Consumer Strategies Report June 2005/Research

Right now, health clubs are falling short or overshooting the mark. al berrios & co. has conducted an in-depth study on the health club industry, from consumer behavior to expansion models and have identified two key areas requiring attention:

1. The consumer group targeted by products and services
2. The financials behind expansion

The motivation for this study was a lack of substantial growth in health club industry during the recent fitness trend. While from 1993 to 1998, attendance at health clubs grew 39%, the growth actually dropped slightly to around 28% from 1998 to 2002 . According to industry data put together by the International Health, Racquet and Sportsclub Association, which has been gathering attendance statistics from 1987, attendance has grown steadily over the past fifteen years, showing no apparent signs of weakness. However, in an environment where the CDC has ten-year health objectives for key national fitness statistics and political candidates include fitness agendas on their campaign platforms, this steady growth seems sluggish.

Through an extensive survey of an internet audience and conversations with personal trainers and industry experts, al berrios & co. has determined that health clubs are not maximizing their marketing efforts by too narrowly defining their target market and are overshooting their expansion threshold, which is due to in part to the lack of effective marketing strategies.

These points are intertwined, but for the sake of examination, we will analyze them separately and provide insight into potential synergies after that analysis.

After examining the marketing statements of health clubs, it was easy to point to "active, fitness-conscious adult consumers" as the target audience for product and service positioning. Using Bally Total Fitness as an example, their current strategic direction includes scaling back on expansion and focusing on getting value from their recent slew of capital expenditures related to that expansion. In order to begin signing up a broader range of potential members, Bally's has expanded its target to people 18-54, including people over 34 for the first time. In addition to this they have hired a chief marketing officer and creative director to begin more effectively marketing to certain markets within their target such as women, men, seniors, and Hispanics. Bally's has begun to more effectively take stock of their capabilities and has finally aligned their marketing efforts with those capabilities.

Bally's example is a good one for a firm trying to make the first steps. A more advanced marketing strategy requires a stronger analysis of potential consumers than common sense provides as well as more in-depth knowledge of the industry. A key finding of our consumer study is that a primary reason that respondents went to the gym was for the social scene. This makes sense considering the history of the fitness club industry as an offshoot of the private club business, where socialization and a sense of belonging are at the core. The implications this has for marketing strategy, both product and service development as well as advertising, are vast and surprisingly unexplored.

The most prominent trend in the industry has been towards over-expansion which is evidenced by a high depreciation expense as a percentage of revenues among publicly held health club operators. While the high depreciation is not a problem, it signals that the amount of assets being depreciated are not balanced with revenues. Strategic expansion is a good idea, but financially, capital budgeting techniques utilized are based on poor forecasting due to poor market research and intelligence. In other words, strategic expansion may actually prove false positives.

Here again, Bally's provides us with a good example of this phenomenon. After expanding extensively from 1997 to 2002, Bally's was forced to restructure large quantities of long term debt with a $175M loan facility and has held off on expansion and focusing on realizing the fruits of their capital expenditures. The problem with their initial expansion strategy was lack of proper forecasting, specifically in over estimating market share and sales, leading to weak revenues figures. Hence, Bally's marketing-centered reaction.

Our analysis, which draws from the wealth of research we have conducted over an 8-month review, yields some very interesting insights, on both an industry-wide and firm level.

- Expand traditional view of target market, but keep effective niche marketing (men, women, ethnic, lifestyle groups) in mind.
- Examine needs, wants, and motivations of members more closely to market to specific subgroups.
- Integrate social aspect of health clubs into marketing communications and product/service development.
- Expansion is supportive of marketing goals and effective marketing (market research and communications) is supportive of expansion efforts. They must be in balance for either to be worthwhile investments.

Remember: The costs incurred by these investments must be financed through raising debt or equity or prices. The effect of higher prices is negative as shown by statistics gathered by the IHRSA that indicate the "top performing" clubs have poor member retention which we have determined is due to the higher annual pricing structures.

al berrios & co. surveyed 493 consumers using our iResearch methodology. We then supplemented our survey by interviewing 16 trainers. And finally, interviewed 3 experts in the financials of the industry.

Disclaimer: The recommendations, commentary and opinions published herein are based on public information sometimes referenced via hyperlinks. Any similarities or likeness to any ideas or commentary from any other sources not referenced is purely coincidental. al berrios & co. cannot control any results occurring from advice obtained from this publication nor any opinion(s) conveyed by any reader of this publication.

al berrios & co. does and seeks to do business with companies covered in its research reports and studies. As a result, the reader should be aware that the firm may have a conflict of interest that could affect the objectivity of this report or study. Readers should consider this report or study as only a single factor in making any strategic or investment decisions.

(c) 2001-2005. All Rights Reserved. al berrios & company, inc. Published by al berrios & co. This Report may not be reproduced or redistributed in any form without written permission from al berrios & co., subject to penalty.

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