High stakes on the high Seas: bigger ships mean higher profit margins for Miami-based Royal Caribbean Cruises

South Florida CEO, July, 2005 by Jaime Hernandez

Size matters to Royal Caribbean Cruises Ltd. and its CEO Richard D. Fain. The size of the company's ships, that is.

Fain and Royal Caribbean have duked it out for years with longtime Miami-based neighbor and competitor, Carnival Corp., for everything from potential passengers to acquisitions of smaller cruise lines. Carnival always came out on top in those bouts, prompting Royal Caribbean to invest in a new strategy: bigger, costlier ships that carry more passengers ready to part with their money in return for on-board amenities that most other cruise lines don't offer.

Fain says the race is to be the best, not the biggest, but concedes that larger vessels are necessary for Royal Caribbean to be profitable.

"Our ideas are bigger than the real estate," says Fain, Royal Caribbean's CEO since 1988. "We've never set out specifically because we want to build the biggest ship. We just set out to build the best we know how. The larger ship gives us an economy of scale."

So far, the approach is working well for Royal Caribbean, the world's No. 2 cruise line--No. 8 on SouthFloridaCEO's annual Top Public Companies list and No. 30 on the Top Employers List. The company saw revenues jump last year to $4.6 billion from the $3.8 billion it earned in 2003. Net income for Royal Caribbean--which runs contemporary brand Royal Caribbean International and premium brand Celebrity Cruises Inc.--went up from $280.7 million in 2003 to $474.7 million in 2004.

Only rival Carnival--No. 5 on the Top Public Companies List--earned higher revenues than Royal Caribbean: $9.73 billion and net income $1.85 billion for 2004, through its 12 separate cruise lines that operate 75 ships.

Some analysts credit Fain as a major reason why Royal Caribbean has been able to compete with Carnival despite that corporation's massive expansion during the 1990s. Carnival entered the decade flush with cash and with little debt, allowing it to consolidate with several cruise lines, including P&O Princess Cruises plc, Holland America Line Inc., and the luxury Cunard Line.

"They [Carnival] started in a corvette," says Kristoffer Garin, who recently authored the book "Devils on the Deep Blue Sea," which details the cruise industry's rapid growth during the past several decades. "Fain took over [Royal Caribbean] and the company was leveraged to 75 percent of its market cap."

Garin says that after Fain assumed control, Royal Caribbean became more cost efficient, minimizing the amount of freebies given to customers while focusing on offering more value as a way of rending more profit from the thousands of passengers on its ship. Still, he says that while Carnival has the bulk of the market share, Royal Caribbean has an edge because it does not cut corners as much as Carnival Cruise Lines, Carnival Corp.'s contemporary brand and Royal Caribbean's chief competitor.

"Royal Caribbean has always [positioned] its product in a way that critics could argue are much more emotional than bottom-line oriented," Garin says. "They would tell you that those extra investments are indispensable to their brand. It's been a point of pride at Carnival from the very beginning to never give the customer anything they don't pay for."

Under Fain, Royal Caribbean reorganized and offered public shares in 1993. The company merged with Celebrity in 1997 and nearly acquired P&O Princess in 2001 during a bitter bidding war with Carnival. Fain says he also takes pride that the company has introduced some the biggest and elegant cruise ships in the industry. The Sovereign of the Seas, for example, at 73,000 tons was the largest cruise ship in the world when it launched in 1988. Next spring, Royal Caribbean will introduce the Freedom of the Seas, which is more than twice the size of the Sovereign and will be the world's biggest cruise liner.

[Drawing Passengers Onboard]

Like most other leisure industries, the cruise lines were hurt when fewer Americans opted to travel in the months following the Sept. 11, 2001 terrorist attacks. To make matters worse for Royal Caribbean, the company had several ships on order when the attacks occurred, says John Maxwell, an industry analyst for Merrill Lynch in New York. Royal Caribbean spent nearly $2 billion on new ships in 2001 and 2002, money it had a hard time recouping after the attacks.

Since then, the company has seen its net income increase and shipbuilding debt decrease. Maxwell says Royal Caribbean spent $1 billion on ships in 2003, $630 million in 2004 and will spend about $400 million this year. Its Royal Caribbean International line currently has 19 ships with three more expected by the end of 2008, while the Celebrity line has 10 vessels and no plans to add more.

Industry observers say cruise companies are shying away from incurring debt and instead are using cash to pay for new liners. That is possible now that demand has rebounded. Cruise Lines International Association (CLIA), an industry trade group, recently reported more cruise travelers than berths. Royal Caribbean alone reported an occupancy rate of more than 105.7 percent for approximately 61,000 berths in this year's first quarter. The demand helped prompt the company to send its Enchantment of the Seas to the Netherlands in March to undergo a $60 million expansion project. The 8-year-old ship was literally cut in half to make way for a new, 73-foot midsection that will add 151 staterooms.