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Peloton's Flat Tire
On the 1-year anniversary of The Flywheel, we look back at the flywheel that started it all
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The Flywheel turned one last week! I published the first ever Flywheel piece on August 25, 2020. Having a newsletter for a year presents a cool opportunity to follow the same company over time, revisit arguments made, and see what was right and what was wrong.
In that spirit, we're going deep again on the subject of that initial post—Peloton—because there have been some surprising developments over the past few months.
Let’s get to it!
A year ago, you couldn’t get your hands on a Peloton without waiting 3 months. If you ordered one today, not only would it arrive within 2 business days, but you’d pay almost 40% less.
Ladies and gentlemen, the rise and fall of Peloton.
Peloton was one of the biggest winners during the big COVID rally in spring and summer of 2020. By mid-August when I wrote my maiden piece, $PTON was pushing $70 a share, up over 3x since its early-March lows. It would end the year in the $165 ballpark. The company even posted its first ever profitable quarter.
Then the wheels came off.
Since the end of 2020, Peloton's financial profile has gone downhill in epic proportions. Look at this breakout of quarterly net income for the past two years.
(Note, Peloton's fiscal quarters are off relative to calendar quarters. Q1 is July-September, and Q4 is April-June)
Although this looks dramatic—and, truly, a loss of $301m in Q4 2021 compared YoY with a gain of $90m is an eye-catchingly abysmal result—it's worth putting these numbers into perspective. The way we'd typically do this is to look at them as a percentage of revenue, which is also listed on the chart. In this case, the net margin is -32%, and it's about 50% worse than its worst quarter to-date on this measure (if we exclude its first ever quarter as a public company).
That Peloton would dip from the heights of the early COVID boom was not surprising. But this is something entirely different.
Plainly, this was a disastrous result, and in this piece we're going to try to understand what on earth happened to Peloton's business over the past 6 months, and what it means for the company's outlook.
What happened to Peloton's profits
If I had to choose only one figure to explain what happened to Peloton's financials, it would be gross margin.
Hardware gross margin simply fell off a cliff. When Peloton sells a bike, there are direct costs associated with fulfilling each unit, such as manufacturing, shipping, distribution, warranty replacements, etc. Whatever is left after these costs is gross profit.
Historically, Peloton's gross profit margin was in the low to mid 40s. So if they sold a bike for, say, $2,400, the gross profit would be around $1,000.
In this most recent quarter, the gross profit of the same bike would be below $300.
There are two ways gross profit can take a nosedive: costs can go up, or price can go down. In this case, I think both happened.
The original Peloton bike cost $2,245. With the launch of the Bike+ in September 2020, at $2,495, the price of the original bike was reduced to $1,895. Between the two models, they may have figured, the average price would remain roughly in the middle, where the original price had stood.
The problem is that the Bike+ didn't have enough interesting new features. As I highlighted in December, a swiveling screen and slightly better speakers weren’t likely to move the needle.
Based on these results, it looks like customers agree with me.
Peloton thought they had an iPhone. They don't.
Just last week, Peloton further dropped the price of the original bike to $1,495, which we’ll discuss a little later.
It's a little harder to assess this side of the house. I've done some rough estimations of the number of units Peloton sells each quarter and can use that number to back into the per-unit cost. These numbers aren't perfect because there is a lot I don't know.
However, my model does show a ~10% increase in per-unit cost. Peloton cites increased costs related to Treadmill recalls, which we'll come back to a bit later.
Operating Expenses (OPEX)
A hit to gross profit is a problem because it’s what a company uses to cover its fixed costs—in other words, the costs that don't vary 1-to-1 with each unit sold, like marketing, employees, R&D investments in new products, etc.
Remember those beautiful profits Peloton showed in Q4 2020-Q2 2021?
In the December piece, I argued that Peloton's short term profitability is mainly due to a temporary decrease in operating expenses. I even showed this nifty chart—I've updated it to include the more recent quarters this time around.
The argument then was that gross margin was flat, so the per-unit economics hadn't changed all that much. Instead, they reduced other costs, like marketing, and that was artificially showing Peloton to be a profitable business. The implication is that when OPEX goes back to 'normal' levels, the company will lose its profits.
This is exactly what happened in this recent quarter. OPEX went back to 59% of revenue, which isn't terribly out of line with its earlier history. However, this time the major difference is the gross margin line didn't remain flat; it tanked (as discussed above). This double whammy caused a massive decline in net profit margin.
Peloton needs to figure out how to either get its gross margin back to where it was, or it will be forced to reduce its operating expenses.
Peloton's top line growth has slowed down materially as well. Growth rates of digital revenue, which are the $39/month subscriptions for hardware customers and $13/month subscriptions for digital-only customers, continue to inch higher over time. But digital is typically only ~20% of total revenue.
This slowing growth is driven by hardware revenue.
Since revenue is price times quantity, much of this is due to the price cuts we discussed above. But I think quantity is also down (or rather, up less than you'd expect).
For one thing, sales of the Tread that I preemptively declared a flop in August 2020 have been suspended since a recall in May of this year. Turns out you could get hurt (or worse) using the thing if you didn’t tread carefully.
Presumably, without these issues, tread revenue would be higher, but probably not much higher: in the recall announcement, Peloton showed that only ~1,000 Treads had been distributed prior to the recall. My flop call is looking pretty good at this stage.
I think bike unit sales have slowed down too. Again, my analysis isn't bulletproof on this one, but I've calculated that units are up 'only' 75% YoY, while previous growth rates were in the 200-300% range.
In Peloton's Food Network Opportunity, my first piece, and later in my year-end update, I laid out several hypotheses about Peloton’s business. Since many of you were not subscribed when those pieces went out, allow me to summarize the main arguments:
Peloton is overly reliant on hardware success for its core business and is underinvesting in its non-hardware opportunities (social network effects, data, and talent).
The recently launched Peloton Tread was a flop and the digital subscription was no better than free workout classes on YouTube; this highlighted that Peloton is essentially a one product company (the bike), and that when the bike starts breaking down they will likely lose customers.
Though Peloton turned a profit for the first time in its history, its profitability wasn't sustainable. Rather, it was driven by a temporary reduction in operating expenses. Among others, Peloton was essentially not spending money to market its product because (1) it was flying off the shelves anyway, and (2) they were having trouble keeping up with demand on the manufacturing side, so more demand wouldn't have helped. The argument was that once manufacturing issues and COVID both subsided, Peloton was likely to revert to unprofitability.
Without cherry picking, it appears these hypotheses are almost entirely correct, at least so far.
In fact, I probably erred in not going far enough. Maybe because it was my first piece, I lacked the confidence to make big claims (I've worked on that problem).
Hardware is hard. Each new SKU is really expensive, so every bet is a big bet by nature. Even if you avoid building products that injure people and lead to recalls of thousands of units, which is far from a given, you are still at risk of building something nobody wants and finding out too late. This appears to be the story of Peloton so far.
The Bike was a smash hit, but Peloton made a strategic mistake. Rather than doubling down on the fervent excitement of Bike users—the unique, special sauce of Peloton—by building richer and deeper ways for them to engage, they gambled on new hardware products in pursuit of ever larger markets.
The tactics behind this strategy didn’t work out particularly well.
The Tread was not only a flop in terms of customer demand, but also in terms of the tablets that fell off and hurt people.
The Bike+ appears to also be a flop. Though I missed it in my December piece, in retrospect, it could have been an easy call: there was simply nothing much new there. A swiveling screen and some better speakers..it's just not much.
When the original bike came out, it was a new and novel enough concept to attract a large, growing, and excited audience. Peloton interpreted that to mean that people would buy new products because they were made by Peloton, even at higher prices. But those passionate users already owned a bike, and once you own one bike, you’re not likely to buy another.
These new hardware launches didn’t add much new to the market, but the truth is there never could have beenanything new. Peloton's delusions of grandeur notwithstanding, ultimately, we're talking about an exercise bike and a treadmill.
What is unique about Peloton are those Bike users who still ride rather consistently, and Peloton still has time to properly invest in its experience and save the company from financial ruin along the way.
It's easy to say in retrospect that Peloton should have instead invested in its software, data, community, and talent. But it was also easy to say that in whatever the opposite of retrospect is, because that's exactly what I argued a year ago with my very first shot on goal. I only now have the data to show that it would have likely been the right move.
The good news for Peloton is that it’s not too late. With over 2 million Connected Fitness Subscribers, the company’s term for subscribers with a bike or tread, the user base is there to be built for. But time is most certainly running out; my original thesis was that customers would likely be one-and-done with Peloton hardware, and I’ve seen nothing to change my mind on that as yet.
Looking at the latest quarterly report, management mentions that the coming year (fiscal 2022) will see a “continued prioritization of subscription growth over near-term profitability”. In other words, we need to sell some damn bikes no matter what.
As mentioned above, Peloton recently cut the price of the original bike by another 20% (to $1,495) starting last week. This seems to validate the argument that demand is sluggish for new bikes.
Perhaps these massive losses will have Peloton thinking twice about its future hardware roadmap, and instead convince them to beef up its digital, social, community, and data efforts as outlined here.
My Personal Peloton Journey
The first thing I did after signing a lease in DC last year, after 7 months of bouncing around, was to place an order for a Peloton bike. 8-10 weeks later, I had my bike. COVID was in full force, the gyms were closed, I was starting to gain the COVID fifteen, and so I rode that thing.
Perhaps because I had interviewed with Peloton for a product role early in 2020, I was in the mindset of thinking about it as a product manager. And so the more I rode, the more curious I became about Peloton the business.
Before looking at a single financial statement, I had the sense that Peloton was under-delivering on its potential. I wanted the excitement to carry on beyond the 30 minutes on the bike instead of just ending there. With millions of fervent bike riders, this felt possible.
It’s not an exaggeration to say these questions are responsible for the launch of The Flywheel.
My own personal use of my Peloton has ebbed and flowed almost in direct proportion to the severity of the COVID restrictions in my area. When gyms are closed (or masks are required), I use the Peloton more, but when I can go to the gym I much prefer to be around people.
I now wonder to what extent this is the higher-level, more straightforward story of Peloton, and in all likelihood an entire set of companies: COVID tricked them into believing it had a grander business than it really did, and it led them astray.
The story of 2022 will be how or if these companies can correct course.
One Year of Flywheels
It’s been a wild year! That first email went to 6 people, including myself.
Today I’m sending the 20th Flywheel to over 4,100 of you. And this, despite essentially dropping off the face of the earth since April, with just the one measly article since then. I’m truly blown away by how far this has come, and what I’m left with is a strong sense of opportunity.
I’ve been open about my struggles to publish consistently since going full time on my startup, Swapstack. Despite the opportunity that The Flywheel presents personally and professionally, it’s been difficult to prioritize it.
In terms of content, I’m somewhat torn which of the following directions to take with The Flywheel:
Focus on public company write ups (like Peloton above, or DoorDash), with a focus on financial statement analysis.
Focus on startup/small company write ups + The Podcast. Most of my very popular articles have been these ones (see On Deck and Bubble)
One interesting angle here is an opportunity to invest in early stage startups who want my help telling their Flywheel story, and hopefully I’ll have the chance to bring these opportunities directly to you.
Same as the previous bullet, but with a focus on climate tech startups.
Follow the same companies over time, much like I’ve done with Peloton.
These aren’t necessarily mutually exclusive. So, over the next few months I’ll be experimenting with each of these areas. Perhaps a clear winner will emerge; perhaps not. Either way, I know that for this to be a sustainable, long-term endeavor for me, I need to be flexible and follow the ideas that are most interesting and fun for me to write.
Meantime, if you have a strong sense of stuff you’d like to read from me, feel free to reply to this email and tell me!
And with that, let’s have a quick look back at some notable articles:
Most Read Issue
This one wasn’t particularly close. Coming in at over 12,000 views—more than 2,000 higher than 2nd place—is Million Dollar Newsletter, a look into Packy McCormick and his newsletter Not Boring’s rise to prominence. Turns out having someone with a massive following have a vested interest to share your article helps quite a bit! Beyond that, I think the creator economy/
My Favorite Issue to Write
They are all my babies, but Stitch Fix’s Long Thread was my favorite article to write. It was the first time I dove deep into quarterly and annual statements, and was able to draw unintuitive insights from them. That post was super fun to research and write, and it was also the first one that semi-blew up.
After this one, I started to feel like this whole Flywheel thing could be legit.
Least Favorite Issue to Write
Probably Death and Turbotaxes. Although I was fired up about the subject, it just didn’t make a ton of sense as a Flywheel piece. I struggled to figure out why I was writing the piece, and what I was trying to communicate. It’s not surprising to me at all that it was my worst performing piece thus far!
That’s it for today’s edition of The Flywheel. Thanks a ton to Tanya and the Foster community for helping out with this one. Let me know what you thought of this piece by clicking one of the links below👇🏼.
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