Thursday, 6 December 2012

A Shake Up at CP

Canadian Pacific (CP) railroad recently announced substantial job cuts. The plan is for a one quarter cut in its work force by 2016.The job cuts will be achieved through attrition and not filling jobs when people quit or retire. CP has been the subject of much discussion lately with claims that the company is inefficient.

From the CBC:

"The strategic moves are the latest for the railway since a new board of directors installed CEO Hunter Harrison in the summer following a bitter proxy fight with the company's largest shareholder."

CP can be compared with its competitors to see how efficient it is. To calculate technical efficiency I use data envelope analysis (DEA).  DEA is a non-parametric approach to the estimation of production functions. I use three inputs (employees, total assets, total operating costs) and one output (total revenues). Data are averages over the years 2005 - 2011. For those interested in the technical details, I use the 2 stage input approach with variable returns to scale (VRS).

The DEA results are presented in the above table. Total technical efficiency (CRS_TE) can be broken down into pure technical efficiency (VRS_TE) and a scale effect. The total technical efficiency measures indicate that only Canadian National and Union Pacific are efficient since their CRS_TE measure are equal to one. The other companies are inefficient. CP for example, can reduce its inputs by 6% and still produce the same output. Kansas City Southern in even more inefficient because it can reduce its inputs by 10% and produce the same output. In the case of Kansas City Southern, the pure technical efficiency measure of 1 indicates that allocation of inputs to output is efficient and the inefficiencies are coming from the scale effect which measures the size of the company. Four companies have increasing returns to scale (IRS). CP suffers from a technical efficiency effect and a scale effect.  CP needs to get bigger and use its inputs more efficiently. CP's recent announcement on job cuts is a move in the right direction.

CP's share price suffered through 2011, but has recovered nicely since this summer when new management took over.

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