MSC Cruises: From One Second-Hand Ship to a Major World Player.

In 1970, Italian Gianluigi Aponte founded the Mediterranean Shipping Company (MSC) with a single second-hand ship and just

$5,000 in capital to move cargo between Europe and Africa. Despite a challenging, price-based competitive environment, MSC has since prospered and grown to become the world's second largest container operator behind Maersk, with a fleet of over 400 ships and operations in 150 countries. MSC ventured into passenger cruises in 1989 with the acquisition of Lauro Lines, a division they would later rebrand as MSC Cruises. By 2003 they had recognized that they could not successfully compete in the growing cruising sector with the low-cost second-hand ship approach that had worked so well in their shipping container division, so they embarked on a substantial new-ship investment program. Today they have 12 new luxury cruise ships in operation and are the world's fourth-largest cruise operator and the leading cruise brand in Europe. They plan to become the world's third largest cruise line by 2025.

Reinvention of the Cruising Industry

Cruise ships were initially designed for overseas transport and were popular for that purpose up to the 1960s, when long-range air travel became more affordable for the broader market. At the time it appeared that the era of mass passenger ship travel was over, surpassed by superior technology of airlines, which were able to provide faster, cheaper, and more flexible travel options. And this was the case for the next 30 years or so, as cruise ships essentially targeted affluent retirees looking for an upmarket experience. While this may be an attractive segment from a profit perspective, the market lacked size and growth potential. For example, in 1990 less than 4 million people worldwide went on a cruise. Around this time, major cruise operators started to consider how they could compete in the broader holiday market. They certainly didn't have the speed advantages or the choice of destinations of airlines, nor did they have the facilities of hotels and resortsso how could they compete? The answer lay in the reinvention of the industry to be halfway between a form of transport and a resort, essentially repositioning cruise ships from transportation vehicles to mobile holiday destinations. This has been delivered over time through the design of new, larger ships that incorporate shops, restaurants and bars, entertainment, swimming pools, waterslides, casinos, movie theaters, and even rock climbing and ice skating. The bulk of the cabins are now constructed on the outside of the ships, where most of them have their own balcony. These resort-style facilities, combined with the experience of visiting several countries during a one-week cruise, help provide consumers with a unique holiday experience that cannot be directly matched by their non-cruise competitors. The result of the industry's transition to essentially be the destination itself is that demand has substantially increased. By 2004 there were 9 million passengers worldwide and an estimated 24 million people

on cruises in 2016. The significant increase in passenger numbers is a result of improved cruise ship facilities, the increased choice of destinations,

the growing word-of-mouth influence of satisfied customers, and an overall reduction in price (ships have become larger, providing greater opportunities for economies of scale).

The Major Players

The other major driver of the cruise industry has been the shift towards a more concentrated market. In the 1970s and 1980s there were around 30 cruise brands. But today 80 percent of the market is controlled by three corporations. For instance, the market leader in the international cruise industry is the Carnival Corporation, which runs 10 brands of cruise ships, including Carnival, Princess, P&O, Cunard and Holland. Across these brands, Carnival operates just over 100 ships, with a combined passenger market share of 48 percent in 2015. Royal Caribbean Cruises is the number two player in the market, and in third position is Norwegian Cruise Lines. MSC Cruises is now the fourth-largest cruise line ahead of Disney, holding 5 percent market share across their ships. Unlike their larger competitors, MSC operates their entire fleet under one brand.

Demographic Segmentation

Effective market segmentation of potential cruise passengers is an effective way to grow market share. In the cruise industry, the

common approach to demographic segmentation is to split the market into five segments; namely, families, singles, honeymoon

or romantic couples, seniors, and the disabled. These market segments have different preferences for the on-board facilities and processes. For example, families seek flexible dining experiences and on-board service and activities, whereas seniors are more price-sensitive (as they are more likely to be regular repeat cruise line passengers) and more interested in entertainment. Singles look for social spaces (bars and cafes)

and group activities. MSC Cruises tends to focus on the family market segment for shorter cruises and the seniors market segment for longer

cruises. And coming from an Italian heritage, they are quite "Mediterranean-inspired," providing more basic on-board facilities

rather than water slides and rock climbing. In order to attract family groups, they offer "children travel free" packages along with kids' clubs and a family games room.

Cruise Pricing Considerations

While the operating profit margin for each cruise line will vary, the average margin in the industry is around 10 percent. As the overall industry revenue is now approaching $40 billion, this means that the total industry net income is around $4 billion. Again, on average, cruise lines only generate around 70-75 percent of their total revenue from passenger ticket sales. The remaining revenue is generated from the sale of beverages, excursions and tours, shop sales, casino gaming, Internet access, laundry services, spa and beauty services, photos, and premium dining and alcohol. As in airline pricing, each cabin on a cruise ship represents inventory to be sold. Due to the high fixed-cost structure and the relatively low cost of an extra occupied cabin, it is in the cruise line's interest to sell as many cabins as possible (much in the same way that airlines seek to sell as many seats at the best possible price). And like most holiday industries, cruising has seasonal demand, with demand higher in the warmer months. Consumers also use a mix of buying approaches, from early planners (who are generally more price-sensitive), to people looking for the "right holiday" (and are less price-sensitive), to last-minute deal hunters. This mix of consumer behavior means that cruise pricing needs to be dynamic. Therefore, for popular high-season cruises, the prices can be increased. But for low-season or poorly booked cruises, special deals need to be offered. One way of doing this effectively (without offering low prices to the entire market) is to offer special deals in certain countries or through selected travel agencies.

The Case for Cost-Based Pricing

Cruise operators typically have a high fixed-cost structure. First there is the significant cost of the ship's depreciation. As the industry

is moving towards larger ships with more facilities, the cost of these newer ships are usually in the range of $500 million to $1 billion, and they are also likely to need major refurbishments in future years in order to maintain up-to-date. Depending on the financial structure of the cruise company

involved, another major fixed cost is the interest expense associated with each ship's capital cost. As MSC is a privately owned company, they do not have access to public equity funds and are more likely to rely on borrowing and profit reinvestment to help expand their fleet. The final major fixed cost is the ongoing maintenance and running costs of the ships. One of their major variable costs is wages. Large cruise ships

usually have over 1,000 staff on board. With around 75 percent of staff members involved in passenger-contact roles such as in restaurants, bars, shops, and entertainment, it is difficult to reduce staff numbers without negatively impacting customer service levels. Fortunately for the cruise lines, they are generally able to keep staff costs down by offsetting wages against the staff's food and accommodation on board.

Other significant variable costs include fuel costs, port, charges, and food and beverage. While these variable costs would be quite substantial, their very high fixed-cost structure is likely to be far more significant given their overall capital investment. This highlights the importance of cost recovery when setting prices for a cruise.

The Case for Competitor-Based Pricing

The Internet has transformed how consumers make decisions, and this is also true of the travel industry. When deciding on a

holiday, consumers are no longer reliant on travel agents and instead use review websites such as TripAdvisor to help guide their decisions. They have a greater affinity for shopping around and comparing deals, making them more price sensitive than ever before. A first-time cruising operators offering similar cruises may be primarily assessed on the basis of price. And not only are cruises competing against other cruise offers, but consumers are also likely to assess their potential holiday choice against indirect competitors such as traditional flight and resort destinations (which are often packaged together as one deal).

The Case for Customer Value-Based Pricing

The third pricing strategy discussed in the chapter is setting prices based upon the perception of value. Since the reinvention of the industry, cruises have tried to position themselves as the destination itself, providing the unique ability to transport customers through multiple countries within the comfort of a floating "hotel" room. Cruises usually offer a completely packaged experience, including accommodation, food, entertainment, shopping, casinos, spas, fitness centers, activities, kid's clubs, and the opportunity to meet new people. This overall package of benefits means that the entire holiday is organized, usually with something for everyone, regardless of age or interests. Obviously, this all-in-one holiday solution would represent significant value for many consumers.

MSC Cruise's Approach to Pricing

Like most other cruise lines, MSC works hard at making the upfront cost of the cruise appear attractive while trying to maximize

their other revenue streams in order to be profitable. They usually promote their cruises using a headline price in their advertising based upon their interior cabins (the lowest priced cabins). As the consumer moves through the booking process, they are offered improved cabin types and improved service packages in order to up-sell the customer to a higher price point. There may be up to 20 different cabin categories,

depending on deck, cabin size, view, and whether they are interior or exterior and mid- or end-ship. This is a similar approach to most other "mass-market" cruise lines (but not the high-end luxury cruises that are less price-sensitive). This creates quite a competitive, and somewhat confusing, set of prices across the various cruise offerings. In addition to the accommodation cost of the cruise, while most meals are included, there is an additional charge for some specialty menu items. Beverages also attract an additional charge, with passengers usually prompted to opt for a drinks

package that is levied at a daily rate. This does not include premium alcohol, which is usually a further charge. Moreover, on most cruise lines, including MSC Cruises, passengers are told not to tip the staff. Instead, there is a daily charge levied on each passenger that is then allocated to all staff members. Additional costs are also levied on passengers for excursions and tours, Internet usage, shop purchases, casino gaming, video games, spa treatments, and so on. Therefore, as you can probably guess, passengers who take on a beverage package, go on tours, use the Internet, and make purchases will have a substantial bill to cover at the end of their cruise. But this situation would not be significantly different if the consumer was staying at a resort. However, some first-time customers may be concerned by this approach to pricing, particularly

if they had thought that virtually everything had been paid for at the start of the cruise.

The Outlook for MSC

MSC has plans to introduce one new cruise ship per year (on average) up until 2025, when they expect to surpass Norwegian Cruise Lines to become the world's third-largest cruise operator. They plan to generate most of their increased market share with an increased focus on the popular Caribbean voyages sector. However, one of the biggest challenges they face is getting their pricing right, against competitors from other cruise lines and from an array of traditional holiday solutions, such as resorts, theme parks, and tour operators. In addition, in today's Internet based world, consumers are better informed and are looking for new experiences and, of course, great value.

Questions:

1. Outline the competitive advantages of a cruise versus a traditional flight-resort holiday package. Which holiday choice would you prefer? Which one would you be willing to pay a premium price for?
2. The ease of comparison on the Internet tends to encourage price-based consumer decisions. What could MSC Cruises do to help take the consumer's focus off price to some extent and consider other attributes?
3. Which of the three pricing strategies discussed would work best for MSC Cruises, given their overall market share growth goals? Why?
4. Review MSC's pricing approach of providing a relatively low up-front price but then relying on additional sales for profitability. Outline the strengths and weaknesses of this approach.
5. Do you agree with MSC's overall approach to pricing? What recommendations would you have for them, particularly as they have a similar pricing structure to the market leaders?