THE GOLF INDUSTRY - A SUPPLY AND DEMAND ANALYSIS With: Fazio Golf Designers, the National Golf Foundation

and Pulte Homes PART II

FURTHER ANALYSIS - Understanding Industry Cycles Cyclicality of industries can be examined from two perspectives. The first is cyclicality in relation to external factors or conditions in the overall environment (e.g., economic and social conditions). The second relates to how the industry reacts to these external factors and the impact that these industry actions have on the cycle. The external factors combined with the internal reactions affect the length of the cycle and the amplitude (the height of the peaks and troughs) of the oscillations. External drivers of industry cyclicality According to Tom Fazio, Golf course design and capital investment will continue to follow the economic times. Its been that way for more than a hundred years. Fazio was particularly interested in using the rich historical database of economic indicators in order to better understand golfs business cycles in particular, where it is currently, how it got there, and where it is headed. While no statistical correlations between golf supply and demand with individual macroeconomic variables were found, a decade-by-decade view of economic conditions and how they have influenced change in golf course supply is presented in Figure 11 below.

Figure 11. Golf Course Supply and Macroeconomic Conditions

Economists have suggested many theories to explain fluctuations in business activity. Some theory suggests that momentous innovations have an impact on investment and consumption and, therefore, on output. Most economists, however, believe that the immediate cause of cyclical change occurs as a result of changes in the level of spending. Certain cause-and-effect relationships as well as parallels between previous expansion and contraction periods in golf development could be drawn through interviews with Joseph Beditz and Tom Fazio. When asked to identify the economic conditions that had fueled previous expansion and contraction periods, they provided a number of thoughts. For example, according to Fazio, the 1970s were a terrible time for the development of the supply of golf. The September 1974 Real Estate Investment Trust crash made 1975 the leanest of years in the design business. The oil embargo in the late 70s and escalating interest rates through 1981 contributed to the decline in course development through 1986. The tax law changes instituted by Ronald Reagan in 1986 made it more desirable to build again, starting a new uptrend. The economic, political and social characteristics of the different decades could explain some of the cyclicality of golf course development. Joseph Beditz identified similarities in the previous expansion cycles. In particular, previous expansion cycles shared an increase in the availability of cash. In the 1960s, the golf industry cashed in on the increased availability of government money for rural development. In the late 80s and 90s, individual entrepreneurial investment capital was available and fueled new course development. This money came with high expected returns, and the developments, unlike in the 1960s, were mostly high-end, large-budget projects. Internal drivers of cyclicality The dynamic growth rates in golf course development are not unlike cyclic behavior seen in many other industries. Industries ranging from the cattle industry to the commercial real estate industry all witness similar patterns of behavior. The cattle cycle is simple. As cattle prices rise, suppliers respond by producing more. For that, they need more breeding stock. Holding back breeding stock reduces the number of animals going to slaughter, which pushes prices even higher in a self-reinforcing cycle. It takes a year or more before calves are born to larger breeding herds. Even more time passes before the cattle can be brought to market. More than two years pass before operators reaction to higher prices actually results in higher slaughter numbers. In other words there is no instantaneous response of supply to demand as typically portrayed in economics textbooks. Eventually though, more fat cattle are marketed. Because so many ranchers expanded their herds simultaneously, the increased flow becomes excessive. Prices drop; suppliers see little profit and cut their herds, further reinforcing price declines. Again, a

couple of years pass before slaughter numbers drop in response to lower herd sizes. Beef prices then rebound and the cycle starts all over again.1 Commercial real estate is another example where boom and bust behavior has been readily observed. Rents rise over time and many developers foresee profits from new buildings. It takes time for new buildings to come on line. And, prices remain high for some number of years as developers acquire property, permits, and designs and then build the new buildings. But, just like in the cattle example, many developers have the same idea at the same time and once all of the new buildings come on line, vacancy rates increase and rental rates drop. While some can ride it out, others go broke and eventually excess capacity goes away, rental rates and prices begin to rise and the cycle begins again. Economist Edward Lotterman states that Office buildings and cattle are not the only items that follow such a pattern. Anytime there is a long lag time in producing something, the cycle of responses to increased demand can become exaggerated, oscillating widely around any long-run trend. 2 The behavior in the commercial real estate industry has been widely studied and the following factors have been identified as possible explanations for oversupply cycles: Influx of capital seeking investment opportunities Strategic behavior where each developer says, If my project goes ahead and others projects do not, I will be able to capture profit. But, if we all build, profits will fall and we will all lose money combined with a lack of information about which projects will go to completion, which will be delayed etc. What is individually rational behavior leads to a collectively irrational outcome Environmental and regulatory policies create lags and delays and extend forecasting horizons, making mistakes more likely Development budgets typically allocate too little for research. As a result faulty data and poor forecasts of supply and demand create a tendency for too many projects to be started during a boom and delays projects during a bust System dynamics wherein markets respond to current prices, not taking into account lags and cycles which ensure a backlog due to supply lags. Building completions at some point exceed current demand. Overshooting of supply is likely, especially if demand growth subsequently falls off due to macroeconomic cycles.3 Its not hard to conceive that these very factors are contributors to the dynamics in the golf course industry as well. So, given that the golf industry, like most, will continue to be affected by economic and socio-demographic shocks and trends, what, if anything, can industry players do to ensure that their responses do not exacerbate the cycles (i.e., create an oversupply of golf courses)?

1 2

Edward Lotterman: Of Cows and Commercial Real Estate. March 2007. Edward Lotterman: Of Cows and Commercial Real Estate. March 2007. 3 Max Kummerow. A System Dynamics Model of Cyclical Office Oversupply. 1999.

FURTHER ANALYSIS Balancing Supply and Demand The concepts of supply and demand are the most fundamental in economics and create the theoretical foundation for a market economy. The relationship between supply and demand is the underlying force behind the efficient allocation of resources. At equilibrium, the intentions of the buyers and those of sellers are matched. When disequilibrium occurs, shortages or surpluses are created. In the golf industry, when demand is greater than supply, overcrowding occurs, prices increase, and new supply is created which ultimately returns the market to a state of equilibrium. Conversely, when there is excess supply, prices fall to the point where some courses are no longer profitable and must close, thereby decreasing supply and returning the system to equilibrium. There are many components to equilibrium in the golf industry. And, while much of the data discussed here is focused at state or national levels, because golf is offered predominately in local markets, analyses conducted for the purposes of investment or marketing decisions must be conducted at local or regional levels. In other words, business strategies must be targeted to the characteristics of the consumers within an appropriately-defined geographic context. Supply that is well-matched to the demand characteristics of a given region will help ensure that equilibrium is maintained. Characteristics of Supply The supply of golf courses can be looked at across a wide range of characteristics. And, these characteristics must be closely examined when making decisions about new investment in golf courses, modifications to existing courses, or golf course marketing and promotion strategies. One way to look at supply is in aggregate (i.e., how many golf courses are there in a given geographic region) as shown in Figure 12. The median number of courses per capita in 2006 was 67.8. California has the fewest number of courses per capita at only 25 per one million residents. Although California has the greatest number of courses in the US, the vast state population creates a low density of supply. In addition, low concentrations of courses in New Jersey, Texas and New York may signal opportunity for additional development. South and North Dakota have the greatest number of courses per capita at 155 and 179 respectively, largely caused by low state population figures. Heavy concentrations of courses per capita in Iowa, Minnesota, Wisconsin, and Michigan are not surprising based on high participation rates in those states.

Figure 12. Golf Courses per Capita by State

California New Jersey Maryland Alaska Texas Louisiana Nevada New Mexico New York Georgia Washington Virginia Utah Delaw are Tennessee Colorado Connecticut Oregon Arizona Illinois Rhode Island Alabama Pennsylvania Missouri Massachusetts Mississippi Florida Oklahoma Haw aii North Carolina Ohio Kentucky West Virginia Arkansas Indiana Idaho South Carolina Michigan New Hampshire Wisconsin Kansas Minnesota Maine Montana Vermont Wyoming Nebraska Iow a South Dakota North Dakota 0
Source: National Golf Foundation

20

40

60

80

100

120

140

160

180

Supply Per Million Residents

Supply per capita statistics within a given state or geographic region are not necessarily reflective of market saturation. In some areas, golf participation is not entirely derived from residents; it may also be driven by tourism. For example, a 2006 article on Arizonas economy stated that out-of-state tourists arriving on golfing trips pumped at least $1.1 billion into the economy, not including what they spent directly on the sport.4 Some states see golf courses as a way to boost tourism and economic growth. So, thoughts about supply and investment might also look beyond the participation rates
4

Golf Industry Sees Bright Future after Slump. The Arizona Republic. May 15, 2006.

of resident populations to take into account populations that may be drawn to the area (either as tourists or even as new residents) as a result of new supply. While the aggregate numbers provide an interesting high-level picture, given the diversity of demand and golfer preferences, and the need to match supply with demand, a whole range of additional characteristics must be considered. For example, as discussed above, some courses are private and restrict play to members whereas others (e.g., municipal and daily fee) are open to the public. Clearly, the pricing structures and, therefore, the demand for the various types of courses will be different. Public daily fee courses, for example, are low- and mid-budget courses usually targeted toward local residents that cannot afford more upscale or private courses. Highend daily course, on the other hand, are targeted toward a higher income residential base as well as corporate outings and tourists. Location is particularly important for both of these types of courses as they draw primarily on residents as their customer base. Private clubs cater to higher income golfer and also have business and social considerations. Even within private clubs there is variability (low-end to high-end). Other types of private specialty golf courses include destination private courses and high-end country clubs. Additional variations include theme courses with holes similar to design of famous golf holes around the country and urban and leisure resorts which include lodging. 5 Other differentiating characteristics of golf courses include: Pricing Course design and quality Facilities design and quality Location Amenities Offerings (e.g., Executive, Par3, and Abbreviated) These additional characteristics and others are important to consider when analyzing the supply of golf courses. Understanding all of the characteristics of the existing supply and those which are most important to target populations is critical to investment decisions in new golf courses. Matching course characteristics with levels and types of consumer demand is critical to achieving equilibrium in the market. Characteristics of Demand Segmenting demand is just as important as segmenting golf course supply. Golfers and potential golfers differ greatly across a whole host of socio-demographic and consumer preference characteristics.

Stephen F. Fanning: Segmentation of Golf Course Markets, January 2003

Increases in population affect demand. Overall, the number of people in the United States is expected to increase 25%, resulting in a population exceeding 350 million people by 2025.6 But, to what degree will a larger population help golf? Clearly, not all people are equally likely to play golf. A variety of population characteristics will drive participation rates within a population. For example, income, as mentioned above, age, ethnicity, health status, longevity, availability of leisure time and preferences are all important drivers of the demand for golf. Income Many assume that wealth is a principle driver of golf participation. As shown in Figure 13, many of the states with the lowest median income also have the lowest participation rates. This relationship does not hold across the entire continuum of income, however.
Figure 13. Median Income and Participation Rate Correlation, 2005

While there is a statistically significant correlation between the two variables (f=.0066) the variability in median income explains only 14% of the variability in participation rates nationwide. Clearly, a number of factors other than income affect participation. If, as predicted, the increasing population swells the size of the middle class, the impact on golf may not be favorable. Recent trends in income distribution suggest that the middle class, represented by the third and fourth quintile of the population, is losing wealth to the upper quintile and upper 5% of the population. As shown in Table 6, the
6

U.S. Census Bureau. Current Population Reports: Population Projections of the United States by Age, Sex, Race, and Hispanic Origin: 1995 to 2050.

proportion of wealth held by middle income groups has been declining. And, most believe that this trend will continue into the future. With raising costs (particularly energy and gas costs), disposable income is on the decline for many Americans.
Table 6. Changes in Income Distribution

Quintile Lowest 20% Second 20% Third 20% Fourth 20% Highest 20% Top 5%

1929 12.50 13.80 19.30 54.40 30.00

1936 4.10 9.20 14.10 20.90 51.70 25.60

1947 5.00 11.80 17.00 23.10 43.00 17.20

1955 4.80 12.20 17.70 23.70 41.60 16.80

1969 5.60 12.40 17.70 23.70 40.60 15.60

1985 4.80 10.90 16.90 24.30 43.10 16.10

2001 4.20 9.70 15.40 22.90 47.70 21.00

Source: US Census Bureau

Ethnicity The diversity of the population is also expected to increase over time. By 2025, nonHispanic whites are expected to maintain majority status by a very slim margin, making up only 60% of the population. The Hispanic and Asian populations are expected to nearly double to represent 19% and 7% of the population, respectively.7 According to US Census information, the states that are expected to realize the greatest increases in minority population: New York, West Virginia, Pennsylvania, Connecticut, and Rhode Island. The states with the smallest projected increases in minority population: Maine, New Hampshire, Vermont, Hawaii, and Alaska.8 Will a more diverse population increase or decrease the demand for golf? Data on minority participation rates presented earlier were not favorable for golf. Will minority participation rates remain the same going forward and, if so, how will that affect demand? Age Age also affects demand, as discussed briefly above and as shown in Figure 14. The number of retired people in the US is expected to increase significantly, doubling by 2025. This segment, with a considerable amount of current disposable income, can afford financing for second homes and leisure activities more than any previous generation.9
Figure 14. Average Annual Rounds Played by Age, 2005

US Census Bureau. Current Population Reports: Population Projections of the United States by Age, Sex, Race, and Hispanic Origin: 1995 to 2050. 8 US Census. State Population Projections, 1995 - 2025. 9 US Census Bureau. Current Population Reports: Population Projections of the United States by Age, Sex, Race, and Hispanic Origin: 1995 to 2050.

As age increases so does the number of annual rounds played, with the exception of golfers in their thirties. After age 40, the number of rounds played increases at a significant rate accelerating to 41.6 rounds per year by age 70. So long as future retirees behave like previous generations, the NGF predicts 75 to 100 million additional total rounds per year as a result of the retiring Baby Boomer population. Capitalizing on the retiring Baby Boomer population represents a significant opportunity for many golf course developers. Under its Del Webb brand, Pulte Homes is the nation's largest builder of active adult communities for people age 55 and over. Research conducted by Pulte over the past two decades noted significant changes in where people indicated they would retire. According to Pultes DeLozier, The changes include the desire to retire in place rather than retire to the sunshine. This change appears to be driven by the commute to grandchildren factor, where retirees report the need to be within a 3 to 6 hour drive to their grandchildren. DeLozier also suggested that, the hot spots for future golf development designed to appeal to retiring baby boomers, would be in the Carolinas, Georgia, Tennessee, and Colorado. And, while the historically strong markets for retirees, Arizona, Nevada, and Florida, should not be ignored, future markets were likely to surface along major eastwest highway networks near large centers of population. A sampling of relevant characteristics from selected US states is presented in Table 7, below. In order to determine whether a geographic location is suitable for new investment in golf, an analysis of a wide array of information is required. And, as discussed above, analyses will need to be conducted at local and regional levels given the importance of proximity to targeted residential populations.

Table 7. Selected US States, Supply and Demand Characteristics

Nevada Golf course supply per million population Median income Golf participation rate % population over 65 2004 Projected % population over 65 - 2025 % minorities - 2004 Projected % minorities 2025 Seasonality of golf 39.7 $48,496 17.9% 11.2% 21.1% 40.8%

Iowa 137.5 $45,671 23.9% 14.7% 22.6% 8.6%

New Jersey 33.7 $60,246 17.5% 13.0% 17.3% 38.3%

Colorad o 50.7 $51,518 22.2% 9.9% 20.1% 29.1%

Alaska 34.3 $37,502 24.7% 6.4% 10.4% 35.0%

Florida 59 $42,440 20.1% 16.9% 26.3% 38.7%

California 25.3 $51,312 17.5% 10.6% 13.0% 58.0%

39.6% 8.9% 44.8% 29.8% 42.9% 41.4% 66.3% Year Year Year Round Seasonal Seasonal Seasonal Seasonal Round Round

Source: National Golf Foundation and US Census Bureau: State Population Estimates and Projections

As shown in Figure 15, there are many characteristics on both the supply side and the demand side that must be taken into account in seeking out new opportunities. Future investment in golf course supply must be in right place, at the right time, of the right type, and must incorporate all of the appropriate characteristics desired by the target population.
Figure 15. Matching supply and demand characteristics

Example supply characteristics Geographic location Type (e.g., municipal, daily rate, private) Design Level of difficulty Price Amenities Offerings

Example demand characteristics Size of population Age of population Minority composition Disposable income Health status Availability of leisure time Player skill levels Player preferences

Fazio noted that, A careful analysis of supply and demand could provide insight into opportunity for new course development. It seemed apparent to Fazio that there was saturation in some states; yet opportunity to build in certain geographic areas still existed. States with high participation rates and low supply, states with appeal to the retiring Baby Boomers, states with available and affordable real estate, and states with a climate that allowed participation during the majority of the year would continue to provide opportunity for development.

FURTHER ANALYSIS - Demand Curve Changes According to Pultes DeLozier, the cost to develop golf courses continues to escalate. There is an ever increasing amount of land required to build courses as developmental regulations require greater corridors of space around playable areas. New environmental regulations also contribute to the escalating costs. And finally, todays litigious society has also increased the expense to develop new supply as developers need to find ways to protect against liability. Joe Beditz further explained, A rule of thumb for new development states that, for every $1 million spent on design and development the operator will need to charge $10 per person in green fees just to breakeven. As the expense continues to spiral upward, the cost to play golf gets so high that it becomes cost-prohibitive for large segments of the population. The implication is that golf consumption is stuck on its demand curve. Growth can not be stimulated by lowering prices alone because the cost of producing a round of golf is increasing. Golf demand can be increased in relation to income growth or other events that shift the demand curve to the right. According to theory, an increase in demand - the decision by consumers to buy larger quantities of a product at each possible price - can be created by: 1) A favorable change in consumer tastes and preferences; 2) an increase in the number of buyers; 3) an increase in income; 4) changes in consumer expectations; and 5) prices of related goods. In order to create a favorable change in consumer preferences, new course design and development would need to address the issues of time, money and inclination, which according to Beditz were restricting participation from new, former and infrequent golfers. An NGF/McKinsey study suggested that stimulating demand in the industry would require an understanding of the barriers to growth and the changes necessary to address them, and a product marketing plan to improve offerings for potential golfers.10 When Fazio and Beditz met at the end of January 2007, they discussed how the industry participants might work together on stimulating demand in order to reverse the trend of negative growth in golf courses. Several ideas were proposed and discussed. Beditz suggested that one of the problems was with the type of supply, and building consensus within the different supply-side constituencies. We dont have the right type of supply, we have sold all the Lexus we can sell; we need to build more Kias, more affordable golf courses that are geographically positioned in the right communities. Beditz and Fazio agreed that the type of supply that would have the greatest potential for success would be that developed in conjunction with real estate, especially in up-and-coming retirement communities. The states that win the migration game, with new rooftops will present opportunity for new development. Many in the industry suggested that shorter courses, that cost less to build and take less time to play, would build demand in new segments of the population.
10

The National Golf Foundation and McKinsey & Company. A Strategic Perspective on the Future of Golf. January 1999.

Increasing demand can be focused on increasing the number of rounds played per current golfer or increasing the total number of people who play golf. There are different views on which of the two strategies would be most effective. Fazio, like many in the industry was hesitant about making changes that might alienate current avid golfers. We need to be careful that we build courses that are what core golfers want. The committed players account for the vast majority of spending in golf. On the other hand, marketing golf at the facility level in order to stimulate an increase in demand among latent or non golfers was of particular interest to Joe Beditz. Responsibility for player development rests largely with existing golf course operators, explained Beditz. Golf is local, it occurs within an 8-12 mile trade of a course. There is absolutely latent demand from former, infrequent, and non-golfers. Yet, there are almost no programs at the local level. There is no serious attempt to develop and exploit the appetite that exits. According to the NGF/McKinsey study, targeted programs, tailored products, dynamic pricing, and skills training would lead to an enriched understanding of golf, would deepen appreciation for the game, and would ultimately increase demand. Operators should have the enlightened economic self interest to make this happen, explained Joe Beditz, Player development will pay for itself - the annuity is in the rounds revenue. A FINAL THOUGHT Was it possible that golf could remain in a slow period of development for as long as the previous contraction period, for an additional 15 years? Beditz stated, Unless something is done to increase participation rates in segments of the population that will be growing over the next 15 years, the unwelcome trend is likely to continue for many years. Fazio agreed.