailTex appear to be one of those rare cases in which the founder does indeed grow in tandem with a booming company. Which returns us to the old question: Is there a natural limit to an entrepreneur's effectiveness? If there's one for Bruce Flohr, he hasn't reached it yet.

Last updated: Feb 1, 1993




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