Chapter 3 Norwegian Cruise Line

How “Made for China” Fails

On a cold and humid winter day, Carol Zhao, a travel agent from Shanghai, received an invitation to a party in Miami. She flew across the Pacific Ocean and arrived at the dazzling three-story beach mansion. There, the mansion’s owner, Frank Del Rio, president of Norwegian Cruise Line (NCL), and NCL’s executive team were waiting for her and her peers from China’s tourism sector. NCL was aiming for the booming Chinese market and planned to send a customized cruise ship there to grab a share. It thus gathered a delegation of leading Chinese travel agents, whom Del Rio referred to as “partners,” and sought input from them.

Apart from NCL’s hospitality, which included air tickets, accommodations, and wining and dining (rare treatment from an international cruise company), what struck Zhao most was NCL’s determination. She remembered what Del Rio said: No matter how tough it got in China, NCL would work with its partners to get through it.¹ That was 2016.

Fast-forward to February 2018: Del Rio brought encouraging news at the company’s quarterly earnings call, and despite a difficult environment, NCL had reported a profit. “We remain optimistic that the vast opportunities possible in China will come to fruition,” he said.²

Yet only a few months later in July, NCL decided to move its cruise ship Joy out of China, just a year after the ship had arrived. The news shocked the cruise industry.

A Latecomer’s “Weapon”

NCL started cruising from China in 2015. After years of planning, it set up a China branch, headquartered in Shanghai, with offices in Beijing and Hong Kong. By then, the market was crowded. Costa Cruises had entered in 2006 as the first international cruise line, followed by Royal Caribbean three years later. By the time NCL arrived, rivals had been dispatching their ships from Chinese ports for years. Undeterred, Del Rio saw advantages to being a latecomer. “It is no secret that the early entrant lost money here for many, many years because there wasn’t an established marketplace,” he said. “So if you’re astute and observant you learn from past mistakes, and we hope to learn from past mistakes, not repeat them.”³

One rival in particular offered a host of lessons: Royal Caribbean was intent on dominating the market. Unlike other cruise lines, which often sent smaller, older ships to China, Royal Caribbean entered with Legend of the Seas, which accommodated nearly 2,000 passengers, making it the largest cruise ship in China at the time. Its arrival created a sensation. Two years later, Royal Caribbean brought in Voyager of the Seas and Mariner of the Seas, both even bigger. Two years after that came Quantum of the Seas, a then record-breaking behemoth. Royal Caribbean bragged that the ship was longer than five Boeing 747s,⁴ parked nose to tail. Coupled with its heavy spending on marketing, Royal Caribbean’s China fleet set the company apart. Though it entered China behind Costa, Royal Caribbean enjoyed better brand recognition.

Inspired by Royal Caribbean, NCL set out to build a new ship that wasn’t just large but also customized for the Chinese market. It was built by Meyer Werft, a German shipyard known for constructing spectacular ships, and designed to accommodate 3,883 passengers. To cater to Chinese tastes, the ship boasted special features. On its topsides was 333-meter-long artwork depicting a phoenix, designed by a Chinese professor from the prestigious Central Academy of Fine Arts. Inside, it provided suites for extended families. “You know the one-child policy,” said Del Rio. “Often you have that child’s parents and grandparents. So we built different cabin configurations for that kind of situation.”⁵ The ship had 60% more retail space than was typical, because of the Chinese people’s reputation as eager shoppers. Around 50 luxury brands, including Bulgari, Gucci, Prada, and Armani, awaited passengers on board. The ship had three casinos, a laser-tag course, and the first go-kart track at sea. Other features aimed to replicate Chinese culture. These included teahouses, karaoke rooms, gaming rooms with mahjong sets, and Chinese restaurants.

NCL also tried to accommodate Chinese consumers’ aversions. The Chinese, for example, are not sunbathers. So NCL reduced the size of the pool deck and turned that area into a “tranquility park,” filled with faux grass and trees, where tai chi and yoga were offered.

With all of the costly customization, the Joy embarked with high expectations. Harry Sommer, NCL’s executive vice president for international business development, called it “the premier ship in China” and predicted it would “command the highest prices.”⁶

Smooth Sailing

While the ship was under construction, NCL managed to acquire a license from the Ministry of Transport in just a few months. The government in Shanghai awarded a tax reduction. The entry permit and preferential tax treatment came easily not because China wanted to curry favor with NCL but rather because of how badly the country wanted a cruise industry.

Cruising in China had barely existed before 2006, when Costa Cruises sent in its Allegra. Since then, the market had grown at an astonishing rate, as much as 40% annually. Between 2012 and 2016, the number of passengers surged from 216,700 to 2.1 million.⁷ These passengers mainly traveled on ships owned by international companies like NCL and Costa.

Though China had mastered the construction of aircraft carriers and battleships, cruise-ship building was not among its competencies. Only in 2018 did the China State Shipbuilding Corporation, the country’s largest shipbuilder, form a joint venture with Carnival to develop China-built ships. A few Chinese companies had bought cruise ships elsewhere to test the waters, but a lack of knowledge and management skills often impeded their growth. As a result, the industry remained dominated by foreign lines. “It’s not enough to just have some cruise ships and salespeople to get travelers on your ships,” said Weihang Zheng, general secretary of the China Cruise and Yacht Industry Association. “To run a cruise line, there is a whole system to learn.”⁸

The central government had been encouraging the development of the cruise industry. Its 13th Five Year Plan had included the cruise sector, and Premier Li Keqiang had advocated for the industry several times. Local governments along the coast, including those in Shanghai, Tianjing, and Guangzhou, had built ports, improved infrastructure, and developed preferential policies in hopes of attracting cruise ships.

NCL set up its Shanghai office in October 2015. David Herrera, a senior vice president, was sent from Miami to oversee it. The company hired Alex Xiang from Royal Caribbean to lead the sales team. Xiang said he was drawn to the company’s culture. “They value family,” he said. “It came from Frank’s Cuban heritage, and it’s definitely compatible to the Chinese culture.”⁹ Del Rio was born in Havana and left Cuba with his family at age seven. He married his high school girlfriend, Marcia, who also had emigrated from Cuba. An accountant by training, he started Oceania Cruises with a used vessel and 20 employees—eight of whom were family members. He had grown the company into a fleet of six ships, capable of carrying 5,300 passengers, when it was acquired by Norwegian Cruise Line in 2014.¹⁰ He then became NCL’s CEO.

Xiang, reflecting on his time at NCL, believed the culture created a work environment that enabled NCL to operate flexibly and adapt quickly to changing market conditions. (He’d end up being proved right, but not in the way he imagined.) Another trait that struck him was NCL’s “partner first” attitude. That came from a lesson Del Rio had learned from Renaissance Cruises’ bankruptcy shortly after September 11, 2001. As the chief financial officer and then co-CEO of Renaissance, Del Rio knew the cruise line had marginalized travel agents. He now regarded them as a lifeline.¹¹ In China, where travel agents are responsible for over 85% of ticket distribution, that view dovetailed with market realities.

Zhao, director at China International Travel Service, saw firsthand how serious Del Rio was about cultivating relationships with agencies like hers. She recalled offering suggestions on customizing a Joy restaurant to fit Chinese customers’ tastes. A year later when the ship arrived in China, she and her peers found that many of their ideas had been implemented. “It’s hard to imagine any other cruise line would do this,” she said.

To prepare for Joy’s arrival, NCL increased its team in China to 60 people. It also abandoned its no-ads-in-Asia policy, running spots on TV as well as posting ads in busy subway stations and elevators of high-end office buildings. It sought out endorsements from Chinese opinion leaders and became the first cruise company to use WeChat, China’s dominant social media platform, to promote a cruise ship’s arrival.

In a particular coup, it landed Leehom Wang, a Chinese American pop star, as Joy’s “godfather.” Del Rio thought Wang’s international profile matched the image NCL wanted to project with Joy, a ship designed to combine features of the East and West. Whether Joy achieved what Del Rio envisioned is debatable, but associating Wang with the ship turned out to be a coup. According to Zhao, with several foreign ships docked in China’s ports, many customers couldn’t remember either “Norwegian” or Joy, despite NCL’s many ads. Some would simply ask for tickets to the ship where “Leehom Wang is the captain!”

For further marketing, NCL partnered with ecommerce giant Alibaba. Alibaba’s mobile payment tool, Alipay, was integrated into the shops on Joy. This made shopping on board easier than on competing ships. Elsewhere, Chinese customers had to use either a dual-currency credit card or cash to shop, given that all the transactions were completed in dollars. NCL also offered an Alipay-only discount and did a preview cruise for 1,700 VIPs and guests from Alibaba. “Many of them were Alibaba’s platinum store owners,” Xiang said. “They livestreamed their journey on the cruise, great exposure for us.”

NCL’s cruise itineraries didn’t offer quite the same level of enticement. They were limited to trips to Japan, with stops in Fukuoka, Nagasaki, Okinawa, and a few other cities. In theory, South Korea was an option. But relations between China and Korea had grown tense over the deployment of a US missile defense system in Seoul, so NCL took Korea off its destination list, as did other cruise lines. Even so, Joy’s early trips proved popular. “Before Joy’s debut, tickets for the whole summer had been sold out,” Xiang said.

NCL wanted to position Joy as a premium ship, so prices were set high. “Ours were close to Royal Caribbean’s and 10% to 15% higher than other cruise companies,” Xiang said. The average price of five- to seven-day trips was between 4,000 RMB and 4,500 RMB ($570–$640), which ranked fifth or sixth among all the markets NCL operated. “Taking into consideration Chinese consumers’ income, our ticket sales were pretty good.”

The Ship Goes South

Everything worked well, until it didn’t. After a few months of operation, NCL noticed that Joy’s retail and casino sales were slackening. Cruise lines in China banked on duty-free shops and gambling. Chinese travelers’ love of high-end brands—Chanel bags, Tiffany necklaces, Rolex watches—is well known among retailers. Cruise lines, including Royal Caribbean and Carnival, had thus enlarged the size of their onboard stores. Royal Caribbean’s Quantum of the Seas had once boasted the biggest shopping center, at 750 square meters, but it was surpassed by Joy’s 900 square-meter marketplace. Joy’s casinos, too, were supersized on account of Chinese consumers’ reputed affection for games of chance. Gambling is illegal in China, but national laws don’t apply on the high seas.

Some of NCL’s offerings performed as expected. The Bulgari store broke the chain’s worldwide record by having the highest average sales per unit area. “Bulgari was awesome,” said Jing Lin, a 32-year-old lawyer who traveled with her husband and her parents. Lin bought a necklace there, finding it “much cheaper than buying it in China and even 10% cheaper than stores in Japan.”¹² Another popular onboard shop was Godiva. Its cheapest ice cream was $5, a deal compared with the $7 someone would have paid in Beijing or Shanghai. The rest of the shops lacked appeal, Lin said. “There’s no price advantage compared to shops on Carnival or Royal Caribbean. In general, most of us were just window shopping to pass time.”

The casinos didn’t deliver the expected results either. Joy’s customers were mainly middle-class people with families. Many of them had only a limited willingness to risk their money on a slot machine or card table; their gambling was strictly an amusement. “Our casino revenue was not better than other markets NCL operated,” Xiang said.

Shopping and gambling revenue, though lackluster, had not been expected to be major profit contributors, and their shortfalls didn’t doom NCL’s plans. “The main profit of onboard consumption comes from food, beverage, and offshore sightseeing,” said Xiang, “especially beverage—the gross margin could reach [up] to 85%.”

Onboard dining had been designed to cater to Chinese tastes. From Chinese hotpot to Japanese sushi, French haute cuisine, and American steaks, Joy’s 20 restaurants promised an edible adventure. Yet most customers dined only on complimentary fare, leaving over half of the premium restaurants underpatronized. Lin and her husband had dinner at Neptune’s, a Western-style seafood restaurant. It charged $48.88 per person, making it the most expensive offering on the ship. Her parents didn’t join them, as they thought the restaurant too pricey.

Like any other cruise ship, Joy had plenty of bars, offering an array of drink styles. It’s normal for a Westerner on a cruise to down six or seven drinks a day. Yet for Chinese tourists, a couple of drinks, or even none, is the norm. Culture is part of the reason. The Chinese usually drink during meals, when beer, baijiu (a Chinese liquor, similar to vodka), or red wine is served with food. Younger Chinese will drink at bars, but older, more traditional folk, who were Joy’s main customers, tend not to. Even Lin said she bought only three cocktails on her whole journey. The rest of the time, she either got free lemon water or used the electric kettle in her room to boil water. The kettle was part of NCL’s customization: The Chinese love drinking hot water, but having access to it also gave them a reason not to buy drinks onboard.

Price was another deterrent. There’s not much difference between the price of drinks onboard and off-board for Western tourists. They could buy a pint of beer at their local bar for five to seven dollars and saw similar prices on cruise ships. Yet for a Chinese tourist, five dollars could buy a substantially bigger bottle of beer at a neighborhood shop. NCL couldn’t lower its drink prices because of its procurement practices, Xiang said. International cruise lines often use global sourcing for onboard supplies, except for perishables. NCL was no exception. “We could have tried local sourcing to lower the price,” said Xiang, “but Miami was not willing to make an adjustment for just one ship, one market, especially [when] the result was not guaranteed.” Beverage consumption became the biggest point of divergence between Chinese and Western consumers. That was critical—because, as Xiang already noted, drinks typically provide high margins.

Zhao, the travel agent, said NCL may have misjudged its potential market in China. From her experiences selling tickets to Chinese tourists, she said the majority fell into the lower-spending category. “There were luxury brands, fancy restaurants, and bars for a couple hundred high-spending tourists. But were there enough things for the vast 90%? They were the backbone of revenue.”

NCL made changes to accommodate the travelers who were coming aboard. It added milk tea to its beverage menu and provided a nonalcoholic beverage package at eight dollars per day, though it required customers to buy it for their whole journey. Those changes didn’t bring much improvement. NCL also considered more aggressive onboard marketing. Other cruise companies used amplified announcements to promote their products and services. Some even sent their staff around their dining rooms to pester people to buy wine with lunch and dinner. Yet those techniques didn’t align with NCL’s premium brand image and its global operational standards. “They were definitely not elegant,” said Xiang, “but think about how Meituan or Ctrip got started and how they won. They relied on this very aggressive marketing approach.” (Our Sequoia chapter includes more information about Meituan and Ctrip.) NCL clung to its standards and got stuck with the bill: “Our onboard revenue was one of the worst among all the markets,” said Xiang.

Another revenue stream that trickled was sightseeing. In the West, tourists often book their off-ship excursions with cruise lines directly. The lines organize the tours and profit accordingly. But in China, this part of tourism remains in the hands of travel agencies. There is a historical reason. China opened overseas tourism to its citizens in the 1990s, when the government allowed travel agencies to organize group trips to Singapore, Malaysia, and Thailand. Though traveling independently was allowed later, joining a group was for a long time the only option for someone who wished to go overseas. Even today, the language barrier, the difficulty of applying for a foreign visa, and the higher cost of going solo often discourage Chinese tourists from organizing their own trips. On top of that, the travel agencies didn’t charge customers extra for sightseeing; they baked it into the price of the cruise ticket customers bought. That matched Chinese tourists’ perception of how a cruise should work: a ticket should cover everything. The arrangement looked like a bad deal for travel agencies, but they made their money on the back end: They’d receive commissions from stores for bringing in shoppers. NCL did receive fees from travel agencies but not enough to compensate for its lost revenue.

The Last Straw

With onboard revenue failing to meet expectations, NCL depended even more on ticket sales. Those, too, didn’t turn out as planned. A cruise line’s revenue consists of tickets and onboard spending, with a typical ratio of about 70% tickets to 30% onboard revenue. Joy was profitable its first year in China, largely thanks to ticket sales. But the unique approach to ticket distribution in China influenced those solid early results. In the West, over 50% of tourists book their tickets directly with cruise companies. In contrast, cruise lines in China sell over 85% of their rooms through travel agencies as full-ship or half-ship charters; the agencies commit to the charters, buy the needed number of tickets from the cruise line, and then sell the tickets to individuals or groups.

NCL had started to sell tickets one year before Joy’s arrival, and the big new ship gave travel agencies enough confidence to commit. Their orders supported those positive first-year numbers. Yet when the travel agencies started pitching to Chinese tourists, they found Joy to be a hard sell. “Overall the ticket selling wasn’t good,” said Zhao. NCL thought Joy should command the highest prices, but the market didn’t agree. In the eyes of Chinese tourists, Royal Caribbean, not NCL, was the premium player and thus deserved a premium price. This perception was a result of Royal Caribbean’s decade-long effort to build a strong brand in China. In addition, Royal Caribbean had created a special sales team, with several hundred reps, that was sent to the travel agencies to help sell tickets. They helped convince customers who showed an interest in NCL or any other cruise line that it was worth the extra money to travel with Royal Caribbean.

A surge in the supply of cruises exacerbated NCL’s predicament. Joy was not the only ship that entered China in 2017. Carnival’s Majestic Princess arrived too, landing in Shanghai that July. They joined Royal Caribbean’s Quantum of the Seas, which had come two years prior, so the world’s three dominant cruise lines were docking at the same port. Add in other ships, like Star Cruises’ SuperStar Virgo and SkySea Cruise Line’s Golden Era, and there could be seven big boats in Shanghai. Still more ships were moored in other Chinese ports, like Tianjin, Guangzhou, and Shenzhen. The law of supply and demand affects cruise lines, just as it does everything else: When the supply exceeds demand, companies can’t charge what they want.

Because of the oversupply, NCL had to find a way distinguish itself, which was what Joy’s China-specific design was supposed to do. Recall that Joy had been tailored for the Chinese market. But paradoxically that didn’t help with ticket selling—it may have even backfired. The Chinese-style trappings looked too familiar to those who saw cruising as an exotic Western-style experience. “If it’s too Chinese, then it’s hard to sell,” Zhao said. Chinese tourists were more drawn to features that felt foreign, like the British-style afternoon tea on Carnival’s Majestic Princess, where sweet pasties, cakes, and tea were served by the cruise staff wearing white gloves.

As a result, travel agencies couldn’t fill the ship at the prices they expected and had to start discounting. When one of them lowered the prices, others followed. Zhao’s company sold tickets at less than 2,000 RMB (around $303) during its worst time, way below the price paid to NCL. “The majority of us were operating at a loss,” she said. Afterward, agencies sent reports of their losses to NCL and sought compensation. “I knew we already signed the contract, but we really had no choice.” NCL, the cruise line that put “partners first,” returned to the negotiation table and agreed to provide additional cabins at no cost. Yet for Zhao, that just added more supply, without addressing the underlying issues. “The hole just became larger and larger,” she said.

Alaska Calling

As difficulties accumulated in China, NCL released a new ship in Alaska in April 2018. The Bliss, which cost $1 billion to build, became a hit and reported a record profit. “That was by far the most successful launch we’ve ever had,” said Andy Stuart, NCL’s president at the time. Within a few months, NCL decided to move Joy to Alaska. “It was one of our more complicated decisions—after all, we had designed Joy for the Chinese market—but the more we watched Bliss perform, the more we realized this was a big opportunity,” Stuart said.¹³

NCL announced Joy’s departure and promised to send another ship, Spirit, as a replacement. In a statement released then, the company said its commitment to China endured. Yet it only took a few months for NCL to reverse course. Spirit never arrived. NCL had set sail for other seas, leaving China marooned.

In April 2019, after 19 months in China, Joy steamed across the Pacific, destination Alaska. Before that journey, NCL had spent $50 million on an overhaul. The Chinese elements were removed, retail space and casinos were downsized, bars were added, and the spa and gym were expanded. US tourists probably wouldn’t ever sense its past life in China.

Applying the Framework

Norwegian Cruise Line operated for less than two years in China before quitting. The decisive factors in that failure were as follows:

NCL was just one more cruise company navigating crowded waters, with insufficient alpha assets. Unlike Royal Caribbean, which spent years building a brand in China, NCL didn’t have a brand advantage and couldn’t command the premium prices that Royal Caribbean did. Nor could it compete with the market coverage of Carnival, which operated several ships in China—cruise ships, in effect, serve as their own massive billboards, and Carnival had more. NCL only had Joy, and its itineraries (short trips to Japan) resembled those of its competitors.
NCL didn’t commit to the Chinese market in the way that Royal Caribbean and Carnival had. Joy operated for only 19 months, a record short time for a foreign cruise company in China. Then again, as with Amazon, NCL’s decision to focus on Alaska may have maximized shareholder value in the long term and, from that perspective, may be hard to fault.
In formulating its strategy, NCL misperceived which Chinese consumers would be drawn to its cruises. Joy’s large shopping area and three casinos seemed designed to attract the nouveau riche, who jetted around the world to shop and gambled enthusiastically. In reality, NCL found itself serving the emerging Chinese middle class, people who could afford a nice vacation but were prudent with their funds. They didn’t want to get sloshed in the onboard bars. They preferred to drink during meals, and NCL (to its credit) wasn’t willing to try to strong-arm them to do otherwise.
NCL bet heavily on Joy’s China-centric design. But being different didn’t equate, in Chinese consumers’ eyes, with being better. From the phoenix artwork on the topsides of the ship to the teahouses and karaoke rooms, Joy had many Chinese characteristics. Yet “Western-ness” is an attribute that can be valuable to foreign companies. As Chinese consumers become richer, they want to experience new things, so in this particular market, adapting the product too much to local tastes was likely the wrong strategy.

These elements and other factors in the framework are noted in Table 3.1, along with our subjective assessment of the decisive factors.

Table 3.1: Summary of Success Factors for Norwegian Cruise Line
Factor		Explanation
Demand	▲	Strong and growing demand for cruising in China.
Access to market	▲	Unfettered access to the market, with several strong Western competitors already operating.
Advantage		No significant alpha assets.
Commitment		Invested in one ship and operated it for only 19 months, then abandoned China, possibly because of high opportunity costs.
Governance		Followed the typical multinational’s China branch model. Strategic decision-making mainly happened at the headquarters.
Leadership		Led by an American executive who came from the CEO’s inner circle. Seemed to lack knowledge of Chinese consumers.
Strategy		Market segmentation and NCL focus proved inaccurate. The luxury consumer did not materialize as expected.
Product		Ironically, significant localization likely detracted from the desirable foreignness of cruising.
Agility		Not particularly agile, but this likely hampered only tactical sales and marketing efforts.
Luck		The emergence of Alaska as a promising alternative target of opportunity was unexpected.
Note: Upward-pointing triangles indicate a positive factor. Downward-pointing triangles indicate a negative factor. The number of triangles is our subjective assessment of the relative importance of the factor. We omit indicators for those factors that we do not believe were significant for this case.

In China, Amazon and NCL—both successes elsewhere—possessed few alpha assets. That, combined with their limited willingness to invest in the face of compelling alternatives, led them to quickly say “bon voyage” to China. Next we’ll focus on Hyundai, a company that had substantial alpha assets and bet billions over more than a decade.