3.1 Wetting the Whistle
3.1.2 Operational Aspects
firm’s income from ships and aircraft if the country in which the firm is organized (e.g., Panama, Liberia, and the Bahamas) offers equivalent exemptions to American companies.11These rules were initially established to promote international ship- ping and trading by air.
traveler by 10 P.M., but once a cruise ship sails or the airplane lifts off, there can be no additional passengers boarded. For a ship, this may mean that berths remain unsold for at least 3 and as much as 7 days—a fundamental feature that sometimes creates more pressure to discount prices here than even in the hotel and airline industries. Given the relatively long turnaround times and the greater onboard, high-profit marginal revenues (and tips for crews) that can thus be generated it makes economic sense to try to fill a ship to the brim through price discounting.
Many of these elements are reflected in statistical measures such asyield, which is defined as the average gross revenue per available berths (i.e., units of capacity) andoccupancy rates—the equivalent of occupancy rates in hotels, only with the assumption that there are two passengers per room.15 Other related measures include the number of passenger-cruise days (PCD), which is essentially the number of passengers times the number of days cruised, andavailable passenger- cruise days(APCD), which is a gauge of industry supply (capacity).16APCD may also be referred to as Available Lower Berth Days (ALBD).
Of these metrics, however, perhaps the best overall summary is provided by the net revenue yield(NRY), which equals cruise revenues minus expenses (such as commissions and transportation) divided by available berths times days of operation17:
NRY¼ revenuesexpenses
available berths
ð Þ ðdays of operationÞ
A figure of 6 % or above is considered to be an indicator of good performance.
Changes in yield (akin to same-store sales in retailing) are an important variable because they drive changes in profitability, return on invested capital (ROIC), and hence also the price-earnings valuation multiple carried by a cruise company’s shares. The air/sea mix, which is the ratio of passengers purchasing airline and cruise tickets linked together to those only booking cruises may sometimes provide another useful analytical metric, but changes in the mix normally do not substan- tially affect operating income.
many ships are now providing upgraded and much differentiated (ship-within-a-ship) services to passengers paying premium prices. Such guests also tend to spend more while onboard.
15Unlike in hotels, if more than two people stay in the room (some cabins can accommodate three or four passengers), the occupancy is considered to be over 100 %.
16For stock valuation purposes, it is also sometimes useful to calculate enterprise value (EV) per berth. EV as described in Chap.2, is number of shares outstanding multiplied by share price to which the amount net debt is added. Asset valuation comparisons on a time series basis as well as for one cruise-line company versus another can be made by taking EV and dividing by the number of berths. For example, Carnival’s long-term historical average was $370,000 per berth, but 2 months after the terrorist attacks of September 11, 2001, the value per berth had declined to
$275,000 per berth or 25 % below this average.
17This revenue yield aspect is similar to the RevPar (revenues per available room) metric that is used in the hotel industry, but in the cruise industry it’s called revenue per available lower berth day (ALBD).
Gross cruise costsare equal to total operating expenses plus expenditures on marketing, selling, and administration, whereasnet cruise costsexclude costs of commissions, transportation, and miscellaneous.
As in the hotel industry, ship service categories are segmented into markets that fall broadly from luxury to premium to contemporary to budget to economy classes with the precise definition of each depending on the cruise line’s marketing targets and the amenities and service levels provided in each category.
Thespace ratioof a ship, however, is measured in terms ofgross registered tons (GRT), which has nothing to do with weight. GRT is instead a measure of the amount of usable space per passenger on a ship. By definition 1 GRT is 100 cubic feet of permanently enclosed volume, which means, for example, that a ship of 18,000 GRT carrying 750 passengers provides a space ratio of 24 tons per passenger. On modern ships, the passenger space ratio (PSR) averages more than 44 and may range as high as 60 on luxury-class services.18PSR and cabin size are by far the most important determinants of the prices paid for cruises of similar itinerary and duration.
Although cruise revenues are generated from many different sources, the onboard sale of beverages usually ranks high in contribution to profits, even though most of the revenue is derived from cruise ticket sales. Other large sources of onboard revenue would also often include sale of shore excursions (with margins
>50 %), retail sales from shops, specialty restaurants, jewelry and art auctions (with at least a 35 % cut of sales to the ship), and promotions of photo, beauty salon, and health spa services. With only 30 % of passengers typically interested in gambling, casino revenues often do not contribute proportionately as much to total income (perhaps 10 %) as is frequently assumed.
As might be expected, the costs of providing various onboard services also vary by type of market segment. Excluding labor and overhead, food costs on a per diem or per passenger-day basis might be as high as $25 to $30 on the luxury end, as low as $8 to $11 for the mass-market segment, and somewhere in between for so-called premium segment cruises.
18Although the PSR is calculated by dividing the GRT by the number of available berths, Cartwright and Baird (1999, p. 108–109) note that the calculation can be made using an assump- tion of maximum occupancy, PSR(m), or assuming all cabins are being occupied by two persons, PSR(2). Differences in estimated average PSR(m) by type of service as of 1998 can be seen as follows:
PSR(m) Size in s.f.
Standard 29.8 125
Premium 47.5 155
Luxury 61.6 210
According to Cartwright and Baird (1999, p. xxii), the wordtonnagecomes from the medieval tun, meaning a barrel. Because GRT is a measure of enclosed space, the addition of an extra deck can dramatically increase GRT. In contrast, the size of warships is measured by the amount of water they displace. The International Convention on Tonnage Measurement in 1982 set the definition of GRT.
126 3 Water and Wheels
However, because the operating (variable) costs of a cruise do not rise propor- tionally with the number of passengers, the industry has moved to increase the average ship-carrying capacity. As ship size rises from around 1,500 berths to 2,600 berths and with occupancy levels of around 100 % (and ranging as high as 110 % when more than two people are in a cabin), the cash flow (EBITDA) margin before corporate expenses can move up from 45 to 55 %. The breakeven occupancy level for the larger ships meanwhile tends to decline to 50 % as compared to 60 % for the smaller ones.19Yet once a ship reaches the size of about 2,000 berths, the benefit from further scaling up begins to rapidly diminish.
Also, yield management strategies that have been successfully implemented in the hotel and airline businesses have not been especially helpful to the cruise industry for two reasons: Leisure, as compared to business travelers, are much more sensitive (elastic) in their demand as a function of price; and the all-inclusive nature of cruises (including five meals a day) leads to marginal costs per unit that are much higher than in hotels and airlines.
Table3.3shows an estimated percentage profit and loss statement that is typical for the largest companies (and which does not change much over time). The middle of Table1.6meanwhile provides a more aggregated view of the cruise industry’s operating performance indicating that pretax margins (pre-interest expense) in this sector are among the highest in the travel business.20It is notable that the industry—
dominated by the publicly owned giants Carnival, Royal Caribbean, and Norwegian (with approximate respective market shares of 50, 25, and 10 % in 2015)—has been able to shield so much pretax profit because of political effectiveness at minimizing taxes and in addressing and deflecting criticisms relating to safety, health, and environmental issues.21As critical focus on these issues intensifies, industry profit margins will likely be narrowed.22
19Larger ships can also spread the high fixed cost of onshore infrastructure facilities over a larger revenue base and also a multitude of brands but must, as described by Mouawad (2015a), operate their complex systems with great efficiency.
20These margins, but not the actual dollars of profit, are affected by theair/sea mix, which is the number of cruise passengers who purchase airline tickets with their cruise fare as a percent of the total number of paying passengers. There is no affect on operating profits because the airfare component of a cruise package is passed through the books of the cruise line as a corresponding revenue and expense item. A lower air/sea mix results in a higher margin because the same amount of profit is taken as a percent of a smaller sum of revenues.
The air/sea mix has been trending down from around 30 % as cruises in the United States have begun to originate from more seaports within a day’s driving distance. In European and Asian markets the trend has been just the opposite.
According to cruisemarketwatch.com, the average line in 2011 derived around 75 % of revenues from ticket sales 13.5 % from casinos and bars, and 4.9 % from shore excursions. On the cost side, 31 % was related to core operations, 11 % to shipboard payrolls, 10.6 % to agent commissions, 10 % to depreciation, and 7 % to fuel costs. See also Bull (2013).
21Klein (2005) writes (p. 1) that “Governments believe they need cruise ships more than the cruise ships need them.” Brown et al. (2013) discusses the benefits and costs for communities that ships commonly visit. Mouawad (2013a) suggests that large ship sizes might impair safety.
22Becker (2013, pp. 82 and 125-165) provides several examples of cruise industry issues that need to be addressed: “The air pollution from just one of the docked giant ships is the equivalent of