Inflation and high interest rates: Cruise industry shows resilience in macroeconomic turbulence
By Kari Reinikainen
In the recent past, inflation has hit multi-decade highs in many countries. In an effort to curb this, central banks have raised interest rates to levels last seen before the financial crisis of 15 years ago. In this challenging context, cruise industry has once again shown its resilience.
In principle, higher interest rates might lead to a situation where contemporary cruise-market consumers curtail their spending. At the same time, those at the upper end of the wealth bracket might benefit from higher rates in the form of better returns on savings. The reality is more complicated.
Real household income, which takes into account the effect of inflation, certainly has suffered from escalation of prices. As OECD figures show, income contracted in both OECD and G7 countries last year, whereas in 2021 it still showed an increase.
While the effect of rising inflation is obvious in the 2022 figures, 2021 figures benefited not only from lower inflation but also from various measures that governments had in place to help people financially during the Covid-19 pandemic.
All this might bode ill for the contemporary and perhaps even the premium market segments of the cruise industry. But there are at least two other powerful forces in play, and so far these have worked in favour of the industry: a change in consumer behaviour, and cruise lines’ yield management techniques.
Jason Liberty, CEO of Royal Caribbean Group, said in the first quarter 2023 conference call that consumers continued to shift preferences and spending from goods to experiences, resulting in a strong entertainment and travel spend.
“This trend continued in the first quarter, where spend on experience was 24 per cent higher than 2019 and double the spend on goods. Further, our research shows that consumers plan to continue prioritising leisure travel over other spend. Our addressable market is plentiful and continues to be meaningfully larger than it was in 2019,” he said.
Edwina Lonsdale, managing director of the London-based agency Mundy Cruising, which focuses on the upper end of the market, said that the bottom line was that strong financial markets benefited those who had wide-ranging investments.
Those who have been fortunate and hard-working enough to accumulate sufficient wealth to support themselves in their later years have, in most cases, included a travel budget, which takes priority in the early and pre-retirement years.
“This magic spot is the time when mortgages are paid off, children have completed college and are – hopefully – self-sufficient,” she told CruiseTimes. “The potential travellers have more time because they are stepping back from their businesses, they are fit and healthy, and above all they have a sudden sense of urgency as they recognise their mortality: their parents become frailer and pass away, their friends begin to get ill, and they realise that all the ‘one day’ trips suddenly need to be now.” Lonsdale added that the pandemic had heightened this sense of urgency, and now we are seeing plenty of once-in-a-lifetime trips being booked.
Complicated picture
With many different factors in play, it is difficult to point out exactly what effect each one has on the cruise market, according to KfW IPEX-Bank, a German lender to shipping businesses. Evidence suggests that brands at the upper end of the market and those with more focus on the US source market are faring best in the current environment.
“Generally, we don’t see inflation as a substantial threat for the cruise lines,” the bank said in response to CruiseTimes’ written questions. “From our point of view, the demand side still shows a positive development in the overall cruise market, with several brands which are able to return to the pre-crisis booking levels and often even stronger prices.”
But in practice it is not so clear-cut. “The precise impact of the inflation is impossible to analyse, as simultaneously catch-up effects after Covid still have an influence, and in certain regions customers still book much later compared to pre-Covid. Therefore, booking developments are more difficult to analyse,” continued KfW IPEX. “The overall development is not homogeneous. We see products in the luxury, premium, and upper contemporary segment (especially in the North America source market) seem not to be substantially impacted by inflation. Products with a lower target price, which focus on the mass market, especially in the European source market, show a softer development.”
So the picture is rather complicated. “It could be assumed that inflation might have a higher impact on products in the budget segment or lower mass contemporary segment, and that inflation has a different impact in Europe than the USA. It could be assumed that, without the current substantial inflation level, in 2023 nearly all cruise brands would reach or exceed their performance of 2019,” the bank concluded.
Multiple causes
In these turbulent economic times, multiple impacting factors intersect, and in the midst of the storm it is difficult to clearly assign the causes and effects for the cruise industry:
- Inflation levels are accompanied by a drop in unemployment (to an all-time low in Europe, and to a lesser extent in the USA), which increases the number of potential customers.
- At the same time, salaries increase, and significantly or partially offset inflation.
- The higher the income, the less inflation impacts the household budget. High-income households are also those that benefit most from key rate hikes, because they are positively exposed via their investments.
- Possible projection for the coming decade is that the low-cost-mass-demand segment will erode and be replaced in value by more upmarket clientele, but not on the same ships, and not with the same cruise products.
- The costs of flights, often necessary to get to the port of embarkation, are reputed to be 20 per cent higher than the pre-pandemic level. This certainly affects package price and, indeed, demand.
The message is largely the same from Mark Ittel, partner and senior vice president of ports and maritime at Bermello Ajamil & Partners, another cruise industry consultancy firm. “Based upon the recent quarterly earnings calls, there seems to be little negative impact on the demand side of cruise overall,” he said. “However, there are multiple cruise market segments with a larger range of ticket pricing that may see some variations in demand due to the current economic situation.”
Industry players have maintained a good track record of performance during economic downturns, as they can adjust cruise length, ticket pricing, and so on, and their nimble business model is beneficial in this environment.
“It is more difficult to predict how the luxury/expedition cruising segment will perform, as they have a smaller overall demographic, but generally these are not individuals with fixed incomes, et cetera. So, as referenced, they should continue to do well financially with higher interest rates in various markets, allowing for little impact on cruise travel,” said Ittel.
Recession resistant
Shannon McKee, president of the Miami-based marketing and sales consulting group Access Cruise, Inc., which specialises in product and business development in the cruise industry, pointed out that, for years, the cruise industry had been considered recession resistant.
“Despite the unfortunate circumstances during the global pandemic, I still believe this to be true,” said McKee. “I wouldn’t say they are completely recession-proof, but they certainly fare better than the land-based hotels and resorts.”
It is widely believed that cruising continues to be the best-value vacation regardless of whether you are sailing with a contemporary or luxury brand. Having so much included in your ticket price, such as food and activities, provides a vacation value that can’t be matched through land-based venues.
Luxury cruises offer just as much value as the contemporary brands for the level of service and amenities received. While the onboard spend on certain services and some luxury goods may fall, due to inflation, the cruise ships still have the appeal of value to fill their cabins.
“If you listen to the earnings calls, the large cruise conglomerates are filling their cabins, especially with their contemporary brands,” said McKee. “The top four major conglomerates account for about 85 per cent of the cruise capacity. I suspect their revenue management teams are very busy, diligently working to price according to the market demands.”
Alexandre Poisson, senior consultant at Yield Tactics, a French specialised consulting boutique firm serving airlines, rail companies, and cruise lines, among others, said: “We do not see direct correlation among inflation, interest rates, and cruise demand. First of all, in the cruise industry the average price levels are the result of a confrontation between supply and demand according to the precepts of yield management. In the USA, certain indicators, such as the Fred St. Louis Producer Price Index for Cruise Bookings, even suggested that prices could have returned to the levels of 2012.”
Sophisticated methods
Aside from the appealing product offering, recession resistance, and strong demand, the industry’s resilience can also be attributed to its increasing emphasis on revenue generation and price discrimination techniques.
Cruise lines use sophisticated methods to drive revenues, according to Aidin Namin, who, together with Dinesh Gauri and Robert Kwortnik, wrote the 2020 paper “Improving revenue performance with third-degree price discrimination in the cruise industry”, published in the International Journal of Hospitality Management.
They noted that, in general, price discrimination came in three degrees. First-degree price discrimination was common in revenue management practice, whereby a supplier set different prices for the same product based on consumers’ willingness to pay, such as different prices for economy-class airline seats, depending on when the seat was booked. With second-degree price discrimination, also known as self-selection, the supplier set discounts based on options offered, such as a group booking a large number of hotel rooms. Third-degree price discrimination involved offering different price levels to consumers based on the groups to which they belonged, such as members of a loyalty programme.
“Applying a finite mixture modelling method, analysis of proprietary customer data from a leading cruise brand unveiled hidden segments of consumers based on their individual attributes and illuminated the ways they make their purchase decisions,” the authors wrote.
Using a state-of-the-art latent class technique, this study identified two classes, or segments, of cruise consumers and revealed their demand patterns for this short-lifecycle product. The findings highlight the opportunities for cruise companies to implement third-degree price discrimination by using extant customer data.
The analysis suggests, for example, that travellers who are single, female, or living farther away from cruise embarkation ports can be enticed by discounts on high-tier cabin types earlier in the cruise booking window. Such a pricing policy targets a travel segment of growing importance and would enable the cruise company to lock-in demand for this group who might otherwise delay their purchase in the hopes of getting a better price later.
This pricing approach underscores the role of timing in implementing third-degree price discrimination policies. It would help the seller to motivate earlier purchase of higher-tier or more expensive cabin types, potentially generating a sense of “out-of-stock” urgency among other buyers, who would then be more likely to accept higher prices for these cabin types.
“Similarly, analysis of the findings suggests that this cruise line might offer price promotions/discounts early in booking periods on lower-tier cabin types for buyers who are male, married, or those who live close to embarkation ports,” the authors wrote. “This pricing tactic would have the advantage of balancing the traditional top-down booking of different cabin types on a cruise ship. That is, in general, expensive cabin types sell out first, so offering small discounts for buyers with these individual attributes would help the seller to stimulate demand for lower-tier cabin types earlier in the booking window and subsequently reduce supply for late bookers who would need to increase their reservation prices to obtain scarce inventory.”
Continued recovery of the demand side remains crucial for the cruise industry, as it has billions of dollars committed to newbuildings on order and in the form of debt that needs servicing. That the industry has fared so well in the face of the macroeconomic turbulence is a testimony to its resilience. If Royal Caribbean’s conclusion that consumer spending has shifted from goods to experiences is correct, the cruise industry could be quite well positioned to weather future storms, too.
