Distribution issues slowing cruise growth in China

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Royal Caribbean's Ovation of the Seas in Tianjin, China.
Royal Caribbean's Ovation of the Seas in Tianjin, China.

While the world grows more anxious over the growing possibility of a trade war between the U.S. and China, the bigger issue for cruise lines sailing out of the world's most populous country isn't tariffs or technology transfer. Their bogeyman is distribution restrictions.

International cruise lines are increasingly frustrated with the limits on how their products can be sold in China.

While in most parts of the globe, cruise lines can sell their voyages retail through travel agents, in China they've been funneled into chartering their vessels to wholesalers that are then responsible for filling the ships.

"China is a B2B market much more than a true consumer market," Carnival Corp. CEO Arnold Donald said in a recent conference call. That means most of the communication and marketing to customers is out of the cruise company's control.

In a speech in March in Shanghai to about 300 Chinese travel agents, Ken Muskat, CEO of SkySea Cruise Line, said that the Chinese market is being held back by its reliance on the wholesale model.

"Are we going to stay status quo or hit 4 to 5 million passengers?" Muskat asked the crowd. "Cruising won't go away, but will it grow?" 

Muskat said that to stimulate more cruise business, other channels of distribution must be exploited.

At SkySea, which is partly owned by Royal Caribbean Cruises Ltd. (RCCL) and recently announced it is shutting down for unrelated reasons, the move was away from 100% charter and toward working with smaller agencies, Muskat said.

"You need to embrace the evolution of distribution so you don't miss out," he told the agent group.

Suboptimal growth and a lack of connections to customers aren't the only problem with the charter sales model.

Donald said that when a charter contract is booked, the cruise line recognizes 100% of the revenue on its books immediately, even though the actual sailing might be months away.

"Now, when they book that full-ship charter with us, there may have been no guest booked at all," Donald said. "And so you are recording a 100% in January for June sales."

But because of their clout, the charter companies are allowed to come back after the sailings and renegotiate the price if their own sales didn't meet expectations. Among other things, that makes business forecasts unreliable.

"Even though you recorded it, then there's claims and credits on the back end," Donald said.

That problem was evident in 2017. Many cruise lines chartered their ships early in the year on the typical short itineraries from Shanghai that travel to Korea and southern Japan. But in March, the Chinese government began discouraging travel to, and business dealings with, South Korea in response to the country's installing a new U.S.-built missile defense system.

For six weeks in March and April, new charter business dried up. Meanwhile, itineraries that went only to Japan were in less demand, forcing wholesalers to lower their prices to fill the cruises.

So the charter companies asked the cruise lines to rework the charter price, lowering the cruise industry's profits from the China market last year.

International cruise lines have been sailing from China since Costa Cruises began selling there 2006. At the time, there was barely any model for cruise sales. Travel outside China for most citizens had long been highly restricted.

As a result, the distribution system for such travel was undeveloped, limited to a few state-owned enterprises (SEOs) that the government controlled. Today it is still dominated by those SEOs plus some very large OTAs in China's larger cities, sources said.

Zinan Liu, president of RCCL's China and North Asia Pacific Region, said the wholesale model is probably the most efficient one at this time because it gives agencies exclusive access to the inventory and the market power to sell at higher prices.

"The bulk purchase of cabins also enables charter agencies to negotiate sizable shopping commissions with tour operators which are an additional revenue stream," Liu wrote in an email. "Consequently, cruise lines can also get higher yields because of revenue sharing with trade partners."

However, Liu added, "As capacity grows, the wholesaler system is problematic, as it may not achieve the penetration as much as a retailer system."

Royal Caribbean International, like other cruise lines, is trying to reduce its reliance on wholesalers. In a November conference call, Royal president Michael Bayley said the line was quite pleased with the results of new direct-sales efforts and that progress had been made in expanding the base of sellers beyond the traditional wholesalers.

Norwegian Cruise Line is also pursuing direct sales after receiving a license to do so in November. In a conference call, Norwegian Cruise Line Holdings CEO Frank Del Rio told analysts that having a channel where the cruise line has more control over pricing "would be a good thing."

Norwegian is also selling cruises in China through a partnership with Alibaba, the Chinese version of online retailer Amazon.  Del Rio said Alibaba alone controls some 83% of online purchases in China, adding that the Alibaba partnership will be particularly helpful in targeting pitches to guests willing to pay more to go on a cruise.

Cruise lines are also moving to break down the charter model into smaller pieces. Carnival brands in China, rather than charter entire ships, are beginning to work with travel agencies that will sell large groups.

With that model, Donald said, Carnival can forecast better because it only has to recognize 10% of the revenue initially, with the rest coming as the group is activated. "We think overall it gives us greater clarity," he said. "It lowers the risk, the concentration of risk."

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