Case 1-1: Bally Total Fitness

By: Nicole Diana, Caitlin Larrick, John Meade,

Yanqing Pan, & Laura Salt
Dukez
January 23, 2017
1954 words
 Bally Total Fitness Holding Corporation, 20041
Headquarters Chicago, Illinois Total Revenue $1.048 bln
CEO Paul A. Toback Locations 412
Geographic
NYSE Ticker (BFTH) 29 States, D.C., & Canada
Exposure
Phone
(773) 380 - 3000 Members ~3.6 mln
Number
Website www.ballyfitness.com Employees ~23,200

External Environment Analysis

The external environment plays a huge factor in determining the success of Bally Total

Fitness. Thus, an analysis of the general external environment includes determining the threats

Bally faces and the opportunities they should exploit to set themselves ahead of competitors.

There are six most common forces that affect a firm's external environment: specific

international events, technological change, economic climate, sociocultural trends, legal

conditions, and demographic trends. These forces affect the firms either positively, creating

opportunities, or negatively, creating threats.

One specific, major international event that occurred between 2000 and 2004 was the

September 11th terrorist attacks on the United States. This caused people to seek comfort in their

own communities by finding things to do near home. Another external force that did not

significantly affect Bally, but should be considered when analyzing the entire external

environment, is technological change. During this time, websites such as Wikipedia, Myspace,

and Facebook were launched and drastically changed how the internet was used. This change in

technology affected all industries creating a new platform to reach potential and current

customers. After the September 11th attacks, the country went into panic and the stock market

declined drastically. After these declines, the economy eventually leveled out and by 2004 was

moving upward. The economy directly affects Bally's external environment because this
determines how much discretionary income people have to spend on luxury items such as health

club memberships.

Sociocultural trends were a huge driving force that positively impacted Bally, creating

many opportunities. Obesity was an epidemic in the United States at the time. From 1994 to

2002 the percent of overweight and obese American adults jumped from 56% to 65% as seen in

the graph below.2

This rapid increase in obesity in the U.S. created urgency for people to become healthier.

Bally conducted a survey in 2004 in which they found out that 64% of people were embarrassed

by the nation's obesity and 97% of people felt poorly about their own bodies.3 These statistics

give a great indication as to why the memberships at health clubs were rapidly increasing during

this time.

The Securities and Exchange Commission was investigating Bally's accounting

procedures in 2004 as well.4 This had a huge effect on the external environment regarding legal

and political conditions. The SEC's investigation was a threat to Bally's brand and ability to

attract customers. Finally, the demographic trends affecting Bally during the late 1990's and early

2000's were the increase in older customers. During this time, the demographic trends greatly

affected the health club industry and Bally. On the left below is a graph showing the 10%

increase between 1988 and 2001 of health club members over the age of 55 and a 21% decrease

of members between ages 18 and 34.5 This is because memberships were more prevalent among
higher-income households, shown in the graph on the right.5 Members in retirement had more

disposable money to spend on ancillary services, such as personal training

Club Membership by Annual Household Income5

11.00%

21.00%
46.00%

22.00%

$25,000 $25,000-$49,999
$50,000-$74,999 $75,000+
and nutritional products, which was a huge

opportunity for Bally.3

Core Health Club Members by Age (% of Total)5
100%
9% 14%
90% 19%
80%
34%
70%
39%
60% 42%
50%
40%
30% 53%
42%
32%
20%
10%
4% 5% 7%
0% 55+ 35-54
1988 1997 2001

Porters Five Forces

Within the health club industry, there are thousands of companies that provide their

services to millions of Americans. In 2004, there were more than 26,000 health clubs operating

in the US with over 41 million members. The industry believed it was going to continue growing

based on the high concern Americans showed about their health.6

 Health Clubs and Membership Statistics in the U.S., 1987 - 20046
45.0

40.0

35.0

30.0

25.0

20.0

15.0

10.0

5.0

0.0
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Health Clubs (thousands) Health Club Memberships (mlns)
Core Health Club Members (mlns)
 The total capital required to open a small health club could be as low as $25,000 to

$35,000, so the threat of new entrants is very high. Although the leading companies occupied

33% of the industry revenue, there is still 67% of revenue unaccounted for which be directed

towards the new entrants. To neutralize the threat of entry, the incumbents should try to build

economies of scale. This will allow them to offer competitive pricing compared to their peers

due to the cost cutting abilities of large firms.4

Porters second threat is the threat of rivalry. Within the health club industry, product

differentiation is low because most of the health clubs offer the same amenities as their

competitors. To neutralize this threat, health clubs will try to offer additional products or services

to their members to differentiate themselves from their competitors. An example of this is how

Bally offered consultation to members who had weight-loss goals. The company also offered a

special juice bar for their members who could take advantage of this unique opportunity after

they finished their workout.4

Within the health club industry, the threat of substitutes is extremely high as customers

can resort to sources of exercise outside of fitness centers. To neutralize the threat of substitutes,

these companies need to keep their prices low but at the same time be able to turn a profit. Health

clubs will not be able to stop their members from leaving, but if they keep their prices low and

keep offering additional amenities, they may be able to keep their retention rate higher than the

rest of the industry.

In 2004, there were six large suppliers of exercise equipment within the health club

industry. Since the lesser known equipment producers usually target the at home gym market, the

larger supply companies do not have a lot of power within the health club industry since the
product differentiation is so low. Since there are substitutes for the suppliers, the suppliers power

is checked and they cannot raise their prices without the threat of losing their buyers.4

The final threat in Porters Five Forces Model is the threat of the buyers. The buyers in

the health club industry are the customers who are planning on purchasing memberships or the

ones who are purchasing their outside products. Since there are so many customers in the health

club industry, no single buyer produces a large amount of a company's revenue. So when one

buyer walks away it will not materially affect that company. To neutralize the threat of buyers,

health clubs need to keep their prices low and keep offering new and exciting amenities that will

catch the buyers attention.

Industry Structure

The Health Club Industry is characterized as having a fragmented structure. The industry

consists of more than 26,000 health clubs, ranging in sizes.4 There are no clear, dominant firms in

this industry due to the sheer number of companies offering the same amenities. The barriers to

entry are low, considering the low costs associated with starting a health club. A Hirschman-

Herfindahl Index (HHI) value of 108.66 proved our prediction of a fragmented structure.7 This

was calculated using the market shares of the top 20 health clubs with the industry's revenue of

$14.1 billion, which considers the very low percentage of market share of the companies below
the top 20 to not have a significant enough impact to change the structural outcome.7,8 The

computations for HHI are found below.

Company Market Share (%) (Market Share)^2

24 Hour Fitness 6.96 48.41
Bally Total Fitness 6.77 45.78
Town Sports International, Inc. 2.43 5.92
LifeTime Fitness 1.82 3.32
The Wellbridge Co. 1.23 1.52
The Sports Club Co. 0.93 0.86
Equinox Fitness Clubs 0.83 0.69
Tennis Corp. of America (TCA) 0.64 0.41
Western Athletic Clubs 0.58 0.34
Sports & Health Clubs 0.55 0.30
Spectrum Clubs Inc. 0.53 0.28
Club One 0.40 0.16
Leisure Sports Inc. 0.36 0.13 There
Gold's Gym International 0.35 0.13
is not East Bank Club 0.33 0.11 a
Fitness USA Supercenters 0.30 0.09
New York Health & Racquet Club 0.25 0.06
Five Seasons Sports Country Club 0.23 0.05
Lucille Roberts 0.23 0.05
Health Fitness Corp. 0.22 0.05
Total 25.94 108.66
dominant company in that industry right now, so theres an opportunity for Bally to penetrate the

market and enhance the barriers to entry. A fragmented market offers a unique opportunity for

consolidation. Given the low interest rate environment from 2002 2004 following the collapse

of the tech bubble, there was an opportunity for a large firm like Bally to take advantage of cheap

financing and acquire smaller participants in the US market.9 Many of the firms listed above

such as Golds Gym have a strong brand name and geographic exposure, offering an opportunity

for inorganic growth by Bally. Acquisitions would allow Bally to develop economies of scale

which would in turn drive profitability and allow them to grow organically in the future. Ballys

brand recognition is one of its strengths, and it should utilize that through aggressive organic and

inorganic growth to capture the market power a strong company maintains.

Financial Analysis

We utilized data offered in the case and pulled external sources to do further quantitative

analysis on the state of Bally leading up to and during 2004. Using Exhibit 6 from the case, we

analyzed Ballys Gross Margin and EBITDA Margin to get a clear look at the companys

profitability. We found that Ballys Gross Margin increased leading up to 1998 where it hit a

peak of 42.39% before starting a multiyear decline towards 15.72% at the end of 2003. This can

be attributed to the Cost of Goods experiencing a 6.34% compound annual growth rate (CAGR)

from 1994 to 2003 while Total Revenue experienced only a 4.15% CAGR for the same period.

This inability to keep costs down flowed through the income statement and is a major reason the

company experienced negative net income from 1994 1997 and 2002 2003. Similarly,

EBITDA margin experienced its highest value of 15.73% in 2000 but gradually declined as well

before hitting a low of 5.76% in 2003. We were unable to include Net Income Margin in our

analysis due to it taking on negative values in multiple years. Our Margin Analysis for Bally is

shown below.10
 Bally Margin Analysis
45.00%
40.00%
35.00%
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00% Gross Margin EBITDA Margin
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

The companys inconsistent margins did little to instill confidence in the company, and

the decline of the companys stock price from the end of 2000, shown below, roughly follows the

trend of the margins as the company proceeded to lose around 90% of its value from the end of

2000 to the end of 2004. (Bloomberg)

 A look at Ballys publicly-traded competitors shows that the company looked relatively

worse off than its peer group.

Company (Ticker) ROA ROE ROS WACC P/E P/B

Bally (BFTH) -6.06% - -2.89% 8.12% -4.61 -0.10
Lifetime Fitness (LTM) 5.05% 11.53% 9.63% 6.73% 25.37 3.49
Health Fitness Corp. (HFIC) 8.13% 13.08% 3.24% 12.15% 22.31 3.17

We utilized Bloomberg to look at Operating Ratios for Bally and its competitors. Its not

surprising to see the rapid decline in value of the company over the period given Ballys

operating metrics. The company experienced negative net income for the 12 months ended

December 31st, 2004. As a result, the company posted a negative Return on Assets (ROA) and

Return on Sales (ROS) for the period. The company had negative shareholders equity, so

computing a digestible Return on Equity wasnt possible. The companys WACC at the time was

8.12%, higher than its ROA, indicating that Bally was performing poorly in terms of economic

measures. Ballys performance also lags behind its industry peers, Lifetime Fitness (LTM) and

Health Fitness Corporation (HFIC). We attempted to find relative valuation metrics for Bally as

well, but given its negative net income and book value we arrived at negative Price to Equity and

Price to Book. LTM and HFIC demonstrate more normal operating metrics that one would

expect to find when looking at publicly traded companies, though all companies are experiencing

ROA < WACC so there needs to be improvement across the industry in regards to economic

performance.11

Recommended Course of Action

Bally clearly has a number of problems it needs to deal with if it wants to survive in the

business environment of 2004 and onwards. The first option is to internally improve profitability
by cost cutting, particularly the labor costs, as we saw in Exhibit 4 that though Bally has

significantly more employees than other market participants, it does not have the highest revenue

among its competitors. A possible solution would be to automate certain processes to take out the

need for human labor. As mentioned before, the market for U.S. Fitness Centers is very

fragmented with no single participant taking up more than 7% of the total market share. This,

coupled with the low interest rate environment following the collapse of the tech bubble, means

there are opportunities for aggressive inorganic expansion via levering up and acquiring

competitors across the nation. This would allow Bally to increase their market share and

gradually develop economies of scale as a result of their new size. Lastly, if Bally wanted to

disregard market share they could potentially divest some of their less profitable stores and focus

more on their profitability for a period of time, allowing them to cultivate a stronger company

before pursuing expansion in the future.

 Works Cited
1 Bally Total Fitness Holdings 10-k (2005, June 30). SEC Edgar. Retrieved January 23,
2017, from
https://www.sec.gov/Archives/edgar/data/770944/000095013705014370/c00352e10vk.ht

2 - Prevalence of Overweight and Obesity Among Adults: United States, 1999-2002. (2010,
February 03). Retrieved January 23, 2017, from
https://www.cdc.gov/nchs/data/hestat/obese/obese99.htm

3 - Bally Total Fitness Holding Corporation SWOT Analysis. (2004). Bally Total Fitness
Holding Corporation. SWOT Analysis, 1-9.

4 Wells, John R., Elizabeth A. Raabe, and Gabriel Ellsworth.

"Bally Total Fitness (A): The Rise, 19622004."Harvard Business School Case 706-450,
November 2005. (Revised December 2016.)

5 Wells, John R., Elizabeth A. Raabe, and Gabriel Ellsworth.

"Bally Total Fitness (A): The Rise, 19622004."Harvard Business School Case 706-450,
November 2005. (Revised December 2016.) Exhibit 2

6 Wells, John R., Elizabeth A. Raabe, and Gabriel Ellsworth.

"Bally Total Fitness (A): The Rise, 19622004."Harvard Business School Case 706-450,
November 2005. (Revised December 2016.) Exhibit 1

7 Wells, John R., Elizabeth A. Raabe, and Gabriel Ellsworth.

"Bally Total Fitness (A): The Rise, 19622004."Harvard Business School Case 706-450,
November 2005. (Revised December 2016.) Exhibit 4

8 - U.S. health club industry revenue 2000-2015 (2015, December 31). In Statista.
Retrieved January 23, 2017, from https://www.statista.com/statistics/236120/us-fitness-
center-revenue/

9 Board of Governors of the Federal Reserve System (US), Effective Federal Funds Rate
[FEDFUNDS], retrieved from FRED, Federal Reserve Bank of St. Louis;
https://fred.stlouisfed.org/series/FEDFUNDS, January 23, 2017.

10 Wells, John R., Elizabeth A. Raabe, and Gabriel Ellsworth.

"Bally Total Fitness (A): The Rise, 19622004."Harvard Business School Case 706-450,
November 2005. (Revised December 2016.) Exhibit 6
11 Bloomberg L.P.