cruise economics

28 THE JOURNAL OF TOURISM STUDIES Vol. 7, No. 2, DEC. '96

The Economicsof Cruising:

An application to theshort ocean cruise market

Adrian O. Bull

Introduction

Since the 1960s, cruising has developed from being a substituteoff-season use for passenger liners normally engaged on line voyagesto a substantial, and often footloose, sector of tourism activity. Shipshave become destinations or floating resorts rather than primarilymeans of transport, and markets have been balkanised into manytypes.

This paper proposes that one of these types - the market forshort ocean cruises - can be defined in economic terms as a separatemarket. Globally, this market has perhaps the highest internationalprofile in terms of cruising, and displays characteristics ofinternationalisation and economic organisation which are unique. Thepaper analyses and discusses the main microeconomic issues involved,with particular reference to operating economics and the marketstructure of the industry.

Categories of cruising market - an economic perspective

In order to investigate the economics of cruising, it is firstnecessary to define cruising products and market places. Oneapproach (Hobson, 1993a) is to treat the whole of cruising as being asingle, but segmented, market, where products are highlydifferentiated according to consumers’ requirements, but where thereis an assumption of overall competition and substitutability. Hobson,for example, suggests that there are four market segments: mass,middle, luxury and specialty.

AbstractThis article offers amicroeconomic analysis of theinternational market forshort ocean cruises, as themajor element of globalcruising activity. It drawsattention to some specificissues in cruising economics,such as problems with units ofmeasurement and themultinationally footloosenature of resource acquisitionfor the industry. The paperoffers an analysis of supplyconsiderations and discussesthe market structure of theindustry as a competitiveoligopoly dominated by threecruise lines as suppliers andthe Caribbean as the maindestination cruising region.Key variables are shown to beeconomies of scale, pricingand product differentiation.

Adrian O. Bull is PrincipalLecturer in Tourism at theUniversity of Lincolnshire andHumberside, England.

THE JOURNAL OF TOURISM STUDIES Vol. 7, No. 2, DEC. '96 29

With differentiated products, thenotion of what constitutes anindividual and specific marketmay be problematical. Any twoor more products are usuallyconsidered to be of the samegeneric commodity class if thereis a reasonably high level ofsubstitutability between them,which may be measured by apositive cross-price elasticity ofdemand. However, there is noclear definition of the degree ofsubstitutability (or of a specificvalue of cross-price elasticity)necessary to determine the cut-off point for products to beclassified as being within thesame market. This lack ofdefinition results in considerablelegal argument in antitrust lawcases (Watson, 1977).

The boundaries of a cruisingmarket may be ‘defined’qualitatively by recognitionamongst producers, and amongstconsumers, that the productstraded are performing essentiallythe same function, or possesssome basic homogeneouscharacteristics. This implies, forconsumers, that there is somedetermination of indifferencebetween products based on thesecharacteristics. In the long runthis may lead to an identifiableprice nexus amongst cruiseproducts, although in the shortrun the differentiatingcharacteristics between productsand the way they are marketedmay produce price and demandvariations which suggest thatproducts are not really in thesame market at all (Dilley, 1992).Within any one market, the levelof homogeneous characteristicsshould be such as to createsubstitutability on both thesupply and demand sides(Carlton & Perloff, 1990). Insupply terms this implies thatboth the production function andthe cohesiveness of the marketplace constrain the pricing ofproducts.

A market may be bounded withina geographic area (Watson,1977). As location theory shows,in terms of supply, production

costs and methods may differgreatly from one area to another,or transport costs may be so highas to constrain supply areas(Isard, 1956). In terms ofdemand, transaction costs andpoorer consumer informationabout more spatially remotealternatives act as constraints.In addition, governments mayimpose trading regulations whichbound markets.

Whilst it is evident that manycruise lines draw upon customfrom around the whole world,owing to the inherentlyinternational nature of mostcruising products, the aboveanalysis suggests that there arein economic terms severalcruising markets, which arebounded both geographically andby limitations on substitutabilityin both supply and demand. Thiswould produce a range ofmarkets whose operation woulddiffer notably one from another.A schema of such markets mightresemble those shown in Table 1.

The last of these markets, that

for short ocean cruises, is thelargest and most heavilyresearched area of cruising. Theremainder of this paper will usethis market as an exemplarbecause of its importance, buttransferability of findings toother markets would be limitedby those differences outlinedabove.

The short ocean cruisemarket

This market accounts for thelargest area of activity incruising, with a majorcontribution to specific regions ofthe world’s tourism. There aredifferent units of measurement,such as cruise passengernumbers, berths available, andpassenger days. A feature ofcruise industry reporting isdisagreement over statistics.

Passenger numbers are cited asa measure of demand (Fells,1995), although perhaps they aremore a measure of consumernumbers at market equilibrium.World ocean cruising numbers

Table 1: Overview of Cruising Markets.

Location /type Comment Supply / markets

River, canal and Several markets Small, shallow-draft vessels,lake cruises according to location often domestic markets,

cabotage-limited

Special interest Worldwide markets, Often purpose-built vessels,(such as sail, highly differentiated specialist crews, a degree ofeducation or ) monopoly throughexploration differentiation

Long distance ocean Single world market Large vessels, often relyingcruises, including on ‘tradition’ and luxury,RTW cruises resources acquired inter-

nationally

Extended ferry Usually domestic or Joint product with car ferry‘mini-cruises’ between country pairs, services (see Peisley, 1992a)

especially in W Europe

Short ocean cruises World market, but Mostly large vessels, usuallyheavily dominated by purpose-built for mass U.S. demand. market cruisingDifferentiated by location, dominatedby the Caribbean


(over 99% of whom are short seacruise passengers taking a cruiseof less then 14 nights) areestimated at 6.3 million (Darnill,1995), or 5.7 million (CLIA,1996). Growth of 10-12% perannum in the decade to 1993 hasbeen followed by static numberssince then.

Berths available are a measureof supply, assuming constancy ofship operation. In 1995, some129,000 berths were availablein ocean cruise ships (Fells, 1995;Peisley, 1995), although somepercentage of these are alwaysout of service, owing to refits,maintenance or shiprepositioning. The geographicalallocation of supply is stronglyoriented to the Caribbean, asshown in Table 2.

There is disagreement, however,over the number of berthsavailable from individualsuppliers, since there is cross-chartering and shifting owner-ship of ships and lines. Thisissue will be further explored inthe section on market structure.

Passenger days are the mainoutput measurement of theindustry worldwide. For 1994,they are estimated at 34.9 million(Blum, 1995) and 37.7 million(Fells, 1995). Blum estimatesthat about one-third of these(12.2m) are days spent in theCaribbean. For 1995, CLIAestimates a usage of about 37million passenger days world-wide, related to a supply of some46.3 million passenger berthdays, giving utilisation of 80%.

applied to international tourismsuggests that capital will besourced internationally fromwherever it has the highestmarginal efficiency over theinvestment cost (Bull, 1995), andthat other factor inputs will beobtained usually from thetourism destination country,unless there are significantsavings or productivity benefitsavailable by acquiring themelsewhere and the hostgovernment imposes no importcontrols on these factors. At thevery least, land and tourismresources must normally besourced from the destinationcountry.

No such limitations apply tocruising. Cruise l ines canoperate as almost perfectmultinational corporations,provided that they operate cruisesectors between ports of differentcountries. [If cruise lines operatebetween ports of the samecountry, then cabotage rules arelikely to apply, which usuallyrestrict carriage to operators ofthat country. There has beenconsiderable debate recently inthe U.S. Congress about theeffect of cabotage. Other thanAmerican Hawaii Cruises, allocean cruises operating from theU.S. are foreign-operated, andescape cabotage rules by sailingto, or back from, non-U.S. ports.]Not even land and tourism

This utilisation rate comparesvery unfavourably with those ofthe previous ten years whichranged between 88% and 98%. Itis caused by a sharp increase inthe supply of berths as new shipsare launched, coupled with astatic or marginally decliningdemand. Although there is dis-agreement over precise statistics,most commentators concur thatthere is a general trend towardsoversupply (Miller, 1996).

Sourcing factor inputs

Cruising provides an extremelygood opportunity for multi-national operation in tourism,accompanied by internationalacquisition and deployment offactors of production whereverthere is the highest marginalproductivity.

Conventional investment theory

Table 2: International Cruise Capacity 1995, in Percentage of Berths.

June December

Caribbean 25 50Mediterranean 20 2Alaska / West Coast of North America 17 0Rest of the world 30 30Out of service 8 18

Total 100 100

Source: Adapted from CLIA (1996).

Table 3: Source of Inputs for Major Cruise Lines.

Company ownership: USA, Israel, UK, Norway, Greece, Ukraine

Capital: USA, Japan, Germany, UK

Marine registration: Panama, Liberia, Bermuda, Cyprus, Bahamas(Hobson, 1993a)

Ships: Norway, Finland, Italy, Germany (yards such asMeyer Werft, Fincantieri, Kvaerner, BremerVulkan and Alsthom Atlantique)

Officers: 26% Italian, 22% Greek, 21% Norwegian, 8%British (adapted from Schwartzman, 1994)

Crew: Mostly international, with many southernEuropeans and Filipinos

Bunkering: Cheapest source on cruise or repositioning


resources need to be acquiredfrom a specific country. As aresult, cruise lines are relativelyfootloose businesses which sourcefactor inputs from a range ofcountries. Table 3 shows wherethe major cruise companiesacquire their major inputs.

The footloose nature of cruisinghas been an advantage tocountries which otherwise wouldearn little from tourism (Bull,1995). For example, CTC Lines,now Ukrainian-owned, wasdeveloped by the former SovietUnion to earn foreign exchangeby operating cruise ships invarious parts of the world(Peisley, 1992b) and supplyingservices to passengers from allthe main demand markets.

Ocean cruising therefore isunusual in being a high-capitalbut footloose industry with wideopportunities for inter-nationalisation.

Operating economics

In shipping, costs aretraditionally divided into capitalcosts, fixed running costs, andvoyage costs.

• Capital costs include those ofpurchasing and depreciatingvessels, together with interestpayments on investmentcapital.

• Fixed running costs are allthose which are incurred whena vessel is put into service (notlaid up), and include all areasof insurance and indemnity,crewing wages, stores,surveys, repairs and landsidemanagement costs.

• Voyage costs, which of courseare variable in respect tovoyages, include port charges,fuel costs, voyage-relatedstores, agency and otherlandside handling costs.

In comparison with cargo vesseloperation costs, those in cruiselines are particularly high incertain areas. Firstly, cruise

ships are expensive capital itemsin compar ison with cargov e s s e l s of similar tonnage.Typically, a container liner or drybulk carrier of 50,000 - 100,000tonnes may cost US$50-100m(Apelbaum, 1994). Vessels formass market short ocean cruisesare currently being built ,typically at around 70,000tonnes, at a cost of US$300-350m(CLIA, 1996). This differencereflects the cost of passengera n d extra crew accommodation,high quality public areas andamenities, and a generally lessutilitarian design. Depreciationand insurance costs areaccordingly higher, together withexpensive passenger liabilityinsurance.

Secondly, wages costs are com-paratively high in cruisingcompared with cargo operation.Where a cargo ship of 50,000tonnes may need 20-30 crew(Apelbaum, 1994), cruise vesselsof similar size have crews of 400-600 (Schwartzman, 1994) ofwhom more than three-quarterswill be ‘hotel staff’, catering staffand leisure/entertainment per-sonnel. Voyage-related storescosts, especially for food,beverages, linen and disposables,are similarly high. A cruise lineris in effect both a ship and a

resort, and therefore bears thecosts of both.

A total cost function for cruiseships is likely to resemble that inFigure 1, and is similar to thosefound in many capacity-constrained tourism serviceenterprises (Bull, 1995).

Fixed costs, including the vesseland its depreciation, adminis-trative costs and wages for thosecrew who are permanent,represent a high proportion oftotal costs. A vessel cannot besubdivided, so that there is noreal flexibility in supply. Voyage-related costs are incurred when aparticular cruise is operated,regardless of the number ofpassengers. Variable costs arefrequently comparatively smalland relate to the directprovisioning, accommodation andhandling (both at sea andlandside) of passengers.

If all berths are sold at their fullprice, then total revenueincreases as the line TR1 inFigure 2, and the maximumprofit position (total revenueminus total costs) will be that offull capacity and maximumrevenue. Profit will be theamount represented by the lineAC in the figure.

Costs

Variable costs

Total costs

Voyagecosts

Output

Full shipcapacity

0

Fixed costs

Figure 1: The cost structure of cruise shop operation


Costs

0

Total costs

Output

Full shipcapacity

A

C

B

TR1

TR2

bunkering.

• In the longer term, takingadvantage of internaleconomies of scale; this isachieved by operating largerand more economic ships (forexample, Carnival, Princessand Royal Caribbean Cruisesoperated 28 ships betweenthem in 1995 with a meanship size of 47,362 tons and1429 berths (Schwartzman,1994), but between 1995 and1998 are commissioning 15new ships with a mean shipsize of 76,370 tons and 2013berths (Fells, 1995)).

• Making use of the investmentin larger ships to expand anddiversify the supply ofcomplementary products onboard, such as bars, boutiquesand casinos (Kalosh, 1995);these are in a strong tradingposition effec tively asmonopoly suppliers to on-board passengers.

A consequence of investment inlarger units is concentration onmass market cruise types andlocations. In order to maintainhigh passenger utilisation rateswith very large vessels, suppliersgather cruises into areas of highdemand, such as the Caribbeanall year round, and Alaska andthe Mediterranean in summer.These areas have good access to,and short flying times from,generating markets, as well aspopular and attractive cruisinggrounds, weather conditions andports-of-call. Larger vessel sizesalso mean that cruising isphysically concentrated to placeswith deep water access andcanals or docks with adequatewidth (some new vessels are toolarge even for the PanamaCanal). Such mass marketconcentration inevitablyinfluences the nature of theindustry and market structure.

Market structure

If there is a positive, but notinfinite, cross-price elasticity ofdemand between products in a

If the market is not strongenough to sell all berths at fullprice, the cruise l ine cannoteasily reduce the number ofberths available (and hencepassenger days) without takinga ship out of service. Doing thiswould mean that althoughvariable and voyage costs wouldbe saved, the fixed costs (as inFigure 1) would still be incurred,as would laying-up costs. It istherefore preferable to try tomaintain passenger numbers inalmost any way possible, themost common of which isdiscounting (Belsky, 1994;Hobson, 1993b; Kalosh, 1995;Miller, 1996). This may meanthat total revenue only reachesthe line TR2 in Figure 2. Fillingthe ship stil l results in thesmallest poss ible loss on acruise, represented by the lineCB. As long as this loss is lessthan inescapable fixed costs, iti s preferable to maintain thesupply of cruises. It is alsoimportant to maintain ships inrevenue-earning service for asmany days in the year aspossible, since any shipundergoing maintenance orsitting in port between cruises isa costly wasting asset;turnaround times are minimised(Bull, 1995).

Thus, short and medium-termsupply decision in cruising arerelated to maintaining demandand revenue, and achieving costreductions. Demand and revenuemaintenance is related toproduct, pricing, and otheraspects of competitive marketing,which are considered in thefollowing section on marketstructure. Cost reductions can beachieved in a number of ways:

• Using flags of convenience formarine registration enablescruise lines to source crewsfrom low-wage labour marketsas well as avoiding operatingtaxes or the enforcement ofcostly regulations (Mentzer,1989).

• Reducing crew numbers or on-board service, althoughpassenger-crew ratios andservice quality are importantproduct differentiation itemswhich contribute to higherselling prices and less-elasticdemand (Peisley, 1992b).

• Saving fuel costs by sailingmore slowly, spending time inports-of-call where a ship actsas a floating resort hotel, andincluding in itineraries portswith cheap or low-tax fuel

Figure 2: Cruise costs and revenue


market place, then the structureof that market is one ofmonopolistic competition oroligopoly. A monopolisticallycompetitive market has manyfirms, and no restriction on entry.Despite similarity in the basiccharacteristics or performance ofproducts, each firm sells aversion of the product which isdifferentiated from others. Giventhe definition of the short oceancruise market offered earlier inthis paper, this is what suppliersare doing. However, full mono-polistic competition impliescontestability (Baumol et al. ,1982) where it is possible for anynumber of firms to operatesustainably. Free entry to andexit from the market will allowthe possibility of a large numberof firms being present. Barriersto entry into a market mayinclude patents and legalrestrictions, contrived barrierssuch as heavy branding andadvertising, and economies ofscale which cause output atminimum average cost to belarge relative to the size of themarket.

There are clear barriers to entryin the market for short oceancruises, in the forms of heavycapital requirements, registrationand licensing regulations, andthe increasing economies of scalein operating vessels of larger size.The market has thereforedeveloped an oligopolisticstructure, in which a smallnumber of suppliers dominate thesupply of short ocean cruises.Table 4 shows how supply isconcentrated in the hands of afew firms.

During the 1990s there has beenrelatively high turnover amongstsuppliers, with some exits fromthe industry, a number ofmergers or takeovers (which haveled in part to the predominanceof companies such as Carnival),and inter-company trading ofvessels. Since a single largecruise ship can account for up to1.5 - 2% of market capacity,trading in these mobile assetscan quickly alter relative volumes

of supply and the level ofconcentration in the industry.Concentration has increased sothat the “big three” suppliers -Carnival, Royal Caribbean andP&O/Princess - account foralmost half of all capacity. Inaddition these companies arereputed to be the most profitablein the industry (Miller, 1996),and are predicted to grow at theexpense of smaller, less-wellcapitalised suppliers (Kalosh,1995).

In relation to the broad choice ofstrategy open to oligopolists,between competition and co-operation, there is relativelyminor overt co-operation betweensuppliers, through the CruiseLines International Association(CLIA). Although CLIA memberscontrol 96% of berths offered toNorth American consumers(Murphy, 1996) which representssome two-thirds of the worldwidemarket, CLIA’s economic role islimited to cruise promotion anddistribution activity. Individualsuppliers operate mainly asoligopolistic competitors, usingproduct differentiation andpromotion as major strategicweapons (Hobson, 1993b; MintelInternational Group, 1993). Forexample, Carnival Cruises arevertically, or quality, differen-tiated as inexpensive, the‘Macdonalds of the industry’ andas ‘fun’ cruises (Trumfio, 1995),whilst Cunard verticallydifferentiates its products asprestigious and sophisticated inorder to maintain a pricedifferential.

Horizontal product differen-tiation, that is, distinguishingproducts by offering differentcharacteristics rather thandifferent quality levels of thesame characteristics, allowscruise suppliers to segmentmarkets and specialise. Whilstthis may apply to all suppliers,who may differentiate by offeringdifferent specifications of a keycruising product characteristicsuch as food (Marti, 1995), it isparticularly important forsmaller companies to enablethem to create a measure ofmonopoly in niche markets. Forexample, Walt DisneyCorporation is entering the cruiseindustry with family cruisesoffered as a complementaryproduct to theme park visitationin Florida (Zbar, 1995). At thesame time, cruise suppliers seekto differentiate their productsfrom those of land-based resortswhich in many ways aresubstitutes.

For the type of oligopolystructure indicated, pricingactivity is very important. Withdifferentiated products andcapacity constraints, at thedevelopment and entry stage fora cruise line or for a new vessel,decision making is likely to beCournot-type, representingcompetition to set output levelsand install f ixed productivecapacity. Hence, there isconsiderable competition to buildnew ships of the most efficienttype and size (Darnill, 1995).Once capacity exists, pricesbecome the strategic variable,

Table 4: Major Suppliers of Short Ocean Cruises 1995(number of berths available for short ocean cruises)

Operator Berths % of market

Carnival Corporation 25800 20P&O Cruises (inc Princess Cruises) 16600 13Royal Caribbean Cruise Line 16300 13Kloster (inc NCL and RCL) 10000 8Cunard Line 6000 5

Total 129000 100

Source: Adapted from Peisley (1995) and CLIA (1996).


need to receive higher prices toremain profitable. The option ofusing older vessels providessavings in capital costs, butusually means higher runningcosts as well as problems inmeeting upgraded maritimehealth and safety regulations.

Suppliers of cruises will continueto seek growth in revenue by thesale of complementary goods andservices such as add-on shoreexcursions, on-board casinogaming and shopping. The lattercan be in an advantaged positionthrough having a captive market,but will continue to bring about(perhaps unfair) competition withshops and services in ports-of-call, many of which rely on cruisepassengers for the bulk of theirtrade.

As a result of these actions, theshort ocean cruise industry islikely to remain a competitiveoligopoly, with high globalconcentration among massmarket operators of large shipsaccompanied by a larger numberof smaller, specialist suppliers.

new areas. However, there areconstraints on the latter, in termsof consumer access, touristicinterest, climate, and a range ofsuitable ports-of-call. Shortocean cruises are in many cases asubstitute product for land-basedresorts, competition from whichcan strongly influence demand.

The planned growth in the supplyof berths for short ocean cruisingremains at a high level. Becauseof long construction times, newinvestment in ships locks ingrowth in supply up to five yearsahead, assuming that oldervessels are not scrapped at thesame rate. The average size ofmass market cruise ships isincreasing, owing to economies ofscale, but this makes supply evermore ‘lumpy’ and will continue toforce operators to concentrate ondemand management strategiesto ensure high utilisation.Inevitably this means continuingcompetitive downward pressureon cruise prices for as long asthere is excess supply inparticular places or at particulartimes.

Smaller operators continue tomodify and differentiate theirproducts to sell in specialistmarket segments. This maynecessitate the construction ofspecialist smaller cruise ships,such as ‘explorer’ or sail-assistedvessels. With fewer economies ofscale in construction andoperation, these vessels oftenoperate at higher average costthan larger liners, and operators

denoting Bertrand-Edgeworth-type decision making. This two-stage approach is typical of sunk-cost models (Schmalensee, 1992).The concentration on price as astrategic variable is enhancedsince cruises are services whichare non-storable and perishable,so that producers must adjustprices to influence demand or beleft with useless output (Carlton& Perloff, 1990). As a result,cruise prices vary according tosuch differentiating charac-teristics as the crew-to-passengerratio or the age of the ship(Mentzer, 1989), but for anysimilar package of characteristicsprices are highly competitive.Table 4 shows daily rates chargedby a number of operators forsimilar cruise products in 1995.

Table 4 indicates that, given thedegree of differentiation betweenoperators, ships types andservices, and differing cruiselocations and lengths, there isstill a high degree of homogeneitywithin prices, suggesting aclosely competitive oligopolymarket structure.

The economic outlook forshort ocean cruising

Most commentators agree that asa sector of tourism, cruisingdemand demonstrates con-siderable and continuing growth.Much of this growth involves thedevelopment of demand from newsources, particularly from Asiaand from Europe, and theextension of cruising grounds into

Table 5: Per diem prices for short ocean cruises, 1995(Prices per berth in an outside twin/queen stateroom on a newer,midsize, standard-class cruise vessel)

Operator US$ Operator US$

American Hawaii 251 Norwegian Caribbean 261-335Carnival (liners) 228-252 Premier 224-302Celebrity (liners) 240-293 Princess (liner) 230-300Commodore 232-246 Regency (newer ships) 212-240Costa 199-299 Royal Caribbean (liners) 218-361Cunard (Countess) 268-310 Royal 228-355Holland America 213-286 Sun Line 217-274

Source: Adapted from Schwartzman (1994).


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