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-1057275-112712500to:Robert Iger, President and Chief executive officerfrom:Burrows & Hoffman, PEAK entertainment consulting firmTHRU: Kevin Mayer, Executive Vice PResident, Corportate Stategy and Business Developmentsubject:Barriers to entry in the theme park industrydate: CREATEDATE \@ "MMMM d, yyyy" \* MERGEFORMAT August 28, 2014Burrows and Hoffman (B&H) Peak Consulting continued its analysis of the Walt Disney Company’s theme parks by looking at the theme park industry’s barriers to entry. According to Michael Porter’s five forces framework, barriers to entry in a particular industry limit the ability of new firms to enter; low barriers mean high competition, which drives down the entire industry’s profits (2008). B&H did a preliminary analysis of market concentration to determine the competition level of the theme park industry. We found that the four-firm concentration of the theme park market is extremely high at 70.3% (U.S. Census Bureau, 2007). In other words, the sales of the four largest firms in the industry—Disney, Universal, SeaWorld, and Six Flags—account for 70% of the entire industry’s sales. The theme park industry is the second most concentrated industry within the U.S. entertainment and recreation sector, second only to the circus industry (U.S. Census Bureau, 2007). Therefore, as such a powerful oligopoly, the theme park industry does not have very high competition, suggesting that the industry has relatively high barriers to entry. Barriers to Entry. For the purposes of this analysis, B&H looked at the barriers to entry for entirely new companies. Although the large competitors within the theme park oligopoly market occasionally open new parks, they already own part of the market and therefore do not face the same barriers to entry by simply expanding. B&H therefore focused only on new, currently nonexistent competition for this analysis. The following barriers limit the ability of new competitors to enter the theme park industry. Supply-side Economies of Scale. Porter’s first barrier to entry, supply-side economies of scale, refers to a firm’s ability to spread fixed costs over large volumes (2008). Firms that can lower their average fixed costs through higher volumes enjoy higher economies of scale, and are therefore more efficient. The necessity for high volume forces potential industry entrants into one of two situations: 1) enter the market with large volumes, or 2) accept cost disadvantages (Porter, 2008). The first is relatively impossible for new entrants; Appendix A shows that every new park—not owned by one of the existing oligopoly firms—that has opened in the last 30 years has attracted fewer than 2 million first-year visitors (compared to Disney’s 75 million per year attendance). Therefore, new entrants must be willing and able to accept cost disadvantages in the short-run. To illustrate this point, B&H analyzed the most recent attempt of an outside company to enter the theme park industry. Hard Rock Park, which opened during the summer of 2008 in South Carolina, spent $385 million in capital investments (Young, 2013). Its owners projected first-year attendance at 3 million, and it planned to charge $50 per ticket. Assuming target attendance (which is not a good assumption, given projected vs. average attendance of almost every new theme park in Appendix A), Hard Rock was set up to operate at a loss of $78 for each customer, just in fixed costs. When the Great Recession caused theme park attendance and revenues to plummet (Appendix B), the new park lost money at a rate it could not sustain. Hard Rock Park closed by the end of that same summer. The new park, independent and not backed by any large company, was unable to sustain such massive losses, even in the short-run.Demand-side Benefits of Scale. As Porter explains, demand-side benefits of scale “limit the willingness of customers to buy from a newcomer and reduce the price the newcomer can command until it builds up a large base of customers” (2008). In other words, new theme park operators do not have a loyal customer base, so they cannot enter the market and expect to charge Disney prices. They are at a pricing disadvantage until they create their own brand and loyal customers. Hard Rock entered the market with a $50 ticket, $25 under Disney’s price at the time. Based on the recession and Hard Rock’s poor numbers, it probably still charged too high. Not that this is a unique situation; it appears that most new theme park owners miscalculate how much they can influence that willingness of customers to buy from them. Almost every theme park that has opened in the last 20 years has attracted fewer first-year visitors than projected (Appendix A). Therefore, the existing theme park giants like Disney command the demand-side benefits of scale with loyal customer bases, making this a particularly difficult barrier for new entrants to overcome.Capital Requirements. The capital requirements for entering into the theme park industry are enormous. The industry “rule of thumb” is to invest $100-$110 per projected first-year visitor (Kaak, 2011). Even for a small-scale park with one million projected first-year visitors, the capital requirement is $100 million. The industry is extremely specialized, so it is very expensive to build completely new rides and infrastructure for a new park. These extreme startup costs and the guaranteed cost disadvantages mean that many entrants are deterred without even considering formidable competition like Disney. Unless the theme park is backed by an already large and profitable organization (i.e. when Disney builds another Disney park), startup companies must look to investors to finance the capital and initial operations of the park. This is particularly difficult, because investors tend to look at potential resale value (Porter, 2008). Investors are far more likely to front the capital costs if the assets have substantial resale value (e.g. airplanes). Even in the best cases, resale in the theme park industry takes years due to the specific nature of the assets; owners spend years looking for potential buyers of individual rides, eventually selling off park rides though extremely discounted and piece mail deals. For example, the failed Hard Rock Park is still trying to find buyers for some of its rides six years later. It is fortunate to have found any, which is probably attributable to how new its assets (rides) were at the time of bankruptcy. There are hundreds of abandoned theme parks around the world (MacDonald, 2014), because of resale difficulties. Many of these abandoned parks are vandalized and overgrown with vegetation, serving as testament to the challenges of both entry and exit in the theme park industry.Incumbency Advantages Independent of Size. There are certain advantages that incumbents such as Disney enjoy, such as favorable geographic locations, established brand identities, and experience (Porter, 2008). These advantages serve as more potential barriers to entry for aspiring theme park owners. Disney already owns the market in both of America’s destination theme park locations (Themed Entertainment Association, 2013). An entrant would probably avoid both Orlando, FL and Los Angeles, CA, since the major theme park players already command those markets. Additionally, Disney has an excellent history of theming and branding CITATION Bry99 \l 1033 (Bryman, 1999). It would take decades for a new theme park to build a similar reputation. Disney also has the most experience in the industry, since Disneyland was the first modern-day theme park. Its 60 years of experience clearly gives Disney an industry advantage; Disney parks have only continued to grow and expand since Disneyland opened in 1956. New entrants would have to overcome all of these factors just to survive its first few years of certain financial losses.Restrictive Government Policy. Finally, government regulations in the theme park industry create high barriers for potential entrants. The government mandates that all theme park rides be periodically tested by independent companies that are licensed by National Association of Amusement Ride Safety Officials (NAARSO) (Clave, 2007). Not only do new entrants have to quickly gain experience in building, maintaining, and operating safe rides, but they also have to pay high inspection fees to comply with the regulations.Considerations. Fortunately, the high barriers in the theme park industry mean that Disney and its other oligopoly partners do not have to spend many resources defending their market shares against new entrants. When Hard Rock Park opened, none of the existing firms launched aggressive retaliation measures. Their previous investments in size, brand, location, and a loyal customer base kept business high. Experience also plays a large role; Disney has spent 60 years perfecting its pricing strategy. It knows how to effectively use pricing mechanisms, by offering bulk discounts in the form of multi-day and park-hopper passes (second-degree price discrimination) and in the form of child, military, and senior discounts (third-degree price discrimination). Disney uses these strategies to charge higher prices to those customers that value the Disney experience more, which in turn maximizes revenue. When Hard Rock Park opened, the owners charged a flat $50 rate for everyone, to include young children (Young, 2013). They refused to change prices, even while facing the recession and painfully low attendance. The owners incorrectly assumed that the demand for Hard Rock Park was more inelastic than it really was, and the lack of pricing experience showed. Therefore, the oligopoly firms like Disney do not need to spend much effort defending against brand new companies; these firms will often weed themselves out through their inexperience.Conclusion. The barriers to entry are quite high in the theme park industry. Brand new entrants do not significantly threaten Disney enough to spend resources retaliating. Therefore, Disney should continue to focus mainly on its oligopoly competitors and the threats that those close substitutes pose to Disney demand. ReferencesBaye, M. (2010). Managerial economics & business strategy. New York, New York: McGraw-Hill/Irwin.Bryman, A. (1999). The Disneyization of society. The Sociological Review, 47(1), 25-47.Clave, S. E. (2007). The global theme park industry. (pp. 426-429). Cambridge, MA: CAB International. FRED Economic Data. (2012). Total revenue for amusement and theme parks, establishments subject to federal income tax, employer firms. Retrieved from Economic Research Federal Reserve Bank of St. Louis: Association of Amusement Parks and Attractions. (2014). Ride testing & inspection. Retrieved from Industry Marketplace: , Kelly T. (2011). Theme park development costs: Initial investment cost per first yearattendee. Retrieved from: , Brady. (2014). 21 creepiest abandoned amusement parks. Los Angeles Times. Retrieved from: , M. E. (2008). The five competitive forces that shape strategy. Harvard Business Review, 86(1), 25-40.Themed Entertainment Association. (2013). TEA/AECOM 2013 theme index & museum index: The global attractions attendance report. Themed Entertainment Association (TEA). Retrieved from . Census Bureau. (2007). Arts, entertainment, and recreation: Subject series. Retrieved from : , Josh. (2013). Hard Rock Park 10: Why the park closed. Retrieved from: AFirst-Year Performance of Entering Theme Parks (1956-Present)Note: From Theme park development costs: Initial investment cost per first year attendee, Kelly Kaak, 2011.Appendix BTotal Revenue for Amusement and Theme Parks (2002-2012)Note: From Total revenue for amusement and theme parks, establishments subject to federal income tax, employer firms, FRED Economic Data, 2012. ................
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