1. Why was CN’s performance before privatization so poor?
2. How did privatization contribute to CN’s turnaround? Was it sufficient to launch CN on the road to prosperity? Why not?
3. What role did the NAFTA play in CN’s turnaround strategy? What opportunities did the NAFTA offer CN? What challenges, if any, did CN face because of the NAFTA and its strategy?
4. Do you think CN’s NAFTA success story will continue unabated, as CN’s CEO, Hunter Harrison, claims? Why?

The analysis of the case focuses on answering the Questions for Discussion:

1. The background section shows how CN’s performance was negatively affected by its status as a Crown corporation as well as the restrictive regulatory environment in Canada. The results were that CN had too many employees and too much trackage (i.e. its network was too big). CN’s regulatory environment did not allow it to cut staff and abandon unprofitable rail lines. Existing legislation more or less guaranteed rail employees a job for life, whether their job existed or not. Moreover, employee cuts were not acceptable to CN’s political masters, giving another definition to the concept of shareholder value. In terms of trackage, the fact that legislation forced rail companies such as CN to justify the abandonment of rail lines in terms of the benefits to the public interest made it practically impossible to get rid of unprofitable lines.

This situation caused CN to be unprofitable, owing to its inflated costs. In addition, deficits did not allow CN to invest in new equipment and technology. Government financing was limited to funding deficits. Therefore, rail maintenance was kept to a minimum. This had for effect to make CN’s operations even more inefficient. It also contributed to the unreliability and slowness of CN’s rail transportation service. Combined with the fact that most rail prices were fixed by the National Transportation Agency, CN was increasingly losing customers to trucks and U.S. railroads (for transborder and overseas traffic)—which faced a friendlier regulatory environment after the enactment of the Staggers Rail Act of 1980.

In 1987, the Canadian government passed the National Transportation Act (NTA ’87) with the aim to deregulate the rail industry and, thus, allow it to compete on a more leveled playing field with U.S. railroads as well as trucks. Although the NTA allowed rail prices to be set in large part according to market forces, which led to a rapid decrease, it still made the abandonment of unprofitable rail lines difficult and costly. It also did not do anything to facilitate cuts in employment.

Things only began to change when the Canadian government was no longer willing to fund CN’s financial deficits repeatedly since it was trying to reduce its own fiscal deficit in an effort to cut down public debt. That’s when Paul Tellier was appointed CEO with a mandate to turnaround CN.

In sum, CN’s regulatory burden as well as its status as a Crown corporation led it to have excess costs as well as be unable to fund investments that would improve its productivity and reliability. This situation also made it difficult for CN to attract customers with lower prices and high-quality service (reliability, flexibility, speed, etc.).

2. Using the third and fourth sections of the case, students should be able to answer the second question by arguing that privatization in November 1995 and the accompanying deregulation of the rail industry as a result of the enactment of the Canadian Transportation Act (CTA) in 1996 would eliminate the constraints that CN faced previously as a Crown corporation operating under the NTA ’87. As a result, CN would now be able to shed its excess weight (i.e. redundant employees and unprofitable rail lines). This cost-cutting exercise—combined with a sanitized balance sheet resulting from the Canadian government assuming a large portion of CN’s long-term debt and a change in CN’s corporate culture (i.e. a focus on financial, as opposed to political, shareholder value)—made it easier to tap capital markets for financing much-needed investments in infrastructure upgrades as well as information technology.

In sum, privatization and deregulation set the stage for CN to enter a virtuous cycle (as opposed to the vicious cycle it experienced before November 1995): less costs mean profits, which attract more capital to fund more investments, which lead to greater operating efficiency and effectiveness, thereby generating more profits through more revenues and lower costs.

3. The answers to the third group of questions are to be found in sections five to nine of the case. Clearly, the largest impact of the NAFTA (including the earlier free trade agreement between Canada and the United States) was to increase the demand for transborder traffic in goods, which grew three to seven times faster than east-west inter-provincial trade within Canada. Therefore, CN management had to find a way to take advantage of this rapidly growing demand.

Given CN’s transcontinental rail network in Canada with only a transborder link to Chicago, it was difficult to take advantage of the growth in demand originating from NAFTA trade flows. Two options were available to CN management: M&As and alliances with U.S. railroads; building its own rail lines in the U.S. The latter was not a financially feasible option given the large infrastructure costs involved. Therefore, CN management decided on the first option. This led to the acquisition of Illinois Central (IC) and the marketing alliance with Kansas City Southern (KCS). These two transactions transformed CN into a North American railroad that could take full advantage of the growth in transborder trade associated with the NAFTA. One call to CN by customers was now sufficient to get their goods shipped from Canada to Mexico. In addition, CN’s expansion southward provided it with economies of scale as well as speed since its trains could now travel longer without interruptions for transferring cars or goods to another carrier’s network.

The proposed merger with Burlington Northern Santa Fe (BNSF) was meant to entrench these benefits arising from being a NAFTA railroad since the merged network would span the North American continent from Los Angeles to Halifax and the Gulf of Mexico to Prince Rupert. However, the merger was stopped dead in its tracks by the Surface Transportation Board (STB), the U.S. rail regulator, as a result of competitive and service concerns arising from previous mergers in the industry. Although opinions from competitors, customers, labor unions, and public officials on the BNSF-CN merger and its consequences were mixed, the STB decided to impose a 15-month moratorium on any rail M&As in the U.S. while it reviewed its merger procedures and standards. CN and BNSF challenged the legality and competitive fairness of the moratorium in court but lost their appeal. As a result, they abandoned their merger project because the delay would have turned them into lame ducks until the merger was approved, if so. As always, regulatory uncertainty is costly for business.

This episode with the STB shows again how regulation and government can affect (positively and negatively) companies’ strategy as well as what companies and other stakeholders can do to affect regulatory decisions in return. During the moratorium and the STB’s public consultation process to devise new merger rules, CN was actively involved by submitting written briefs to the STB commenting on proposed rules in order to highlights flaws in the rules as well as raise concerns about rules that would hurt its interests and competitiveness. One example of this is provision § 1180.11, which required additional information for transnational mergers and acquisitions. In this case, CN argued that this provision contravened the NAFTA whereby companies from all three member states must be treated the same way as national companies. No discrimination is allowed, contrary to what provision § 1180.11 called for. To add political weight to its case, CN convinced the Canadian government, through its embassy in Washington, to submit a brief to the STB supporting CN’s arguments. This shows how the NAFTA is important for protecting the interests and maintaining a level playing field for companies operating and investing in another NAFTA country.

Nevertheless, NAFTA remains a limited regional integration arrangement. As CN’s acquisitions subsequent to the failed merger with BNSF show, it has to get approval from regulatory agencies in both Canada and the U.S. for cross-border M&As. If the NAFTA was like the European Union, then there would only be one supranational competition authority to deal with. The same can be said when it comes to safety and security. CN must deal with authorities in both Canada and the U.S., although as the section on border security shows there is a relatively high degree of cooperation between the Canadian and U.S. governments. In the end, the fact that the NAFTA is only a free trade agreement as opposed to an economic union means that CN must be a Canadian business for its Canadian operations while it must be a U.S. business for its U.S. operations. Otherwise, it cannot successfully operate as a true North American company. Only to the extent that different parts of the Canadian and U.S. governments have managed to integrate and standardize their rules and procedures is it possible for CN to operate in an integrated fashion. However, this integration and standardization process is fragmented between various units and levels of the Canadian and U.S. governments. It is not unified like in Europe with its supranational political institutions (Commission, Parliament, and Council).

In sum, it is important to focus on the increase in the demand for cross-border traffic created by the NAFTA, the opportunity that this represented for CN, and the resulting NAFTA strategy (acquisitions and marketing alliance in the U.S.) adopted by CN to take advantage of this opportunity. It is also important to note how CN used the NAFTA to defend its interests in the U.S. and prevent an discrimination against it on the basis of its “nationality” by the STB or other regulatory agencies. Furthermore, one needs to understand that the implementation of CN’s NAFTA strategy is dependent on regulation imposed by both the Canadian and the American governments. Finally, one cannot forget that the absence of political integration and harmonization between the two governments, given that NAFTA is only a free trade agreement and not an economic union like in Europe, requires that CN keep both a Canadian and an American identity in its respect of national regulations, in spite of its integrated North American structure and operations.

4. The final question follows from the case’s conclusion. From the case, we can deduct that CN’s expansion in North America is severely constrained following the STB’s new merger rules that make it more difficult to realize large-scale mergers. Since the new rules were published in 2001, CN has been limited to smaller acquisitions, such as Wisconsin Central (WC), BC Rail and Great Lakes Transportation. There are not many interesting opportunities left for CN to acquire small rail lines to expand its network, unless it decides to expand further south. However, KCS controls TFM, the Mexican railway. So as long as the marketing alliance with KCS remains solid (something that needs to be continually reassessed), CN’s North American strategy and position is not threatened and there is no real need to expand its physical network to Mexico.

So how does CN continue to grow its revenues if expansion possibilities in North America are limited and the growth in NAFTA trade is declining? CN has two options. On the one hand, it can decide to expand internationally and acquire railroads abroad and apply its North American know-how to make them highly efficient and effective. This strategy would mean replicating CN’s North American strategy in other parts of the world. The question then is where? Europe? Latin America? East Asia? In answering these questions, it is important to consider several entry criteria: demand growth, competition, industry consolidation, quality of the infrastructure, government regulation, country risk, etc. The CN has not adopted this option for now. It is indeed trying to sell the few railroads it possesses overseas, which were obtained in the WC acquisition.

On the other hand, CN can maintain its North American focus and aim to increase (organically) its share of the market. This can be done by directing more of the overseas traffic flows onto its network. This means that goods destined to the United States could instead arrive in Vancouver, Prince Rupert, Halifax, or Montreal and then be transported to anywhere in North America via CN’s network rather than arrive in Long Beach or New York and then be transported anywhere in the U.S. via a competitor’s network. It is this second strategy that CN has adopted for now. This is why it has opened offices in China in late 2004. This way, it can direct goods coming from and going to China onto its network. CN is also in the process of setting up a new subsidiary called CN Worldwide, which is based in the Netherlands. CN Worldwide will act as a freight forwarder in order to act as a one-stop shop for transatlantic shippers. If CN Worldwide is successful in Europe, then CN is likely to expand its operations to other parts of the world, most probably East Asia. The ultimate goal with these strategic actions is to feed CN’s North American network and grow its market share.

Finally, CN must remain a leader in using information technology to improve its operating efficiency and effectiveness in order to attract an increasing share of the North American market.