01/06/2011

With contributions from Cindy Palusamy, CP Strategy Inc.

A large and growing market
The search for the fountain of youth continues unabated in the 21st century, best evidenced by the boom in the spa business in the past decade. Industry experts calculate annual global spa revenues north of $40 billion, inclusive of services and products. The International Spa Association recently reported that there are 150 million active spa goers world- wide. The sheer size of the market makes it one of the largest leisure industry segments, but with no clear leader at the helm. A broadening understanding and appreciation of alternative healing and wellness regimes by consumers coupled with the burgeoning invest- ment in and supply of spas (mostly in hotels and resorts) has resulted in an industry growing by double digits annually over the last decade.

Hotel spas grab the lion’s share
Many of these consumers are checking into hotels on their quest for their next spa experience. While hotel spas consist of only 14% of the market in terms of units, they register about 41% of total industry revenue (ISPA, 2005). Travel agents concur: in a survey by SpaFinder 65% of travel agents said spa bookings were up in 2006 and stated that spa facilities / access to a spa are the most important considerations when making vacation plans.

Most relevant to the hotel companies is the impact on average daily rates, which some studies put at a 50% uplift for destination resorts with spas. As a result, hotel groups are investing heavily. A recent article reported that the top hotel groups (and related developers) are spending close to a half-billion dollars in the next few years on their spa facilities. Top of the list is Hilton Hotels, which has recently announced a deal with spa operator Spa Chakra, using LVMH’s Guerlain and Acqua di Parma brands within various luxury properties (Waldorf, Conrad and selected Hilton hotels). Hilton further commented that it and its property partners would invest $200 million to develop 70 new spas across its global hotel portfolio, more than doubling its current count of 65.

Day spa model has been a challenge
The largest investment to date in day spas has been by US-based private equity firm Northcastle Partners. When Northcastle acquired Red Door and the Mario Tricocci Sa- lons, they inherited a typical day spa model with its own locations—both freestanding and in department stores. The company owned the full p&l and in turn covered capital expenditures and funded working capital. While Northcastle is not commenting on its invest- ment, Red Door has not seen growth in the number of its freestanding locations to match that of the sector as a whole. In fact, Red Door has had to adapt its business model and now operates a significant number of its locations from within hotels under management contract.

Now consider another leading spa group, cruise ships specialist Steiner Leisure. Its 2001 acquisition of the land-based Greenhouse and related day spas probably seemed attractive as a way to quickly build a proprietary distribution platform for its Elemis product line and leverage its longstanding expertise in cruise ship spa operations. However a ship business, with a captive audience and relatively little off-peak times, is vastly different to a day spa business, requiring substantial customer acquisition and retention costs. The acquisition proved disastrous and Steiner was quick enough to exit the day spa business at a significant loss. Steiner has since seen record double-digit growth, fuelled both by services as well as the spectacular success of the Elemis product line, which is now a $100 million plus global spa brand also distributed wholesale in non-spa channels.

Renewed interest in spa distribution channel by beauty manufacturers
Along with interest by hotels, there seems to be renewed interest in spas from leading beauty manufacturers, after an unsuccessful foray in the 1980s and 1990s. Estée Lauder opened and subsequently closed Lauder spas in the late 1990s: opened mostly as concessions in department stores, the spas never fully realised their potential. L’Oréal opened and closed Helena Rubenstein spas within a couple of years but has remained in the spa business via product lines. LVMH acquired and sold Bliss over the course of five years, although their heart was probably more in the brand potential than in the spa business itself. Shiseido owns one of the largest spa skincare brands globally, Decléor, but has focused on purely being a supplier to the industry.

Recent announcements by various hotels on future investments in the spa sector bode well for beauty manufacturers as a distribution channel. Historically, the biggest drawback for such companies to service the spa sector has been low volume opportunities as a result of a fragmented customer base. As global hotel companies take a more strategic and centralised view towards the business, more significant and “deliverable” opportunities for cosmetic brands are arising.

Not all spas are equal
Amongst the challenges facing the business lies a classic identity crisis. The use of the word “spa” has come to mean everything from three-room day spas to 40-room megaspas to doctor-led medispas. The differences between the various formats are considerable. Successful day spas require private-label brands (70%+ margins) and a strong local, repeat business to survive. Hotel spas require strong links to hotel reservations and marketing programs to ensure consistent guest usage.

Geographical differences further complicate matters. Western market spas derive value from product and benefit greatly from hosted environments (hotels, retailers, etc) to subsidise upfront capital expenditures. Developing market spas – where there are real growth opportunities – derive value from service due to low labour costs and benefit from captive affluent audiences accustomed to paying a significant premium for spa services.

All told, the industry’s basic classification system and available statistics have failed to capture the true picture of the market. Interested participants need to look at the business with a far more detailed eye. Restaurants serve as an interesting comparison. The highly fragmented restaurant business is quite similar in cost structure to spas. The restaurant industry does not however classify itself along location (cruise ship, hotel, etc.). Rather, the industry has defined itself along a matrix of price and volume. High price and low volume food establishments generally equal fine dining establishments. Low price and high volume equals fast food. The same can be applied to spas. Some spas focus on quick treatments and focus on volume. Others are five-star service, low volume and high prices. Mixing the two together to draw conclusions is the equivalent of lumping McDonald’s and Ducasse into one category.

Similarly, the industry has given little thought to yield management. A key lesson from the airline industry is that the value of a product (i.e. airline seat) changes as a function of time and day. The same holds true for spas: a treatment on a weekend or after work is more valuable than a treatment mid-morning on a weekday. Spa owners need to develop effective pricing strategies to ensure revenue optimisation.

The spa market will likely remain at the forefront of discussion as opportunistic investors seek to bring some order to this growing industry. No clear leader has emerged with the right formula for success. Until then, our money will be on “bundled” groups, where good locations meet good operators meet good brands, as with the recently announced Hilton / Spa Chakra / LVMH deal.