For anyone interested in fitness, the rise of CrossFit has not gone unnoticed. Founded in 2000, the company and philosophy of exercise has only really gained international traction in the past several years. What is CrossFit and why has this business model shaken up the fitness industry?
First, let's discuss the economics of the typical gym or fitness center. These establishments tend to have a large area for weight-lifting, numerous treadmills and stationary bicycles, and often a studio area for small classes. Members join the gym, often with a hefty sign-up fee, and pay a consistent fee every month.
Initially, this sounds like a fantastic idea for a business: provide customers with access to a room with equipment and then count the money as it comes in. In reality, it is not so simple.
These gyms have fairly low barriers-to-entry. To lease or buy weight lifting equipment, though expensive, requires no special expertise and the facilities can go in most buildings. The fact that there are numerous alternative establishments, combined with the fact that many people can simply buy their own gym equipment, has driven down prices. Many of these gyms charge fees as low as $30 per month. While it's true that variable costs are relatively low, the up front purchase of equipment must be covered. These facilities also have costs of SG&A, skilled staff, liability insurance, franchise fees (if the gym is part of a franchise), and lease on the property. Since fitness-enthusiasts demand a large variety of equipment with low waits even at peak hours, the costs for the equipment increases and the facility must be large enough to accommodate sizable groups. With the high fixed costs, these gyms must make up the cost with volume, locating in a centrally-located area where membership will be high.
It is fairly obvious that there is not much these gyms can do to improve margins, other than lower costs or cross-sell into other services. With a fixed gym size, there are only so many customers they can accommodate, but cross-selling may not require much extra space. Hence the increasing trend of smoothie bars selling protein smoothies at high markups and trainers always anxious to sell you on personal training sessions, at a very hefty price per hour.
CrossFit, on the other hand, initially sounds like a horrible proposition. CrossFit membership fees are often extremely high; seeing fees over $100 or even $200 is very common. Equipment in a CrossFit gym is minimal and classes are the only option, decreasing the flexibility for the member. On the surface, it is quite shocking that CrossFit gyms are able to break even.
The difference is that CrossFit gyms do not need such a vast membership to survive. In fact, they have turned both the revenue and cost models around. Instead of a high volume of customers at small average revenue per user (ARPU), CrossFit focuses on a smaller number of customers at high ARPU. Fixed costs are fairly low and variable costs are slightly higher, due to the need for additional trainers for an increasing member base.
CrossFit gyms have some equipment, but a small fraction of what is available at a big-box gym. Some of the most expensive gym equipment such as treadmills, elliptical machines, and stationary bicycles are not used in any CrossFit gyms. CrossFit gyms tend to be located in inexpensive, unused warehouse space; in fact, the members often take pride in the austerity of the design. Since the gyms do not require such vast memberships, these facilities can be located almost anywhere and do not need to be in densely populated areas. The only increased cost is that of certified trainers, which are required to be present for every class that is offered.
So the one final key to the equation. It is clear that CrossFit gyms have reduced costs significantly, but how have they been able to charge members the exorbitant fees that they charge? Why are people willing to pay that much for what, on its surface, amounts to much less?
For many people, normal gyms have become a commodity: a treadmill at one gym is the same as a treadmill at the next, so consumers tend to choose purely based on hours, price, and location. The philosophy of CrossFit, Inc. is to provide brand-building and trainer certification, but allow individual gyms the freedom to customize almost everything else. In this way, each gym is unique and has its own culture. The idea behind this brand licensing model, as opposed to the franchise model, is that individual gyms will be pushed to innovate and the best ideas will rise to the top quickly. These gyms also provide a much more interactive experience, enabling community-building that is absent from a normal gym. In a way, CrossFit has attracted a middle segment of the market: those who did not receive enough value from a simple gym membership, but also did not have a high enough willingness to pay for consistent, expensive personal training. These consumers get a personalized experience and are willing to pay a significant premium over normal gym membership. In this way, CrossFit offers real, sustainable value to the fitness community.
Will CrossFit survive the test of time? Or will it soon be forgotten, like so many other fitness trends? Only time will tell, but the business model and approach to fitness are certainly providing rapid growth that has the owners of traditional gyms on notice.
Full disclosure, I am currently a member of a CrossFit gym. I had been a member of a more traditional gym for the seven years prior to joining CrossFit.
Sunday, June 23, 2013
Sunday, June 9, 2013
Business Lessons from my Honeymoon
When you marry an MBA, conversations can take some weird turns. As my wife and I met in the MBA program at UNC Kenan-Flagler, it is not uncommon for a light conversation to turn into a Wall Street Journal op-ed. During our recent honeymoon in Costa Rica, at one point we were discussing whether the all-inclusive resort was watering down my drinks, and the next moment we were discussing whether you can truly grow an economy primarily based on tourism (we later found out that the largest industry in Costa Rica is actually microchip manufacturing, but I digress).
This honeymoon was actually my first experience at an all-inclusive resort. It was also my first experience as a high-value customer (HVC) as we spent more money on our room than we would have if it were not our honeymoon. This experience highlighted several relevant business concepts that I thought were interesting.
The Pareto Principle. This states that, in many situations, 80% of the outcomes come from 20% of the causes. This has numerous applications, but the one where I’ve heard it used most is that, in many businesses, 80% of the profits come from 20% of the customers. How is this applicable? On this vacation, we were members of that 20%. We reserved the best room in the hotel, got massages, bought expensive excursions, and left with numerous souvenirs. While spending like that was probably a one-time event for us, the hotel definitely wanted us to recommend it to other couples for their honeymoons. As such, we were treated very well when we were there: there was a basket of fruit in our room upon arrival (along with a note congratulating us on our wedding) and we were often able to get priority seats at restaurants during the week. Clearly, this hotel knew that targeting honeymooners can provide a significant boost to margin.
Value-based pricing. Nearly everyone realizes that most pricing is value-based rather than cost-plus. This means that sellers price based on an estimation of how valuable the product is to you, rather than simply adding a percentage to the cost of producing the product. All-inclusive resorts have this down to an art. The most obvious example was sunscreen. At the hotel store, there were cigars, souvenirs, snacks, and numerous other items, all at fairly reasonable prices. The one product that was priced at probably 6x what it would cost in the U.S. was sunscreen. The reason is fairly obvious: if a cigar is very expensive, I may just decide to not smoke one. But the cost to me is very high (sunburn or possibly skin cancer) if I forget sunscreen and decide not to buy it. Therefore, in this scenario I would value sunscreen very highly. All-inclusive resorts are masters of this, since most people do not rent cars as they plan to stay at the resort the entire time and therefore cannot go to another store where sunscreen is less expensive.
Spoilage. In hotels as in airlines, there is very little additional cost to an additional customer, assuming an empty room or seat is available. Therefore, hotels and airlines are incentivized to price in a manner that fills all of the capacity, while segmenting in a way that still extracts the maximum value from the customers with a high willingness to pay. We went to Costa Rica during rainy season, when these hotels tend to be less full. Our hotel partially solved this problem by offering local deals to Costa Ricans for the weekends. By offering these discounts only locally, they do not cannibalize the Americans who want to go on vacation. But a Costa Rican who may not be thinking about a vacation could be motivated to take one for the weekend and fill an empty room, preventing that room from “spoiling.” This does not work perfectly with all-inclusive resorts, as there are more substantial variable costs (due to drinks and meals), but the concept is still valid.
Outsourcing. At our resort, there was a table in the lobby with people selling guided tours throughout Costa Rica and Nicaragua. When we told them to bill our room for a trip to Granada, they said that they are not associated with the hotel. At first, this made no sense to me. But the company running the resort does not necessarily know anything about running excursions. By selecting the best company it can find, allow this company to solicit for excursions in its lobby, and then charging a hefty fee (potentially even a percentage of tour fees paid), the company can guarantee a significant revenue stream without straying from their core competency of running a resort. In fact, many companies should question why they would do something in-house when it can be outsourced to experts.
Check back in some time and I’m sure I’ll have business lessons that I learned from being married.
This honeymoon was actually my first experience at an all-inclusive resort. It was also my first experience as a high-value customer (HVC) as we spent more money on our room than we would have if it were not our honeymoon. This experience highlighted several relevant business concepts that I thought were interesting.
The Pareto Principle. This states that, in many situations, 80% of the outcomes come from 20% of the causes. This has numerous applications, but the one where I’ve heard it used most is that, in many businesses, 80% of the profits come from 20% of the customers. How is this applicable? On this vacation, we were members of that 20%. We reserved the best room in the hotel, got massages, bought expensive excursions, and left with numerous souvenirs. While spending like that was probably a one-time event for us, the hotel definitely wanted us to recommend it to other couples for their honeymoons. As such, we were treated very well when we were there: there was a basket of fruit in our room upon arrival (along with a note congratulating us on our wedding) and we were often able to get priority seats at restaurants during the week. Clearly, this hotel knew that targeting honeymooners can provide a significant boost to margin.
Value-based pricing. Nearly everyone realizes that most pricing is value-based rather than cost-plus. This means that sellers price based on an estimation of how valuable the product is to you, rather than simply adding a percentage to the cost of producing the product. All-inclusive resorts have this down to an art. The most obvious example was sunscreen. At the hotel store, there were cigars, souvenirs, snacks, and numerous other items, all at fairly reasonable prices. The one product that was priced at probably 6x what it would cost in the U.S. was sunscreen. The reason is fairly obvious: if a cigar is very expensive, I may just decide to not smoke one. But the cost to me is very high (sunburn or possibly skin cancer) if I forget sunscreen and decide not to buy it. Therefore, in this scenario I would value sunscreen very highly. All-inclusive resorts are masters of this, since most people do not rent cars as they plan to stay at the resort the entire time and therefore cannot go to another store where sunscreen is less expensive.
Spoilage. In hotels as in airlines, there is very little additional cost to an additional customer, assuming an empty room or seat is available. Therefore, hotels and airlines are incentivized to price in a manner that fills all of the capacity, while segmenting in a way that still extracts the maximum value from the customers with a high willingness to pay. We went to Costa Rica during rainy season, when these hotels tend to be less full. Our hotel partially solved this problem by offering local deals to Costa Ricans for the weekends. By offering these discounts only locally, they do not cannibalize the Americans who want to go on vacation. But a Costa Rican who may not be thinking about a vacation could be motivated to take one for the weekend and fill an empty room, preventing that room from “spoiling.” This does not work perfectly with all-inclusive resorts, as there are more substantial variable costs (due to drinks and meals), but the concept is still valid.
Outsourcing. At our resort, there was a table in the lobby with people selling guided tours throughout Costa Rica and Nicaragua. When we told them to bill our room for a trip to Granada, they said that they are not associated with the hotel. At first, this made no sense to me. But the company running the resort does not necessarily know anything about running excursions. By selecting the best company it can find, allow this company to solicit for excursions in its lobby, and then charging a hefty fee (potentially even a percentage of tour fees paid), the company can guarantee a significant revenue stream without straying from their core competency of running a resort. In fact, many companies should question why they would do something in-house when it can be outsourced to experts.
Check back in some time and I’m sure I’ll have business lessons that I learned from being married.
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