The Economics of Owning an Affiliate, Part 1: Defining Costs

An athlete doesn’t need to understand physics, but a good athlete moves as if he understands physics. Similarly, a business owner doesn’t need to understand economics, but a successful owner will behave as if she understand economics.

We tell our athletes to move the bar straight up, and it becomes immediately obvious that doing so allows them to move more weight and do so safely. It is not necessary or useful to explain that

• Work = Force x Distance x Cosine of the angle between the applied force and the direction of movement.
• Applying the force in the exact direction of the desired movement causes the angle between the two to be 0 degrees; the cosine of 0 is 1; and this maximizes the work.

On the other hand, affiliate owners don’t typically have coaches guiding their business decisions. So, it is may be helpful to discuss the economic forces that affect an affiliate. The odds that you will make decisions as if you understand economics go up if you actually do understand some basic economics.

Like CrossFit, affiliates are infinitely scalable. Most start out small, where the consequences of missteps initially are not great. It is also possible to start out large, and seriously screw up. I am doubtful that it remains possible to open an affiliate in Manhattan without investing $1.5 million, and I am certain that there are affiliate owners that have managed to spend two to three times that amount. Between the two extremes, there is still room for considerable financial risk. Most new affiliate owners struggle with the decision to sign a lease, and quit a job.

To have a general discussion of an affiliate business model, it is necessary to define five types of costs:

• Fixed Costs
• Variable Costs
• Sunk Costs
• Opportunity Costs
• Externalities

The classic fixed cost is rent. If you’ve signed a lease, the rent is the same, whether you have no paying members or 100 paying members. If you have an Internet provider, that bill is also fixed, regardless of membership, shirts sales, or anything else. Your annual affiliate fee is also a fixed cost.

The first calculation a small affiliate usually does is to take the monthly rent and divide it by the number of people they need to pay a monthly membership to estimate what they will need to break even. If the rent is $6,000 per month and the membership is $150 per month, the hope is that with 40 members, the owner (who usually starts out teaching all the classes himself) will not need to pump more money into the business. This is a significant oversimplification, but it is a start.

Variable costs are proportional to the number of members. When the owner starts out teaching all the classes herself, it’s easy to imagine that there are no variable costs unless and until it comes time to hire the first coach, so that the owner isn’t all but living at the box. For a large affiliate like CrossFit NYC, we have a clear model for our variable costs. For every five members, we run about one class per week.  A class costs us about $75 (explained here) so each new member has a variable cost of about $15 per week ($65 per month). This is not an exact science. If we add 10 members next month, we may not add any classes. (We certainly wont add another Front Desk person.). But if we add 100 members over the next six months, odds are we will add about 20 classes per week and a corresponding amount of support staff. There are other components to our variable costs (bathroom supplies, barbells, etc.) but salaries are probably the primary component of variable costs.

Sunk Costs are costs that cannot be recovered if you go out of business. If you spend $10,000 on equipment, you will get something back if you close your doors, but certainly not what you paid. If you spend $200,000 to build out a warehouse and turn it into a nice box with showers, that money will probably be gone, if and when you close. In Manhattan, sunk costs (much of it legal, for getting permitting and zoning approval from the government) can now run $1 million. In theory, a legal CrossFit affiliate in Manhattan can get something subletting their facility to another gym business, but for the most part, it’s all a sunk cost.

Opportunity Cost as it applies to affiliate ownership is the income you give up when you quit your job (or when you choose to teach for free rather than pursue other income opportunities). Before he left us, a young coach showed me his business plan to leave New York, return to his home town and open an affiliate. Conspicuously absent was any acknowledgement that he was giving up a $75,000 per year income to pursue his plan. He had himself teaching all the classes, and thus decided he would have zero labor costs. It was the simple model of rent on one side and membership income on the other. His $50,000 in projected profit was less than he was earning doing far less work for us.

Externalities are one of the least acknowledged costs associated with a CrossFit affiliates. Externalities are costs that are paid by outside parties as a result of your operation. The externality that is most relevant to affiliates is the noise and general nuisance that can be claimed by neighbors. Neighbors tend to insist their suffering is great, and affiliates tend to believe that it is minimal. In Manhattan, the reputation of CrossFit affiliates being a nuisance to the community has resulted in the local government applying a level of scrutiny during the zoning process that had previously been reserved for bars and nightclubs. When we opened our second location, we paid in excess $400,000 in sunk costs (legal and building) to guarantee that our operation would have no negative externalities on our neighbors. We got off cheap. I estimate that another affiliate has spent five times as much—all sunk costs.