Peloton: Pedalling Forward
By: Iman Khan & Shrey Bangera
The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.
Backpedalling Through Peloton’s Past
Peloton is a fitness equipment company renowned for its bikes, treadmills, and indoor rowers. The equipment is internet-connected, offering live and on-demand fitness classes through a subscription service. Peloton transforms stationary biking into a virtual spinning class experience, complete with instructors, music, leaderboards, and performance metrics. The company currently operates in the US, Canada, Germany, Australia, and the UK. Peloton has seven product lines, with its flagship offering being its bikes. The company also sells treadmills, and accessories for its bikes, offers content on its app and in-person workout classes in New York and London, and has a clothing line in collaboration with Lululemon. Peloton reports two revenue streams: Connected Fitness Products, which includes the sale of its Bikes and Treadmills, apparel, and accessories, and its Subscription Revenues, which includes subscriptions to its apps for on-demand fitness classes and related fitness content. Initially, the Connected Fitness Products segment comprised the majority of revenue, but that has changed in the past year, with the segment only comprising 40 percent of revenues, down from 80 percent of revenues in 2020.
The Rise and Fall
Peloton went public in September 2019, debuting with an initial share price of $29 at a market capitalization of $8.1 billion. Within a year, the company rode a wave of surging demand for home fitness solutions, propelling its stock price to a peak of $163 per share and a market capitalization of just over $45 billion by December 2020, as the pandemic ushered in an era of unprecedented growth and expansion for the firm. This golden period saw Peloton aggressively increase production and optimize its delivery systems to meet the soaring demand. However, a critical oversight occurred when Peloton interpreted this pandemic-induced boom as a long-term shift in consumer behaviour rather than a temporary surge. As the COVID-19 restrictions eased, a significant portion of Peloton's customer base returned to traditional gyms, leading to a dramatic downturn in sales. This downturn was stark, with sales in the Connected Fitness Products sector plummeting by 31 percent in 2022, and an even steeper 48 percent decline in 2023. The rapid expansion coupled with declining sales meant Peloton was left with substantial excess inventory, exacerbating its financial challenges. Further compounding these difficulties were issues of product quality, including recalls, and problems with malfunctioning pedals and seat breakages, all of which played a role in eroding consumer trust and investor confidence. These cumulative problems orchestrated a staggering plummet from all-time highs of $167 to roughly $4 per share translating to a market capitalization of $1.5 billion, narrating a cautionary tale of misjudged market dynamics and the overall shift in consumer behaviour in the fitness industry.
The Broader Fitness Industry
The workout and fitness equipment industry has undergone dramatic transformations in recent years, accelerated by the COVID-19 pandemic. The forced closure of gyms and fitness clubs worldwide led to an unprecedented shift towards home fitness, significantly impacting consumer habits and industry revenue streams. In 2020, the global fitness industry saw an estimated 32.5 percent decline in revenue, with the U.S. sector experiencing a 58 percent decline in the same period. The pandemic not only disrupted traditional gym attendance but also prompted a surge in home exercise equipment sales and digital fitness solutions, reshaping the market landscape.
As gyms and fitness clubs faced closures and restrictions, the home fitness industry seized the opportunity to cater to the newfound demand. The introduction of high-quality, internet-connected exercise equipment by companies like Peloton allowed individuals to bring the gym experience into their homes. This trend is supported by a notable preference for home workouts, with 52 percent of U.S. adults exercising regularly at home compared to 28 percent at gyms. Despite the initial cost, Peloton's premium equipment and subscription services tapped into the growing market, offering an appealing alternative to traditional gym memberships.
The global home exercise equipment market is projected to grow at a CAGR of 4.9 percent during the forecast period of 2023-2030, signalling a sustained interest in home-based fitness solutions. Conversely, the global Gym Membership Market, which generated $48.5 billion in 2022, is anticipated to grow to $70.1 billion by 2032, showcasing a CAGR of 3.8 percent from 2023 to 2032. These trends indicate a dual expansion in both home fitness and traditional gym memberships, reflecting a more hybrid approach to fitness in the post-pandemic world.
Peloton’s Current Jam
Peloton faces numerous financial challenges, beginning from its capital-intensive manufacturing operations and the high costs associated with its retail footprint. The company is currently navigating through a financial crisis, burdened by $1.7 billion of debt. This financial pressure stems from significant investments made to upscale manufacturing and supply chain capabilities—approximately $1 billion in debt issued in February 2021—to cater to the pandemic-driven demand surge. However, as this demand waned, Peloton found itself issuing an additional $750 million in debt the following year to sustain operations amidst declining sales.
The financial performance of Peloton's Connected Fitness Products segment particularly highlights the company's struggles. Over the past two years, this segment has seen fluctuating margins, with a notable dip to a gross margin of -17.7 percent in 2023 from -11.2 percent in 2022. These figures starkly illustrate the segment’s inability to generate sufficient demand to cover the costs incurred, leading to a pressing need for strategic reassessment.
In response to these challenges, Peloton has embarked on a major restructuring plan aimed at alleviating some of the immediate financial pressures. Key actions include exiting North American manufacturing to partner with third-party providers, reducing headcount, and shuttering some assembly and distribution facilities. While these steps may offer temporary relief, they do not fundamentally address the underlying issue of shifting consumer behaviour that has led to the company's current situation.
Peloton’s decision to close 16 of its locations, signals an attempt to streamline its retail presence. Yet despite this, Peloton still maintains 42 U.S. locations and more in Canada, Australia and the United Kingdom. This action offers only a part of the solution, much like the shift to third-party manufacturing facilitated through an extended relationship with Taiwanese manufacturer Rexon Industrial Corp. The major challenge lies not just in its operational model but in its ability to adapt to and anticipate changes in market demand and consumer preferences.
As Peloton navigates this low period, the effectiveness of its strategic realignments remains to be seen. The company's journey underscores the importance of agility and foresight in today's rapidly evolving market landscape, where consumer behaviours can shift dramatically and without warning.
Peloton's Saving Grace
Despite facing numerous challenges, Peloton remains a top contender in the fitness industry, displayed by its esteemed brand, widespread recognition, and a deeply engaged customer base. The brand's influence is evident through its trainers, some of whom have garnered over a million followers on Instagram, creating a close-knit community that connects with fitness enthusiasts globally. Peloton's appeal is further underscored by its subscription metrics; a community that surpasses 3 million subscribers with an exceptionally low churn rate of 1.2 percent, showing unparalleled customer loyalty. This loyalty translates into $2 billion in annual recurring revenue, displaying Peloton's significant growth potential anchored by its scalable, software-centric business model.
From a financial perspective, the subscription segment of Peloton shines, having witnessed a gross margin increase of 510 basis points over the last two years, climbing from 62.1 percent in 2021 to 67.2 percent in 2023. This growth starkly contrasts with the challenges faced by the connected fitness product segment, highlighting the subscription service as Peloton's most lucrative and promising revenue stream. Moreover, with a customer lifetime of 152 months, Peloton dramatically outperforms competitors like Equinox, which has a lifetime of 24 months, further solidifying Peloton's position in the market and affirming its role as a leader in delivering enduring value to its customers.
Case Study: IBM
For many years, IBM dominated the computer hardware sector, known for its mainframes and personal computers. However, the rapid evolution of the digital world necessitated a significant strategic shift for IBM to stay competitive. Recognizing the need to adapt, IBM gradually shifted its focus towards software and services, moving away from its traditional hardware business. This transition was not only a response to evolving technology but also a strategic decision influenced by increased competition and decreased margins in hardware sales. For instance, by the early 2000s, the profit margins for hardware, particularly PCs, had become very small, often in the low single digits, in stark contrast to the software and services sectors, where margins could exceed 50 percent.
This transition was driven by a strategic vision that prioritized long-term growth over immediate returns. In a notable move reflective of this shift, IBM sold its PC division to Lenovo in 2005, a decision that marked the beginning of its journey away from hardware. This was not just a divestiture but a clear signal of IBM's commitment to reinventing itself in the face of a changing industry landscape.
IBM’s pivot towards a service-oriented model was further emphasized through substantial investments in research and development, as well as strategic acquisitions aimed at enhancing its software and cloud services. The acquisition of Red Hat in 2019 stands out as a significant milestone in this strategy, boosting IBM’s capabilities in cloud services and open-source software.
Through these strategic decisions, IBM successfully transitioned from a hardware-centric company to a leader in software and services, illustrating the importance of adaptability and foresight in the technology sector.
Greasing the Gears: Peloton’s Path to Profitability
Step 1: Offload Inventory and Exit Lease Agreements
Peloton’s shift towards a SaaS model necessitates a comprehensive review of operational strategies, with the primary challenge being the disposition of its substantial $522.6 million in inventory. For instance, a potential solution could be targeting luxury hotels – a sector where Peloton has previously made inroads. As highlighted in a 2023 Tegus interview with Sam Walter, Peloton’s Former Director of Global Product Marketing and Head of Marketing for Canada, the brand’s strong loyalty is evident, with many members indicating a preference for hotels equipped with Peloton facilities. This preference underscores the potential for capitalizing on Peloton's high-end market appeal to liquidate inventory effectively.
Operational streamlining also involves a strategic withdrawal from manufacturing activities. Contrary to prior expansions, Peloton should scale back its engagement with Taiwanese manufacturers, and gradually completely shut down manufacturing operations. Currently, Peloton has around $838.3 million in Lease Obligations for office space, retail locations, and warehouses, with more than half of that amount due in the next five years. The company must go ahead and exit these leases first over the next two years, and subsequently exit the rest of the leases within the next five years. Despite the shutdown of manufacturing and retail operations, Peloton’s commitment to existing customers must remain steady, with plans to continue offering robust hardware support, warranty services, and product maintenance.
On the retail front, a significant reduction in Peloton’s physical footprint is proposed, with the exception of maintaining studios in London and New York for content creation. This selective closure strategy aims to reallocate resources more judiciously, addressing the initial financial and logistical challenges of downsizing. This notion was echoed in a Tegus interview with a PERCH Group, a Debt Collector in the UK, Head of Business Development, who advocated for reinvesting savings from the hardware business into software enhancements, highlighting the importance of continual software updates.
This multifaceted approach is designed to facilitate Peloton’s smooth transition to a SaaS model, optimizing operational efficiency and ensuring ongoing customer satisfaction through focused investment in digital capabilities and a strategic realignment of physical assets.
Step 2: Development and Transition
Content expansion represents a key facet of this enhanced strategy. While Peloton is already broadening its library, this proposal suggests a more radical enrichment – incorporating an additional 1,000 hours of diverse fitness content. From high-intensity interval training to mindfulness and yoga, it should aim to transcend current offerings, attracting a wider audience. This can be done by implementing innovative ways to deliver its content such as virtual reality workouts, which is a content form that is gaining traction. Peloton can utilize its expertise in content creation to find unique ways to interact with and retain its current customer base while attracting customers in new demographics.
Moreover, Peloton should start forging partnerships with at least 20 top fitness influencers over the next two years, significantly expanding beyond Peloton’s current collaborations. This initiative aims to harness a collective reach of over 50 million followers, introducing fresh, exclusive content and unique training sessions to engage users and attract a new segment of fitness enthusiasts to the platform. This move is seen as a key differentiator, leveraging influencer reach to enhance Peloton’s community engagement and content diversity.
In addition, Peloton’s strategy for content expansion hinges on several key enhancements to its digital platform. The company should aim to overhaul its Peloton app, targeting a 25 percent increase in server capacity to accommodate growing user loads, a move necessitated by a 40 percent surge in app usage over the past year. This upgrade will not only improve user experience but also prepare Peloton for future scalability.
Together, these initiatives form the cornerstone of Peloton’s strategy to stay ahead of SaaS competitors, focusing on content diversity, strategic influencer collaborations, and technological upgrades to solidify its market position and fuel its growth in the digital fitness domain.
Step 3: Scaling and Diversification
The third phase of the proposal is geared towards amplifying Peloton’s market reach and diversifying its audience through a reconfiguration of its subscription models and an aggressive push for global expansion. Peloton should start by introducing a range of tiered subscription options – starting from a basic plan at $12.99 for access to on-demand classes, up to a premium offering at $39.99 featuring personalized training programs, comprehensive health metrics, and exclusive live sessions – Peloton could cater to a broad spectrum of user preferences and financial capacities. This strategy is poised to significantly widen Peloton’s user base, appealing to both budget-conscious individuals and those seeking a more immersive fitness experience. Concurrently, Peloton’s venture into new geographical territories is a critical component of its growth strategy. By targeting regions with burgeoning health and wellness awareness, Peloton could capitalize on the scalability of its SaaS model to facilitate a smoother entry into markets such as Asia-Pacific and Latin America, regions projected to see a compound annual growth rate of over 7 percent in the digital fitness market by 2025.
This dual approach of refining its subscription offerings and executing a calculated global expansion is designed to unlock new revenue streams and establish a more resilient foundation for Peloton’s future, ensuring its competitiveness in the rapidly evolving digital fitness landscape.
