Charleston Corporation

The meeting of the Information Technology Steering Committee had started at 9:00 A.M. It was September 2001, and the leaves were just beginning to turn brown in Asheville, North Carolina, headquarters of Charleston Data Services (CDS), a part of the Information Technology Division of the Charleston Corporation (see Exhibit 1). The people at the meeting, however, were beginning to see red. It was now almost 2:30 P.M., and they had yet to break for lunch. Everyone was hungry, tired, and frustrated.

The joint chairpersons, who had called the meeting, were Ted Townsend, vice president of Charleston Data Services and Philip McDaniels, vice president of Electronic Communication Systems (ECS). Both men were seated at the center of the large, U-shaped, conference table. McDaniels, who usually allowed Townsend to run the meeting, was flanked by his two key people; Charles Rhoades, director of Network Development, and James Ridenour, director of Network Operations (see Exhibit 2). Also in attendance were three of Townsend's key people; Brian Pannell, the director of Applications Development, Richard Cheung, director of Technology and Linda Hoover, the director of Information Centers (ICs). Two other members were Ron Pierce and Sheila Malone. They were representatives of Charleston’s Logistics Services Company (LSC). Pierce is vice president of LSC Marketing, and Malone is director of LSC Sales (see Exhibit 3). Others around the table were representing the Transportation Group, the Materials and Maintenance Group, the Energy Resources Division and the Real Estate Division.

PROBLEM BACKGROUND

All of the people, if asked, would say that the meeting was long overdue. Most had an agenda they wanted to address; some had an axe to grind. Much of the sometimes emotional, and always lengthy, discussion that followed can be summarized in the following paragraphs.

Ron Pierce, vice president of Marketing, brought up one of his serious concerns when he said, "I have been told that, historically, application software maintenance has averaged only 40 percent of CDS's programming support budget. I know it's really your decision, Ted, but in Marketing we are affected severely and directly by CDS's large allocation of IT resources to maintenance of older systems versus new system development. I understand that in the last two years 70 percent of your budget has been allotted to this purpose. Speaking on behalf of the LSC Marketing users, I have some serious questions about that decision for the long term and how it will affect the Charleston Corporation user community in general."

____________________________________________________________________Names, locations and other data in this case have been disguised.

Townsend responded, "That's true, Ron; we have expended nearly $80 million in the last two years, but what you call maintenance was really an effort to re-design our old, existing software. Also, $40 million of this was new one-time money earmarked for the specific purpose bringing our application software portfolio up to a standard as good as or better than the rest of the industry. Even though we aren’t yet where we need to be, I think the money was well-spent. It works out to about one dollar per line of program code that has been checked and fixed as necessary, which is about average by industry standards. I would bet most of you don't realize that we were running some applications that were over 20 years old. Those old legacy systems with their problems are what had been causing the severe overload in maintenance. But to keep costs down, we examined each of our software systems for potential problems and then determined whether we should (1) leave it alone, (2) fix it (3) build, in-house, a new replacement system, or (4) buy or lease off-the-shelf a new replacement system; however, we found that surprisingly little software is available to suit our special needs. Fortunately, we determined that most systems required only fixes, mostly to provide a modern Windows-like user interface. Even then it was very time-consuming, labor-intensive work that required the hiring of many temporary contract programmers, but on the other hand, to replace all that software with completely new systems would have cost over $150 million.”

"I think you're being a mite hard on us, Ron, but for another reason," remarked Brian Pannell, director of Application Development. "I've suspected for some time now that we have many users who are not truly educated in the use of the systems they already have. I guess you'd call them unsophisticated. My bet is that there are quite a few of them who don't really know how to reap the maximum benefits of the systems that are already available to them. And yet, they continue to request us to develop new applications for both mainframe and small server environments. To make matters worse, I am currently running a nine-month backlog of requests for problem fixes and enhancements."

"That may be true," agreed Linda Hoover, director of Information Centers "but I think that new Information Center training program we've worked out with one of our unions, the Brotherhood of Railway, Airline, and Steamship Clerks, will change all that. Everybody knows that on-the-job training is essential, but now it's going to be supplemented with more formal, classroom training. Besides mainframe systems training, the curriculum includes basic skills like the use of Windows, Internet, the electronic mail system, word processing, typing proficiency, business arithmetic and number accuracy, accounting principles, and even telephone skills. Courses in more sophisticated techniques using spreadsheets, graphics and databases, are available for the more motivated people who have a need to manage and analyze their own data. And we’ve designed the training curriculum so they'll be allowed to skip areas that they understand or repeat portions that require more intensive study. The union is with us all the way on this. They realize that if the people they represent are going to be a part of the transportation industry of the future, they're going to have to prepare themselves to use new, evolving technologies. Everyone involved is really excited about it. My people can't wait to get started; however, I am a little concerned about pulling this off with the low staffing levels in our Information Centers."

Townsend, attempting to avoid having to listen to everyone’s’ favorite gripes and to get the discussion back on track, said, "Thank you very much, Linda. I didn't realize the training program was that far along. I'd like to move on now to a subject of high priority for Information Technology Division. Not that we're deaf to the pleas of our own people; however, you may recall that another objective placed on the division when it was formed in 1997 is to acquire external, revenue generating clients who would be interested in purchasing or leasing the special supply-chain management, transportation management, and financial management software systems we have developed at great expense over the years and are now modernizing. That’s the main reason why we got the special, one-time budget in the first place. We were also tasked with selling the implementation and consulting support services that go along with the software. This objective has recently taken on added importance to top management because of falling revenue and profits generated by our core transportation activities. I don’t know how realistic this plan is at the moment. We have not yet acquired many clients beyond what we have in providing billing and collection services for a few small trucking companies which are business partners with us, rather than competitors. Our transportation industry billing and financial software is now first-rate as a result of last year’s modernization effort, and we should be able to generate more of this type of business soon. The real problem in moving forward is due in large part to some difficulties in getting the sales effort underway. At any rate, I personally still think our top priority must be to continue to modernize the rest of our current IT environment. These are the systems that make our entire organization function on a day-to-day basis, and they must be up-to-date and functioning properly before we can expect to market them to outside clients. I would propose that all of us together at the conclusion of this meeting request our president, John Mathews, to continue to fund EDS at an increased level for at least one more year to finish the improvements in our current systems.”

"That may be your priority," Pierce quickly added, “But I have some doubts that we can sell enough software and IT services to non-competing transportation companies to make it worthwhile. Given the addition tasks placed on my sales group, my priority has to be on making our job easier by fixing the real problems with some of our current systems, and that goes well beyond what you have described. Putting a pretty Windows interface on those problems will not make them go away. For example, from the point of view of an end-user in sales and marketing, one big problem with our current systems is that the total contribution to the bottom line can't be determined when a shipment moves in the multimodal, all-in-one, door-to-door shipping manner because our railroad, barge and trucking companies all have their own revenue accounting systems which are not integrated. The situation gets worse when we use one of our select carrier business partners to complete shipments to locations we don't normally serve. How can we price our services if we can’t figure out the bottom line result? And what is going to happen when the acquisition of Cook Lines is finalized? I think attempting to salvage these old legacy systems is a waste of time and money. If I thought more about it, I'm sure I could think of more examples, and I'd bet that everyone else here could think of some too."

Richard Cheung, director of Technology, saw an opening and commented, “Over the last several years as you all know, Charleston Southern Railroad, like other railroads has lost transportation business to the trucking industry. Many of our rail customers who are manufacturers complain that rail transportation was too slow and inconsistent for their just-in-

time freight delivery needs. Rail still carries the heavy, bulk commodities like coal and grain, but trucks have taken over the transportation of the more valuable consumer type goods. We need to make better use of information technologies like global positioning systems and transponders on every rail car, truck, barge and ship, all integrated with our dispatching and scheduling systems so that we know at all times where every shipping item is located. Right now we can only do this for railroad cars, so when an item requires multimodal shipping, especially with a business partner trucking firm, we lose track. I won’t say that the software modernization project isn’t the top priority, but I believe our service can be vastly improved if we were to request an extra $30 million for this new technology.”

Charles Rhodes saw his chance and jumped in; "For some time now, Jim Ridenour and I have been saying that the answer to many of these problems to is move away from our current mainframe-centric environment with its expensive, proprietary operating system software and toward decentralized computing. Sure, the mainframe environment is ‘bullet proof’ with 99.99 percent availability, compared to 99.9 for the best of the new network technologies. It’s also capable of storing massive amounts of data and can handle a very large number of concurrent users, but applications developed for this type of environment, in contrast to the client-server environment, are typically difficult for users to learn and operate, plus the users are more likely to need to rely on IT professionals to get the information they need. So why are we spending so much money to modernize our legacy systems?”

Ridenour chimed in, “We also need to de-emphasize our current obsolete network technology and make a better effort at taking advantage of the newest Internet technologies by building Intranets to support our internal operations and Extranets to provide better service to our customers and business partners. A basic website is no longer sufficient to compete in our industry. Every month, we purchase millions of dollars of fuel to run our equipment plus other materials and supplies. I have read that some companies are saving 10 percent on their procurement costs by use of electronic purchasing using virtual private network technology. Other websites are being set up to act as clearinghouses for freight shipments. They bring together carriers and customers. I don’t know if these clearinghouses are an opportunity or a threat to us, or even if they will still be around next year, but we cannot ignore them. Now is the time to take action. Of course all of this would not be cheap. In addition to the application software acquisition and/or development costs, we would require $25 million to upgrade our networks, servers and user workstations and an addition of 30 -35 people to support the networks. Maybe more Information Center staff would be needed as well. We need to move fast here; so we cannot take the time to develop electronic commerce software in-house; we need to go out and hire a consulting firm/systems integrator like Ariba or CommerceOne to build these capabilities for us and to help interface them to our back-office systems. This could cost another $5 million. I think this would be a better allocation of any extra IT budget funds. I also think our users and top management would be pleased with the results."

Townsend, rather annoyed, asked, "Can we get back to an immediate CDS problem?" Even though we are not developing many completely new systems right now due to our other priorities, I'd still like to talk for a minute about system development deadlines. It seems odd to me, but deadlines are established by the users. We try our hardest to get them to relax those

desired completion dates, but they always act like each one is set in concrete. They just don't realize the amount of effort and detail work that goes into developing new systems. Getting control of this situation is critical if we are to free up enough programmer time and other resources to finish our software modernization project.”

"I'll second that motion," Brian Pannell said, "but, at the same time, I believe we have to take part of the blame for missing the deadlines, whether they are realistic or not. I don't have a complete answer to the problem, but, in some ways, we're rigidly constrained by our Systems Development Life Cycle (SDLC) approach to developing new systems. We use it in the design of all of our systems. Our users may not realize its shortcomings; however, I'm sure all of us in CDS do. Our SDLC automatically creates backlogs. It makes it almost impossible to meet our deadlines, and yet we need to have a structured design process to maximize the likelihood that our finished systems will perform as specified by the users. I intended to bring up SDLC even if no one else has any interest because I want everyone to understand some of the constraints CDS must work with. So I brought along some PowerPoint slides to show to our user friends. Do you suppose we have time to show this and discuss it for a couple of minutes, Ted, before we go to lunch?"

Townsend quickly surveyed the room, noting the temperament of the group and replied, "Okay, how about taking 10 more minutes maximum and then go to lunch. We can take some more time on it later if there are any questions left unanswered when you finish."

Pannell darkened the room and opened a PowerPoint slide that displayed the five steps of the SDLC as he interpreted it.

The five steps of the SDLC are:

1. Systems investigation 2. Systems analysis 3. Systems design 4. Systems implementation 5. Systems maintenance

Pannell described each of the steps in a little under a minute and then stepped back out of the way. Most of the group showed little interest or sympathy for Pannell’s problem as they quickly left the room.

COMPANY BACKGROUND

Charleston Corporation was created in 1989 by the acquisition of the Central Carolina Railroad by the Charleston Southern Railroad. The central premise of the acquisition was that joining two rail systems with non-overlapping service areas could result in improved customer service, increased profitability, and enhanced shareholder value without running afoul of anti-trust laws. The holding company, Charleston Corporation, was created and headquartered in

Asheville, North Carolina. In 1997 the company was restructured into four major divisions: Energy Resources, Real Estate, Information Technology, and Distribution.

Charleston Corporation revenues in 2001 were $5.6 billion, down $473 million, or 7.7 percent, from 2000. The 2001 net earnings were $319 million compared to $340 million in 2000. The declines reflect growing competition from other rail and trucking firms. (see Exhibit 4 for financial highlights).

Distribution Division

The distribution division was organized internally into three business groups: Transportation, Materials and Maintenance, and Logistics. Each group operates independently under a chief executive officer with one purpose: to provide premier shipping services to Charleston customers.

The Logistics Group focuses on the development, marketing and selling of transportation service packages. Logistics Services Company, the major part of the distribution group, is headquartered in Stowe, Vermont but has sales offices throughout the East coast region. One of its major goals is to plan the marketing strategy for Charleston's all-in-one, door-to-door shipping service which is supposed to coordinate any shipment across any number and type of carrier; rail, truck, barge and ship, whether owned by Charleston or by a select business partner. LSC's vice president for Marketing, Ron Pierce, oversees the activities of Sheila Malone, the director of Sales. Sheila is responsible for selling all Transportation Group services. Recently she and her staff haven also been given the task of selling CDS/ECS developed software and services.

The Materials and Maintenance Group, through its Hardware Materials Company (HMC), supplies and maintains the 60,000 freight car fleet owned by its main customer, Charleston Southern Railroad. It is headquartered in Charleston, South Carolina.

The Transportation Group is the operating arm of the company. Charleston Southern Railroad operates in the Atlantic seaboard states and has typically generated between 40 and 50 percent of Charleston Corporation’s revenue. Its headquarters are in Charleston, South Carolina. Mid-America Barge Lines operates a barge transportation network which covers over 12,000 miles of inland waterways. Its headquarters are in Hannaford, Ohio. Charleston Motor Express (CME) provides the trucking arm of the multimodal all-in-one, door-to-door transportation service offered by Charleston. CME is headquartered in Washington, New Hampshire. Cook Lines, an ocean-going steamship line, is to be acquired in the third quarter of 2002 after receiving expected approval from the Department of Transportation. This acquisition is expected to complete Charleston's objective of becoming a complete transportation company. Cook Lines' headquarters are in Wilmington, Delaware.

Energy Resources Division

The Energy Resources Division's major property is Gulfcoast Gas which was acquired in 1993. Under the new organization this group continues to direct the company's activities in natural gas transmission, oil and gas exploration, and the management of Charleston-owned coal reserves. It is headquartered in Galveston, Texas.

For the short-term, gas production and transmission appears very promising. Demand for gas is growing, especially for the generation of electricity in areas with air pollution problems. The company has a strong competitive position based on its cost of service, established customer base, financial resources and positive relationships with regulatory agencies. The company’s principal challenge is to plan a strategy for expanding facilities and services. Management believes long-term opportunities in energy production and energy trading are there for companies that have proven expertise, the ability to respond quickly, and a strong financial base.

Real Estate Division

Historically, Charleston's strategy has been to convert unneeded real estate holdings from various parts of the company into cash. This strategy provided an immediate return with little risk, but it offered only limited opportunity for the company to capitalize on significant long-term growth prospects in the real estate area. The creation of the Real Estate Division in 1997 signaled a change in the corporation's strategy. The Real Estate Division was given full responsibility for all real estate activities. It explores various options for development as well as sales of company owned real estate. The division is headquartered in Asheville, North Carolina and currently manages assets that have an estimated value of $750 million.

Information Technology Division

Charleston Corporation management is aware that in today's fiercely competitive business environment information technology can be used to create a competitive advantage which can be the difference between success and failure. It sees Charleston Corporation as an all-in-one, door-to-door transportation company, rather than simply a railroad. The Information Technology Division was created in 1997 to serve as a key building block in structuring the future growth and competitiveness of Charleston Corporation. Headquartered in Asheville, North Carolina, it has its own president, John Mathews.

The division, consisting of Charleston Data Services and Electronic Communication Systems, is attempting to develop and manage information technology solutions for outside clients as well as for Charleston Corporation's own business units. The division is expected by Charleston top management to exploit what are believed to be significant future growth opportunities in the transportation-related information technology market. It is expected that outside sales of CDS/ECS developed systems will make the division a significant profit center some time shortly after 2002. Currently, the division has only a few small clients for billing and collection services which account for less than five percent of the division's activities.

The division currently employs nearly 650 people. Approximately one-half are mainframe application programmers, with the remainder serving as systems analysts, network specialists and user support personnel. In 2001, CDS anticipates spending $86 million to support its information technology activities; ECS will spend $43 million. CDS runs a total of six interconnected IBM mainframe servers. All told, CDS and ECS combined support some 6,500 networked mainframe connections throughout the Charleston organization. Office automation activities, including electronic mail and Internet access, are handled over a system of proprietary local and wide area networks (described below). Internally developed software is used to support marketing, logistics and supply-chain management activities including transportation management, scheduling, warehousing , inventory, and billing. The accounting, finance, human resource management and payroll functions are handled by highly modified purchased software.

CDS uses the Information Center (IC) approach to manage end-user computing. The ICs were created in 1998 to provide technical support for end-users. Each major corporate location has its own IC, employing a total of approximately 75 people in all ICs combined. The goal of the ICs is to combine centralized IT resource management with distributed user support; all aimed at providing fast, low-cost solutions to user problems. The IC in each location is responsible for purchase and maintenance of all PCs and related software, network equipment, training and support in the use of IT. Each IC has a manager who reports to Linda Hoover (see Exhibit 5).

Information Technology Division's relationship with Charleston Corporation has become somewhat uneasy. Although the division has had the financial backing of the parent corporation, in return the parent corporation wants a software and IT services outsourcer and supplier that will soon start turning a profit on its own to help justify its existence.

COMPUTERS

Currently there are two lBM 9121 mainframes in Stowe (both four years old). At the Asheville headquarters there four IBM 9021 mainframe (all six years old). They are fully depreciated, and so their only direct cost is operating system software leasing and hardware maintenance at a total of $57,000 per month. This cost continues to rise as the machines age. The Stowe and Asheville facilities are connected by a dedicated T1 data transmission line which can transmit data at 1.5 Mb per second.

Two new IBM S/390 Multiprise server systems, which can be leased for $36,000 each per month, including operating system software and hardware maintenance, are on order with delivery promised in March, 2002. If leased, one of these systems will be placed in Asheville, the other in Stowe and connected to the company wide area network. These two new systems are estimated to have enough processing power to replace all six current mainframes and satisfy future needs out to 2005.

DATA COMMUNICATIONS

Data communications capability is an integral part of Charleston's technology needs. E-mail, Internet and mainframe access must be available at all corporate locations. That capability has been largely achieved through Charleston Southern’s extensive railroad rights-of-way which have in the past allowed the low-cost installation of a significant amount of copper wire, coaxial cable and optical-fiber. Design, installation and maintenance of all company networks is the responsibility of ECS. The company currently does not sell access to its communications facilities to external companies even though there is considerable excess capacity on many network segments. However, on occasion, service is provided to important transportation customers as a sales inducement. This is an opportunity that ECS has been instructed by John Mathews to explore in spite of ECS concerns about security.

Data Transfer System (DTS)

DTS is a Wide Area Network (WAN) that connects employee, customer and business partner local area networks to the company’s back-office mainframe systems. It was built over a period of time between 1990 and 1992 and utilizes a combination of company owned cables laid along railroad right-of-way and telephone company leased lines. DTS creates dedicated, secure data links which, along with back-office systems, provide the following capabilities:

1. Bills of lading: Bills of lading exchange provides an electronic link between the customer and the freight terminal. Predefined shipment profiles stored in the computer minimize the amount of information required from the customer. After the shipment is loaded, added services such as weight reporting and notification of actual freight charges are also available.

2. Freight billing: Electronic freight billing data exchange allows freight billing data to be transferred directly into a customer's accounting system. It enables customers to quickly produce reports that summarize transportation activity. Customers also can use Charleston's electronic funds transfer capabilities for payment.

3. Electronic mail: Typical uses of electronic mail include rate quotations, billing inquiries, freight claims, and communications with freight agents. E-mail is also used for transportation equipment placement and ordering, notification of unscheduled railcar movements and for the release of unloaded equipment.

4. Rate retrieval: This service allows Charleston's customers to interrogate other select business partners’ databases for published rates as well as to request special price quotations for locations that Charleston does not serve. Often, a shipping arrangement can be made utilizing nothing more than computer-transmitted information.

Automated Switching Circuit (ASC)

The local area networks operating within each company location or building is called, Automated Switching Circuit (ASC). The primary purpose of ASC is to provide access from every desktop to the DCS system. ASC was installed in 1991 as a proprietary network, based on IBM's early token-ring technology. Over time, this has proved to be a bad decision. Token ring technology, although state of the art in the early 1990s, has since been overtaken by Ethernet technology. The network was modified in 1997 to allow low-speed access to the Internet.

CONCLUSION

The meeting attendees filed back into the conference room at 3:45 P.M. and found Townsend and McDaniels already waiting in their seats. In addition, John Matthews, the president of Information technology Division, was sitting back in one corner of the room.

Townsend again opened the meeting by saying, "I am sure John Matthews, our president (John waved a friendly greeting) needs no introduction, so let's proceed with the meeting. I'd like to identify the three topics discussed earlier that are most important to our future and will have to be addressed at some point in our deliberations or follow-on actions."

"First, there was much discussion about the state of our current systems this morning. We all should realize that we must forge ahead with needed enhancements of our current mainframe back-office systems in spite of the cost in order to gain operating efficiencies and maintain competitive advantage.”

“Second, is the issue of Information Technology Division becoming an outsourcer and supplier of transportation industry application software and related services. We all know how strongly John feels about this.”

"Third, our DTS and ASC systems, which were state-of-the-art when they were designed, are getting very expensive to operate and maintain. They are difficult to learn to operate, and they are slow. I know that companies like Federal Express and United Parcel Service are making extensive use of the Internet to serve part of the purpose of our DTS/ASC systems. We need to decide how much longer we can survive with the current systems and where we go from here."

"With those brief comments as a foundation, I'd like to open the discussion for some hard-headed suggestions from the group. We want to hear from everyone, and I would request that we all be very open-minded about all comments; let's not dash water on any ideas until we've really kicked them around and are certain they are not realistic.”

EXHIBITS

EXHIBIT 1. Charleston Corporation structure

EXHIBIT 2. Information Technology Division

CharlestonCorporation

Information Technology Division

Energy Resources Division

Distribution Division

Real Estate Division

Charleston Data Services

ElectronicCommunications Systems

Gulfcoast Gas

Materials and Maintenance Group

Transportation Group

Logistics Group

Charleston Southern Railroad

CharlestonMotor Express

Mid-America Barge Lines

Cook Lines (to be acquired)

Hardware Materials Company

Logistics Services Company

EXHIBIT 3. Logistics Services Company (LSC)

PresidentInformation technology Division John Mathews

DirectorAdministration

Vice President CDS T. Townsend

Vive President ECS P. McDaniels

DirectorBilling and Collection Services

Director Finance

Director Application Development B. Pannell

Director Information Centers L. Hoover

Director Technology R. Cheung

Director Network Development C. Rhoades

Director Network Operations J. Ridenour

PresidentLogistics Services Company

EXHIBIT 4. Charleston Corporation Inc., Financial Highlights.

(Dollars in millions, except per share amounts)

For the Year (ending August 31): 2001 2000 1999--------- --------- ---------

Revenue $5,642 $6,115 $4,541Operating Income 678 719 476

Vice President Finance

Vice President Administration

Vice President Marketing R. Pierce

Vice President Operations

Director Sales S. Malone

Director Advertising

Director Pricing Strategy

Director Customer Relations

Net Earnings 319 340 201 Per common share:

Net Earnings 2.85 3.01 2.03Cash dividends 1.06 1.14 1.01

Stock price range: high 26.41 32.06 28.01 low 18.48 22.49 15.71

At year-end:Cash 144 291 242Working capital 75 178 187Debt ratio 32.8% 29.1% 31.8%

Return on Equity: 8.9% 9.3% 5.6%

EXHIBIT 5. Information Center Organization

Director Information Centers L. Hoover

Manager Information Center Asheville

Manager Information Center Charleston

Manager Information Center Stowe

Manager Information Center Washington

Manager Information Center Hannaford

Help Desk

Purchasing

Hardware Maintenance

Software Support

Training