Throughout this century, railroads have been a primary mode of transportation for many products, especially for such bulk commodities as coal and grain. Yet, by the 1970s American freight railroads were in a serious financial decline. The Congress responded by passing landmark legislation in 1976 and 1980 that reduced rail regulation and encouraged a greater reliance on competition to set rates. Railroads also continued a series of combinations to reduce costs, increase efficiencies, and improve their financial health. In 1995, the Congress abolished the Interstate Commerce Commission (ICC)—the federal agency responsible for overseeing rates, competition, and service in the rail industry—and replaced it with the Surface Transportation Board (the Board). Rail shippers and others have expressed concern about the lack of competition in the railroad industry, the extent to which railroads are using their market power to set rates, and the quality of service provided, especially for those shippers with fewer alternatives to rail transportation to move their goods to market. They have also questioned whether the Board is adequately protecting shippers against unreasonable rates and service. By the 1970s, America’s railroads were in serious financial trouble. In a 1978 report to the Congress, the U.S. Department of Transportation (DOT) indicated that in 1976, 11 of 36 Class I railroads studied were earning negative rates of return on investment, and at least 3 railroads were in reorganization under the bankruptcy laws. Some of the railroads’ problems were due to federal regulation of rates that reduced management control and the flexibility railroads needed to react to changing market conditions. Prior to 1976, almost all rail rates were subject to ICC oversight to ensure they were reasonable. The Congress sought to improve the financial health of the rail industry by reducing railroad rate regulation and encouraging a greater reliance on competition to set reasonable rail rates. The Congress did so by passing two landmark pieces of legislation—the Railroad Revitalization and Regulatory Reform Act of 1976 (4R Act) and the Staggers Rail Act of 1980. The 4R Act limited the ICC’s authority to regulate rates to those instances where there was an absence of effective competition—that is, where a railroad is “market dominant.” Furthermore, the Staggers Rail Act made it federal policy to rely, where possible, on competition and the demand for rail services (called differential pricing) to establish reasonable rates. Among other things, this act also allowed railroads to market their services more effectively by negotiating transportation contracts (generally offering reduced rates in return for guaranteed volumes) containing confidential terms and conditions; limited collective rate setting to those railroads actually involved in a joint movement of goods; and permitted railroads to change their rates without challenge in accordance with a rail cost adjustment factor. Furthermore, both the 4R Act and the Staggers Rail Act required the ICC (now the Board) to exempt certain railroad transportation from economic regulation. The Staggers Rail Act required ICC to exempt railroad transportation from regulation upon finding that the regulation was not necessary to carry out the rail transportation policy and either (1) the transaction was of limited scope or (2) regulation was not needed to protect shippers from an abuse of market power. During the 1980s, railroads used their increased freedoms to improve their financial health and competitiveness. The railroad industry has continued to consolidate in the last 2 decades, a condition that has been occurring since the 19th century. In 1976, there were 30 independent Class I railroad systems (comprised of 63 Class I railroads); by early 1999, there were 9 railroad systems (comprised of 9 Class I railroads) and half of that reduction was due to consolidations. (See fig. 1.1.) The nine remaining Class I railroad systems are the Burlington Northern and Santa Fe Railway Co.; Consolidated Rail Corporation (Conrail); CSX Transportation, Inc.; Grand Trunk Western Railroad, Inc.; Illinois Central Railroad Co.; Kansas City Southern Railway Co.; Norfolk Southern Railroad Co.; Soo Line Railroad Co., and Union Pacific Railroad Co. In 1998, the Board approved the division of Conrail’s assets between CSX Transportation, Inc., and Norfolk Southern Corporation. Conrail is expected to be formally absorbed by CSX Transportation and Norfolk Southern in 1999, leaving a total of eight Class I railroad systems. Railroads consolidated to reduce costs and increase efficiencies, making them more competitive. For example, one of the justifications for the 1995 Burlington Northern-Santa Fe merger was to provide shippers with more efficient and cost-effective “single line” service. Both the Board and the railroads involved expected reduced costs and improved transit times because the railroad on which a shipment originated would no longer have to transfer the shipment to another railroad for routing to its final destination. Cost reductions and increased efficiencies were also expected from, among other things, rerouting of traffic over shorter routes, more efficient use of equipment, and increased traffic densities. Consolidations were also justified as providing competitive benefits—both within the rail industry and between railroads and other transportation modes. For example, the Board in its 1996 approval of the Union Pacific/Southern Pacific merger expected the merger would intensify rail competition in the West between Burlington Northern and Santa Fe Railway and the combined Union Pacific/Southern Pacific. The acquisition of Conrail by Norfolk Southern and CSX Transportation is expected to yield benefits—both by diverting substantial amounts of highway freight traffic to railroads and by introducing new railroad-to-railroad competition in those areas previously served only by Conrail. As Class I railroads consolidated, non-Class I railroads increased their importance in providing service. For example, in 1980, Kansas was served by seven Class I railroads (see fig. 1.2); in 1997, this number was three. Between 1991 and 1996, Class I railroads reduced their mileage operated in the state by about 1,400 miles while non-Class I carriers increased their mileage by about 1,700 miles (175 percent greater than in 1991). (App. I shows how Class I and non-Class I rail mileage changed in Montana, North Dakota, and West Virginia from 1980 to 1997.) In 1995, the Congress passed the ICC Termination Act of 1995, which abolished the ICC. The act transferred many of ICC’s core rail functions and certain nonrail functions to the Board, a decisionally independent adjudicatory agency that is administratively housed in DOT. Among other things, the Board approves market entry and exit of railroads; approves railroad mergers and consolidations; determines the adequacy of a railroad’s revenues on an annual basis; adjudicates complaints concerning rail rates on traffic over which a railroad has market dominance; adjudicates complaints alleging that carriers have failed to provide service upon reasonable request; and exempts railroad transportation from economic regulation under certain circumstances. The ICC Termination Act made several significant changes to railroad regulation. For example, the act eliminated the requirement for railroad tariff filings. However, the act did not alter railroads’ authority to engage in demand-based differential pricing or to negotiate transportation service contracts containing confidential terms and conditions that are beyond the Board’s authority while in effect. Several of the Board’s functions are particularly relevant to this report: the (1) responsibility for determining the adequacy of a railroad’s revenues, (2) jurisdiction over rail rate complaints, and (3) jurisdiction over complaints alleging that carriers have failed to provide service upon reasonable request. First, the Board is required to determine the adequacy of railroad revenues on an annual basis. In addition, the Board is required to make an adequate and continuing effort to assist railroads in attaining adequate revenues—that is, revenues that under honest, economical, and efficient management cover total operating expenses plus a reasonable and economic profit on capital employed in the business. Second, the Board is also responsible for protecting shippers without feasible transportation alternatives from unreasonably high rail rates. Where the Board concludes that a challenged rate is unreasonable, it may order the railroad to pay reparations on past shipments and prescribe maximum rates for future shipments. The Board does not have authority over rail rates for car movements made under contracts or for movements that it has exempted from economic regulation. Only about 18 percent of the tonnage moved in 1997 was subject to rate reasonableness regulation by the Board. The remainder was either moved under contract (70 percent), according to the Association of American Railroads (AAR),or was exempt from economic regulation (12 percent). Furthermore, rates on rail traffic priced below the 180-percent revenue-to-variable cost threshold are not subject to regulation by the Board. According to the Board, over 70 percent of all rail traffic in 1997 was priced below this threshold. Third, the Board has the authority to adjudicate service complaints filed by shippers. The Board’s process for handling formal service complaints, like its rate complaint process, is an administrative litigation process, in which parties to the dispute file pleadings, disclose and receive information from each other, and present evidence. If the Board decides a case in favor of the complainant, it can require the carrier to provide the shipper with monetary compensation or to adopt or stop a practice. Moreover, the Board is authorized to impose “competitive access” remedies, under which shippers can obtain access to an alternative carrier. However, to obtain permanent relief, the complaining shipper must demonstrate that the rail carrier currently providing the service (called the incumbent carrier) has engaged in anticompetitive conduct—that is, the carrier has used its market power to extract unreasonable terms or, because of its monopoly position, has disregarded the shipper’s needs by not providing adequate service. As discussed in chapter 5, the Board also has other procedures for providing temporary relief from service inadequacies without a showing of anticompetitive conduct where the carrier is not providing adequate service. The Board may also address service deficiencies through emergency service orders.