Challenging Times Ahead for Fitness Clubs By Zach Brown

Feb 19, 2015

Gyms/Sports Clubs Slump

US sport clubs and fitness centers need to get off the couch to combat recent sluggish results. Despite the

positive trend in active fitness participation, people are spending less money at the gym. The fragmented 27

billion dollar fitness industry is full of its fads and trends, but if the big box fitness clubs aren’t willing to evolve

fast, they will get left behind. Consumers are willing to pay high membership fees for fitness clubs that contain

variety, social atmosphere, specialized group classes, and amenities. The biggest threats to the core business

model of mid-priced big box sports clubs are the growth in low-price gyms; the shift towards boutique workout

studios, outdoor boot camps and online do-it-yourself fitness media; and the increase in rent expense.

Declining Industry Sales

Sports clubs reached their peak

revenue growth back in 2004 and

sales trends have been deteriorating

ever since. Aside from the

2008/2009 recession that saw a

decline in all consumer expenditures,

Americans cut their spending on

sports clubs for the first time at the

end of 2013 and revenues have been

in decline since then. The key forces

driving the decline in consumer

spending on sports clubs are (1) the

increase in do-it-yourself fitness

programs guided by online content

and fitness trackers, and (2) the

emergence of low-priced gyms like

Planet Fitness.

Below is an illustration of the impact of low-price gyms on the overall industry. These cheaper gyms are

affecting the fitness club market in three ways: membership growth, declining revenue per member, and the

emergence of a price war. This trend will create a bifurcation in the industry where the winners are the low-

priced, “bare minimum” gyms and the high-priced, luxury fitness clubs.

The sports club market is very fragmented and

becoming more elastic. The top three players

(24 Hour Fitness, L.A. Fitness, and Life Time

Fitness) own less than 20% of the market. The

only two publicly traded fitness chains left are

Town Sports International (CLUB) and Life

Time Fitness (LTM). Town Sports and Life

Time could not be more different in their

business models, but both have plunged into

negative same-store sales growth; reflecting

real declines on stores open thirteen months or

longer. Because these two companies must

freely share their financials, we will take a

closer look at their trends and formulate some industry-wide takeaways.

Quick Study of Town Sports and Life Time Fitness

Town Sports owns and operates 159

mid-value clubs on the East Coast

through the regional brand names New

York Sports Clubs, Boston Sports

Clubs, Philadelphia Sports Clubs, and

Washington Sports Clubs. Town has

actively managed the recent trend

towards specialized group classes

through fee-based course offerings of

Pilates, TRX, Kettlebells, and VBarre.

In addition to the courses, Town

recently allocated existing square

footage to an “Ultimate Fitness

Experience” (UXF) that can be used as

a cross-functional training zone.

Town’s new “BFX” initiative

demonstrates its adaptive qualities by opening smaller boutique fitness studios focused on specialty group

classes and personal training that should yield improved revenue from increased membership and course fees.

Despite Town Sports’ efforts to cater to the growing demand for small, social fitness classes, it has struggled to

produce comparable store sales growth. In the last twenty-four quarters, Town has grown same store sales only

six times. The chart above illustrates Town’s underperformance to the industry since the 2008/2009 recession.

Life Time Fitness has a starkly different business model aimed at creating a community fitness center with

diverse offers ranging from spas and cafes to fitness centers and organized endurance sport competitions. Even

though Life’s approach to the fitness club business appears too varied and unfocused, it grew same-store sales

for eighteen quarters straight before dipping negative in mid-2014. The focus on family membership and

different levels of club luxury to meet local demographic demand has outperformed the industry for over six

years.

Life Time operates 108 stores spread out across twenty-nine major markets with a higher percentage of

locations in Minnesota, Texas, and Illinois. Instead of proposing a single fitness club format, Life Time Fitness

has Bronze, Gold, and Platinum fitness centers as well as Life Time Athletic centers for Onyx and Diamond

platforms. This varied level club format is a double-edged sword offering the consumer a range of premium

choices while matching the local market’s appetite for luxury with the appropriate club format. The amenities,

services, and activities that make Life unique include: squash courts, spas and swimming pools, rock climbing

walls, massage therapy, athletic leagues, martial arts, summer vacation camps, and dance classes.

Industry Trends Seen in Town Sports and Life Time Fitness

Town Sports and Life Time Fitness highlight many recent developments in the fitness club arena. The most

current evolutions are in pricing structure, revenue mix, and joining fees. The single greatest challenge fitness

club operators face is the bifurcation of the industry into low-price and luxury markets. This spread will

squeeze middle market fitness centers causing margin compression on the low end and industry consolidation

for clubs that can’t adapt or compete.

The bifurcation of the fitness club market is driving the change in the landscape more than any fitness fad.

Gyms like Planet Fitness, Retro Fitness, and Crunch Fitness grab memberships from mid-priced fitness centers

and have caused clubs to offer more competitive pricing options. Although this pricing is great for the

consumer, the quality of the fitness club usually matches the value paid. Premium fitness clubs such as Life

Time’s Diamond luxury fitness centers and Equinox gyms are performing well by offering better products,

services, and classes. Life’s CEO Bahram Akradi claims they are capturing the top 20% of the market and are

providing a far better experience than the boutiques. One of the key differentiators between luxury and mid-

priced fitness clubs is the quality of personnel operating the gyms and teaching classes. Equinox is famous for

its celebrity fitness trainers who are commonly found on highly rated fitness videos. Life Time’s executives

claim that employee retention is highly correlated to membership retention so they focus on superior staff and

have determined that its worth the cost.

Town Sports is drastically changing its core business model and implementing a new “High-Value, Low-Price”

initiative that will affect forty percent of their existing clubs. Town executives suspended their highly

anticipated “BFX” club rollout in order to focus all energy on the lower price-point offering gyms. Town

estimated membership will increase at new “HVLP” centers from 2,500 members to 6,000. Town Sports CEO

Bob Giardina commented on industry pressures, stating that consumers are starting to have more choices in

terms of their exercisability not only

with clubs, but also with studios and

outdoor boot camps.

The change in revenue mix is a clear

winner for all sports clubs. Gyms

are growing revenues through in-

store offerings such as personal

training, health supplement

products, small group training, child

centers, and health/fitness

diagnostics. Over the last eight

years, the combined share of

auxiliary sales as a percent of total

revenue for Town and Life has

steadily grown from 22% to 28%

over eight years while membership

dues as a percentage of the revenue

mix have fallen from 73% to 67%.

The model is quite simple: get the consumer in the door and then increase the share of his/her wallet through

products instead of membership dues. Non-membership revenues generate higher profit margins due to the use

of existing capital or the sale of low cost products.

Joining fees are declining at medium-price fitness centers because consumers frequently view the initiation fee

as too great of a financial barrier for entry and gym operators see it as a governor on membership. The

reduction in joining fees complements the increased focus on non-membership revenue by generating sales each

time the customer enters the club.

How to Stay Relevant in the Middle-Market

Mid-priced fitness clubs face some serious challenges in 2015 and beyond. Three strategies middle market

gyms may pursue to exist in the future bifurcated industry: 1) reduce square footage, cut staff, and squeeze

operating expenses to slim down to the low-price model; 2) diversify store offerings similar to Life Time

Fitness in order to capitalize on luxury demographic markets and low-price competitive arenas; and 3)

strengthen brand name through superior service that clearly differentiates from low-priced market, offer high

value low cost amenities on a monthly basis, attract frequent/committed members, and focus on quality club

level offerings over quantity of stores.

“If you can’t beat ‘em, join ‘em.” Cutting down a mid-priced chain of fitness stores to a low-price model has

some competitive benefits. The initial slimming of excess square footage, staff, corporate costs, and premium

products will be painful, as will the loss of mid-level members, but the ability to offer slightly better existing

equipment for no extra capital cost can generate a small but meaningful margin over low-end competitors. This

is not the most glamorous approach for most mid-tier gyms, but it’s better than closing the doors permanently.

Life Time Fitness has proven that the diversified club portfolio strategy can be successful. The strength of this

model lies in the flexibility of the format to meet the local market’s appetite for luxury. Premium offerings

executed properly yield higher margins. The challenges to this approach exists in the executives’ ability to

effectively manage such a wide range of club formats. The potential mismatch in offerings or execution of

offerings is detrimental to either membership numbers or profitability.

The third strategy hinges on the ability of the company to clearly differentiate a better product offering than the

low-price gyms. This is a real challenge that is never complete because even if a chain of fitness centers is able

to creatively differentiate itself, the low-price competitors will attempt to mimic the successful plan and

eventually close the gap. Management must stay one step ahead of the game by being very creative, forward-

looking, and incredible executors. A viable strategy to prove value over low-end gyms is to offer free or low

cost amenities on a frequent basis. This could be in the form of free towel services, one free thirty minute

personal training service every quarter, discounted supplements, free sports drinks, etc. Consumers will pay

more for a strong brand name supported by superior customer service. A strong tactic in this strategy would be

to attract high-usage customers that workout multiple days a week and leverage the in-store offerings of

auxiliary products to boost high margin sales. Lastly, sustainable growth would be better achieved through

managing same-store sales growth at quality club locations versus mass store portfolio expansion. A slow store

expansion would ensure ideal locations that target demographics that will chose a mid-priced fitness over low-

price gyms.

Here is a quick example a middle-market fitness club could employ that incorporates many strategies listed

above: supply members with free advice on useful ways for fitness bands/trackers to be implemented into their

fitness plans and used in daily workouts. Trackers could be given to members for a free week trial of the

product. This example demonstrates a product offering that differentiates the club, adds value for little to no

cost, gives the customer the satisfaction of a “perk”, and leverages in-store sales through the eventual sale of

fitness bands and trackers. This would be a creative strategy that embraces the new tech trend instead of

competing against it. Note: at the writing of the article the author is not aware of any current offerings of this

example in any gyms.

Chart Addendum