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Outside the Box: Peloton never had a moat to protect the business – and that’s why it will be sold

Most companies try to accelerate their growth because they want to convert it into a competitive advantage — in other words, a moat. Peloton, which experienced substantial growth at the height of the pandemic and is now going through major changes, including layoffs and a new CEO, never created one.

In fact, it’s looking increasingly likely that Peloton
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will be acquired by a firm that will use it to deepen its own moat because the model as a stand-alone seems to have run its course.

With every product, you eventually exhaust the current market. You need to go deeper and build a true competitive advantage, or moat, if you want to stay ahead of all those who will start copying you and convince the unconvinced.

Moats can be intellectual property, such as a patent, copyright, or trademark; state-granted exclusivity to customers or assets; system rigidity, or switching costs; and scale-base, where a company, by virtue of its scale, either reduces its cost on the supply side or increases its value to customers on the demand side.

More moats mean more competitive advantages, yet many growing companies – including Peloton – struggle with this concept.

Though Peloton has a strong brand, it failed to create a competitive advantage that deepens over time. That’s even though it fares better than the average gyms, which have an average yearly churn rate of 30%. Peloton’s is less than 8%.

But the problem with moats that are based on customer stickiness is that while they help retain current customers, they don’t translate into a competitive advantage that can be used to attract new customers.

“ We like companies that grow – as we should – but growth also hides significant pitfalls. ”

In a world where you’re expected to grow continuously – and your stock valuation is tied to your growth rate rather than your profitability – the ability to build a competitive advantage that allows you to attract new customers is an absolute must. 

The only way Peloton could achieve this is by either lowering costs via scaling, which would translate into lower prices, or by increasing the value of the product and service via a network effect. There are limited economies of scale with the bike, primarily because most of the costs lie with manufacturers, suppliers, shipping, etc.

When it comes to subscriptions, in 2021, Peloton counted 2.49 million monthly connected fitness subscribers, an increase of 87% year over year, while its entire member base totaled 6.2 million. Digital memberships are priced at $12.99 per month and all-access memberships at $39 per month.

If more people are convinced to pay a membership fee and the churn is very low, then even with a very high cost of acquisition, the company should still make money on each customer.

But over time, Peloton had to decrease the price of its monthly subscription, which is clearly not a demonstration of excess and increasing value.

Does the firm have any network effect (demand-side economies of scale) that allows it to increase its value to both existing and prospective customers? Counter to statements by others, I would argue that it doesn’t. If I own a Peloton bike and a friend gets one too, am I better off? We could join the same live sessions, or we could track each other’s progress, but unlike Peloton’s former CEO, who “saw everything except the community,” I still fail to see the real value of this network and how it enables connection among people. I’m not saying there is no word of mouth and virality, but real value? I don’t see it.

We like companies that grow – as we should – but growth also hides significant pitfalls. Everything looks great as long as you are growing, then the music stops, and the lack of a real competitive advantage is exposed. The big fall in Peloton’s shares came after announcing that sales of connected fitness products fell 17%, while subscription revenue grew 94%.

What to watch

So what’s next for Peloton? In the absence of having a moat, the new CEO should think about making the company more attractive for a potential acquisition. Interested suitors could include Apple
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+1.30%
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given Apple Watch and its focus on fitness; Netflix
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which is facing its own slowing growth and expanding viewership; and Disney
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given its interest in having a captive audience and its ownership of ESPN.

In the meantime, Peloton should look at cutting costs and building economies of scale as it has too many employees given the simplicity of its model. In fact, over the last few years the general and administrative expenses have been growing faster than revenues, which means the layoffs are barely sufficient to address the cost structure.

But Peloton should not only focus on cost, given that it’s never competed on price. Rather, it should focus on becoming the two-sided marketplace it originally wanted to be. For example, it could allow instructors to directly monetize on the platform, similarly to YouTube or TikTok.

If you look at the cost structure, Peloton spends a significant amount on the live sessions. It should find a way to “externalize” the cost of producing these by allowing instructors to create their own content (i.e., sessions), but then share the revenues from the subscriptions with these instructors. This doesn’t just have to be limited to sessions on Peloton devices. Instead, it could allow the company to become the YouTube of fitness – an area Apple is vying to build – thus giving it a platform for a moat it can continue to build upon over time.

When the company was growing fast, the inefficiencies and lack of a moat were not as obvious. Maybe the combination of cutting costs and market skepticism will force it to innovate and create a sustainable competitive advantage – which is precisely what it was missing the last few years.

Gad Allon is the faculty director of the Jerome Fisher Program in Management & Technology at the University of Pennsylvania in Philadelphia.

More opinion on Peloton: Peloton isn’t out of the woods yet, even with a new CEO — here’s what to watch

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