The Diet Business Is Getting A Lot SkinnierMichael Schroeder
Three years ago, Patti Allen decided to trim down for her wedding. So the 23-year-old secretary at a religious-entertainment booking company in Mobile, Ala., joined the local Physicians Weight Loss Center. Six weeks later, she died after her heart failed at a movie theater. She had lost 21 pounds by following the plan's low-calorie diet, according to a lawsuit filed by her mother, but the diet induced a potassium deficiency that led to her fatal heart attack.
Before the case was decided, company Executive Vice-President Clifford G. Kocian called that charge "absolutely unfounded." On June 5, however, a county court jury awarded Allen's mother $15 million. The company now won't discuss the matter, or say whether it plans to appeal. It's just another in a series of bad blows for the suddenly flagging diet-center industry. Through the 1980s, the revenues of commercial diet centers grew by 18% annually, to $2 billion in 1990, according to researchers Marketdata Enterprises Inc., in Valley Stream, N. Y. This year, however, revenues may fall. The recession has hurt, as many dieters have turned to cheaper, do-it-yourself liquid diets. But the main problem is mounting public concern over the safety of diet-center programs.
SHAKEOUT. The bad publicity began with hearings early last year chaired by Representative Ron Wyden (D-Ore.). Now, the Federal Trade Commission is investigating 14 diet companies. "I still have serious questions about commercial diet centers," says Wyden, who favors tougher regulation if the misleading advertising and other questionable practices the hearings uncovered aren't halted. But so far, the companies have made few changes -- and they're starting to pay the price.
For one thing, there's a shakeout under way in diet land. Last December, the 162-center Trim 4 Life chain in Los Angeles closed down, felled by the industry scandal and too-rapid expansion, industry sources say. The company couldn't be reached for comment. Other chains are closing outlets, and some could be pushed over the edge by big legal expenses. Even Weight Watchers International Inc., a unit of H. J. Heinz Co. that has escaped scandal, saw attendance at diet meetings fall 40% below normal in the prime post-holiday slimming months of January and February -- though Chief Executive Charles Berger says business has picked up.
Diet centers, 85% to 90% of whose clientele are women, generally promote weight loss by prescribing low-calorie, prepackaged foods. Men tend to prefer over-the-counter liquid diets, which they take on their own. That's why Slim-Fast Foods Co. has done well with its TV ad pitches by Los Angeles Dodgers manager Tommy Lasorda. Other versions require a doctor's prescription, since liquid diets can be harmful if overdone. Such diets got a boost in 1988, when talk-show host Oprah Winfrey revealed that she lost 67 pounds using Sandoz Nutrition Corp.'s Optifast. Last November, though, Winfrey swore off liquid diets after her weight ballooned again.
To compete, some diet-center chains lure women with hype. Nutri/System Inc., for one, ran ads headlined: "Lose all the weight you can for $89," when the program really cost about $3,000 per year, according to Wyden hearings testimony. Nutri/System's chief executive, Donald A. McCulloch Jr., countered that the ads refer to a sign-up fee and added: "The ads clearly state that the cost of food is extra." The company still runs similar ads -- with food costs footnoted.
Ads by other companies lambasted at the hearings boasted of clients losing 60 to 115 pounds in a few months. In fact, losing weight so fast can be dangerous. Studies show that, like Winfrey, 90% of dieters regain the weight lost within two years. Many of the ads have been toned down. But, Wyden says, "there's still a lot of garbage out there."
Nutri/System's latest ads seem to be a case in point. In them, the company claims its diet ranks tops in a study by Healthline, a magazine "written in collaboration with Stanford University." Stanford, however, says it conducted no research involving Nutri/System, although Healthline editor Paul Insel is an associate professor at Stanford's medical school. In early June, Stanford won a temporary restraining order in federal court in San Francisco that stopped the ads -- which the university claims make "unauthorized and misleading" use of its name. Nutri/System, meanwhile, has countersued Stanford, explains a company spokeswoman, "because of unfounded statements from Stanford to the media" about the ads. And both Weight Watchers and Jenny Craig Inc., a Del Mar (Calif.) diet chain, have sued Nutri/System over reference to them in the ads. Insel didn't return calls.
SUFFERING. Nutri/System is also now the target of hundreds of customer lawsuits, the first of which are expected to be heard in Miami this fall. Plaintiffs charge that their gallbladders became diseased and often had to be removed because of Nutri/System's diet, a low-calorie food regimen that dieters buy from the company for $50 or $60 a week. A company spokesman says the problem is caused by obesity, not the diet. Still, the controversy is hurting Nutri/System. Marketdata estimates that its revenues will fall about 30% this year, after more than doubling, to $1 billion, in 1990.
Some of Nutri/System's U. S. franchisees are suffering, too. Take Keegan Management Co. in San Jose, Calif., once Nutri/System's largest. In 1989, it earned $1.7 million on revenues of $49 million. Then, in 1990, revenues plunged 40%, and the company lost $780,000 from operations. Keegan's shares have fallen from $11 when it went public in late 1989, to $1.37 now. So Keegan has sold 73 of its 75 centers to other franchisees or back to Nutri/System -- and now makes sofas instead. Keegan President Kenneth W. Keegan blames the troubles mainly on "negative publicity from gallbladder lawsuits." Nutri/System declined to comment for the record on Keegan's difficulties.
Physicians Weight Loss is struggling, too. More than a third of its 443 centers have closed in the past 18 months. Now, a dozen irate franchisees claim in lawsuits filed in U. S. District Court in Akron that founder Charles E. Sekeres has used the company to line his pockets.
Sekeres paid himself $36.3 million from 1986 to 1990, or 27% of total revenues, according to company documents. This distribution of profits came from steep 10% royalties on franchise revenues and from up to 160% markups on supplements and foods that franchises are required to buy. The suits also allege that much of a mandatory payment into the company's national advertising fund was funneled to an ad company controlled by Sekeres. Vice-President Kocian denies that. And he argues that payments to Sekeres aren't overly high, since he owns the company and took no money out of it in its first seven years.
SIDE EFFECTS. More troublesome is the charge in the franchisees' lawsuits that the Physicians Weight Loss diet program is "grossly deficient." Its centers don't give that impression. They look like doctors' offices, with staffers meeting clients in what appear to be examination rooms -- replete with charts, stethoscopes, and other medical paraphernalia. But franchisees say dieters don't get much supervision. The company's one-week training course for staffers is inadequate, they say, because dieters' time with a doctor is often minimal.
Franchisee Vincent L. Buchanan says he contacted 30 doctors before a third-year medical resident agreed to spend one night a week at his clinic. Most doctors were leery of fast weight loss, he says. Last year, he shut his Mishawaka (Ind.) center. Problems finding a doctor aside, bad publicity, high fees, and a bad economy made business too tough, he says.
Kocian terms the criticism sour grapes from franchisees who have suffered financially during the downturn. Training, he contends, is adequate because franchisees get several months' worth. And he says many centers have both a nurse and a doctor to counsel dieters -- which he says makes the company's approach safer than others'.
In any case, the company has made few changes since Patti Allen's death. It has introduced several new diets, including a low-calorie, high-fiber one that doesn't require big doses of vitamin and mineral supplements. The Allen suit alleges that Patti developed a potassium deficiency despite taking a potassium supplement. But the company still offers the diet she used. Now, though, customers are shown a "Dieter's Information Sheet" listing possible side effects of fast weight loss -- from bad breath, hair loss, and muscle cramps, to gallbladder damage.
Diet Center Inc. is also under fire from its franchisees, more than 350 of whom have sued. Diet Center earned $17.6 million pretax on revenues of $45 million in 1988. But late that year, Thomas H. Lee Co., a Boston buyout firm, mounted a $164 million leveraged buyout of American Health Cos., Diet Center's parent, and Diet Center has been in trouble ever since.
When business turned down in 1989, new management boosted franchise royalties by 41% to help cover ads, training, and $20 million in annual interest expense. But many centers couldn't make money under those terms, and about a third of some 2,300 clinics have had to close, says DC FAST, the franchisees' association.
As a result, Diet Center has rolled back its daily franchise fee to the original $1.20 per dieter. But "it may be too late," says Barry J. Walters, vice-president of DC FAST. Diet Center lost $19.5 million in the nine months ended on Dec. 31, according to financial statements obtained by BUSINESS WEEK from franchisees. Walters has closed four of his 18 centers in Chicago. Some franchisees say things are so bad that it now takes Diet Center months to ship them food. The company disputes this, saying that it usually ships products promptly. Otherwise, it provided only a limited written response to BUSINESS WEEK's questions.
Not every chain has been marred by scandal. Jenny Craig raised $100 million in new capital last year. Now, industry watchers say Kraft General Foods Group is considering buying the 500-center chain, though neither company will comment.
And Weight Watchers may benefit from the controversy. Many nutritionists favor its gradual approach to weight loss based on eating small portions of a balanced, low-fat diet. This method has a better chance of keeping weight off. It's also hard to accuse Weight Watchers of profiteering: Its program costs just $10 per week on average.
CEO Berger's strategy is to boost supermarket sales of low-cal Weight Watchers foods, now 60% of the company's $1.3 billion revenues. To sell more to the roughly 1 million weekly attendees of Weight Watchers meetings, he is testing new centers in Kansas City, Mo., where dieters must buy Weight Watchers food five days a week, rather than any brand as they could in the past. He plans to expand this program if it works.
Meanwhile, Berger wants to distance Weight Watchers from quick-loss programs. He refuses to join a new trade association, the American Weight Management Institute -- set up last year to police practices criticized by Wyden. He calls it "nothing but a lobbying group by competitors with big problems." Institute President Patricia P. Bailey says she doesn't consider Weight Watchers to be different from other center operators and hopes it eventually will join.
With about 25% of U. S. adults obese, there will always be customers for quick diets. "Many people are desperate," says Buchanan. "They view side effects as a risk they're willing to take." True, perhaps, but it's a shame anyone thinks that way: Health hazards don't have to be the price of a trim waist.