Shifting Sands Underfoot

MAJOR FACTOR: Joseph Toy of Hawaii Hospitality Advisors LLC says timeshare products, such as Hilton's Grand Vacations Club in Waikiki, are growing here.

In the busiest stretch of Hawaii's busiest resort area, the Royal Hawaiian Shopping Center sits as a monument to a bygone era. A monolithic cement fort that replaced an idyllic coconut grove much beloved by locals and visitors alike, the center for two decades has served its main purpose well: selling as many high-end retail wares to Japanese tourists as possible. During much of the 1990s, many local residents never once set foot in the center. Those who did often received shoddy treatment from salespeople, who preferred the big commissions they earned from Japanese shoppers. A few shops catering to local folks survived on the upper level, but, make no mistake, the mall was built for yen alone.

How the times have changed at the Royal Hawaiian. In 2003, a popular Mainland casual dining restaurant chain, the Cheesecake Factory, is scheduled to open an 11,000-square-foot, 385-seat branch there. That's just one of the changes in line for the center. Randy Yeager, the president of Honolulu consultancy Retail Strategies, which handles leasing for the Royal Hawaiian, says, "A very predominant part of the new mix will be more value-oriented, moderately priced goods and restaurants that cater to both the East-bound and the West-bound tourist. Those will have the greatest opportunity for long-term success." Yeager plans to add more middle-of-the-road retailers to appeal to Waikiki's increasingly value-oriented, middle-class clientele.

For a look at the other side of the coin, hop a flight to the Valley Isle, where developer Bill Mill's latest project, the Shops at Wailea, represents a sea of change on the Neighbor Islands. The 70-store retail center boasts luxury tenants such as Louis Vuitton and Tiffany. As the Neighbor Islands have swung steadily upscale and are now equal to the task of supporting high-end retail shops, Oahu is furiously reinventing itself to draw a broader mix, as global tourism shifts have shut off the shopping valve in Waikiki.

Diminished expectations for visitors from the East is just one of several big shifts under way in Hawaii's tourism sector, including: soaring prospects for the Neighbor Islands, rising tides for the cruise-ship industry and room booms for the timeshare sector.

THE LAND OF THE SETTING SUN

Despite the climb of the yen against the dollar in the fall and summer of 2003, Hawaii's most profitable tourism market stubbornly refuses to return to past form. In 2002, approximately 1.5 million Japanese tourists came to Hawaii. That's a whopping 32 percent less than the 1997 peak of 2.2 million. That tally may show a slight rebound in 2003. But most inside the visitor industry have given up any hope of returning to the bubble peaks.

While SARS and the war on terrorism share some of the blame, structural changes in Japan and the Japanese visitor market underpin what increasingly appears to be a case of long-term stagnation. Rising unemployment in Japan and continued economic troubles - the banking system still faces a massive, unresolved problem with bad loans - has weighed heavily on the Japanese traveling public.

Although the Japanese economy has emitted some positive signs of late, "Japan's trend has been a sequence of false recoveries, each of which was followed immediately by a recession. They have had about three recessions in the last 10 years. You can't really be that optimistic about more than the next few quarters and even then that's kind of sketchy," says Paul Brewbaker, vice president and chief economist at Bank of Hawaii.

Even worse, Hawaii is no longer such an international shopping paradise; peripatetic Japanese shoppers can find equal or better selections in Seoul and Shanghai, often at prices undercutting those in the Islands. These same Japanese tourists are wiser and more wary of Hawaii. The old schemes of packing the Japanese into tightly scheduled group tours that invariably included bus tours and planned shopping excursions to specialty retailers such as DFS Hawaii have lost appeal. (See sidebar on page 11.) In particular, younger Japanese visitors want a less structured Hawaii experience and those that still want structure are dying off - literally - at a rapid rate.

At a minimum, this will make it harder for companies to continue to attract Japanese travelers. "Most of our Japan business was driven in from the group tours. That piece of the business has been the hardest hit," says Paul de Ville, president of retailer Hilo Hattie. "We're looking at ways to reach out to the free and independent travel business. That represents more of a growth market."

De Ville has some breathing room as most of his sales go to Mainlanders. But the ongoing shift threatens entire sectors of the visitor economy originally built to transport and cater to group tours. Worst of all, no one expects Japan to bounce back to form anytime soon, and all the major resort operators and tourism businesses are planning accordingly.

VISITOR APPEAL: Keith Vieira, Hawaii director for Starwood Hotels and Resorts, says we need to shore up the U.S. group market. Photo: Ronen Zilberman

"If you walk down Kalakaua now you'll see more sunglass shops, Tommy Bahamas, things that are appealing to both U.S. and Japanese travelers, as opposed to a time when there was nothing but Louis Vuitton and Prada," says Keith Vieira, director of Hawaii operations for Starwood Hotels and Resorts. That's not to say Japanese visitors will cease to be a big part of Hawaii. They are still the biggest spenders in the Islands on a per visitor basis. "We aren't going to abandon the Japanese market, but we have to shore up the U.S. group market. I think it will take longer than people think to come back to 2000 levels," says Vieira.

LOOKING WEST FOR GROWTH

While the Far East is far from a growth market these days - nascent visitor markets in China, Taiwan and Korea have been frozen by more stringent visa requirements resulting from the War on Terror - there are plenty of other areas growing in the Islands. Visitor tallies from both the eastern and western United States have grown steadily, with arrivals from the western region hitting 2.5 million, the highest level since 1989. Those visitors continue to eschew Oahu for the Neighbor Islands, with Maui and Kauai, and, to a lesser degree Kona, receiving the fruits of this shift.

According to DBEDT projections, by the end of 2003, Honolulu International Airport's share of total domestic airline seats coming into Hawaii will have fallen to 65.6 percent, compared to 75.2 percent in 2000. In comparison, Maui, Kona and Lihue all are gaining a bigger share. Airline seat shifts are something of a lagging indicator that follows demand and they pointed squarely to lagging occupancy on Oahu during 2003.

Ironically, the shift may be helping Hawaii's two airline companies. Both Aloha and Hawaiian have shifted resources away from highly unprofitable interisland routes and emphasized Mainland routes to underserved markets such as Oakland, Phoenix and Sacramento. These long-haul routes, while still competitive, offer better long-term profit prospects than the short hops between islands, particularly as more and more visitors would rather skip Oahu altogether and will pay a slight premium to do so. By moving to these underserved areas, the airlines may be tapping into rapidly growing new visitor markets that were formerly inaccessible. For millions of West Coasters, long weekends in Hawaii are now a real option, since they no longer have to drive or fly additional hours to a major airport. This has shown up in improving revenues for both Hawaiian and Aloha, although neither has attained solid profitability to date in the wake of the Sept. 11 attack.

THE BIG BOATS ARRIVE

An increasing percentage of visitors who land on Oahu are sailing right back out again. The number of cruise passengers in Hawaii rose by an impressive 52 percent in one year, from 159,000 in 2001 to 242,000 in 2002. That number continues to climb in 2003; cruise passenger tallies were up 16.7 percent from the first half of 2002 to the first half of 2003, according to DBEDT. More cruise juice is on the way. Norwegian Cruise Lines plans to add two more ships to Hawaii routes and boost the number of passengers from 145,000 in 2003 to 400,000 by 2005, a 175 percent increase. (See related story on page 12.) The 255,000 additional passengers represent a 6.3 percent increase in total visitor arrivals from the U.S. mainland, a respectable increase over that period, considering the relative maturity of the market segment. "We as a state will be going from a world where cruising has a low impact to one where it has a high impact. There are some fundamental changes going," says Frank Haas, vice president of marketing at the Hawaii Tourism Authority.

What's more, the big boats seem a particularly strong lure for comparatively free-spending East Coast arrivals. They make up more than half of all domestic cruise passengers and currently outspend the average Hawaii cruise passenger by about

10 percent. Some of this may be attributable to the string of frigid winters back east. The surge could continue for some time. East Coast arrivals still lag behind historical highs of more than 2 million and with more boats coming in they will have more choices. According to forecasters, there will likely be another cold winter to chasing them to Island shores. "We are substantially under-penetrating the U.S. East market," says Joseph Toy, chief executive officer of Hawaii Hospitality Advisors LLC.

The cruise boom could also have played a significant role in upping Hawaii's airline seat count. The total domestic seat count for 2003 is projected to hit a record high of 5.9 million, besting the previous high-water market in 2000 by 4.6 percent.

TIMESHARE CLOCKS IN

While hotel construction has basically ground to a halt, a handful of timeshare projects are on the boards that represents the only real growth in new resort construction around Hawaii.

As of January 2003, Hawaii ranked fifth in the country in number of timeshares, with 73, lagging behind only Florida, California, South Carolina and Colorado, according to the American Resort Development Association On the south and north shores of Kauai, on the Leeward Coast of Oahu and in Waikiki, plans are afoot for new timeshare towers. "Timeshare is becoming a major factor. Previously it was a Kauai product. Now we see it growing everywhere," says Toy.

Exact figures on timeshare units are somewhat tricky to get, as many are cross-listed as condominium hotels. That said, according to DBEDT, the number of timeshare units in Hawaii has increased from 3,825 in May 2000 to 4,555 in May 2002, a 19 percent increase. That jump far outstrips the general growth of the industry. Maui has witnessed the fastest timeshare growth. In 2002, Maui had 1,313 units, or 28.8 percent of the state's total. That's up from 829 units in 2000 or 21.7 percent of the state's total, a whopping 58 percent increase.

For baby boomers nearing retirement, timeshares have proven an alluring alternative to a second home or vacation club. Resort operators and developers are happy to oblige them. In timeshares they get to offload the capital cost of purchasing and paying for construction and keep the part of the revenue stream they want the most, the operational profits from servicing the properties. Banks are happier to finance timeshare

projects than traditional hotels, from which they may not get most of their money back for many years.

This is a far cry from the days when there seemed to be no ceiling to valuations on the resort properties then sprouting

like mushrooms on the golden beach havens of Princeville, Poipu, Kaanapali, Wailea and Kohala. However, it is probably par for the course in a visitor industry that is shifting like the sands of Waikiki.

DFS: Down, But Not Out

NOT-SO-EASY STREET: DFS Hawaii's Julian Levy wants to bring Hawaii operations, including the relatively new DFS Galleria on Kalakaua Avenue, back into the black. A cool Brit, who arrived in Hawaii in the summer of 2003, Julian Levy lives in posh Kahala. However, as the president of DFS Pacific Group and the head of DFS Hawaii, Levy is hardly living easy. The exclusive operator of Hawaii's duty-free concessions and a major retail force in the state, DFS Hawaii has been whiplashed by a perfect storm of SARS, fears of terrorism and Gulf War II. Over the past three years that unhappy troika has decimated Japanese visitors who make up 94 percent of DFS Hawaii's duty- free customers. The Japanese who did come spent less due to the weak yen and continuing financial troubles back home. Things may be brightening a bit for Levy and DFS, though. The decline of Japanese visitors appears to be slowing. In September 2003, DFS finalized a reduction in its minimum annual guaranteed state rent obligation to an average minimum of $36 million per year through May 2006 for exclusive rights to the duty-free business. However, DFS isn't out of the woods yet, according to Levy. "With the severe business fluctuations we have experienced since 9/11, it is difficult to be confident of future conditions," he says. Aside from questions of global instability, DFS must deal with other challenges in global retailing. Across Asia, luxury brands are more widely sold and for far less than ever before. DFS Hawaii must also fight harder for the limited time spent here by Japanese visitors, who can now choose from a wide variety of luxury stores, including international flagship stores from Louis Vuitton, Prada, Chanel and Tiffany. French luxury-goods giant LVMH Moet Hennessy Louis Vuitton owns 60 percent of DFS Hawaii parent, the DFS Group, with the other 40 percent held by Robert Miller. During the bubble years, DFS Hawaii employed nearly 2,000 and grossed close to $1 billion from duty-free sales and retail-store locations around the state. Today DFS employs about 1,000 and grosses less than $400 million, according to Hawaii retail experts. DFS' downward revenue slide has outpaced overall declines in spending by Japanese tourists belying larger problems. Today, the fastest growing retail segment in the Land of the Rising Sun is discount shopping, which increasingly includes luxury brands also sold by DFS. Add to that broad deflation in Japan, with wider selections of marquee names, as well as very low prices on luxury goods in nearby Korea and China, and DFS Hawaii loses allure. "Consumers everywhere have come to understand that prices need not be high and can be lowered with more stores and competition. A 50 percent discount is nothing special," says Kurt Barnard, president of Barnard's Retail Consulting Group. Terrorism continues to hurt DFS indirectly. Long lines at Hawaii departure checkpoints often prevent Japanese visitors from purchasing DFS wares at the airport in the requisite 45 minutes before their flight leaves. As a result, sales are approximately 10 percent below where they should be in comparison to historical Waikiki sales. However, Levy says there is nothing wrong the DFS business model of catering to Japanese visitors. DFS Hawaii's tally of Japanese spending per visitor in yen terms has held steady in Hawaii throughout the past three years', says DFS vice president Sharon Weiner. Further, DFS has actually augmented foot traffic by upping the number of travel agency tour groups who take their arrival briefings at the Waikiki store. Levy also points out that many Waikiki single-brand retailers such as Tiffany and Boucheron and Louis Vuitton aren't sold at DFS. And DFS claims it still beats any other shop in Wakiki on price of designer goods. He says, "We have been able to improve our selection and that appears to be driving more visits to our stores and to producing higher spending per visit." DFS will need plenty more of that to pay off the $65 million sunk into the Waikiki flagship store that opened two years ago. Levy may well lead the company back to the black, but it certainly won't be easy.