Peloton Bike : Riding The Quarantine Wave

Peloton Bike : Riding The Quarantine Wave

Peloton stock price has soared during Covid

Peloton Bike : Our research focuses on Peloton Interactive, an innovative fitness technology company that rose to prominence and saw explosive growth as a result of the COVID-19 pandemic and stay-at-home orders.

We researched the role that network effects play in allowing Peloton to attract and retain a strong user base, and our paper explores a few pricing models that Peloton could employ to increase customer conversion.

Peloton CEO John Foley

Additionally, we focus on how Peloton’s pricing strategy has changed specifically after the onset of the COVID-19 pandemic, and how it can sustain its growth after the pandemic ends. 

Peloton piqued our interest as it demonstrates the importance of technology and evolving economic strategies during the pandemic. With consumers unable to go to the gym or attend in-person fitness classes during quarantine, the demand for at-home fitness equipment and classes has skyrocketed, bringing Peloton significantly more attention recently.

We begin by discussing Peloton’s current product offerings, the fitness industry at large and the competition that Peloton faces. In addition, we researched customer acquisition and retention strategies, pricing models, as well as how Peloton stays relevant and innovative in the always developing market. 

As this course involves many different economic models surrounding pricing strategies, consumer behavior, and product differentiation and value, specifically in a technological market, we apply these models to Peloton’s business model to determine actions it can take to add value to their products, acquire more consumers, and overall earn more profit.

We concluded that the fitness giant can optimize its freemium pricing model for fitness subscriptions and better utilize second degree price discrimination on exercise equipment in order to further expand their user base and increase profits.

Description 

Peloton Interactive is the largest interactive fitness platform in the world. Founded in 2012 with the help of a Kickstarter campaign and based in New York City, it is a pioneer in at-home fitness technology.

Peloton offers both interactive fitness equipment and workout program subscriptions. Its Connected Fitness equipment portfolio consists of a stationary bicycle and treadmill, both of which are sold in a standard and premium “+” version. This equipment is sold alongside a premium Connected Fitness subscription, and Peloton also offers a basic Peloton Digital app that does not require any equipment. 

The global fitness equipment industry was worth an estimated $11.9 billion in 2019, with Peloton taking a 7.3% market share (Huddleston 2019). Peloton has sustained rapid growth in the past year and more than doubled its annual revenue – in fact, Peloton turned a net profit for the first time in the most recent quarter ended September 2020.

In addition, Peloton CEO John Foley estimates there are around 200 million paying gym members in the world, at least half of whom could be potentially converted to Peloton users instead (Thomas 2020). According to its annual report, Peloton’s member base has grown 137% year-over-year to just over 3.6 million members as of last quarter, suggesting a vast market yet to be captured. 

Peloton’s target demographic consists of 18-70 years old with $50k or more income, which amounts to around 65 million consumers in the United States (Schneiber 2020).

With its cheapest Bike model starting at $1,895, Peloton is not targeting the general population, but rather wealthier individuals who prioritize fitness yet do not have time to go to the gym. As such, the demand for Peloton’s products has been relatively inelastic so far.

However, Peloton has made efforts to make its products more affordable and broaden its user base, having recently lowered the Bike price from a previous $2,245, and offering a Peloton Digital app for $12.99 a month. We will discuss both of these pricing strategies in further detail. 

Due to the innovative nature of its products, Peloton faces competition on a few different fronts, including the traditional fitness equipment industry, the boutique workout class segment, as well as digital fitness apps.

With fitness equipment, Peloton’s closest competitors include other interactive equipment companies that offer cheaper alternatives such as NordicTrack, Echelon, and new innovative fitness technology like Mirror, as well as more established manufacturers like Life Fitness and Precor.

Peloton’s live workout classes draw competition from high-end fitness studios including Soulcycle, Equinox, OrangeTheory, and Flywheel Sports, which offer similar high-energy workout classes. Finally, Peloton’s digital app competes with a broad range of personal fitness apps, perhaps most notably Apple’s recently released Fitness+ program, as well as the Echelon app. 

Peloton’s rapid growth and innovation at the intersection of fitness equipment and technology present constant challenges in a cutthroat regulatory environment. Peloton must defend itself from scrutiny and accusations from regulators and collaborators, while also being vigilant of competitors attempting to copy its technology.

For example, the National Music Publishers’Association (NMPA), a U.S. music-publishing trade organization, filed a lawsuit against Peloton last year for using thousands of unlicensed songs in its workout class videos (Spangler 2020). The NMPA sought over $300 million in damages, and Peloton recently settled.

On the other hand, Peloton’s competitor Flywheel launched a subscription service in 2017 named FLY Anywhere to compete directly with Peloton, utilizing a technology similar to Peleton’s patented Leaderboard system for increasing user engagement. This led Peloton to sue Flywheel for copying its design, and Flywheel recently settled, eventually filing for bankruptcy. Peloton

must fight legal battles to protect its status in the growing at-home fitness industry, especially with more competition arising during the pandemic. Peloton’s high profile forces it to take more responsibility for its actions and to be proactive in legally protecting its technology. These recurring litigations can pose a significant risk to Peloton’s core business, preventing it from fully devoting its resources towards developing and optimizing new products and features. 

Analysis 

Customer Acquisition & Retention 

Having started from nothing, Peloton’s rise to one of the leaders in the fitness industry is largely attributable to their customer acquisition and retention strategies. A key differentiator for Peloton is the studios and showrooms they have across the country. These act as physical points of contact for consumers to see the products in person and directly speak to Peloton associates, 

who can sell people on the bikes and treadmills. In addition, Peloton offers a 30 Day Home Trial for prospective consumers to actually bring the product home with no commitment. With Peloton’s superior product quality, this offering significantly increases the likelihood of consumers deciding to proceed with the purchase.

Similarly, Peloton offers a 90-day free trial to its Peloton Digital app, which serves as an acquisition tool for the higher-priced products. Furthermore, Peloton has a referral program that offers $100 off of Peloton accessories and apparel for each person they refer. Because so many people hear about Peloton through word-of-mouth, this grows Peloton’s reach by utilizing existing customers to share their experiences with friends and family in their lives. 

After acquiring their customers, Peloton uses a variety of strategies to retain them. The first way Peloton adds value to their products is by the variety in their fitness classes and appealing to a wide variety of people. The classes are diverse in content, music genre, structure, goals, and difficulty levels. They also focus on hiring high-quality and diverse instructors that are characterized by their unique styles.

The Peloton users grow fond of their favorite instructors and discourse about the different trainers creates a sense of community for Peloton users. Lastly with pricing, they retain customers by offering the Peloton Digital app at a lower price, which consumers can purchase alone, so that they are more likely to fall in love with Peloton and purchase the higher-priced products such as the stationary bike and treadmill. The equipment requires consumers to convert to the Connected Fitness subscription, which locks the users in the long-run. 

Peloton’s organic demand growth was so strong that it did not spend any advertising dollars in the U.S. in the last quarter – word-of-mouth referrals were more than enough to boost Peloton’s sales. Peloton’s average net monthly churn rate was 0.65% for the most recent quarter.

This means that on average, only 6-7 people out of every 1,000 members at the beginning of each month cancelled their subscriptions. Furthermore, average monthly workouts per Connected Fitness Subscription have doubled year-over-year to over 20 workouts per month.

These figures all point towards extremely high retention rates, which Peloton has been able to achieve through enhancing the interactive nature of its products and taking advantage of network effects. Network Effects 

According to Metcalfe’s Law, the value of a product for a user increases with the number of people using the platform. The same-side or direct network effects are strengthened by having a strong Peloton community because it increases value for the users.

Peloton has a Leaderboard technology that allows users to see fitness statistics of their friends or other users, which motivates them to use Peloton more often and push themselves more. Furthermore, Peloton users have formed a sort of a cult-like community that has its own culture and way of life, which also adds value and uniqueness to the platform. The community also has its own discourse about different classes and instructors, which forms connections to other Peloton users that might not have previously known each other. 

In addition to same-side network effects, Peloton also strengthens its cross-side network effects by adding value for both the instructors and the users. Peloton has implemented technology in their workout classes that allows instructors to give individual shoutouts to users who are doing well in the class or who need encouragement, allowing riders and instructors to form close connections.

However as the number of users increases, there are diminishing returns because they can not have this personal interaction as much. Furthermore, instructor salaries make up a nontrivial portion of Peloton’s expenses, and scaling up would require additional spending to attract and retain the most enthusiastic and well-liked instructors. Therefore, Peloton should find other ways to strengthen their network effects. 

There is an addressable market of 65 million consumers in the US that Peloton should try to acquire through expanding their network effects. One way they can do this is by actively encouraging referrals. While they do have an existing referral program, there is not much effort going into advertising the program and actively pushing users to share their experiences.

Peloton can improve this by utilizing their showrooms to host events where users can invite friends and introduce them to the community. Peloton can also expand on the existing discourse in the Peloton community by hosting their own platform that allows users with similar interests to connect with each other.

This platform can reward user engagement and encourage users to make friends. As for the trainers, they can expand direct network effects to them by strengthening the community amongst trainers by sending them on influencer trips that will also market Peloton.

Freemium Pricing Model


One aspect of Peloton’s business that warrants closer analysis is the pricing relationship between its two subscription services. As the world recovers from the pandemic and returns to business as usual, Peloton can no longer rely on selling at-home fitness equipment to fuel its growth.

Rather, Peloton’s CFO sees expanding its fitness program offerings to be “of paramount importance” in ensuring continued success post-COVID (Eule 2020).

Furthermore, Peloton’s10-K states that “Peloton Digital also helps us attract new Connected Fitness Subscriptions by serving as an acquisition tool for new Members.”

This fits into the freemium pricing model, where the Peloton Digital subscription serves as a basic or introductory plan that converts
customers to the premium Connected Fitness subscription over time.

Although the 10-K does not break down subscription revenues and expenses between Connected Fitness and Peloton Digital, preliminary calculations of cost per subscription suggest that the Peloton Digital app is currently not profitable – and makes up only a minor portion of Peloton’s revenue.

Therefore, it is important for Peloton to optimize the subscription offerings to maximize conversion to the Connected Fitness subscription, and ensure that customers do not churn or permanently stay with the Peloton Digital app.

The freemium pricing model allows us to optimize for two values: namely, the number of fitness programs to offer in the basic Peloton Digital app (𝑄), and the price to charge for the premium Connected Fitness subscription (𝑃).

In the absence of sufficient experimental market data, we made several key assumptions to derive a formula for premium conversion.

We know that the Peloton Digital app currently offers around ten different fitness programs and the Connected Fitness subscription is priced at $39.00, and assumed these values to be optimal for conversion. Furthermore, based on market data and Peloton’s 10-K, we assumed a roughly 20% conversion rate from the Peloton Digital app to the Connected Fitness8 subscription.

From there, we utilized key properties of the conversion formula to back out the coefficients accordingly. We assumed that conversion is quadratic with respect to program offering (𝑄) and is maximized at 𝑄 = 10.

Additionally, we assumed that customers are relatively price-sensitive, and thus conversion decreases proportional to the square of price increase. These conditions together imply the following:

One can verify that this conversion formula is maximized when 𝑄 = 10, and is decreasing in 𝑃. We believe this would be a suitable conversion formula based on Peloton’s current pricing scheme.

From here, we adjusted the profit formula for Peloton’s subscription segment to include profits from both the Connected Fitness and Peloton Digital subscriptions. We made cost assumptions based on the product prices of $12.99 for Peloton Digital and $39.00 for Connected Fitness.

From the 10-K we found the contribution margin of its subscription services to be 63.8%, suggesting a cost margin of 36.2%, which we multiplied by the product prices.

Finally, we divided these numbers by 10 to reflect the average marginal cost per additional fitness program offered. This yielded the following profit formula:


The first product is attributable to the premium Connected Fitness subscriptions and the second product is attributable to the Peloton Digital app subscriptions. Maximizing this with respect to


This suggests that Peloton can increase profits by reducing the price of its Connected Fitness subscription and maintaining the same number of fitness programs in its Peloton Digital app.

Of course, the numbers could look quite different if market research suggests a different conversion formula, or if marginal cost varies.

Therefore, we constructed a few possible sensitivity tables to illustrate alternative possibilities.

First, we solved for the coefficient 𝑏 for the price term in the conversion formula:

by sensitizing the optimal quantity for conversion 𝑄 against the retention rate per 100 customers 𝐶(𝑃, 𝑄), while fixing the current Connected Fitness price 𝑃 = 39. We also tried this by sensitizing the optimal quantity for conversion 𝑄 against the optimal price for conversion 𝑃, while fixing the conversion rate at 20%.

Highlighted are the assumptions we used in our initial calculations:

Using these coefficients for their respective conversion formulae, we calculated profit again for each case: 

1 Link to spreadsheet: 

https://drive.google.com/file/d/1RY4gX7QTj1xXMItLoQRI77We99HxijKE/view?usp=sharing

From this, we can see that as the quantity of Peloton Digital programs and retention rate increase, profit increases. Furthermore, as retention rate increases, the price that Peloton is able to charge 

for the Connected Fitness Subscription increases as well. However, as the quantity of Peloton Digital programs increases, the optimal price for the Connected Fitness Subscription actually decreases.

These observations appear to be intuitive and in-line with what logic would suggest. We can make similar observations with a fixed retention rate: 

Assuming a constant retention rate, profit increases with the price of the premium program as well as the quantity of the basic program. Additionally, we see that the optimal price for conversion can be significantly different from the optimal price for profit maximization.

On top of the various possible sensitivity analyses, the freemium model does have certain limitations, as it considers Peloton’s subscription segment in isolation. The freemium pricing model assumes that all customers start with the basic plan, and some eventually convert to the premium version.

This does not account for higher WTP customers who will purchase the Connected Fitness Subscription along with Peloton Bikes/Treads to begin with. By converting more low-value customers, Peloton could be losing out on value from customers whose WTP for the connected fitness subscription is much higher.

This model could be further adjusted with additional terms to optimize Peloton’s subscription business in the context of equipment sales. 

Pricing During COVID-19 

In response to the COVID-19 pandemic, Peloton could also consider adjusting prices for its main products, the Bike and Bike+. This is important now because the pandemic has tripled its first-quarter sales and they must act now to both maximize the surge in sales and maintain profitability after the pandemic dies down (Thomas 2020).

The questions we considered were the possibility of peak-load pricing, then we determined what was the best second pricing strategy, and finally, we compared second degree price discrimination with third degree price discrimination to confirm that Peloton’s strategies should aim to move closer to third degree price discrimination levels.

First, we considered why Peloton currently uses second degree price discrimination and have disregarded peak-load pricing. Given Peloton’s notoriety for selling a very high-priced, “overpriced” product, and Peloton’s past brand issues, executives realized that raising prices will be detrimental to Peloton’s brand image and its reputation among customers.

Although in earlier startup stages, Peloton increased prices and saw an increase in sales because customers began to perceive it more as a high-end and quality product, doing the same now would have a different effect because the consumer base is already more established than in years past and does not view the brand as low-quality anymore (Mangalindan 2019).

Instead, Peloton should and has lowered its prices this year, since its goal has been to expand its customer base, as stated by its analysts: “As consumers increasingly workout from home amid the pandemic, these new product offerings should help Peloton expand its [market base], particularly as they help reduce the total cost of ownership for consumers” (Newcomb 2020).

Second, in examining just the Bike line, we analyzed the optimal second degree pricing strategy across two customer types, high-value and low-value.

Because they need to expand their customer base and they aim to add to their product mix, we must target both customers and both products and will disregard strategies that only sell to one type.

To determine WTPs for each customer and product (depicted in the chart below), we first assume that for the standard Bike, low-value customers will pay the new, lowered price for the Bike since the price change was meant to attract more lower-income customers, which is $1895.

We set the WTP for high-value customers then, to be the old price of the Bike ($2245) since Peloton customers buying the Bike before the price change were predominantly high-income. The new Bike+ is priced even higher and aimed at high-income customers, so we assume the WTP of high-value customers for the Bike+ is this price, or $2495.

For the WTP of low-value customers for the standard Bike, we assume that other competitors like Echelon that sell much lower-priced, premium bikes are targeting low-value customers, so we use the average price of their premium models, or $2020. 

Low / High of Premium Models : $1895 $2245 $2020 $2495 

Now, we use the model for second degree price discrimination to find the optimal pricing given that Peloton cannot perfectly distinguish between customers.

First, we known the price of the standard Bike (Ps) should be $1895, because we know that if the price of the standard Bike is greater than $1895, then it violates constraint 3) shown above, and if it is less than $1895, then there is more profit to be gained.

For the Bike+, we first try setting the price to be $2495, but this violates constraint 2), and we know we need the following inequality to be true: 

Thus, the price of the Bike+ should be $2145. Based on our analysis, this price is lower than the current price of the Bike+ which is $2495, and the price of the Bike should be the same as what Peloton has now, which is $1895, so Peloton could consider lowering the price of only the Bike+.

The second degree price discrimination model relies on the WTP of the customers and we know that, depending on how the WTPs compare to each other and how similar they are, it will affect the optimal pricing.

Thus, we can see how the differences in WTPs result in the calculated pricing strategy because the gap between low-value customers’ WTP for the standard Bike and that of the high-value customers is smaller than that for the Bike+, so in other words, since low customers have much less value for the Bike+ than high customers, Peloton should sell high customers the Bike+ to pay the lowest information rent possible.

This led to the conclusion that the price of the Bike+ must target high-value customers and the price of the standard Bike must target low-value customers. To find the resulting profit, we calculated the MC and quantity of bikes sold.

For the quantity sold, we assumed that 70% of their revenue is from the bike line, and that was divided by the average price of a bike. For the MC, we used the total costs annually multiplied by the fraction of revenues made up of bike sales and divided that with the volume of sales. Assuming a 50-50 split across high and low-value customers, and given that 𝑀𝐶 = 630
and 𝑄 = 460,000, this generates a profit of: 

In order to confirm that this price is optimal, we consider other pricing strategies and the profit they would generate.

For third degree price discrimination, the profit is: 

We also consider when the price of Bike+ is $2020 and the price of the standard Bike is $2245 – then both segments just buy the plus because the high-value customer will not buy the more expensive bike (which is now the standard Bike), since they get more surplus with the Bike+ (if they buy the Bike, they get zero surplus and if they buy the Bike+, they get 2495-2020=475 in surplus).

This violates that Peloton wants to sell both products, and the profit is not strictly greater than the optimal pricing for second degree price discrimination: 

Additionally, it makes sense that third degree price discrimination is higher since in this case, Peloton would have more information about their customers, and that can only increase their profit.

In second degree price discrimination, they “pay” an information rent of 2245-1895=350 in information rent to each high-value customer, so that each high-value customer does not purchase the low-priced product and buys the high-priced product instead.

Some options to take to gain more information in order to get closer to third degree price discrimination profit levels would be to keep track and analyze historical price sensitivity data, market studies, and webpage tracking so that Peloton could know which customers are which type at each purchase. The pricing analysis above suggests that the Bike+ price should be reduced for maximum profit.

Facts that support the feasibility of this are that Peloton clearly understands and is capable of decreasing its prices as it has in the past, so it is not a completely novel procedure for the company, and that given it is currently the holiday season when savings and promotions are popular among brands.

Peloton can do a trial of decreasing prices to see exactly how well customers respond. However, because we isolated the model to just the bike line, Peloton should also be careful about how decreasing the prices for its bikes will affect its treadmill line, so a further analysis of all 4 products for both types of customers may be needed.

Conclusion 

Peloton’s CEO recently stated, “100 million subscribers, we believe is a reasonable goal” (Thomas 2020). After analyzing Peloton’s business model through the lens of the models and concepts we have learned in this course, we have a few takeaways and recommendations that the company could take to get closer to reaching this goal.

First, they could strengthen their already strong network effects by putting more power into their referral program, fostering a contained Peloton online community, and applying direct network effects to their world-class trainers.

Furthermore, Peloton could acquire more customers and convert more Digital Fitness users to Connected Fitness by optimizing their freemium pricing model, while sensitizing for different conversion scenarios and factoring in the impact of cross-selling its equipment alongside the app.

Finally in light of the way the markets have changed due to the pandemic, Peloton could adjust their pricing strategies of their fitness equipment to match both the growing demand and competition in the fitness industry.

Specifically they could capture more surplus by lowering the price of their premium Bike+ to ensure that high-value customers are buying the high-end product and thus maximizing profit.

As the world reemerges from quarantine, these strategies will help Peloton maintain its competitive edge and continue its trajectory towards 100 million subscribers.

Written by Rachel Hong, Jenny Wan & Daniel Wang

Peloton Bike : Riding The Quarantine Wave

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Peloton Bike : Riding The Quarantine Wave

Edited by Alexander Fleiss

Peloton Bike

Leading Artificial Intelligence and Financial Advisor – Rebellion Research