ROYAL CARIBBEAN IN THE MEXICAN RIVIERA. Royal Caribbean is one of the top two North American cruise lines, and one of the

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1 Pricing Project EWMBA 201-A Professor Catherine Wolfram NEEL GANJOO MELANIE HARRIS ALAIN SAMAHA DILPREET SINGH IVAN STANCHEV ROYAL CARIBBEAN IN THE MEXICAN RIVIERA INTRODUCTION Royal Caribbean is one of the top two North American cruise lines, and one of the top four cruise lines in the world. It is publicly owned with almost $5 billion in annual revenue. The company currently operates twenty ships worldwide on more than a dozen routes, with travel ranging from three to fourteen days. The specific focus of this project is the Mexican Riviera line for Royal Caribbean, departing from Los Angeles, CA for a duration of seven nights. The Royal Caribbean ship that serves the Mexican Riviera route is the Vision of the Seas. To serve its 2452 passengers, the Vision of the Seas offers multiple levels of accommodations, ranging form luxury suites with personal concierge services to small inside cabins. The price of the cruise includes specific amenities and activities, such as dinners and fitness centers, whereas other amenities, like shopping and spa services, can be purchased at additional cost to the traveler. QUALITATIVE ASSESSMENT OF MARKET DEMAND The cruise line industry is not a separate entity, but a small piece of the entire vacation industry. The vacation industry encompasses modes of travel, accommodations, activities, amenities, structure of travel, and ease of travel. Because vacation travel is not a necessity, the overall demand within the travel industry tends to be elastic. Due to the

2 multiple substitutes to cruise lines for vacationers, the cruise industry demand is even more elastic than the overall demand for vacation travel. Another important characteristic of demand within the travel industry in general and the cruise line industry in particular is the high seasonal variability of demand. Seasonal variability is mostly due to two factors weather at the destination (and along the route) and the holiday schedule of vacation travelers. Weather at the destination affects the overall quality of the vacation experience and hence its desirability. For example, demand decreases in the Mexican Riviera during hurricane season. The holiday schedule of travelers, on the other hand, affects the non-monetary cost of booking a vacation in terms of vacation days used from work. Thus, demand tends to increase during the holiday season (e.g. Thanksgiving, Christmas). On Royal Caribbean s Vision of the Seas, less than 10% of the rooms are luxury suites. Primarily, the travelers that purchase the luxury suites are less concerned about the price than about the product they purchase. These travelers can afford most, if not all, vacation options, so they are more concerned with their overall experience rather than the cost associated with their vacation. For this small fraction of Royal Caribbean s customers, demand is inelastic. The majority of vacationers travels on a budget and wants to maximize the return on its investment by seeking the vacation options that provide the highest quality of accommodations and range of amenities for the lowest price. This means that these travelers will examine all their options, or substitutes, before choosing the specific type of vacation to take. Thus, the demand is very elastic. For example, a traveler who lives in Long Beach, California may choose to travel on the Mexican Riviera cruise because he

3 lives near the port of departure. In comparison, a traveler from Des Moines, Iowa may choose to fly directly to Cozumel because, regardless of the port of departure, he must fly to the port. However, any specific traveler that has chosen to take a Mexican Riviera cruise from Los Angeles has an option of fourteen cruise lines. In this market, Royal Caribbean s primary competitors are Carnival and Princess, which offer an equivalent range of packages. Because the remainder of cruises focuses on specific small segments of the market or offers a lesser range or lower quality of service, they are not direct competitors to Royal Caribbean on this route. A traveler would specifically choose Royal Caribbean over its main competitors because Royal Caribbean consistently ranks highest in customer surveys regarding variety of activities, food quality, and entertainment options. QUALITATIVE ASSESSMENT OF COST STRUCTURE Royal Caribbean operates the Vision of the Seas using a high fixed and low variable cost structure. The majority of the costs come from the ship operations and business aspects, regardless of the number of passengers on the ship. The ship operating expenses include, but are not limited to, crew, fuel, entertainment, maintenance, and service personnel costs. Many of the business aspects are included in Selling, General, and Administrative Expenses. Other fixed costs relate to insurance premiums and docking/exclusive use fees at the ports of call. The variable costs include food and nonalcoholic beverages, as these costs vary with the amount of passengers on the ship. Commissions to travel agents are also included in the variable costs, since most passengers use agents to book the cruises.

4 The most significant cost is the initial multi-million dollar cost of buying the Vision of the Seas. When Royal Caribbean chooses to sail the Vision of the Seas on the Mexican Riviera, it does so by considering all available options for the ship. That is, there are opportunity costs associated with Royal Caribbean sailing the ship on another route, or possibly selling it to a different cruise line. By choosing to operate the Vision of the Seas on the Mexican Riviera, Royal Caribbean forgoes the opportunity to use the ship elsewhere. The marginal cost to run a cruise on Vision of the Seas is incredibly small compared to the original cost of buying the ship. However, there is a limited capacity for the ship. If the number of passengers stays within ship capacity, there is a negligible increase in cost for each additional passenger. However, if Royal Caribbean chooses to increase capacity on this route from 2452 to 2453 passengers, the marginal cost will include the acquisition and operating costs of another ship. After this, the marginal cost will return to the low level as described above (Figure 1). 500 Cost ($M) (Cap.) Quantitiy (# of Passengers) Figure 1: Marginal Cost for Royal Caribbean, Mexican Riviera Route

5 There are many internal and external factors that can cause fixed costs to change for Royal Caribbean. Internally, Royal Caribbean could choose to change their quality of service. However, it is highly unlikely that Royal Caribbean would choose to lessen their quality as they have a reputation as a high-end cruise experience. Royal Caribbean could reduce costs, though, by training the service personnel to be more efficient and thus reducing the number of service personnel needed each cruise. Externally, fixed costs may change due to rises in fuel prices and increased fees at ports of call. PRICING STRATEGIES Royal Caribbean prides itself on being an upper-end cruise line when compared to its main competitors (Princess and Carnival) on the Mexican Riviera route. By differentiating themselves within the market, Royal Caribbean, like most firms, chooses to maximize profit. Because the marginal cost to run a cruise on the Vision of the Seas (the only Royal Caribbean ship on the seven-day Mexican Riviera route) is approximately zero up to ship capacity, maximizing profits will occur when revenues are maximized. Therefore, the focus of Royal Caribbean s pricing strategy is on maximizing revenue and capturing as much consumer surplus as possible. This assumes that Royal Caribbean will not sail if revenue does not cover the fixed costs. In order to maximize revenue given its capacity constraint, Royal Caribbean employs a second-degree price discrimination strategy based on versioning. Currently, Royal Caribbean s versioning comes in the form of prices based on the customers preference for quality. The company has segmented its cruise package offerings into four progressively priced quality levels including interior cabins, ocean-view cabins, balcony

6 cabins, and luxury suites. Royal Caribbean can effectively use its customers preference for quality as a price discrimination tool because there are significant differences in the quality of the four packages in terms of location, layout, and size of the cabins, as well as differences in the quality of service provided with each package. Travelers who have a strong preference for higher quality are unlikely to switch to a lower quality package despite the significant price difference. Thus, the company is able to capitalize by charging more for each level of quality than it costs to provide that level of quality. Within each of the above-mentioned four levels of quality, there are subcategories. These sub-categories are again priced incrementally depending on location and size. As the travel date nears, the traveler is given the option to select a specific cabin or to pay a lesser price and wait for cabin assignment based on availability within the segment. For example, Ocean-view Room I (deck 2) costs 609$, Ocean-view Room G (deck 3) costs $619, and an Ocean-view Room guarantee (could be on any deck) costs $559. This allows the company to differentiate its customers based on their risk preferences and charge a premium for eliminating the risk associated with cabin assignment. This strategy is based on the assumption that some travelers have a higher willingness to pay to eliminate uncertainty, and it allows the company to capture additional consumer surplus and maximize occupancy. Royal Caribbean also uses peak-load pricing as a strategy. This takes into account the fact that the Mexican Riviera route faces its highest demand in certain periods such as Thanksgiving and Christmas. Because the demand shifts outward at these times, Royal Caribbean is able to charge higher prices than at other times. For example the price of an interior cabin on 12/09/07 is $549 while the price for the same cabin on 12/23/07 is $999.

7 While Royal Caribbean is quite skilled at using multiple complex pricing strategies to maximize revenues, it could consider including some more pricing strategies. Because Royal Caribbean significantly increases its profit with the extra activities and amenities purchases, such as spa days and tours, one strategy it could employ would be bundling of the extras. By bundling the extras with the cruise package, Royal Caribbean can attempt to increase the purchase of a certain number of extras, regardless of the use. For example, a couple may purchase their cruise package and, while on the cruise, they could each buy one massage and half a dozen alcoholic drinks. A potential package that may appeal to this couple may include two tours, two massages, and two dozen drinks. The couple would then pay more than they originally would have if they didn t buy the package, because they are maximizing their consumer surplus with the amount of goods they are receiving in the package. Royal Caribbean benefits, because even though the total price is less than for the total individual prices, it is gaining revenue by selling additional items to the couple as part of the package. Royal Caribbean could adopt another bundling strategy by offering the Mexican Riviera cruise as a time-share opportunity for a premium price. Royal Caribbean can pair up with time-share exchange businesses and increase repeat customers by allowing them to swap trips between the Mexico Riviera and other cruise destinations and/or land-based destinations. This will help maximize the consumer surplus for travelers, as they will be able to purchase many vacations for a lower total price and Royal Caribbean will gain the additional revenue of having multiple bookings. Similar to the airline industry, Royal Caribbean derives a significant proportion of its revenues from selling high-end luxury suite packages (first-class airfare) to affluent

8 travelers. Therefore, pricing this segment is a very important aspect of the company s overall pricing strategy. Due to the limited capacity of and high demand for high-end luxury suites, especially in peak demand periods, travelers frequently face shortages for luxury suites unless they book well in advance. Royal Caribbean can exploit this opportunity by engaging in first-degree price discrimination. This can be achieved by auctioning off the high-end luxury suites and selling each suite to the highest bidder at his/her willingness to pay. SUMMARY Royal Caribbean is one of the pioneers of the cruise industry and has been operating for many decades. Royal Caribbean s experience has enabled it to apply many mature pricing strategies for operating the Vision of the Seas on the Mexican Riviera since its maiden voyage in While Royal Caribbean is a mature company, the Mexican Riviera line has experienced rapid growth over the last few years. Royal Caribbean has successfully competed in the Mexican Riviera route with current pricing strategies, thus it should continue to employ these strategies. When considering adopting other pricing strategies as mentioned above, Royal Caribbean should only do so without sacrificing the quality on which it has built its reputation.

9 REFERENCES 1. Cruise industry overview-2005 FCCA 2. Statement of the FTC concerning Royal Caribbean Cruises, Ltd./P&O Princess Cruises plc and Carnival Corporation/P&O Princess Cruises plc, FTC File No CLIA 2006 Cruise Market Profile, Report of Findings. Peter Ostrowski, April Royal Caribbean, Vision of the Seas ship facts. From 5. Stars At Sea, Cruise Pricing The Facts. June From 6. Vision of the Seas Review. Maria Harding The Independent Traveler. From 7. The Per-Diem Puzzle, Cruise Line Pricing. M.T. Shwartzman, July Cruise travel. From 8. Royal Caribbean Factiva 06-Q2 Company Report. 9. The Contribution of the North American Cruise Industry to the U.S Economy in Business Research and Economic Advisors, August Cruise Tourism and Community Economics in Central America and the Caribbean: The Case of Costa Rica. Andy Seidl et al. 2005