For those who didn't know, the railroad industry is one of Warren Buffett's pet sectors. In Buffet's words: "It's a business that has real economic advantages". Buffet puts his money where his mouth is, and as a result, Berkshire Hathaway Inc. owns one of the country's largest railroad companies – BNSF. The only other railroad company that matches BNSF's size and scale is Union Pacific (NYSE:UNP). Here is a quick look at how Union Pacific stacks up along Porter's five forces – a model built by Harvard Business School professor Michael Porter in 1979 to help businesses assess their industry position.

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Porter's Five Forces
: A graphical representation by author.

Competition in the industry
Railroad companies primarily compete on speed, terminal dwell, and safety. It's not easy to add new routes, and railroad companies tend to mark their territory. As a result, in the Western states, Union Pacific either has a monopoly or a duopoly with BNSF. The duo has the largest route miles and revenue among the seven class 1 railroad companies in North America.

As seen from the below chart Union Pacific is a formidable competitor and has the second highest market share after BNSF. Bloomberg estimates Union Pacific has 29% market share in non-metallic minerals and 25% in coal and chemicals. The company enjoys an edge being the only railroad operator serving all six Mexico gateways, connecting two of the largest Mexican railroads -- Kansas City Southern de Mexico and Ferromex. 

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Company sources. Chart by author.

Potential of new entrants into industry
The railroad industry doesn't allow easy access to newcomers as it's prohibitively expensive to lay tracks, maintain them, and build new routes. According to the Association of American Railroad, the industry spends 17% of its annual revenue on capital expenditures, much higher than the 3% average for other manufacturing industries. Union Pacific spent $4.1 billion in 2014 and expects to spend $4.3 billion in 2015. 

Existing players have huge networks, leaving very little for new entrants. Laws and environmental regulations that govern the railroad industry present an additional barrier for entry, as getting permits and licenses could be cumbersome and time consuming. It's interesting to note that all seven class 1 railroad companies have been operating for around 100 years or more.

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Company sources. 

Power of suppliers
Union Pacific sources locomotives from General Electric and Caterpillar  -- the world's two biggest locomotive suppliers. Since new manufacturers face high entry barriers, the existing suppliers enjoy good bargaining position.

GE leads the pack in North America with 60%-70% market share followed by Cat in the second position. GE could gain more market share and increase its influence as it's ready to launch its new tier 4 diesel locomotives that meet the new emission standards in the second half of 2015, much ahead of Caterpillar's 2017 rollout. 

But suppliers have their own challenges. According to a Bloomberg report, it took time for GE to win orders for its new tier 4 locomotives. It's only when "Union Pacific and other carriers changed plans, faced with volumes causing gridlock on some tracks," that orders picked up.

Power of customers
Railroad companies have medium bargaining power with customers. The reason being, railroads face competition from trucks and other modes of transport.

Railroads prefer a diversified customer base so that if any industry underperforms, other sectors can mitigate the impact. This has been Union Pacific's strategy. It serves six sectors with low correlation among each other -- agriculture, automotive, chemicals (including crude oil), coal, industrial products, and intermodal. Thanks to this wide exposure, in 2014, when automotive, chemical and coal witnessed low single-digit growth, agricultural and industrial products pitched in with 15% growth each. In its most recent quarter, Union Pacific increased its core pricing 3%.

Pdf
Source: 2014 10-K.

Threat of substitute products
Railroads compete with other modes of transport like trucks, ships and barges, and planes. Union Pacific faces competition from motor carriers and waterway operators. Typically, railroads gain an advantage when fuel prices are high as they tend to be nearly four times more fuel efficient than trucks. The situation reverses when fuel prices fall.

But over the years railroad companies have joined hands with trucks and cargo ships to offer intermodal solutions to shippers. Intermodal has become the fastest growing segment in North American freight transport with nearly 25 million containers and trailers moving across the continent each year. From 2010 to 2014, Union Pacific's intermodal business has grown almost 40%. 

Summing up
Analysis of Porter's five forces reveal that Union Pacific has a solid competitive edge by virtue of its size and efficiencies, faces negligible threat from new entrants, and low to medium risk from suppliers and buyers. Its growing intermodal business has reduced threats from trucks, ships and other substitutes. Net-net-- a solid industry position that bodes well for Union Pacific's future revenue and earnings prospects.

ICRA Online has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway and General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.