Peloton is a content businesse
I wrote this post in mid-September 2020. We’ll have to wait and see how it holds up…
Peloton is not one business but two
Peleton’s first business is hardware. The appropriate lens for a hardware business is unit economics: What does it cost to produce and ship a bike; what can you sell it for; what does it cost to acquire a marginal customer. Even by “tech” hardware standards, Peleton’s margins are low. (Bikes and treads have a 44% gross margin; compare that to 60%+ for Apple hardware, or 80%+ for most software). Peloton must charge a lot for a bike because a bike is expensive to make. This is pretty simple stuff.
Peloton’s second business is content. Content creation is expensive, but content delivery is essentially free. Unlike bikes, the marginal costs of content are zero. Double the audience and the content still costs the same. Whereas the appropriate lens for a hardware business is unit economics, the appropriate lens for a content business is scale. More customers means not just more revenue but also better margins, since the fixed costs are spread across more customers.
Consider a representative Peloton customer to understand the difference in economics. In month 1, Peloton collects $911 in net revenue — $1,895 in revenue for the bike, $39 in revenue for the content subscription, and $1,023 in costs for the bike. Almost all of this net revenue is from the hardware. But by month 22, half of the net revenue from this customer will have come from content, and all of the future upside is driven by content. If you assume an average customer life of four years (a conservative assumption, since Peloton’s 12-month retention is 92%), 68% of net revenue over that time will be from the content subscription.
This doesn’t even account for digital-only customers, or the share of digital-only customers who will later convert to bike customers and thus drive hardware revenue. Today, just under 30% of paid accounts are digital-only, and the share is growing. Think of net revenue over the long term as being a function of two primary factors:
The share of customers that are on digital-only subscriptions (more digital-only subscriptions = a larger share of revenue from content subscriptions)
The average customer lifetime (longer lifetime = larger share of revenue from content subscriptions)
For the average new customer signing up today, easily more than 70% of net revenue will come from content subscription payments. If the average customer life is longer (say, for example, 6 years) and the share of digital-only subscribers goes up (to, say, 60%), then over 80% of Peloton’s net revenue will come from content. (See my math here.)
Peloton is primarily in the content business.
The beauty of Peloton’s two businesses is that they reinforce each other…right?
Why, ultimately, will customers prefer Peloton’s bikes? Because they can’t get the Peloton content anywhere else. Hardware is a commodity; every at-home bike will quickly adopt the best features of Peloton’s bikes, and they will try to compete on price. The strength of Peloton’s hardware business is that it has better content than any of its competitors. What will sustainably set Peloton’s bike apart are the trainers and classes that you can’t get anywhere else. Content differentiation is the moat. (Want more evidence that the exercise bike business is actually a content business? 77% of regular stationary bike users say they choose it because it allows them to watch more TV!)
If you agree with this line of reasoning, the best analogy is the iPhone, which is differentiated less by hardware than by hardware paired with deeply integrated software. Though the build quality of an iPhone is very high, ultimately iOS is the most compelling reason to buy one. iOS has been the tool to keep iPhone margins high. Similarly, differentiated Peloton content is what will allow them to maintain bike margins while competitors try to undercut price.
Why should we think Peloton will be able to maintain a content advantage over its competitors? Look through the primary lens for any content business: Scale. Mirror, NordicTrak, Soulcycle, and everyone else are starting with far fewer hardware customers than Peloton. As a result, they won’t be able to invest in content with the same aggression. This content investment gap will widen the differentiation between Peloton and its competitors; market share will tip even further in Peloton’s favor; and as Peloton acquires customers faster, it will be able to finance more content generation, which will further widen the lead. On and on. This is the virtuous circle of a scaled content business.
To understand the advantages scale provides to a content business, just look at Netflix. Netflix has more subscribers than any of the other streaming services (over 190 million; Disney+ is next with 60). In turn, they invest substantially more in content creation — $16 billion in 2020, almost as much as Amazon, Apple, Hulu, HBO, and Disney+ combined.
Because Netflix has more diverse and differentiated content, you’d expect to see lower churn than the competition. Voila:
Whereas the other platforms can be destabilized by a single show (the end of Game of Thrones for HBO, the end of Homeland for Showtime), Netflix chugs along with a lower baseline churn rate and no isolated shocks. This is also a payoff for Netflix’s head start — their average customer is longer-tenured and as a result churns less. Here’s the crazy part: As good as Netflix’s retention is, Peloton’s monthly churn is less than half of Netflix’s!
Because of its scale, Netflix has become a content utility. It’s what the core cable bundle used to be. The other streaming services are premium add-ons, complements to Netflix rather than replacements:
Peloton has the potential to achieve a level of ubiquity among regular exercisers that matches what Netflix has within the broader TV market. Other niche services will survive, but as complements rather than true competition.
Standalone digital subscriptions will widen Peloton’s bike advantage
By selling digital-only subscriptions, Peloton has expanded its addressable market for content, which will help it widen its content lead. Again, content businesses thrive on scale. As originally conceived, the market size for Peloton’s content business was really small: All the people on earth with a Peloton bike or tread. That’s roughly a million people, a tiny slice of the overall exercising population. A third of American’s exercise weekly, a market many times bigger than the mere 4% of Americans who cycle for exercise, or the less than 1% with a Peloton bike.
Widening the addressable market strengthens the incentive to invest deeply in content, which in turn will widen Peloton’s advantage in bikes. This dynamic — go faster in one part of the business, which reinforces advantage in another, which allows you to go faster still — is the business flywheel in action. (You might argue that the digital-only subscription will cannibalize the bike business, but the bike content is not useful without the bike. Cannibalization strikes me as a silly concern.)
Hardware competitors are too far behind to replicate the Peloton flywheel. Try to imagine Soulcycle trying to compete on standalone content. Yikes. For one thing, Soulcycle only has credibility in cycling — they have “cycle” in their name, after all. Expanding into yoga and running and weightlifting would feel awkward at best. But more importantly, they don’t have the scale to justify investing in a new stream of content when they’re just starting to stand up their at home cycling business. They will have to put every ounce of energy into competing with Peloton’s existing, deeper content library. They’re too far behind to look any further afield.
Peloton’s strategy in a nutshell:
Sell a superior exercise bike with integrated content
Leverage the bike audience to invest in non-bike content
Use the non-bike content dominate adjacent exercise markets (yoga, barre, running, etc.)
Does exclusive integration with Peloton’s bike limit its content scale?
How differentiated will the integration between Peloton’s content and bike be over the long term? If bikes are going to consolidate around a completely standard set of features — which seems pretty plausible — then Peloton will be really limiting its content reach for cycling specifically. Other content competitors will open themselves to the Prime Bike, Soulcycle hardware, etc. and over time assemble an addressable marketing that is more fragmented but substantially larger. In the case of Android, this strategy has produced a fragmented user experience. But do we really believe that the integration of bike content and bike hardware will need to be as deep as that between phone OS and phone hardware?
Eric Stromberg raised this question on Twitter, citing the example of Roku spinning out from Netflix:
This is really compelling. The strategy of “commoditize your complements” almost demands Peloton, as a content company, commoditize the bike.
If anything it may be a question of timing: When should Peloton split these businesses. To date they’ve benefitted from integration because the content has allowed their hardware to stand out. But given they’re primarily a content business, at some point the hardware competition will reach a scale that Peleton’s content business won’t be able to ignore. What are the criteria for timing this split correctly?
Peloton’s true competitors beyond the bike may be the content services with bigger scale
These are the companies that will be able to justify investing hundreds of millions of dollars in fitness content because they have such large customer bases that the per customer costs will look reasonable. Let’s tackle them from least serious to most serious:
Spotify (not serious). I expect a growing share of Peloton’s content will be audio-only. Their guided runs are already great. Spotify wants to own all audio content, and has moved aggressively into podcasts. (Coming soon, I’d assume, are everything from religious content to mindfulness and meditation. Calm, Headspace, and their ilk should worry.) More Americans get their exercise from walking and running than any other way, so it’s not silly to think Spotify’s addressable exercise content market is nearly as large as Peloton’s.
Netflix (not very serious). Whereas Mirror or Soulcycle will be constrained by the number of hardware customers, Netflix is already in tens of millions of American homes. Exercise content isn’t that different from cooking content or any other vertical Netflix is into. They’ll never been in the cycling market — at least not as an integrated offering — but they could blunt Peloton’s expansion into the non-integrated exercise verticals such as yoga.
Amazon (somewhat serious). Honestly, it’s hard to say what Amazon is trying to do with its new bike. Will they bundle the content into Prime and use it as an overall retention driver? Will they just try to push costs as low as possible on the bike and then become a channel for other content creators? (Soulcycle could sell its content through the bike interface while Amazon takes a cut, just as Showtime sells its content through the Prime Video app and Fire TV stick.) This is a reasonable threat, a true “commoditize your complements” approach where Amazon treats the bike as a complement to the content business and just pushes bike prices as low as possible. But I still think a fully integrated solution is just flat out better and will win. Which brings us to...
Apple (serious). The new Fitness+ could bundle content around its own integrated hardware solution: Apple Watch and/or Airpods. This is a real threat to the best-case scenario for Peloton, because the watch and AirPods could provide a meaningfully better exercise experience for runners, yogis, etc. relative to Peloton. Apple also obviously has greater scale to promote the service. Though Apple suffers from the same integration limitations that Peloton does, they have over a billion devices and, I’d imagine, a huge amount over overlap with Peloton’s user base.
Peloton’s market is every exerciser on Earth
I still look at these competitors and think: Peloton is going to be fine. They will have many millions of paying customers, they will crush their bike competitors, and, because of the bike integration, they will have a sustainably different position from Apple should Apple decide to take exercise content seriously. Peloton also has a huge content head start no matter who the competition is.
None of the above really indicates whether Peloton stock is over-priced, of course. I haven’t done any precise math. The stock is currently valued at something like $30,000 per subscriber, which implies a tremendous amount of future growth. And I’ve just compared Peloton to two of the greatest businesses ever built, Netflix and Apple, which almost never ends well. But if you see Peloton’s market potential as “every exerciser on Earth,” then expecting massive growth isn’t crazy.
Questions I’ve wondered about
At some point I had to just stop writing about Peloton. But here are some other thoughts I didn’t get to:
Why is Peloton different from GoPro?
Is Peloton in the content business or the talent business? Are superstar effects most important for lock-in, as Spotify seems to be betting in podcasts? (See their huge payouts for exclusivity among superstar podcasters such as Joe Rogan, Bill Simmons, Michelle Obama, Brene Brown, etc.)
To what extent is Peloton competing within the fitness category (i.e. for time that would otherwise be spent at a gym) vs. within the content category (i.e. for time spent otherwise playing Minecraft or watching Netflix)?
How will Peloton’s economics evolve given current growth rates in connected bikes and digital-only subscriptions? Is this priced into the stock today?
Related Reading
Matthew Ball is the single best current media thinker I’ve read. See his backlog of massive essays.
I’ve been heavily influenced by Shishir Mehrotra’s Four Myths of Bundling.
As I was writing this, Ben Thompson dug into the bundles coming from the big content providers.