Customers that purchase a Peloton bike or treadmill make a significant upfront investment ranging from $1,895 to $4,295. After purchasing Peloton equipment, the value proposition must be meaningfully better for a customer to switch because the sunk costs are so high. Imagine consumers had to pay $1,000 for a TV in which Netflix is the exclusive streaming service for an additional $13 a month. The initial sunk cost would be a deterrent from customers switching to a TV exclusively providing Disney. I'm comparing apples to oranges, and the analogy is far from perfect; still, it illustrates how the initial cost is large enough to dissuade customers from leaving for a competitor later. However, Peloton can't rely on high switching costs to retain customers for the long-term; they need to improve its hardware and software consistently.

For most, sticking to a workout routine is hard! When January comes around, lofty goals are made, but studies show that most goals are abandoned by January 19th. You would expect a business in the fitness industry to have a hard time retaining customers; however, Peloton has averaged a 0.65% net monthly customer churn since 2017. In other words, 99.35% of customers keep using Peloton every month, and 90% keep their membership after 12 months, which is closer to 60% for traditional gyms. Peloton is retaining an insane amount of its customers!

Considering this retention level, when customers purchase Peloton equipment, it essentially locks them into a multi-year subscription revenue agreement ($39/month). Let me breakdown the implications of the high customer retention. First, the gross profit from selling a bike or treadmill (Revenue – Cost to make the bike) is greater than the amount they spend on marketing to acquire customers. Therefore, Peloton immediately earns back the amount they spend on marketing to acquire customers by selling their equipment. After acquiring their customers, the future implied value of the customer from subscription revenues is incredible.

Referencing the diagram below, the critical metric to takeaway is the estimated lifetime value (LTV) per customer is $3,593, which is the future value of subscription revenues. To summarize the value of a customer, Peloton earns back the marketing expense from the hardware they sell, and then expects to gain an additional $3,593 per customer over the next several years.

Source: Peloton (FY 2019)

High switching costs undoubtedly play a role in the high retention because the consumer paid a large sum. Yet, everyone also knows a few people that made an investment in other exercise equipment in their basement that's now collecting dust. So how is Peloton becoming the leader in fitness and retaining most of its customers? A majority of the value-add of being a Peloton user is NOT from the bike or treadmill itself. Don't get me wrong, Peloton sells great equipment, but that is now the bare minimum required in this industry and a fraction of the value of what Peloton has to offer.

A commonly used phrase in 2020 among investors was "Covid-19 accelerated the trends that were already taking place before the pandemic." One exception was boutique fitness studios like Soul Cycle, CorePower Yoga, Barry's Bootcamp, Orange Theory, CrossFit, etc. Before Covid-19, the fitness industry's fastest-growing segment was boutique fitness studios, but that nearly came to a halt and is now slowly recovering. Consumers were paying a premium for high-quality classes because they were hungry for great instruction, experience, and COMMUNITY.

It's tempting to think that the value of joining Peloton is wildly mispriced when comparing it to cheaper alternatives. Prices for memberships to fitness classes seem baffling: SoulCycle ($500 for 20 classes), CorePower Yoga ($149/month), and Peloton ($1,895 + $49/month). However, that grossly undervalues the value of the community aspect. Why don't people want to find yoga YouTube videos for free and save hundreds of dollars a month or buy a cheap stationary bike (Amazon as low as $336)? Because working out alone sucks!

Numerous research studies conclude the benefits of exercising with other people. Here are some of the benefits:

It's more fun!

“In psychology, we have what we call mental blocks, which are certain thoughts and feelings that get in the way of us being able to push ourselves. It might be tiredness or insecurities. When somebody else is involved, it helps us to overcome our mental blocks because we are in it together with someone else.” - Sports Psychologist

Peloton's platform re-creates the community aspect by encouraging peer-to-peer interactions. Also, instructors are trained to talk as if they are talking directly to each user, making a strong connection to the personable instructors and welcoming users in the "Peloton family." Users take pride and ownership over the Peloton community and claim the instructors as their own. Peloton users experience the benefits of group workouts, but in the convenience of their home, which made the company wildly successful during the pandemic when social interactions were limited.

Here are some of the Peloton features that support social interaction and community:

Peloton's community created a strong competitive advantage benefiting from social network effects. Network effects occur when a product or service's value increases as more people use it, which creates a perpetual effect on growth. Peloton dominates in this aspect because when people consider their connected, at-home fitness options and understand the power of group workouts, there is a forceful gravitation pull towards Peloton's community. I chose to buy a Peloton because I had friends, family, and colleagues who were members and could share in the experience. If I bought another brand, the value I would've received would be limited to the quality of equipment and content.

Let me further illustrate this point because it is crucial to Peloton's long-term competitive position. As of December 31st, 2020, Peloton has 4.4 million members and is the world's largest fitness platform. Most people know at least one person that is a Peloton member. Imagine Peloton with 10, 20, 50, and potentially 100 million members, which is their goal for the next 10 to 20 years. If they achieve this growth level, the number of Peloton members you will know will go up by 2x, 3x, 10x, 20x, and so on, making it more enticing each step of the way. When the decision comes for a consumer to decide which fitness equipment to buy, the value of Peloton's vast member base is made known over competing brands. As more users join the community and social interactions deepen, so does Peloton's strategic moat.

E-commerce brands have succeeded by cutting out the middle man and controlling their customers' experience. However, there is a unique value that is hard to digitally replicate that comes from having a physical footprint. Peloton is planning to open in-person studios that will feature live classes, food, and drinks, as pictured below. The company understands the importance of community as their strategy because the value proposition for Peloton is shifting from at-home connected fitness to social network.

Source: Peloton

Increased engagement per user is a strong signal that Peloton benefits from the network effects mentioned above. The monthly workouts per user increased from 7.2 in 2017 to 21.8 at the end of 2020, pictured below in the graph. If members work out close to 22 times a month, that sounds like an addiction, forcing competitors to break members' habits. Peloton's quality of content, software, and user experience creates a desire equal to streaming services or social media, yet Peloton enforces a healthy lifestyle. Television is an easier avenue to hook customers because of the addicting nature; however, for Peloton to replicate that sensation for exercising is an incredible accomplishment.

Full disclosure: my wife and I are victims of the Peloton experience and are now completely addicted.

Source: Peloton

Although the social network effect contributed to increased workouts, Peloton's creative and expansive content library was the main driver. Over the last few years, Peloton expanded the variety of fitness classes, which increased user engagement by completing a full suite of exercising needs. Peloton is now a one-stop-shop for health and wellness with cardio, strength, and meditation classes.

Source: Peloton

As the digital fitness industry grows and matures, the core business model truly becomes a content company. Price being equal, content quality is one of the most important deciding factors.

We're a software company. The entire leadership team comes from consumer Internet… what differentiates us is the software, which includes the streaming and the gamification and the network. We're also a media company on top of that, because we're streaming 12 hours of live TV content each day and have another 4,000 classes on-demand. - Peloton CEO John Foley

A main ingredient in Peloton's secret sauce is music. Music is an essential component of the exceptional content. The tempo of the music plays a role in determining the cadence of your pedaling. Upbeat music is often matched with high cadence performance output, and low-impact rides are matched with slower tempo music. Instructors will also weave the lyrics of a song into an encouraging message or story. Empowering messages in songs might boost your mood, and high-tempo beats can help exercisers get through a challenging workout.

Peloton's first music partnership was with Beyoncé, who signed a multi-year deal to create a series of themed workout classes. Beyoncé has been a Peloton member for several years and brings a large fan base with her to the platform. They also released remixes of three Elvis hits to be used exclusively across a variety of its classes. It marks the first time that artists created exclusive music for Peloton. This is just the beginning of their exclusive content and partnerships with artists.

Peloton has internal tools providing feedback on which music performs better, which music drives higher engagement, what music you're listening to when you set your personal records. They have an enormous amount of data that connects fitness, music, and personal data. Peloton has a unique data advantage with music interacting with fitness.

Peloton’s production of high-quality content in high quantity, in addition to their large customer base, gives them a wide moat. Producing original content becomes a fixed cost that shrinks in proportion to revenue as Peloton continues to scale. I’m going to use fictional, whole numbers to illustrate the point (they are in the ballpark to the actual numbers). Let’s assume Peloton paid $100 million to create all its content in 2020 and had 3 million subscribers, then the cost per customer would be $33. A competitor with only 1 million subscribers that wanted to create an equal amount of content at the same quality, would have to ante up $100 per customer vs. $33 for Peloton. As Peloton continues to grow its user base, its costs per user for content creation will decrease but smaller competitors will get crushed by the cost of trying to keep up. For a competitor to reach Peloton’s scale, they would likely have to lower their prices, but that shrinks their profit margins, which puts them at a disadvantage.

Hamilton Helmer, the author of 7 Powers, wrote this about Netflix, one of the most successful content companies:

If competition offers the same deliverable as Netflix, similar amounts of content for the same price, their P&L will suffer. If they try to remediate this by offering less content or raising prices, customers will abandon their services and they will lose market share. This creates a very difficult position for Netflix’s smaller-scale streaming competitors.

Scale also enhances data, consequently enhancing business decisions. If Peloton uses its existing wealth of user data to build a deeper competitive advantage, the company will be uniquely positioned to win in the future of exercise. They will have the ability to personalize recommendations for users that suggests rides, instructors, type of music, etc. Leveraging their wealth of data and improving the experience will attract more consumers, which will add to the amount of data. Peloton has reached a significant scale to experience the growth momentum from their data asset. As their member-base grows, Peloton will continue to collect data that will help inform future investments.

Peloton's brand is the culmination of everything it does. Their brand is built starting with the delivery experience, quality of equipment and content, apparel, instructor personality, company messaging, and anything they do that interacts with the world. Net Promoter Score (NPS) is a great measurement for a company's brand and customer loyalty. NPS is based on a one-question survey that asks customers to rate how likely they are to recommend the business or product, generating a score from -100 to 100. Peloton has an astounding 94 NPS! A high NPS score means customers love Peloton, and the company is generating a lot of positive word-of-mouth from their referrals.

Brand loyalty has a direct and positive impact on pricing power. The more loyal a customer is, the more accepting they'll be of maintaining a high price or a price increase. It is nearly impossible to find used Peloton bikes online and if you do, most of them are selling at the same price as a new bike. The robust resale market for Peloton gives them a distinct competitive advantage in pricing power.

Positive brand building:

Honorable mention moat:

Mistaken Moats:

Technology has changed the way we interact with each other, but the need for community has stayed constant throughout history. Peloton is at the forefront of developing exceptional hardware & software with community at the center.