case study

TALLINK: CONNECTING ESTONIA TO FINLAND, SWEDEN AND RUSSIA

Jordan Mitchell prepared this case under the supervision of Professor Peter C. Bell solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality.

Ivey Management Services prohibits any form of reproduction, storage or transmittal without its written permission. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Management Services, c/o Richard Ivey School of Business, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail cases@ivey.uwo.ca.

Copyright © 2005, Ivey Management Services Version: (A) 2009-09-30

INTRODUCTION

In August 2002, Enn Pant, the chairman of Tallink, was considering purchasing a new ferry and reassigning the company’s existing fleet to different routes. As Estonia’s sole ferry company, Tallink competed against three Scandinavian companies — Nordic Jet Line, Viking Line and Silja Line — for passengers and cargo on several routes, including connections between Estonia, Finland and Sweden. As part of management’s plan to update their fleet, Tallink had inaugurated its most modern ferry to date in 2002 — the M/S Romantika, a €150-million, 2,500-passenger vessel for the Tallinn to Helsinki route. Tallink’s management proposed purchasing an identical sister ship to run between Tallinn and Stockholm beginning in 2004. If the new ship were purchased, Pant and his management believed there would be an opportunity to redeploy a ferry to start a route to St. Petersburg, Russia.

TALLINK HISTORY

Tallink was founded as a joint venture in 1989 during the dissolution of the Soviet Union. The original joint venture had four partners: the Finnish company Palkkiyhtymä Oy, the City of Tallinn, the Port of Tallinn and the state-run Estonian Shipping Company (Eesti Merelaevandus). The first Tallink passenger ship crossed the Gulf of Finland in January 1990. The Finnish partner, which owned 49 per cent, sold its shares to the Estonian Shipping Company in 1993, and a year later, some of the ownership had been transferred to private Estonian hands. Enn Pant joined as chairman in 1996 and, under new management, the company expanded by purchasing two new passenger vessels: M/S Fantaasia and M/S Vana Tallinn. On the company’s 10th anniversary in 2000, Tallink purchased its first high-speed catamaran and made an agreement with the Finnish shipyard Aker Finnyards to build a new 2,500-person passenger vessel called M/S Romantika to travel between Tallinn and Helsinki. In May 2002, M/S Romantika was launched, which freed up M/S Fantaasia to be redeployed to the Tallinn-Stockholm route.

During Tallink’s 2001/2002 fiscal year (September to August), Tallink sold the Express I catamaran and purchased two of its ferries, M/S Meloodia and M/S Regina Baltica, which had been under charter from the Estonian Shipping Company.

To boost the profile of the Tallink brand and to promote ticket sales, Tallink opened two new sales ticket offices in the centre of two key cities — Stockholm and Tallinn. The company also made changes to its capital structure, selling approximately four per cent of the company to private European and U.S. investment funds. The involvement of the investment funds gave Tallink more access to capital by which to finance new vessel acquisitions. To raise additional funds, Tallink was also considering going public.

TALLINK’S FERRIES AND ROUTES

As of August 2002, Tallink had a total of eight vessels: five passenger ferries, two high-speed vessels and one cargo ship. These eight vessels covered three main routes: Tallinn, Estonia, to Helsinki, Finland; Tallinn, Estonia, to Stockholm, Sweden; and, Paldiski, Estonia, to Kapellskär, Sweden. For the year closing August 31, 2002, Tallink was estimating a total passenger count of approximately 2,747,000 passengers, an increase of 4.2 per cent over the previous year. Cargo units had also increased, growing 21 per cent from 71,953 units to just over 87,000 units.

Tallink was in the process of renewing its fleet over the next five years, which called for the replacement of three of its vessels that had been built in the 1970s. The Exhibits summarize Tallink’s ferries and routes. Exhibit 1 shows photos and specifications of each ferry and Exhibit 2 shows a map of the routes and Tallink’s major financial highlights. Exhibit 3 shows the current routes and the ferries assigned to them.

CAPITAL AND OPERATIONAL COSTS

The capital costs of each ferry depended on its size and age. A new ferry such as the recently inaugurated M/S Romantika was 193.8 metres long and cost €150 million. Tallink used a discount rate of 12 per cent when evaluating asset purchases. Older vessels such as the M/S Fantaasia and M/S Meloodia typically underwent a refit cost every 20 years at approximately €5 million each.

To operate a ferry, there were three main categories of costs, which included fuel, on-board staff and other expenses such as docking fees and off-shore co-ordination. The allocated expenses varied according to the length of the route and the passenger capacity. For example, the high-speed AutoExpress ferries required fewer on-board staff than a larger ship such as the M/S Romantika. The average time to cross between Tallinn and Helsinki aboard an M/S AutoExpress ferry was one hour and 40 minutes as opposed to three hours aboard a regular ferry. To make the trip more enjoyable for longer journeys, Tallink had more extensive on-board shop, bar and restaurant choices as well as live entertainment such as music, plays and cabaret shows. Exhibit 3 shows operational details of each ferry.

In addition, Tallink had a number of other expenses such as off-shore salaries, general administration and marketing expenses that were calculated on an overall corporate basis.

Revenues

Tallink’s revenues were generated from three primary sources: passenger ticket sales, comprising approximately 73 per cent; cargo, contributing approximately eight per cent; and on-board shop, bars and restaurant revenues, making up 16 per cent. The remaining three per cent was derived from other services and licensing activities. Looking forward, Tallink expected minor growth of two per cent to three per cent between Tallinn and Helsinki, which was consistent with the growth of the traffic between the two ports. For cargo sales, Tallink expected increases of approximately eight per cent.

The average price of a return ticket for the Tallinn to Helsinki route was between €35 and €40 for a regular ferry and €55 for a high-speed ferry. The cost of a return ticket to and from Stockholm was between €75 and €80, while the Paldiski to Kapellskär route on average cost between €50 and €70. All prices fluctuated based on the promotional strategies of Tallink’s competitors as well as special deals for carrying automobiles to and from Estonia. The average cost of a cargo unit (classified as a 4088 foot container) was €100 from Tallinn to Helsinki and €250 from Estonia to Sweden (on both of the routes).

Tallink was eager to increase passengers’ on-board consumption at its shops, bars and restaurants. A newer ship such as the M/S Romantika was designed to boost the image of Tallink and to increase on-board sales. Because the prices of many goods such as beer, spirits, tobacco and cosmetics were less expensive in Estonia, many Finns and Swedes took advantage of the on-board duty-free shops to purchase alcoholic beverages or other gifts. While the tax-free status would be eliminated after Estonia’s accession into the European Union in May 2004, many observers felt that the price gap between Estonia and Finland/Sweden would provide solid sales for the next two years.

As one report by Tallink stated,

Special category and space management projects were implemented on board with good results, doubling the revenue per passenger. Special attention was given to promoting high-profile products. Special sections for champagne, malt whiskies and luxury cognacs were developed. Thorough planning, together with support from the suppliers, resulted in the most modern fragrance and cosmetics boutique on the Baltic Sea. This may be the reason for the significant increase in sales of skincare products and cosmetics. Overall, Tallink sees a great potential on the Swedish route, with the strong buying power that the Swedish passengers represent. Compared to the Finnish route, the longer routes to Sweden mean more time spent on-board resulting in more opportunities for consumption.

PROPOSED CHANGES

Tallink believed there was tremendous opportunity to increase traffic and on-board sales between the Tallinn and Stockholm route. By building the new ship to service the growing Tallinn to Stockholm route, management thought Tallink could redeploy M/S Fantaasia to sail the route between Tallinn, Helsinki, and St. Petersburg, Russia.

New Ferry for Stockholm

Tallink’s management proposed ordering a sister ship of the recently inaugurated M/S Romantika. The cost of the new ship would be equal to M/S Romantika at €150 million as all the specifications were practically

the same. Management estimated that the new ship would be operational by 2004 and would command approximately 300,000 passengers per year, leaving every other day from each port (15 return trips per month). Considering that the ferry would be ready for 2004, coinciding with Estonia’s accession into the European Union, many observers predicted growth of between 10 per cent and 30 per cent for the next three years as Swedes became more interested in vacationing in Estonia.

The total passage time was estimated at approximately 11 hours (243 nautical miles divided by 22 knots). Tallink management believed it could reach an average return ticket price of €90 when weighing the relative sales mix of one-way tickets, foot passengers and travellers with vehicles. In addition, management believed that it could sell 10,000 units of cargo at approximately €250 each unit per year. For on-board sales, Tallink was expecting an average consumption of €30 per passenger. The costs associated with operating the new ship would be in line with the recently launched M/S Romantika — 25 per cent fuel, 40 per cent staff and seven per cent other expenses. The minimum staff charge regardless of passengers was estimated to be €12 million. For on-board sales, Tallink used an average estimate of 35 per cent margin.

St. Petersburg Ahoy!

In freeing up M/S Fantaasia, Tallink considered redeploying it to establish a new route between Tallinn, Helsinki, and St. Petersburg. This would make Tallink the first company to offer the service. Management thought the ferry could make the return trip four times a week. The total one-way distance was 232 nautical miles, which included the stop in Helsinki. Tallink was uncertain of the demand for such a journey, but the company believed it could capture between 150,000 and 250,000 people in the first year of operation, growing to over 350,000 in the subsequent three years. The expected average price for a return ticket was estimated at €75. Cargo was estimated to be minimal at 2,000 units at a value of €250 per unit. The number of units of cargo was predicted to grow at approximately five per cent for the next three years. Management predicted that on-board sales would be approximately €8 per person as the prices of alcohol and cigarettes were similarly priced between Estonia and Russia, taking away the impoteus for passengers to stock up on these goods.

To promote the new route, it was predicted that management would spend approximately €2 million on refitting M/S Fantaasia and €3 million on advertising and opening up an office in St. Petersburg to handle bookings. The costs of operating the ship as measured by percentage to revenues were predicted to be 35 per cent for fuel, 35 per cent for staff and five per cent for other expenses. However, the first year staff expenses were estimated to be a minimum of €6 million independent of sales levels. If the project failed, Tallink predicted that they would lose between €10 million and €12 million overall.

One barrier that Tallink foresaw was the lengthy visa procedure for Russian travellers wishing to enter Finland or Estonia. Tallink predicted that the majority of its traffic would be Finnish nationals until some of the visa requirements for Russians were relaxed. Taavi Tiivel, from Tallink’s executive office, talked about some of the visa restrictions and other challenges with the route:

The visa is quite expensive at €35, and getting the visa takes time. For Russian citizens, Estonian and Finnish visas are required both and vice versa. As well, the ice conditions in the eastern part of the Finnish bay are heavy, and in a harsh winter, the route may not be passable. That means the ferry cannot keep to schedule, which increases the running costs. On the other hand, St. Petersburg has enormous travelling potential since the area has 15 million people. The city itself is very attractive, and tourist potential is very much

underutilized. Tourist infrastructure is still underdeveloped, but the speed of development is increasing rapidly.

Other Considerations

In making these two changes, Tallink’s management needed to think about how Estonia’s entry into the European Union (EU) would change the demand of their routes. They were certain that tax-free shopping aboard the ship would be abolished, which could lessen the differential in price on items such as alcohol, tobacco and cosmetics. However, ferry operators proposed redirecting the route from Tallinn to Stockholm through the non-EU region of the Aland Islands, which would permit the sale of tax-free shopping. As well, many Estonians felt that after May 2004, tourism would increase as people could move more freely between the rest of Scandinavia and the three Baltic countries (Estonia, Latvia and Lithuania).

Another consideration involved retaliation from one of Tallink’s three competitors. Some Tallink executives felt that Silja line was in a good position to launch a similar service, potentially stopping on the northern shores of Germany to attract more passengers.

Tiivel explained that beyond the decision to purchase the new boat and set sail to St. Petersburg, there were several other considerations:

If we order the new vessel and if going to St. Petersburg fails, what would we do with MS Fantaasia? What developments and opportunities could arise in Tallinn-Helsinki route? What about high-speed versus conventional ferries? Another possible question would be to consider another destination point such as Riga, Latvia. Currently, there was a very poor sea link to Stockholm.

THE DECISIONS

Enn Pant was proud of the growth of Tallink in the last five years: the company’s sales had grown 10.7 per cent, net profit had climbed 25.7 per cent, the number of passengers experienced a 4.2 per cent lift and the number of cargo units had increased by 11.1 per cent compound annual growth rate. He was keen to maintain the company’s steady growth performance and wanted to lead the pack in capturing the growing traffic between ports in the Baltic Sea. Was it the best time to purchase a sister ship for the Tallinn- Stockholm run and launch a new service between Tallinn through Helsinki to St. Petersburg?

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Exhibit 1

PHOTOS OF TALLINK’S FLEET

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Exhibit 1 (continued)

Source: Company Annual Report 2002.

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Exhibit 2 ROUTES AS OF 2002

CORPORATE HIGHLIGHTS

(in € millions)

2001/2002 2000/2001 1999/2000 1998/1999 1997/1998

Net Sales	177.7	153.2	130.4	116.7	106.9
Equity Ratio	0.241	0.386	0.481	0.394	0.375
EBITDA	34.7	23.3	18.3	14.9	12.3
Operating Profit	18.8	15.4	12.1	9.7	9.4
Net Profit	15.7	16.0	10.0	5.0	5.0
Shareholders' Equity	69.7	54.1	38.6	28.2	23.5
Interest-bearing Liabilities	198.4	70.4	29.7	39.6	32.9
Total Liabilities	220.0	85.9	41.6	52.0	42.5
Cash Flow Provided by (Used in): Operating Activities	33.8	17.2	18.5	not avail	not avail
Investing Activities	(160.6)	(21.6)	(8.9)	not avail	not avail
Financing Activities	130.3	4.9	(8.2)	not avail	not avail
Number of Passengers	2,747,094	2,583,042	2,581,087	2,450,778	2,235,187
Cargo Units	87,208	71,953	65,755	54,366	51,584

Source: Company Annual Report, August 2002.

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Page 9 9B05E016

For use only in the course Analytical Decision Making Tools at University of Massachusetts-Lowell taught by Thomas Sloan from January 22, 2019 to May 14, 2019.

Use outside these parameters is a copyright violation.

Exhibit 3 FERRY DETAILS

Ferry	Romantika	Meloodia	AutoExpress	AutoExpress 2	Regina Baltica	Fantaasia	Vana-Tallinn	Kapella	TOTAL
Route	Tallinn-Helsinki	Tallinn-Helsinki	Tallinn-Helsinki	Tallinn-Helsinki	Tallinn-Stkholm	Tallinn-Stkholm	Paldiski-Kpskär	Paldiski-Kpskär
Km (Return Trip)	160	160	160	160	900	900	840	840
Nautical Miles (Return Trip)	86	86	86	86	486	486	454	454
Type	Cruise/Psgnr/Car	Cruise/Psgnr/Car	High-speed	High-speed	Cruise/Psgnr/Car	Cruise/Psgnr/Car	Cruise/Psgnr/Car	Cargo
Passenger Capacity Date Built Date Converted # of Months operational # of Return Trips in the Year # of Return Trips per month Number of Passengers Avg. Ticket Price Revenues from Passengers Number of Cargo Units Avg. Price/Cargo Unit Revenues from Cargo Total Revs: Pass + Cargo Costs Fuel Staffing Other Total Costs Gross Margin % to Revenues: Pass + Cargo Revs from Shop/Res COGS Gross Margin Gross Margin % Revenue/Passenger TOTAL REVENUE TOTAL COST OF SALES TOTAL GROSS MARGIN % to TOTAL REVENUE	2,500	1,600	575	700	1,500	1,700	1,500	50
	2002	1979	1996	1997	1980	1979	1974	1974
	n/a	n/a	1999		2002	1998	1998/2002	1999
	4	12	12	12	12	12	12	12
	178	750	557	514	97	106	60	140	2,401
	45	63	46	43	8	9	5	12
	445,000	1,200,000	320,000	360,000	145,000	180,000	90,000	7,000	2,747,000
	40.00	35.00	55.00	55.00	75.00	85.00	70.00	50.00	47.33
	17,800,000	42,000,000	17,600,000	19,800,000	10,875,000	15,300,000	6,300,000	350,000	130,025,000
									-
	10,000	24,000	7,000	7,000	2,000	2,000	5,000	30,000	87,000
	100.00	100.00	100.00	100.00	250.00	250.00	250.00	250.00	167.24
	1,000,000	2,400,000	700,000	700,000	500,000	500,000	1,250,000	7,500,000	14,550,000
	18,800,000	44,400,000	18,300,000	20,500,000	11,375,000	15,800,000	7,550,000	7,850,000	144,575,000
	4,700,000	13,320,000	7,320,000	8,200,000	3,981,250	5,530,000	3,020,000	3,532,500	49,603,750
	7,520,000	17,760,000	4,575,000	5,125,000	2,843,750	4,740,000	2,265,000	1,570,000	46,398,750
	1,316,000	2,220,000	549,000	615,000	1,137,500	1,106,000	377,500	157,000	7,478,000
	13,536,000	33,300,000	12,444,000	13,940,000	7,962,500	11,376,000	5,662,500	5,259,500	103,480,500
	5,264,000	11,100,000	5,856,000	6,560,000	3,412,500	4,424,000	1,887,500	2,590,500	41,094,500
	28%	25%	32%	32%	30%	28%	25%	33%	28.4%
	5,500,000	8,500,000	1,800,000	2,200,000	3,400,000	5,000,000	1,700,000	75,000	28,175,000
	3,575,000	5,525,000	1,170,000	1,430,000	2,210,000	3,250,000	1,105,000	48,750	18,313,750
	1,925,000	2,975,000	630,000	770,000	1,190,000	1,750,000	595,000	26,250	9,861,250
	35.0%	35.0%	35.0%	35.0%	35.0%	35.0%	35.0%	35.0%	35.0%
	12.36	7.08	5.63	6.11	23.45	27.78	18.89	10.71	10.26
	24,300,000	52,900,000	20,100,000	22,700,000	14,775,000	20,800,000	9,250,000	7,925,000	172,750,000
	17,111,000	38,825,000	13,614,000	15,370,000	10,172,500	14,626,000	6,767,500	5,308,250	121,794,250
	7,189,000	14,075,000	6,486,000	7,330,000	4,602,500	6,174,000	2,482,500	2,616,750	50,955,750
	29.6%	26.6%	32.3%	32.3%	31.2%	29.7%	26.8%	33.0%	29.5%
Other Add/(Ded) to Revenue	4,950,000
Other Add/(Ded) to Operating Profit	4,244,250
TOTAL GROUP REVENUE	177,700,000
TOTALOPERATING PROFIT	55,200,000
% to TOTAL REVENUE	31.1%

Note: Data per ship has been disguised to protect confidentiality.

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