The Business of Cruising

THE TRUTH ABOUT THE CRUISE BUSINESS WITH AN UPDATE ON CRUISING AND COVID-19

It has now been five plus months since this article was first posted and as of October 20th, 2020 only very limited cruise itineraries have begun. Currently four ships are now cruising in the Mediterranean, cruises to nowhere are just being scheduled out of Singapore and Australia and the American CDC, under pressure, has indicated it will not extend the “do not sail” order past November.

An estimated 15 million people annually take cruises on 23 ocean cruise lines that have experienced incredible business growth year over year. Analysts saw no reason why this trend wouldn’t continue and the primary marketing emphasis has been on luring new customers to cruising rather than taking away market share from other cruise companies.

In the first quarter of 2020 everything changed. A global pandemic moved across the planet with unprecedented speed. Nation after nation closed their borders and ports. While cruise ships were in no way responsible for any real spread and onboard outbreaks left ships more victims than perpetrators, the public relations was and is disastrous. Even if no one is talking about it, the cruise industry will probably never be the same.

As the United States and other countries take drastic measures to financially protect their businesses, industries and citizens, the cruise industry finds itself boxed into a corner. Much of the financial success of cruise companies, rightly or wrongly, has been based over the past fifty years on a maritime, international model. That model now represents its’ largest current threat.

Following are some detailed descriptions on a number of topics regarding how the cruise industry evolved over the past hundred years that include:

A History of How Flagging Ships in Foreign Countries Began
The Advantages of Flags of Convenience
Business Versus Social Needs
The Low Wages Issue
Legal Liability Issues
Safety and Regulation
The Financial Situation and the Future
Changing the Practice of Flags of Convenience
Where Does Help Come From

History

Cruise lines have avoided U.S., British and other countries’ laws and regulations for a long time. Starting in 1920 two U.S. ships, the M/V RELIANCE and the M/V RESOLUTE, ‘re-flagged’ in Panama in order to avoid the U.S. Prohibition.

Rules governing ships at sea come under The International Maritime Organization of which the United States is a member. It requires all ocean ships engaged in international trade to have a country of registry in order to sail in international waters. A ship is considered the territory of the country in which it is registered. The wording “country” pertains to any country, developed or underdeveloped, and under maritime law, ships are the territory of that country and subject its’ laws and regulations.

Over the past fifty years, virtually all cruise ships have been “flagged” in smaller countries like Panama, Liberia, Malta, and the Bahamas. A vessel’s country of registration is commonly referred to as the “flag of convenience”, saving cruise companies taxes, avoiding strict labor laws and providing favorable court venues.

The Overall Benefits Of Flags of Convenience

Cruising is a unique industry and, using flags of convenience, has actually been a benefit to a diverse number of people including employees, passengers and the companies themselves. The usual criticism is that flags of convenience allows payment of subsistence wages far below what is fair. There is also the issue that passengers are not protected by having the option to seek legal remedies in their home courts. In both of these, the truth is much more complicated than it would seem.

Business and Globalization

The first obligation in operating any business in a free market is to return a profit to yourself or your investors and the process involves lowering your costs and expanding your sales. All businesses small and huge pursue that course and at times their goals do not match the needs of society as a whole. The primary way to keep a balance between the goals of a business and the needs of a community is through laws and regulations. This involves everything from local business licenses to international treaties.

The globalization of business has been a huge benefit to many people worldwide. Businesses in developed nations have benefited greatly from using off-shore manufacturing to reduce the labor component of their products. This allows them to reduce selling prices, benefiting their customers, while increasing profits. Labor in less developed countries has also benefited with more jobs, increased wages and an improved standard of living. While there are always problems, trade-offs and abuse, overall, the world has become a better place because of international business.

The Cruise Wage Issue

The cruise industry does not sell a physical product but instead is based primarily on providing an all-inclusive service. In order to do that, one of their significant cost areas is associated with labor. Just like manufacturing industries, the cruise business relies on less expensive labor from all over the world. The difference is you don’t see the people that make your electronics, shoes and clothing but on a cruise ship you get to know them. It is unfair to suggest that they are paid slave wages. The truth is, cruise companies usually pay above prevailing wages in the countries where they recruit staff and while work hours may seem excessive, they are usually better than work hours and conditions back home.

If you talk to cruise ship staff you will find people from over fifty countries and a surprising number that have worked for the cruise lines for many years, renewing contract after contract. It is that flag of convenience concept that allows those employees to work at all. By Western standards they work long hours for little pay. Fifteen hour days for $1,500 to $1,800 a month (with free room and board) is not uncommon, but, compared to wages and working conditions back home, many consider themselves lucky to have these jobs.

It is that flag of convenience labor arrangement that allows for a reduced price of product. If all the cruise companies were required to flag their ships in a major Western country, the cost of an average cruise would probably double. Higher prices would reduce the number of potential passengers by more than half while seriously impacting employment and income in dozens of less developed and third world countries.

Legal Liability Arguments

With more than half of passengers being American, the legal rights and remedies of U.S. passengers are, in fact, reduced because of flags of convenience. This is primarily because most ticket/passenger contracts are written under the registering country’s laws and can include limited-liability clauses that are no longer supported in the United States and many Western countries. Under international maritime law, those clauses are usually enforced in courts of the registering country. Regardless of the attempted litigation location, the majority of courts worldwide still relinquish jurisdiction to maritime laws and those nations of registration.

There are two reasons why this isn’t as serious a problem as many critics will claim. First, most major cruise companies are well aware of the potential public relations impact of seeming insensitive to perceived wrong doing and the media seems always out there waiting for a cruise ship tragedy story to emerge. Second, Western countries are always examining how cruise companies use or abuse the flag of convenience status. In the United States, the courts have been stretching their interpretation of maritime law and jurisdiction in recent years. If cruise companies flagrantly evade reasonable responsibility it could bring on governments’ rethinking maritime law and the flags of convenience policies.

Much of the criticism and notoriety is driven by litigation law firms seeing cruise ships as a potentially huge liability litigation opportunity. If ships decide to start reflagging their ships in major Western countries, the cost of new civil actions could be significant.

Safety, Regulations And Inspections

While there are a lot of criticisms about cruise companies and their ships evading laws, that is not the case in a number of areas. While cruise ships may be considered territories of specific countries and their laws, their ability to sail within the waters of major nations does make them subject to other regulations. Along with international treaties and maritime laws, ship safety, food safety and environmental mandates are all overseen by the governments of cruise ports frequented by ships. Lifeboat requirements and safety drills are required by a number of laws and Coast Guard inspections are common. Often there are regulations covering the qualification requirements of specific crew positions.

How the Pandemic Could Change the World of Cruising

The 2020 pandemic has turned the economies of most of the worlds countries upside down. Governments have forced whole segments of their economies to shut down. After weeks and months of being closed, countless businesses could be devastated, even if the governments offer assistance. In the United States, the administration and government are promising to help major, important businesses but, in the case of the cruise companies, much of their operations have been outside of the country and its’ laws. There are already arguments suggesting that if this industry wanted to operate outside the reach of the government, maybe they are outside of the government’s responsibility as well.

Considering the magnitude of the current financial crisis how much financial reserves do these cruise lines have? Available financial information for one large cruise corporation looks like the following:

2017 10K Filing – Annual Amounts – (Monthly Amounts)

Total Revenue $ 8,780,000,000 ($ 731,500,000)
Total Costs $ 7,153,000,000 ($ 596,060,000)*
Net Income $ 1,625,000,000 ($ 135,428,000)
Total Assets $ 22,295,000,000** Includes Capital Leases
Total Debt $ 7,539,500,000
2020 Cash Reserves $ 243,740,000 (first quarter)***

*Without having access to more financial information this is only an approximation. At full operation monthly costs are around 600 million dollars. In a complete shut down by reducing fuel, provisions and furloughing employees that could be reduced by 40-60%. The company would still be faced with significant operating expenses like servicing debt, headquarters and ship maintenance and operating costs.

**The assumption has to be that a significant percentage of this amount is actually the current value ships. In a market going forward where demand gets reduced by 50% (estimate) the asset value will be seriously impacted and selling ships would probable not be possible.

***This is a current dollar amount which indicates that in a total shutdown those cash reserves would last for one to three months. After that the corporation would be facing defaults on its debt.

The problem is that one has to assume that a major portion of those assets are actual cruise ships. The value of any physical asset is based principally on its ability to generate revenue and resale (liquidation) value in the marketplace. That depends less on their cost to build and, in the case of cruise ships, more on the market and people wanting to continuing booking cruises. Additionally, with a major monthly loss in revenue, cash reserves will vanish quickly.

Everything depends on how quickly cruise schedules can restart and how eager people will be to return to cruising and how soon. Additionally, there are a significant numbers of people holding credits from canceled cruises to be used for future cruises that will reduce monthly cash flow for a while going forward, even if cruising returns to normal booking levels. It would not be surprising to see some companies fail over the next six to twelve months and, at the least, see a number of ships removed from service.

The Thinning of Cruise Fleets is Now Well Underway

October 3rd, 2020 Cruise ships are going to salvage and scrapyard – Turkish workers are currently working overtime to salvage from five cruise ships for scrap metal (below). Among the ships is the Carnival Fantasy, a just refurbished cruise ship along with the Carnival Imagination.

A photograph by REUTERS/Umit Bektas shows three Carnival and two Pullmantur ships in a salvage yard in Turkey. The two Pullmantur ships are the old Royal Caribbean Monarch of the Seas and Sovereign of the Seas sold to Pullmantur just three years ago.

A Cruise Industry Without Flags of Convenience

In the world of cruising there is one ship that demonstrates what eliminating the flag of convenience policy would look like. NCL flagged The Pride Of America in the United States in order to allow it to cruise the Hawaiian Islands. This ship must follow American labor laws and regulations which means the number of hours the crew can work is regulated, pay must meet minimum wage and other U.S. payroll requirements and, additionally, the crew must meet legal requirements to work in the United States.

There are two major consequences of meeting the flag requirements of the United States. The first is the cost of the cruise. On average, a seven day cruise on The Pride Of America costs about twice as much as other NCL seven day cruises. With those sort of price increases how much of the market will no longer see a cruise as financially justifiable?

The second is level and quality of service. While this is a subjective measurement, a number of cruise ship surveys regularly rate The Pride Of America’s service one to two stars lower then the NCL fleet average.

So what you get is a lower quality experience at a significantly higher price. Cruising’s success has been based on a number of factors, but affordability is probably the biggest. Vacation competition includes theme park destinations, all-inclusive resorts and land tours and, dollar for dollar, cruising has consistently been the winner.

Where Does Help Come From

Without some outside help providing cash infusions and significant numbers of people making cruise bookings again, there will be rough seas ahead for this industry.

Throughout the pandemic, cruise ships have been more the victims of hysterical actions taken by local and national governments than a real health threat. Air travel was probably the primary source of worldwide spread of the coronavirus. Cruise ship passengers in too many highly publicized situations were subjected to panic decisions by a number of health agencies that resulted in the amplified spread of the virus onboard in the general populations and a number of deaths. Public opinion has been changed by sensationalized reporting about cruise ships, thus leaving in its wake a public relations nightmare for the industry. After the coronavirus pandemic is over that will still be the case. The real hope for saving many companies in the cruise business is for avid cruisers to come back in large numbers and come back quickly, even at the cost of paying higher prices. The cruise business gained in popularity because it offered a great value in an all-inclusive vacation with the bonus of traveling to distant locations. In that regard – nothing has changed and it will improve but how soon?